A

RESEARCH
PROJECT TOPIC
ON
CAPITAL BUDGETING TECHNIQUES AND
FINANCIAL PERFORMANCE OF FIDELITY BANK PLC

WRITTEN
BY

ALO, CHIGOZIE
11/BA/AC/1072
DEPARTMENT OF ADMINISTRATION
UNIVERSITY OF UYO, UYO

PRESENTED
TO

PROF. EDET R. IWOK

LECTURER IN CHARGE
DEPARTMENT OF ACCOUNTING
UNIVERSITY OF UYO, UYO
CAPITAL BUDGETING TECHNIQUES AND FINANCIAL
PERFORMANCE OF FIDELITY BANK PLC

CHAPTER ONE:

INTRODUCTION

1.0 BACKGROUND OF THE STUDY

The survival of a company depends very much on its ability to generate returns
from its investments (Munyao 2010). Capital expenditures required investment
normally involve large sums of money and the benefits of the expenditures may
extend over the future. One of the most significant decisions made by
management is that most significant of capital budgeting, that is, determining
the best project to invest in to ensure growth and future profitability.

Kadondi, (2012) opines that financial performance of companies can be

measured by use of accounting information or stock market values in a capital
budgeting context. Firms performance is measured over time by using the
average stock market change per year. This value is usually obtained by
calculating the yearly change in stock price. However, it might be difficult for
financial performance to be measured by use of stock price information due to
the following reasons; lack of information on investment practices available to
shareholders, managers place much higher importance on return on capital and
profit growth goals than on shareholders goals. Thus, if managers anyway place
higher importance on return on capital and profit growth goals than on
shareholders goals, superiority in performance might be most correctly
measured using accounting practices.

Accounting to gilbert, (2005) “when the relationship between capital budgeting

techniques and corporate performance is analyzed using earnings per share
(EPS)”, it should be noted that there are other factors, which account for
potentials influence on the relationship. Although these other variables are not
directly related on the relationship between capital budgeting techniques and
financial performance, it is important to take them into account in order to
isolate their effect on performance. these variables includes; firm size, degree of
risk, capital intensity, leverage and industry factors, such as growth, firm
advertising, market shares research and development.

Earnings Per Share (EPS) on stock prices had often been the centre of interest to
researchers, shareholders and investors (IAS 33). This is because EPS is one of
the investment tools to evaluate a company’s performance either in the short or
long term. The estimated earnings can be used to measure the financial health
and performance of a company. EPS can be used as a performance indicator of
the financial standing of the company. It measures the company’s performance
during the year and indicates the progress of the company in the near future.

In other words, EPS is a measurement of business performance as the net

income figure takes account both the results of the company’s operation and the
effect of financing.

Munyao (2010) opines that sophisticated capital budgeting procedure can be

regarded as one of the means a firm use in order to fulfill its objective of
shareholders wealth maximization. This fact indicated that firms can increase or
maximize their shareholders wealth by using sophisticated appraisal techniques.

1.1 STATEMENT OF THE PROBLEM

According to financial theory, the objective of a firm is to maximize the wealth

of its shareholders. The optimal investment decisions are hence, the one that
maximize the shareholders wealth. This fact indicates that firms can increase or
even maximize their shareholders wealth by using sophisticated capital
budgeting techniques. Hence, from a perspective of the finance theory, capital
budgeting and financial performance is expected to be positive.
 Haka, Gordon &Klammer (2008), states that, studies on capital budgeting
sophistication and financial performance of a firm have presented mixed result.
Following the conflicting results on the impact of capital budgeting and lack of
a local study on the same, this study seeks to survey the relationship between
capital budgeting techniques and financial performance in Fidelity Bank plc
and determine the other factors, which influence the selection of project to be
invested in.

1.2 RESEARCH OBJECTIVES

The objectives of the study are to find out the following:-

i. Evaluate the capital budgeting techniques used in investment appraisal

decision in Fidelity bank plc.
ii. Find out the relationship between capital budgeting techniques and financial
performance of Fidelity bank plc.
iii. Ascertain the extent to which capital budgeting techniques are used by
Fidelity bank plc in maximizing shareholders wealth.

1.3 RESEARCH QUESTIONS

The following are the research questions for this study.

i. What are the capital budgeting techniques used in investment appraisal

decision in Fidelity bank plc?
ii. What relationship exists between capital budgeting techniques and financial
performance of Fidelity bank plc?
iii. To what extent has capital budgeting techniques used by Fidelity bank plc in
maximizing shareholders wealth?
1.4 RESEARCH HYPOTHESIS

Based on the objectives of the study, the research hypothesis can be outlined as
follows:

H0: There is no relationship between capital implementation and

financial performance in Fidelity bank plc.

H0: There is no capital budgeting techniques used in investment

appraisal decision in Fidelity bank plc.

1.5 SIGNIFICANCE OF THE STUDY

The study will be important to the following parties:-

To company, especially Fidelity bank plc.

The results of this study will help managers to evaluate the current capital
budget practices in their company’s. by looking at this study, the managers will
be able to see capital budgeting techniques applied across other companies and
how these techniques can possibly improve the company’s wealth or value.
With that, they can make some comparisons with their company’s practices.
This is important because a company’s main objective is to maximize its
shareholders wealth. To achieve this, the company will possibly need the most
reliable tool that can assist in investment decision-making.

Researchers

The study will provide useful information for researchers regarding financial
performance earnings per share and capital budgeting techniques impact in
companies especially Fidelity bank plc. Other than that, researchers can also use
the study as their basis for further research.
To Academicians

The study will also be significant to academicians. It will give detailed

information to them on how far the techniques taught in class differ from that
practiced in the real world. By having this information, academicians will be
able to make some adjustments in trying to accommodate this taught in class
with real life practices.

1.6 SCOPE OF THE STUDY

The study will examine the relationship between capital budgeting techniques
and financial performance using earnings per share in Fidelity bank plc and if
capital budgeting separates the promising projects from the bad ones and also
determine the best project to invest in to ensure growth and future profitability.

1.7 LIMITATION OF THE STUDY

Limitations abound in this type of study; so far the limitations encountered are
as follows;

Access to the documents: Experience has shown that apart from carrying out
academic research out academic research in firms, it is also difficult to gain
access to the documents. This is because that firm has certain secrets which they
will not like any other person to see. This was considered impediment to this
study.

Time constraint: Unlimited study on defilement areas for interest would have
been conducted throughout the world if there were enough time for that. Time
constrain was the most inhibiting factor which otherwise would have enable and
extensive pursuit of knowledge in this area of interest.

Insufficient information: The researcher conducted interview in attempt to see

some of the documents. Document wanted were not obtained because of the
interviewer fear of letting out the companies secret. Some oral information was
difficult to get.

1.8 ORGANIZATION OF THE STUDY

This research is organized into five chapters, chapter one covers the
introduction, statement of the problem, objectives of the study, research
hypothesis, significance of the study, scope of the study, a brief historical
background of the case study, and definitions of terms used in the study.

Chapter two reviews the related literature already written by authors in this
subject.

Chapter three, deals with the research methodology which involves the design
of the study, source of data, population and same size and method of data
analysis.

Chapter four present data collected, analyzed and interpreted through the use of
tables and figures to fully explain the findings.

Finally chapter five presents the summary, conclusion, and recommendations

that will improve the functioning of capital budgeting techniques and financial
performance in Fidelity bank using earnings per share.

1.9 BRIEF HISTORY OF FIDELITY BANK PLC

Fidelity bank plc began operation in 1988 as fidelity union merchant bank
limited by 1990, it had distinguish itself as the fastest growing merchant bank in
the country. It converted to a commercial bank in 1999, following the issuance
of a commercial banking license by the Central Bank of Nigeria, the National
banking Regulator. That same year the bank rebranded to fidelity bank plc.

It became a universal bank in February 2001, with a license to offer the entire
spectrum of commercial, consumer, corporate and investment banking services.
This current enlarged fidelity bank is the result of the merger with the formal
PSB international bank plc and many bank plc 9under the fidelity brand name)
in December, 2005.

Fidelity bank plc today ranked amongst the top ten in the Nigerian banking
industry, with presence in all the 36 states as well as major cities and
commercial centers of Nigeria.

Most capitalized banks, with tier-one capital of nearly USD 1billion (one billion
U.S Dollars).

DEFINITION OF TERMS

Capital Budgeting: This is a long-term plan made for expenditure necessary to

buy fixed asset for the production of the goods and services.

Financial Performance: Financial performance of companies can be measured

by use of accounting information or stock value as a measure of performance;
one is interest in analyzing the change in market values. Firm’s performance is
measured overtime by using the average stock market change per year

Shareholders Wealth: This is the collection wealth conferred on shareholders

through their investment in a company. Members of the board have a fiduciary
duty to the shareholders and a responsibility to protect their investment by
running the company sensibly and in line with generally accepted practices.

Earnings Per Share: This can be define as the reasonable and legal
management decision making and reporting intended to achieve stable and
predictable financial result.

Investment Decision: A determination made by directors and /or management

as to how, when, where and how much capital will be spent on investment
opportunities.
Capital Budgeting Techniques: These techniques are based on the comparison
of cash inflows and outflows of a project. Capital budgeting techniques consist
the following; Payback Period, Discounted Payback Period, Net Present Value,
Accounting Rate of Return, Profitability Index

CHAPTER TWO.

REVIEW OF RELATED LITERATURE

2.0 INTRODUCTION

This chapter deals with review of the ideas and finding of authors and persons
who have previously researched on the subject matter of this study. The
concepts, ideologies and values concerning capital budgeting techniques and
financial performance using earnings per share of fidelity bank are looked into.

Hence, relevant works of other researchers on the subject matter are reviewed.
The outline of the review is given below;

i. Conceptual framework
ii. Theoretical framework
iii. Empirical framework

2.1 CONCEPTUAL FRAMEWORK

THE EVOLUTION OF CAPITAL BUDGETING PRACTICES

Budgeting for capital expenditure has evolved over the decades and its
important has increased (or decreased) over time. Shah, Anwar,(2007),
identifies stages of change in capital budgeting practices and systems.
The first is the great depression years during which efforts were mainly focused
on designing ways to ensure economic recovering. All the time, public
borrowing for financial capital outlays, except for emergence, was not favoured.

The second stage took place during the late 1930’s when the colonial
government in India introduced capital budgeting to reduce the budget deficit by
shifting some items of expenditure from the current budget. It was believed that
the introduction of this dual-budget system would provide a convenient way to
reduce deficits while justifying a rationale for borrowing (Tarchys, 2002).
Tarchys (2002) states that, the third stage refers to the growing importance
attached to capital budgeting as a vehicle for development plans. This was
partly by the soviet-style planning. Many low-income countries formulated
comprehensive five-year plans and considered capital budgets the main impetus
for economic development where capital budgets did not exist, a variant known
as the development budget was introduced.

The fourth stages reflect the importance of economic policy choices on the
allocation of resources in government. The quantitative appraisal techniques
were applied on a wider scale during the 1960’s leading to more rigorous
application of investment appraisal and financial planning (Shaah, Anwar,
2007). In the 1960’s and 1970’s, it was widely believe that government
budgeting allocation, including investment expenditures, could be largely
reduced to a scientific process by system such as zero-based budgeting (ZBB).
Spackman (2002) believed that this turned out to be true.

A fifth stage saw a revival of the debate about the need for a budget in
government, particularly in the United States. Along with the growing
application of quantitative techniques during the 1960’s came the view that the
introduction of capital budget could be advantageous. This view did not gain
much support. A president’s commission in 1999 investigating budget concepts
in USA concluded that capital budget could lead to greater outlays on bricks and
morter, and as a result, current outlays could suffer. The commission advocated
the introduction of accrual accounting.

During the six stages, partly because of the experience of Australia and
Newzealand, there was renewed push by the professional financial institutions
for the introduction of accrual budgeting and accounting.

2.1.1 THE CAPITAL BUDGETING PROCESS

Capital budgeting, or investment appraisal, is the planning process used to

determine whether an organizations long term investments such as new
machinery, replacement machinery, New plants, new products and research and
development projects are worth the funding of cash through the firm’s
capitalization structure (debt, equity, or retain earnings). It is the process of
allocating resources for major capital, or investment, expenditure.

Capital budgeting is a multi-faceted activity. There are several sequential stages

in the process.

a) Strategic Planning

A strategic plan is the grand design of the firm and clearly identifies the
business the firm is in and where it intends to position itself in the future.
Strategic planning translate the firm corporate goals into specific policies and
directions, set priorities, specifies the structural, strategic and tactical areas of
business development, and guides the planning process in the pursuit of solid
objectives. A firm’s vision and mission is encapsulated in its strategic planning
framework.
Identification of investment opportunities

The identification of investment opportunities of investment project proposals

is an important step in the capital budgeting process. Project proposal cannot be
generated in isolation. They have to fit in with a firm’s corporate goals, its
vision, mission and long-term strategic plan. If an excellent investment
opportunity presents itself, the corporate vision and strategy may be changed to
accommodate it. A firm should ensure that it has researched and identified
potentially lucrative investment opportunities and proposals, because the
remainder of the capital process can only be assure that the best of the proposed
investments are evaluated, selected and implemented.

a) Preliminary Screening of Projects

Generally, in any organization, there will be many potential investment

proposals generated. All the proposals cannot go through the rigorous projects
analysis. Thus, a preliminary screening process by management to isolate the
marginal and unsold proposals, because it is not worth spending resources to
thoroughly evaluate some preliminary quantitative analysis and judgments
based on intuitive feelings and experience of the managers.

b) Financial Appraisal of Projects

Projects which pass through the preliminary screening phase become candidate
for rigorous financial appraisal to ascertain if they would add value to the firm.
This stage is also called quantitative analysis, or simply project analysis. This
project analysis may predict the expected future cash flow of the project,
analyze the risk associated with those cash flows, develop alternative cash flow
forecasts, examine the sensitivity of the result to possible change in the
predicted cash flows, subject the cash flows to simulation and prepare
alternative estimates of the projects Net present value (NPV).
a) Quantitative Factors in Project Evaluation

When the project passes through the quantitative analysis test, it has to be
further evaluated taking into consideration qualitative factors. Qualitative
factors are those which will have an impact on the project, but which are
virtually impossible to evaluate accurately in monetary terms. They are factors
such as the social impact of an increase or decrease in employee, members, the
environmental impact of the project, positive or negative governmental and
political attitudes towards the project, the strategic consequences of customers,
positive or negative relationship with labour union about the project, possible
legal difficulties with respect to the use of patents, copy right and trade or brand
names and also the impact on the firms image if the project is socially
questionable.

b) The Accept/Reject Decision

Net Present Value (NPV) from the quantitative analysis combines with
qualitative factors from the basis of the decision support information. The
analyst relays this information to the management with appropriate
recommendations. The management considered this information and other
relevant prior knowledge using their routine information sources, experience
and judgment to make a major decision to accept or reject the proposed
investment project.

c) Project implementation and monitoring once

Once investment projects have passed through the decision stage they then must
be implemented by management. During this implementation phase, various
departments of the firm are likely to be involved. An integral part of project
implemented is the constant monitoring of project progress with a view to
identifying potential bottlenecks thus, allowing early intervention. Deviations
from the estimated cash flows need to be monitored on regular basis with a view
to taking corrective actions when needed.

a) Post-Implementation Audit

Post-implemented audit does not relate to the current support process of the
project, it deals with a post-mortem of the performance of already implemented
projects. An evaluation of the performance of past decisions, however, can
contribute greatly to the improvement of current investment decision-making by
analyzing the past “Right” and “wrong”. The post-implementation audit can
provide useful feedback to project appraisal or strategy formulation.

2.1.2 DECISION CRITERIA

The decision criteria in capital budgeting are the calculated measures that one
can use to compare the cash flows of different projects or alternatives. Before a
decision criterion is selected, it is important to have a clear understanding of the
decision criteria currently available, the following decisions criteria will be
examined in this study; payback period, accounting rate of return, internal rate
of return, and net present value

a) Payback Period (PB)

Linstom, L. (2005), defines the payback period as the expected length of time
for aggregate positive cash flows to equal the initial cost, or the time it is
expected to recover the initial investment. The payback period is defines as the
period within which an investment or a firm would be able to recover or recoup
a project cost outlay. In order to use the technique as a criterion, a cutoff period
is specified and all those projects with payback periods longer than the cutoff
period are not acceptable. The PB technique is popular with managers because it
is simple and readily understood by the managers, it thus lead to selection of the
less risky projects in mutually exclusive decision situations, saves the
management the trouble of having forecast cash flows over the whole of a
projects life and it is a convenient method to use in capital rationing situations.
However, this method does not consider all cash flows after the payback period,
it also ignores the time value of money in that cash flows that occur at different
points are simply added and compared with the initial amount.

a) The Accounting rate of Return (ARR)

Kadondi (2002), defines the Accounting Rate of Return as the average tax profit
divided by the initial cash outlay. The ARR was accounting information as
contained in financial statements to measure the profitability of an investment.
Using this method, managers would choose projects with the highest ARR. This
method has the advantage of using the familiar percentage concept and
evaluates project on the basis of profitability. However, this method is not
reliable as if ignores timing of the cash flows and since it is based on accounting
income and not on the projects cash flows. The method also, does not consider
the time value of money.

b) The Net Present Value (NPV)

The Net Present Value (NPV) criterion is widely accepted as the most reliable
decision criterion to use for capital budgeting. It is defined as the present cash
flows. The discount rate that should equate the rate of return on the net best
investment alternative of similar risk, is also known as theopportunity cost of
capital. The NPV decision rule is to give further consideration on those projects
whose NPV’s are greater than zero. A positive NPV implies that the projected
cash flows indicate a return in excess of the discount rate. Any project that
provides returns in excess of the opportunity cost, certainly adds additional
value of the company, thereby increasing shareholders wealth (Farragher, et at
2001).
NPV takes into account the timing of all the cash flow, it is a measure of the
added value that a project is projected to make the company value, by adding
their NPV’s, one can determine the added value of a selected projects. However,
the implicit assumption in respect of NPV is that all cash flows generated by a
project could be reinvested.

a) The Internal Rate of Return (IRR)

The Internal Rate of Return (IRR) is a measure of the return generated by a

project. The IRR is defined as the discounted rate that gives a net present value
of zero. The IRR is also seen as a rate of discount that causes the present value
of the projected future cash flows to exactly equal to the initial cost of the
project. If managers use the IRR criterion and the projects are independ, they
would accept any project that has an IRR greater than the opportunity cost of
capital.

Analysis by Kadondi, (2002) indicates deficiencies in the IRR criteria. First it

does not obey the value-additivity principle, and consequently managers who
use the IRR cannot consider projects independently of each other. Second, the
IRR rule assumes that funds invested in projects have opportunity costs equal to
IRR for the project. This implicit reinvestment rate assumption violates the
requirements that cash flows be discounted at the market-determined
opportunity cost of capital. Finally, the IRR rule can lead to multiple rates of
return whenever the sign of cash flow changes more than one.

2.1.3 RISK ANALYSIS

Given the impact of capital projects on a company’s long-term viability. It is

important for companies to understand why projects could fail. The calculation
of a decision criterion based on best-estimated predicted cash flows is therefore
not sufficient, as it does not indicate the level and nature of the project risks
(Linstrom, L, 2005).
Hence the need for a better understanding what can go wrong and what the
impact would be on project outcome. A number of risk analysis techniques are
developed for this purpose. These include; sensitivity, analysis, scenario
analysis, decision free analysis and simulation.

a) Sensitivity Analysis

This considers both sensitivity of NPV to changes in key variable as well as the
range of likely variable values. Under this approach, managers assess various
possibilities which are grouped.

Scenario Analysis

This considers both the sensitivity of NPV to changes in key variables as the
range of likely variable values. Under this approach, managers assess various
possibilities which are grouped.

b) Decision Tree Analysis

This is suitable for use in multi-stage or sequential decision where more than
one variable may be dependent of value of other variables. Decision trees are
designed to illustrate the full range of alternatives that can occur. It’s logical
analysis of a problem and enables a complete strategy to be drawn up to cover
all eventualities.

c) Simulation

In practice it may be necessary to produce separate possibilities for all

alternative variables affecting a project, for example, alternative sales revenue
outcomes and different times of costs etc. consequently, a decision tree can
consist of thousands of branches. In addition, the cash flows may be correlated
for over the years; for example, it is also likely to be successful in later years.
This situation becomes complex to use a simple decision tree analysis and this
problem can be overcome by use of simulation analysis with the aid of a
computer.

2.1.4 Performance Measures

Traditional measures of corporate performance are many in number. Common

measures are Return on Investment (ROI), Return on Assets (ROA), Return on
Capital Employed (ROCE), Cost Benefit Analysis (CBA), and Economic
Valued Added (EVA). In this study these measures will be discusses.

a) Return on Investment (ROI)

This is one of the popular measures to corporate performance. ROI is a

calculation of the most tangible financial gains or benefits that can be expected
from a project versus the costs for implementing the project. It is represented as
a ration of the expected gain of a project divided by its total costs. It is
calculated using this formula

ROL = (Net benefits/Total cost)

An ROI ratio that is greater than zero is necessary for an investment to be

economically attractive. Calculating the ROI on various options will help to
ensure that a company selects that most economical and profitable project.

b) Return on Assets (ROA)

This is an indicator of how profitable a company is relative to its total assets.

ROA gives an idea as to how efficient management is at using its assets to
generate earnings, calculated by dividing a company’s annual earnings by its
total assets. It is computed as follows;

ROA = Profits Before Interest and Tax

Total Assets
ROA tells us what earnings were generated from invested capital (assets). ROA
for public companies can vary substantially and will be highly dependent on the
industry.

a) Return on Capital Employed (ROCE)

The Return on Capital Employed, (ROCE) is on of the most important operating

ratios that can be used to asses corporates in, the skills of the management and
occasionally the general business climate. A firm with a high return on capital
employed will probably be a very profitable business.

ROCE is given by Trading Profits Capital Employed where Capital Employed =

Share Capital = Reserves = all borrowing.

b) Cost Benefit Analysis (CBA)

Cost Benefit Analysis (CBA) is normally applied to large public works projects
with societal benefits that are more difficult to quantify.

These intangible benefits are very relevant to an overall determination of what

is a good investment for the public well-being like an ROI calculation, the result
of Cost Benefit Analysis (CBA) is a ratio expressed as a percentage, and
economic attractiveness is determined the same way, above zero is attractive,
and below zero is not. The equation is the same although more costs and
benefits are calculated.

c) Economic Value Added (EVA)

For evaluation of the efficiency of any decision, value creation or value addition
aspect is of utmost importance in the present backdrop of corporate governance
(Mallik and Rakshit 2005).
2.2 THEORITICAL FRAMEWORK

Several theoretical perspective pertaining to capital budgeting techniques and

financial performance are apparent for the purpose of this study, the following
theories will be used.

2.2.1 THE CONTINGENCY THEORY

According to Pike (2009), resource – allocation efficiency is not merely a matter

of adoption sophisticated, theoretical superior investment techniques and
procedures but consideration must also be given to fit between the corporate
context and the design and operation of the capital budgeting system. Pike
(2009) focus on three aspect of the corporate context, which are assumed to be
associated with the design and operation of a firm’s capital budgeting system.
The first aspect is a firm’s organizational characteristics. Decentralization and a
more administratively oriented control strategy involving a high degree of
standardization are characteristic of large companies.

Haka eta (2010), however have an opposite opinion and argue that firm’s will
experience more benefits from using sophisticated capital budgeting techniques,
the more stable the environments. They base their argument on Schall and
Sundem (2010) study which shows that use of sophisticated capital budgeting
techniques declines with an increase in environmental uncertainty.

The second aspect is environmental uncertainty. The more variable and

unpredictable the context of operation is, the less appropriate are highly
bureaucratic, mechanistic capital budgeting structure. Pike (2009) suggests that
firm’s operating in high uncertainty environments are assumed to benefit from
sophisticated investment methods, particularly in appraising risk.

The last aspect concerns behavior characteristics. Pike (1986) identifies three
characteristics, i.e management style, degree of professionalism and the history
of the organization. Administratively oriented capital budgeting control strategy
is assumed to be consisted with an analytical style management, a high degree
of professionalism and a history of undistinguished investment outcomes. The
firm’s financial status may influence the design and effort put in capital.
According to Axelsson, et al (2002), more effort will be devoted to budgeting in
an adverse financial situation, since it will no longer, be as simple to find an
acceptable budget and there will be a need for more frequent follow-up. These
arguments have been applied to capital budgeting by Haka et al (2010). They
argue that the implementation of sophisticated capital budgeting procedure is
one of many means of coping with acute resources scarcity. Another argument
is that since the main value of adequate investment rules is in distinguishing
profitable from unprofitable projects, highly profitable firms are expected to
drive less benefit from such technique that would less successful firms with a
history of marginal projects. Axelsson, et al (2002).

2.2.2 THE INCREMENTALISM THEORY

According to Berry (1990), the literature on budgetary decisions has been

dominated by the theory of incrementalism and its various meaning. This theory
suggests that policy makers use “Rule of Thumb” in order to deal with the
technical complexity of expenditure decisions.

Wildavsky, the founder of this theory, opines that the people who design the
budget are concerned with relatively small increments to an existing base
denoted as their fair share. It follows that budgeting is incremental as their to the
extent that it result in marginal and regularity of changes seen as preserving
stability.
2.2.3 THE REAL OPTIONS THEORY

Myers (1984), proposed the Real options theory. Since then, these notions have
remained of great interest among financial experts and analysts. Chance and
Peterson (2002), have noted that real option theory deals with choices about the
real investment E.g capital budgeting projects. Real options offer a more
efficient way for managers to allocate capital and maximize shareholders value
by leveraging uncertainty and limiting downside risk. Furthermore, it asserts
that the presence of real options can make an investment worth more than its
conventional discounted cash flow value.

Arnold and Schockley (2003), have attributed increased interest in real options
to forces of demand and supply. The demand side for real options reflects
managements need to position the firm to benefit from uncertainty and to
communicate the firm’s strategic flexibility. The supply side reflects a growing
body of literature pertaining to the real options approach. Increasingly,
managers in industries characterized by large capital investments and
considerable uncertainty and flexibility E.g banking, oil and gas,
pharmaceuticals, as well as biotechnology, are contemplating the use of real
options. Real options hold a considerable promise because they recognize that
managers can obtain valuable information after commencement of the project.

2.3 EMPIRICAL FRAMEWORK

Techniques and financial performance.

Thomas Klammer (2008) sought to investigate the association of capital

budgeting techniques and performance in American firms. Attention was
techniques and the relationship of performance and capital budgeting
procedures because the future of the firm is dependent largely on the investment
decisions made today. A total of 369 manufacturing firms were sampled, of
which 184 firms’s responded 48.9%.

The study focused on the operating rate of return as a measure of the firm’s
performance. Capital budgeting techniques tested were payback methods and
the discounting techniques. For testing the association of firm performance of
capital budgeting techniques, the study adopted a hypothesis that, firms having
better performance will have adopted more sophisticated capital budgeting
techniques. A simple regression analysis was carried out to test the hypothesis.
The results of the study indicated that, despite a growing adoption of
sophisticated capital budgeting methods, the regression results did not show a
consistent significant association between performance and capital budgeting
techniques.

Another study by KA et al (2010), aimed to determine the effect on a firms

market performance of switching from naïve to sophisticated capital budgeting
selection procedures. They theoretically stated that, a firm should perform better
if it employs sophisticated techniques than if it uses naïve techniques. The study
had a population sample of 50 firms, out of which 30 firms responded. The
results of the study provided a more definitive conclusion than Klammer’s
(2008) study.

Mooi and Mustapha (2001) understood a study to find out whether the degree of
sophistication of capital budgeting practices affects the firm performance, in
terms of profitability. The study used a sample of 42 firms listed at Kuala
Lumpier Stock Exchange in Malaysia. The study used Return on Assets (ROA)
and Earnings Per Share (EPS) to measure performance of the firms, and used
regression analysis to determine the association between capital budgeting
sophistication and firm performance. the capital budgeting techniques which
were surveyed were NPV, IRR, ARR and PB. From the analysis, 19% of the
responding firms used superior capital budgeting methods whose score was 0%
to 60%, 42.9% of the firms had a score of 61% to 80% of the usage superior
capital budgeting methods, and 38.1% had a score 81% to 100% of the usage of
capital budgeting process should increase the effectiveness of the firm’s
investment decision-making.

Gilbert (2005), carried out a study to determine the application of capital

budgeting methods and their association with firms performance among South
African manufacturing firms. A sample 318 firms was surveyed, but only 118
firms representing 37% responded. The survey tested the application and impact
of payback method, accounting rate of return, net present value and the internal
rate of return. The return on assets was also used as a measure of firm’s
performance. The result of the study indicated that, 15% of the discounting
methods while the rest employed a mixture of both non-discounting and
discounting methods.

Yao et al (2006), conducted a study to compare the use of capital budgeting

techniques and their impact on performance in Netherlands and China. They
compared 250 Dutch and 300 Chinese firms. Out of all the firms, 87 firms
responded, 42 from Dutch and 45 from Chinese companies. The results indicate
that 49% CFO’s in Chinese firm’s use the NPV method as opposed to 9% who
use the traditional investment decision methods. The results indicated that in
both countries, sophisticated capital budgeting techniques mostly NPV and IRR
had a positive relationship with return on assets (ROA) while the traditional
methods showed an insignificant relationship.

Khakasa (2009), attempts to provide empirical evidence on the state of practice

in Kenyan banking institutions in evaluating IT investment ex ante. The result
of the survey showed that the most popular investment appraisal techniques
used in such evaluation in Kenyan banks were cost-benefit analysis, risk
analysis, competition, payback period and return on investment, while the least
popular are the internal rate of return, computer based techniques and the Net
present value of the 41 banks sampled, a total of 25 responses were obtained.
This was a response rate of 60.97%, 100% of the responding institutions
indicated that they used at least of the economic techniques to appraise potential
IT projects. The most popular economic technique is the Cost Benefit Analysis
(CBA) method (92%). While Internal Rate of Return (IRR) ranked the lowest
(0%).

Overall, the study conducted that banks had limited use of discounting
techniques and this raised questions as to the extent of the use of cash flows to
appraise potential projects.

CHAPTER THREE

RESEARCH METHODOLOGY

3.0 INTRODUCTION

This chapter presents the methods and procedures adopted in conducting the
study. The following sub topics are discussed in this chapter, namely;

i. Research Design
ii. Population of the study
iii. Sample size of the study
iv. Source of data and method of data collection
v. Research Instrument
vi. Test validity and Reliability
vii. Method of data analysis
3.1 RESEARCH DESIGN

The study employed a survey design to describe and analyses capital budgeting
techniques financial performance of Fidelity bank. The research design was
chosen because it allows the researcher an opportunity to collect the relevant
data to meet the objective of the study.

POPULATION AND SAMPLE SIZE DETERMINATION

The population of the study comprises all Fidelity banks branches in Nigeria,
which totaled 220 as at October, 2015.

SAMPLE SIZE OF THE STUDY

A sample of 10 Fidelity banks branches was randomly selected out of the total
population of 220 Fidelity banks in Nigeria.

The researcher employed the judgmental sampling techniques in selecting the

sample; the aim of using the judgmental sampling techniques was to make sure
that questionnaires are targeted at a section of the population that gives valid
and relevant information.

SOURCE OF DATA COLLECTION AND METHOD OF DATA

COLLECTION

Data collected were mainly from primary and secondary source.

The primary data was collected from the company through personal interview
and administration of question for the purpose of analyzing the company’s
capital budgeting techniques. The secondary source was collected from the
company’s earnings per share.
RESEARCH INSTRUMENT

The instrument for primary data collected which is the questionnaire is designed
using simple and straight forward questions of the following three steps.

A. Never Always.
B. Almost Never.
C. Almost Always.

TEST OF VALIDITY AND RELIABILITY

Reliability of the measures was assessed with use of Croncbach’s alpha.

Cronbach’s alpha which allows for measurement of reliability of the different
categories. It consists of estimates of how much variation in source of different
variable is attributable to chance or random errors (Selltiz, 2011). As a general
rule, a coefficient greater than or equal to 0.5 was considered acceptable and a
good indication of construct reliability (Nunnally, 2009).

METHOD OF DATA COLLECTION

Data obtained were analyzed in general for the company. Regression analysis
was used to test the capital budgeting techniques and the financial performance
of fidelity bank. The regression equation used was;

ROA: -a+B1+NPV+B2 ARR+B3 PB+B4 IRR+B5 Cont. + E1

Where:

ROA = Return on Assets (Profitability)

NPV = The effect of the Net present value technique

ARR = The effect of the Accounting Rate of Return technique

PB = The effect of the Payback technique

IRR = The effect of the Internal Rate of Return

Cont. = Is a vector of Control Variables

a= a constant

B1, B2, B3, B4, &B5 are regression co-efficient

E1 = Represent the error term

The statistical package for social science (SPSS) was used to analyze the data
into frequency distribution. The primary data from the questionnaire were
analyzed using descriptive statistics, particularly frequencies and percentages.
Information was generalized and summarized using tables and histograms
where appropriate.

QUESTIONAIRE

SECTION A

GENERAL INFORMATION

Instruction: Please kindly tick/mark ( ) the most appropriate answer to the

questions and comment where necessary.

1. Respondents Name ________________________________(optional)

2. Name of organization_____________________________________
3. What is your destination?
·
Investment manager
·
Risk manager
·
Finance manager
·
Any other (specify)___________________________
 1. For how many years have you worked for your current organization?
i. Below one year
ii. 2-3 years
iii. 4-5 years
iv. Over 6 years
2. Legal status of your company?
i. Private company
ii. Public company
iii. Any other specify ______________________
3. What is your highest level of education?
Certificate (SSCE or equivalent) NCE/ND/OND
HND Bachelors PGD Master PH.D

SECTION B

Use of capital Budgeting techniques

4. Please indicate how frequently your company employs the following

evaluation techniques when deciding which investment project to pursue.
Almost Almost
Always Never Never Always
i. Net Present Value (NPV)
ii. Internal Rate of Return
iii. Accounting Rate of Return
iv. Payback Period (PB)
v. Others ______________________________
5. Has there been a major switch in techniques used over the least 5 years.
Yes No
If yes, please specify______________________________________
1. Which of the following techniques does your company favor when deciding
which investment project to pursue
·
Net Present Value (NPV)
·
Internal Rate of Return (IRR)
·
Accounting Rate of Return (ARR)
·
Payback Period (PB)
·
Any others specify ______________________________
2. Please estimate the average proportion of total capital expenditure your
company made in the last five years that should be classified within these
three investment categories.
Replacement projects %
Expansion Projects – Existing operation %
Expansion projects – New operation %
100%
3. Is there at least one member of your staff assigned full time capital
investment analysis? Yes No
4. Does your company possess or capital investment manual (written capital
investment guide line)? Yes No
5. Which technique does your company use to asses a project risk? (Please tick
one per line).
Almost Almost
Always Never Always Never
Scenario
Sensitivity
Decision free Analysis
Simulation Analysis
6. Which of the following approaches is used in your company to determine the
minimum acceptable rate of return (Discount rate) to evaluate proposed
capital investment? (Please tick on only).
 ·
Weighted average Cost of Capital (WACC)
·
Cost of debt
·
Cost of equity capital
·
An arbitrarily chosen figure is used
·
Any other rate (please specify) _________________________

SUMMARY AND CONCLUSION

The objects of this study are to determine the capital budgeting techniques
employed by Fidelity Bank Plc and the effect of those techniques on the
financial performance using earnings per share.

The results of most studies have reported the use of both naïve methods of
capital budgeting and discounted cash flow techniques. The naïve method
includes the payback method and the accounting rate of return. The discounting
cash flow methods otherwise referred to as sophisticated capital budgeting
include the net present value and the internal rate of return. Many companies
seem to prefer the payback method and internal rate of return respectively.

In the literature, it has been argued that the use of capital budgeting practices
may be related to improved financial performance. a number of arguments to
support this have been cited. Some of the studies indicated that sophisticated
capital budgeting techniques mostly NPV and IRR had a positive relationship
with return on asset (ROA) while the traditional methods showed an
insignificant relationship. However, similar studies reported a negative
relationship of the capital budgeting techniques and financial performance. the
studies have indicated that, despite the growing adoption of sophisticated capital
budgeting methods, there is no consistent significant association between
performance and capital budgeting techniques. This indicates that the more
adoption of various analytical tools is not sufficient to bring about superior
performance and that other factor such as marketing, product development,
executive recruitment and training, labor relations, etc, may have a greater
impact on profitability.

Local studies on the other hand have mainly dealt with the application of the
capital budgeting techniques in listed companies and also in the banking sector
particularly found the overwhelming application of the naïve capital budgeting
techniques. Thus, given these conflicting findings in the literature and lack of
sustainable local study on the effect of capital budgeting on financial
performance, this study seeks to establish the effect of the capital budgeting
techniques on financial performance of Fidelity Bank plc.

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