Investment Appraisal Techniques and Their Applications by Finance/ Investment Houses (a Case of Union Bank Plc Enugu Urban)
CHAPTER ONE
Objectives of study
- To determine the effect of Accounting Rate of Return on financial performance of Union bank in Enugu state, Nigeria.
- To establish the effect of payback period on financial performance of Union bank in Enugu state, Nigeria.
- To ascertain the effect of Net Present Value on financial performance of Union bank in Enugu state, Nigeria.
- To examine the effect of Internal Rate of Return on financial performance of Union bank in Enugu state, Nigeria.
CHAPTER TWO
LITERATURE REVIEW
Conventional Capital Budgeting Theory
Woods & Randall (1989) established that in capital budgeting, the NPV criterion is used to measure shareholder’s wealth which is the main objective in financial management. The riskiness of projects cash flows is equal to the firms’ riskiness of other assets cash flows and the firms WACC is used to calculate NPV. Some future investment opportunities (FIOs) are acknowledged by the market due to their uncertainty and risk perceptions.
Conventional Capital budgeting approaches are biased towards FIOs in the long term in potential opposition to shareholder’s interests. Therefore, discounting ought to be done at the required return on equity (Ke) rather than WACC (Ka) to determine shareholders’ wealth attributable to FIOs. The ability to borrow on FIOs basis would increase shareholders wealth by quantifiable amount, if the management has a clear incentive to increase its credibility in the financial markets. When management is either unwilling to divulge information or unable to convince markets of future cash flows, a divergence will exist between the market value of shares and true shareholder wealth (Woods & Randall, 1989).
Neoclassical Theory of Investment
The Neoclassical theory of investment could be based on the optimal capital accumulation (Jorgenson, 1963). Neoclassical theory of investment is based on the assumption of profit-maximizing behavior by firms (Samuel, 1996) and the assumption that the management seeks to maximize the present net worth of the firm. Hence, an investment project should be undertaken if and only if it increased the value of the shares (Tobin, 1969 as quoted by Yoshikawa, 1980). Danielson and Scott (2006) put it clear that, the firms will make set of investments decisions that will maximize shareholders wealth. Hence, the rule is invest in all positive net present value projects and reject those with a negative net present value.
The neoclassical model of optimal capital accumulation may be derived by maximizing present value of the firm, by maximizing the integral of discounted profits of the firm, or simply by maximizing profit at each point of time (Jorgenson, 1967; Eklund, 2013). There are two assumptions regarding the theory of investment decisions as highlighted by Danielson and Scott (2006), first, the primary goal of a firm’s shareholder is to maximize firm value; second, a firm has access to perfect financial markets allowing it to finance all value enhancing projects.
A number of investment criteria can be used by businesses when making investment decisions. These criteria may be grouped into two; Discounted cash flow criteria and Non- discounted cash flow criteria (Pandey, 1976). Under the discounted cash flow criteria there are the following methods: Net Present Value (NPV), Internal Rate of Return (IRR), Modified Internal Rate of Return (MIRR), and Profitability Index. While under the non-discounted cash flow methods are as follows; Pay Back (PB) and Accounting Rate of Return (ARR).
CHAPTER THREE
RESEARCH METHODOLOGY
Research Design
This study used descriptive survey research design. Kothari (2012) states that descriptive research includes surveys and fact finding enquiries of different kinds. This research design was used since it describes the situation as it were, is and how it is likely to be. The findings inform the outcome. Therefore, the approach enabled the study to assess the cash flow methods and investment decision by investment houses.
Empirical Model
The basic concern of this study was to assess the relationship between Investment Appraisal Techniques and investment decisions of Union bank in Enugu state, Nigeria. According to Amuzu (2010) Investment Appraisal Techniques can be measured in terms of Accounting Rate of Return, payback period, Net Present Value and Internal Rate of Return. On the other hand, the variables used to represent financial performance were; profitability, solvency and liquidity.
The study adopted multiple linear regressions that assisted the researcher reach to conclusions. A discrete choice model was employed in this study to analyze investment decision behavior.
CHAPTER FOUR
DATA ANALYSIS AND PRESENTATION
Effect of Accounting Rate of Return and Financial performance
For the analysis of the objective, frequencies and percentages were employed as the preferred descriptive statistical techniques. The helped to determine the effect of Accounting Rate of Return on financial performance in Union banks in Enugu state. The analysis, therefore, opens with the descriptive statistics (frequency and percentage) for the level of agreement on a five point Likert scale of the Accounting Rate of Return (Table 4.6).
CHAPTER FIVE
SUMMARY, CONCLUSION AND RECOMMENDATIONS
Summary of the findings
Effect of Accounting Rate of Return and Financial performance
On the effect of Accounting Rate of Return on financial performance, the study findings suggested that most 243(68.2%) of the investment houses considered cash inflows when investing. Similarly, it emerged from the study that most 270(75.9%) of the investment houses considered the initial cash to be invested when investing. On the other hand, the study findings suggested that majority 293(82.3%) of the investment houses failed to take into account the time value of money when making an investment decision. Moreover, the study findings suggested that most 149(41.9%) of the investment houses had a divided opinion on whether business considered the residual value. Lastly, it emerged from the study that most 248(69.7%) of the investment houses considered the wear and tear. The inferential statistics results reveal standardized regression coefficient for Accounting Rate of Return (b1=0.209), implies that an increase of 1 standard deviation in Accounting Rate of Return is likely to result in a 0.209 standard deviations increase in financial performance.
Effect of payback period and financial performance
The study findings suggested that most 246(69.1%) of the investment houses considered record on the cash generated from sales. Similarly, it emerged from the study that most 249(69.9%) of the investment houses considered the total cost spent in establishing the project/business when investing. On the other hand, the study findings suggested that majority 245(68.8%) of the investment houses never considered estimation of the time it took to get back the money invested when making an investment decision. The study findings suggested that most 297(83.4%) of the investment houses considered capital employed when making an investment decision. Lastly, it emerged from the study that most 276(77.5%) of the investment houses considered wear and tear when making an investment decision. Inferential statistics results revealed that, standardized regression coefficient for Payback period (b1=0.542), implies that an increase of 1 standard deviation in Payback period is likely to result in a 0.542 standard deviations increase in financial performance.
Effect of Net Present Value and financial performance
The study findings suggested that most 235(66.0%) of the investment houses estimated the cash inflows and outflows. Similarly, it emerged from the study that most 264(74.2%) of the investment houses considered the discount rates. On the other hand, the study findings suggested that majority 278(78.1%) of the investment houses never considered summing up all the present values to get the present value of cash stream when making an investment decision. The study findings suggested that most 310(87.1%) of the investment houses never considered time value for money when making an investment decision. Lastly, it emerged from the study that most 267(75.0%) of the investment houses considered wear and tear when making an investment decision. The inferential statistics results revealed that, standardized regression coefficient for Net Present Value (1=0.204), implies that an increase of 1 standard deviation in Net Present Value is likely to result in a 0.204 standard deviations increase in financial performance.
Conclusion
In regard to the literature review, findings and discussions, the study concluded that Investment Appraisal Techniques significantly influence the financial performance of investment houses in Enugu state, Nigeria. Therefore, sensible investment decisions are vital in the improvement of the investment houses solvency, market, liquidity and profitability which results to better financial performance. Moreover, payback period remains the most important predictor of the investment houses financial performance.
On the effect of Accounting Rate of Return on financial performance, the study concluded that, Accounting Rate of Return significantly influence financial performance. investment houses do consider cash inflows, initial cash to be invested and sometimes wear and tear when investing, however, they fail to take into account time value of money. Therefore, Accounting Rate of Return plays some positive role in improving investment houses financial performance.
On the effect of Payback period on financial performance, the study concluded that, payback period significantly influence financial performance. investment houses do consider cash generated from sales, total cost spent in establishing the project/business, estimation of the time it took to get back the money invested and capital employed when making an investment decisions. Therefore, Payback period plays a great positive role for enhanced financial performance.
Moreover, the study concluded that, Net Present Value significantly influence financial performance. investment houses do consider discount rates, wear and tear when investing; however, they fail to consider summing up all the present values to get the present value of cash stream and time value for money when making an investment decision. Therefore, Net Present Value plays a divided role in improving investment houses financial performance.
Lastly, the study concluded that, Internal Rate of Return significantly influence financial performance. investment houses do consider some components of Internal Rate of Return such records on yearly projected returns and wear and tear, however, they fail to consider rate of return from the business and the NPV to be equal to zero when making an investment decision. Therefore, Internal Rate of Return plays a divided role in enhancing investment houses’ financial performance
Recommendations
The findings of the study suggested that due to the importance of investment to the economy of the country and investment houses themselves; investment houses operators need to continuously analyze the investment decisions that make them improve their financial performance.
The government and other stakeholder to focus more on the issue of investment decisions for investment houses. In particular, they should train investment houses on the investment evaluation techniques, their advantages and disadvantages in relation to their financial performance. Knowing these factors of influence will enable investment houses to make better investment decisions by selecting the right investment evaluation technique.
More efforts are needed from the regulatory agencies and government in general toward helping investment houses grow and make decisions as their growth will be good for the wider economy.
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