literature review on capital budgeting

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Page 1: Literature review on capital budgeting

LITERATURE REVIEW

Capital budgeting

Capital refers to an investment in goods or services that provide benefits over a period

of time after their acquisition. (Robert D. Reischauer, Brookings Institution, (April 24,

1998). Capital Budgeting refers the techiniques or process used to make good

decisions concerning investments in the long-term assets of the firm. In other words,

funds or capital raised by the firms are basically used to invest in assests or in any

investment activities that will enable the firm to generate revernues several years for

future use. Therefore, firm has to budget how does these funds are invested. Capital

budgeting decisions is an important aspect for firm’s future operations. This is

because it has huge impact such as unnecssary cost which will be more costly with

respect to competition for the firm for several years if decisions failed to plan

carefully. In nutshell, the amount of capital available at any given time for new

projects is limited; management needs to use capital budgeting techniques to

determine which projects will yield the most return over an applicable period of time.

Popular methods of capital budgeting include net present value (NPV), internal rate of

return (IRR), discounted cash flow (DCF) and payback period. However each method

has it own distinct advantages and disadvantages when evaluating any projects. (http://www.netmba.com/finance/capital/budgeting/)

Discounted Cash Flow Valuation

Cash flow is literaly the cash that flows through a company during the course of a

quarter or the year after taking out all fixed expenses. Cash flow is normally defined

as earnings before interest, taxes, depreciation, and amortization (EBITDA) (Author:

Motley Fool Staff). The valuation of assests, both tangible and intangible is an

important element of corporate finance. There are two basic approaches to valuation

that is from financial statements to cash flows and from cash flows to financial

statements. The former projects historical financial statements into the future and the

latter attempts to construct cash flow statements and use them in forecasting future

financial statements. Our findings anlayze the discounted cash flow valuation method

used to estimate the attractiveness of an investment opportunity. Discounted cash flow

(DCF) analysis uses future free cash flow projections and discounts them to arrive at

present value which used to evaluate the potential for investment. In simple terms,

discounted cash flow tries to work out the value of a company today, based on

projections of how much money it's going to make in the future. DCF analysis says

that a company is worth all of the cash that it could make available to investors in the

future (Author: Ben McClure) (http://www.stock-market-investors.com/pick-a-stock-guides/cash-flow-valuation.html)

DIGI.Com

DiGi.Com Berhad is listed on Bursa Malaysia Securities Berhad with a paid up capital

of RM 77.75 million and a market capitalization of approximately RM 16.8 billion as

at 6 April 2009. Focusing in the evaluation of one of the mega 3G project under taken

by DiGi recently. Capital budgeting and discounted cash flow evaluation methods will

be deployed to evaluate the profitability of this 3G project. NPV and IRR of the

project will be calculated to justify the decision whether the project should be under

taken or not.

Page 2: Literature review on capital budgeting

Malaysian Airline System

A major decision facing airline industry is to either purchase or lease an aircraft.

Since in the airline industry the most capital intensive asset is an aircraft, therefore,

the advantages and disadvantages of either purchasing or leasing are mainly depend

on the airline's capital structure. For an example, MAS in an effort to simplify and

enhance the travel experience of customers, Malaysia Airlines (MAS) is investing

RM480 million in its Passenger Services System (PSS) over 10 years, which will give

benefits worth over RM2 billion over period of 10 years . Business Turnaround

Plan as their good capital investment budgeting for future operations where it has

turned losses into profits between 2006 and 2007. When the Business Turnaround

Plan came to an end MAS posted a record profit of 851 million Ringgit (265 million

dollars) in 2007, ending a series of losses since 2005.

Proton Berhad

PROTON, established in 1983, is Malaysia's largest manufacturer of automobiles.

With operations in key market centers from UK and Western Europe to South-East

Asia and Australia, PROTON manufactures cars to suit a range of consumer demands

and preferences. The product mix includes versatile and reliable four-door family

vehicles, two-door hatchbacks, luxurious sedans, as well as the world-renowned

sports cars from Lotus. PROTON cars are now steadily on track to achieving the

mission for the future, gearing up to achieve the promise of a marquee which builds

cars with passion and soul; cars which are a delight to drive and a pleasure to own. In

addition, to raise capital for future investment Proton expected RM2b revenue over

next four years (FV) in its strategic tie-up with Detroit Electric Holdings Ltd.

(www.protonberhad.com)

(http://biz.thestar.com.my/news/story.asp?file=/2009/11/3/business/5028410&sec=business)

(http://paultan.org/topics/cars/malaysian-makes/proton/page/14/)