Capital Budgeting Practices and Economic Development: A Comparative Study of Companies in Western Europe and West Africa

Abstract:     
Over the years, efforts have been made to increase the developmental strides of African countries. Many projects move from donor countries like the United Kingdom and the United State into Africa to help improve the lives of the people. However, these efforts have not been able to redeem Africa from abject poverty and indebtedness to the West. Various projects that are targeted towards the reduction of poverty are normally completed with no changes in the lives of the people. These projects, in my opinion, have not been scrutinised to assess their capabilities of meeting some stated target.

Capital budgeting practices are some of the vital inputs in the decision-making process of embarking on investment projects. A very good analysis, scrutiny, implementation and monitoring of such projects could yield the expected results for the stakeholders (people of the country). According to Dayananda et al (2002), the capital budgeting practices are used to make investment decisions so as to increase shareholders value. Capital budgeting is primarily concerned with sizable investments in long-term assets, Brealey & Myers (2003). These assets may be tangible items such as property, plant or equipment or intangible ones such as new technology, patents or trademarks. Investments in processes such as research, design, development and testing – through which new technology and new products are created – may also be viewed as investments in intangible assets (IBID).

Dayananda et al (2002), argued that irrespective of whether the investments are in tangible or intangible assets, a capital investment project can be distinguished from recurrent expenditures by two features. One is that such projects are significantly large. The other is that they are generally long-lived projects with their benefits or cash flows spreading over many years. Sizable, long-term investments in tangible or intangible assets have long-term consequences (IBID). This implies that today’s investment will determine the overall corporate strategic position over many years. These capital investments also have a considerable impact on the future cash flows of the organization and the risk associated with those cash flows. Capital budgeting decisions thus have a long-range impact on the strategic performance of the organization and are also critical to its success or failure.

This paper compares the use of capital budgeting techniques by companies in Europe and West Africa, using data obtained from a survey between 225 European and 120 West African companies. The main aim is to analyse the use of capital budgeting techniques by companies in both economic blocs from a comparative perspective to see whether economic development matters in the choice of which technique to use.

The empirical analysis provides evidence that European CFOs on average use more sophisticated capital budgeting techniques than their counterparts in West African. At the same time, however, the results suggest that the differences between European and West African companies is smaller than might have been expected based upon the differences in the level of economic development between both economic blocs. At least, this is evident with respect to the use of methods of estimating the cost of capital and the use of CAPM as the method of estimating the cost of equity.

Number of Pages in PDF File: 24

Keywords: Capital budgeting, Investment Appraisal, Apraisal of West African Firms, George Ekegey Ekeha, Capital Budgeting Practices, Financial Analysis, Project Management in West Africa

working papers series