EFFECTIVE CAPITAL BUDGETING AS A STRATEGY

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EFFECTIVE CAPITAL BUDGETING AS A STRATEGY

CHAPTER ONE

1.0 INTRODUCTION

1.1 BACKGROUND OF THE STUDY

Capital budgeting can be explained in the context of a firm’s decision to invest its current funds in long term activities in anticipation of an expected flow of future benefits over a number of years. However, the investment decisions could be in the form of acquisition of additional fixed assets, replacements and modifications of activities or expansion of a plant. Therefore, the financial manager should give due consideration to the following factors when capital budgeting decisions are involved:

Availability of investment capital and its alternative uses
The huge expenditures or large cash outlay
The gestation period between initial expenditures and returns and
The expectation of higher returns because of factors (a) and (b) above.

Based on the factors above, the manager must not fail to make appropriate investment or selection of good projects because, the volume of fixed assets to exceed current assets and the owners of the company (shareholders) are long term investors, whose high expected returns can only be met with the higher returns from long term assets. These assertions, call for the need to examine the different methods of selecting investments in long term assets which will be discussed in chapter 2.

Therefore, it is the responsibility of management to search for profitable investments by evaluating each investment proposal critically both in terms of its expected cash flows and benefits.

Project proposals must be thoroughly evaluated to determine their economic viability and profit potential and estimating the risk involved and the extent to which this will affect the organization.

Thus, investment decisions are increasingly determining the direction and pace of a company’s future growth and limit the opportunities open to it in much way that the rail tracks determines the speed and direction open to locomotion train. The research is on Coca-Cola Company (Kaduna), to know how they invested on long term projects such as land development, acquisition of fixed assets for production, through the use of capital budgeting techniques as a strategy for good project management.

1.2 STATEMENT OF THE PROBLEM

According to ICAN Pack professional examination II management accounting; capital budgeting is the investment of a firm’s current funds in long tern activities in anticipation of an expected flow of future benefits over a number of years. The future is full of uncertainties considering the fact that the business world is dynamic. Therefore project proposals has to be evaluated properly to ensure that the company’s resources are been properly allocated and utilized wisely to ensure maximum return (profit) that will keep the company growing. The investigative study is therefore an attempt to find out why the selection of which capital budgeting techniques to use in appraising investment proposals is source of problem to management and to proffer feasible solution to alleviate management problems.

However, in every organizational set up, one fact remains that management is always faced with problems of decision making. Besides, they are always concerned with what type of decision would be appropriate to maximize shareholders wealth. The size of the amount to be expended greatly determines the organizational level at which that expenditure decision can be made.

1.3 OBJECTIVE OF THE STUDY

The objective of this research work is to critically examine the policies, practices and techniques of capital budgeting and how these are applied in project evaluation in coca-cola Company. The research work will identify the various problems associated with each techniques of capital budgeting and make recommendation possible to change the company’s approach to capital expenditure management and evaluation. This will enhance the company’s profitability level and increase in shareholders wealth.

1.4 STATEMENT OF HYPOTHESIS

A hypothesis is a tentative statement that has not been emphatically tested. It is an opinion, an idea or suggestion put forward as a starting point for reasoning, explanation or study to determine the correctness of assumed parameters usually by various sampling techniques. In the light of this assertion and in order to obtain a meaningful study, the researcher will use the null and the alternative hypothesis.

Based on the established objectives of the study above, it is therefore hypothesized that:

H₀: The techniques of capital budgeting has no significant effect on good project management

H₁: The techniques of capital budgeting has effect on good project management

1.5 SIGNIFICANCE OF THE STUDY

The importance of effective capital budgeting in the management of business as regard long term investment cannot be over emphasized. This is because the growth and development of a firm, even in its liability to remain competitive and to survive depends upon constant flow of new investment. The national for research work is intended to fashion out modalities and bring into line light the various capital budgeting techniques that can be used in evaluating profit by companies so as to assist management of Nigeria bottling company ltd Kaduna in their allocation of resources to viable project. The research work will also serve as a reference point to student and other researchers who may wish to undertake a similar topic project. In addition, it will help managers faced with capital expenditure on how best company’s fund can be invested on capital project whose benefits are to be realized over a relatively long period.

1.6 SCOPE OF THE STUDY

The study of capital budgeting techniques is so broad especially in a big organization of a public owned company in Nigeria with varying investment portfolios in different sector of the economy. However, this study is confined to “the coca-cola company”.

1.7 LIMITATION OF STUDY

When carrying out this research work on effective capital budgeting techniques as a strategy for good project management; a case study of the coca-cola company, the researcher was faced with some major constraints like time and inadequate cooperation.

1.8 HISTORICAL BACKGROUND OF COCA-COLA COMPANY

The coca-cola company was founded in 1892 with its headquarters in Atlanta, Georgia USA and it is served worldwide. It is a public company that produces beverage that produces coca-cola carbonated soft drinks water and other non-alcoholic beverages.

Revenue is US$ 31.0 Billion (FY2009)

Operating income is $8.23 Billion (FY 2009)

Net income is US$ 5.82 Billion (FY 2009)

Total assets is US$24.8 Billion (FY 2009)

Employees 92,800 (July 2010 and the key people are Muhtar Kent (Chairman and CEO). The company is best known for its flagship product coca-cola, inverted by pharmacist John Stith Penberton in 1886. The coca-cola formula and brand was bought in 1889. The coca-cola company in 1892 besides its namesake coca-cola currently offers more than 400 brands in over 200 countries or territories and serves 1.6 billion serving each day.

The company operates a franchised distribution system dating from 1889 where the coca-cola company only produces syrup concentrate which is the sold to various bottlers throughout the world who hold an exclusive territory. The coca-cola company owns its anchor bottler in North America, coca-cola refreshments.

The coca-cola company is headquartered in Atlanta, Georgia. Its stock is listed on the NYSE and is part of DJIA, S&P 500 index, the Russell 1000 index and the Russell 1000 growth stock index. Its current chairman and CEO is Muhtar Kent.

HISTORY

The coca-cola company was originally established in 1892 as the J.S Pemberton Medicine company, a co-partnership between Dr. John Stith Pemberton and Ed Holland. The company was formed to sell three main products. Pemberton’s French wine coca-cola (later Gowags coca-cola), Pemberton’s Indian Queen Hair Dye, and Pemberton’s Globe Flower cough syrup.

In 1894, the company became a stock company and the name was changed to Pemberton Chemical Company. The new president was D.D. Doe while Ed Holland became the new Vice President Pemberton stayed on as the superintended. The company, another co-partnership, this time between Pemberton, A. O. Murphy, E. H. Blood worth and J. C. Mayfield.

Finally in October 1898, the company received a charter with an authorized capital of $50,000. The charter became official in January 15, 1899. By this time, the company had expanded its offerings to include Pemberton’s Orange & Lemon gay Elixir.

ACQUISITIONS: The company’s recent attempt to buy a Chinese juice maker was failed when China rejected its $4.2 billion bid for the Huiyuan juice group on the groups that it would be a virtual monopoly. Nationalism was also thought to be a reason for aborting the deal. Ramours speculated that an American rejection of a bid for UNOCAL by a partly state-owned oil company played a part in the rejection.

However, the company has a long history acquisition; coca-cola acquired Minute Maid in 1960. Coca-cola acquired the Indian cola brand Thums up in 1993. It acquired Barg’s in 1993. In 2001, it acquired the Odwalla brand of fruit juices, smoothies and bars for $181 million. In 2007, it acquired Fuze Beverage from founder Lance Collins and Casterea Partners for an estimated $250 million.

REVENUE: According to 2005 Annual Report, the company sells beverage products in more than 200 countries. The report further states that of the more than 50 billion beverage servings of all types consumed worldwide every day, beverages bearing the trademarks owned by or licensed to coca-cola account for approximately 1.5 billion (the latest figure in 2010 shows that now they serve 1.6 billion drinks everyday). Of these, beverages, bearing the trademark “coca-cola” or coke accounted for approximately 78% of the company’s total gallon sales.

Also according to the 2007 annual report, coca-cola had gallon sales distributed as follows:

43% in the United States
37% in Mexico, India, Brazil, Japan and the people’s Republic of China
20% spread throughout the rest of the world.

In 2010 it was announced that coca-cola had become the first brand to top £1 billion in annual UK grocery sales.

LOBBYING: In the US, coca-cola is a major lobbying force working to gain favourable legislation. In 2007, that increased to $1.7 million, and by 2008 to $5.2 million. In 2009, total lobbying expenses jumped to $4.5 million or nearly double the previous year. Much of the increased lobbying expenses are due to the industry’s fight against increased taxes on soft drinks and other sweetened beverages. For 2009, coca-cola has 38 lobbyists at 7 different firms lobbying on its behalf.

BOTTLERS: In general, the coca-cola company (TCCC) and/or subsidiaries only produces (or produce) syrup concentrate which is then sold to various bottlers throughout the world who hold territorially exclusive contracts with the company’s produce finished product in cans and bottles from the concentrate in combination with filtered water and sweeteners. The bottlers then sell, distribute and merchandise the resulting coca-cola product to retail stores, vending machines, restaurants and food service distributors.

One notable exception to this general relationship between TCCC and bottlers is fountain syrups in the United States, where TCCC bypasses bottles and is responsible for the manufacture and sale of fountain syrup directly to authorized fountain wholesalers and some fountain retailers.

PRODUCTS AND BRANDS:

The coca-cola company offers nearly 400 brands in over 200 countries, besides its namesake coca cola beverage.

Tab was coca-cola’s first attempt to develop a diet soft drink, using saccharin as a sugar substitute. Introduced in 1963, the product is still sold today, however its sales have dwindled since the introduction of diet coke.

The coca-cola company also produces a number of other soft drinks including Fanta (introduced circa 1942) or 1943) and Sprite. Fanta’s origins date back to World War II when Max Keith, who managed coca-colas operations in Germany during the war, wanted to make money from Nazi Germany but did not want the negative publicity. Keith resorted to producing a different soft drink, Fanta, which proved to be a hit, and when coke took over again after the war it adopted the Fanta brand as well. The German Fanta Klare Zitrone (“clear lemon Fanta”) variety became sprite, another of the company’s bestsellers and its response to 7up.

During the 1990s, the company responded to the growing consumer interest in healthy beverages by introducing several new non-carbonated beverage brands. These included Minute Maid Thices to 90, powerade sports beverage, flavoured tee Nestea (in a joint venture with Nestle), Fruitopia fruit drink and Dasani water, among others. In 2001, Minute Maid division launched the Simply Orange brand of juices including orange juice.

In 2004, perhaps in response to the burgeoning popularity of low-carbohydrate diets, such as the Atkins Diet Coca-cola announced its intention to develop and sell a low-carbohydrate alternative to coke classic, dubbed C₂ coca. C₂ contains a mix of high Fructose corn syrup, aspartame, sucralose, and acesulfame potassium.C₂ is designed to more closely emulate the taste of coca-cola classic. Even with less than half of the food energy and carbohydrates of standard soft drinks, C₂ is not a replacement for zero calorie soft drinks such as Diet Coke. C₂ went on sale in the U.S on June 11, 2004, and in Canada in August 2004. C₂’s future is uncertain due to disappointing sales.

Coca-cola is the best selling drink in most countries and in which Nigeria is a sighted example. While the Middle East is one of the only regions in the world where coca-cola is not the number one soda drink, coca-cola nonetheless holds regions in the world where coca-cola is not the number one soda drink, coca-cola nonetheless holds almost 25% market share (to Pepsi’s 15%) and had double-digit growth in 2003. Similarly, in Scotland, where the local produced Irn-Bra was once more popular, 2005 figures show that both coca-cola and Diet coke now sell Irn-Bru. In Peru, the native Inc Kola has been more popular than coca-cola, which prompted coca-cola to enter in negotiations with the soft drinks company and buy 50% of its sakes. In Japan, the best selling soft drink is not cola as (canned) tea and cottee are more popular. As such, the coca-cola company’s bestselling brand there is not coca-cola, but Georgia.

On July 6, 2006 a coca-cola employee and two other people were arrested and charged with trying to sell trade secrets information to the soft drink maker’s competitor; Pepsico for $1.5 million. The recipe for coca-cola, perhaps the company’s most closely guarded secret, was never in jeopardy. Instead, the information was related to a new beverage in development. Coca-cola executive, verified that the documents were valid and proprietary. At least on glass vial containing a sample of new drink was offered for sale, court documents said. The conspiracy was revealed by Pepsico, which notified the authorities when they were approached by the conspirators.

The company announced a new “negative calorie” green tea drink, Enviga, in 2006, along with trying Coffee retail concepts Far Coast and Chagwa. On May 25, 207, coca-cola announced it would purchase Glaceau, a maker of flavoured vitamin enhanced drinks (vitamin water), flavoured waters and energy drinks, for $4.1 billion in cash.

On September 3, 2008, coca-cola announced its offers to purchase China Huiyuan Juice Group Limited which has a 42% share of the Chinese pure fruit juice market for US$2.4 bn (Hks) 12.20 per share). China’s Ministry of Commerce blocked the deal on March 18, 2009, arguing that the deal would hurt small local juice companies, could have pushed up juice market prices and limited consumer’s choices.

In October 2009, coca-cola revealed its new 90-calorie mini can that gold 7.5 fluid ounces. The first shipments are expected to reach the New York City and Washington D. C. markets in December 2009 and nationwide by March 2010.

SPONSORSHIP: Coca-cola has sponsored the English Football league since the beginning of the 2004 – 05 season. Other major sponsorship include NASCAR, the NBA, the PGA, NCAA championship, the Olympic games, the NRL, the FIFA World Cup and the UEFA Euro, as well as the hit fox singing-competition series America Idol. Coca-cola is a sponsor of nightly talk show on PBS, Charlie Rose in the US.

1.9 DEFINITION OF TERMS

1. MUTUALLY EXCLUSIVE PROJECTS: Project that complete with one another such that the acceptance of one will include further consideration of the other.

2. UNLIMITED FUNDS: The financial situation in which a company is able to accept all independent proposals provided that all of them meet a pre-determined level of acceptance.

3. INDEPENDENT PROJECT: Project with unrelated cash flows in which the acceptance of one does not eliminate the other from further consideration.

4. CAPITAL EXPENDITURE: An outlay that is expected to produce benefits over a period of time greater than one year.

5. CAPITAL RATIONING: The financial situation in which a company has only a fixed amount of funds to be allocated among competing capital projects.

6. RANKING: The ranking of capital expenditure proposal on the basis of pre-determined measures such as rate of return.

7. INCREMENTAL CASH INFLOW: The additional cash expected to result from a proposed capital expenditure either outflows or inflows.

8. INITIAL INVESTMENT: The relevant cash out flows for a proposed project at the time zero year.

9. DISCOUNTED CAPITAL BUDGETING TECHNIQUES: This is the method that gives explicit consideration to the time value of money.

10. NON-DISCOUNTED CAPITAL BUDGETING TECHNIQUES: This is the method that do not explicitly consider the time value of money.

11. AVERAGE RATE OF RETURN: This is the annual accounting rate of return expected on the average investment for a project.

12. PROFITABILITY INDEX: It is the present value of a project cash flow divided by its initial investment.

13. PAYBACK PERIOD: The exact amount of time required for a company to recover its initial investment from a given project calculated on the basis of cash inflows.

14. NET PRESENT VALUE: The present value of cash inflows minus its initial investment.

15. INTERNAL RATE OF RETURN: The discount rate that equates the present value of each inflows with its initial investment associated with a given project thereby making NPV = 0.

16. RISK ADJUSTED DISCOUNT RATE: The rate of return that must be earned on a given project in order to adequately compensate the company owners (shareholder).

17. SENSITIVITY ANALYSIS: An approach that uses a number of possible values for a given variable in order to assess its impact on a company’s return.

18. COST OF CAPITAL: The rate of return a company must earn on its investment to maintain its market value and attract funds.

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