CHAPTER ONE
BACKGROUND OF THE STUDY
An efficient economic system calls for a dependable mechanism to allocate its resources. Christy (1966) describes that land, labour and capital are to be directed to their best uses, and should hence be placed in the hands of those who can use them most capably. In a market economy, this allocation process consists largely of a set of private decisions, which are directed by a network of free markets and flexible prices . Important among these decisions are capital investments decisions that according to Northcott (1995) are vital at two levels: for the future operability of the individual firm making the investment, and for the economy of the nation as a whole. At the firm level, capital investment decisions have implications for many aspects of operations, and often exert a crucial impact on survival,profitability and growth.
At the national level, the proper planning and allocation of capital investment are essential to an efficient utilisation of other resources, poorly placed investment reduces the productivity of labour and materials and sets a lower ceiling on the economy’s potential output. With this in mind it is no wonder that capital investment or capital budgeting is a central application of financial theory .the advantages and applications of sophisticated capital budgeting procedures based on cash flows, risk and the time value of money are seen as tools for maximising shareholders’ wealth, which is the same as maximising the value of the firm (Copeland & Weston, 1992). This fact is oen approximated to the relationship that firms using more sophisticated capital budgeting procedures should be able to perform better over time (Christy, 1966; Klammer, 1973). Empirical studies concerning the adoption of sophisticated capital budgeting procedures have shown that even though the degree of adoption has increased over time, there is an obvious “theory-practice gap” (Klammer, 1972; Schall, Sundem&Geijsbeek, 1978; and Graham & Harvey, 2001). The research therefore seek to evaluate the impact of capital budgeting on organizational performance.
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