literature review on capital budgeting
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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.
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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/)