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A Report
On

Capital Budgeting
Practices in Bangladesh
[Course Title: Financial Management]
[Course Code: FIN2122; Section: 4]

SUBMITTED TO:

Ms. Nasima Khatun

Lecturer
School of Business Studies
Southeast University
SUBMITTED BY:

The Impact Group

FIN2122 (4)

School of Business Studies

Southeast University

SUBMISSION DATE: December 17th, 2016

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IMPACT GROUP
Md. Akib Javed Khan (GL)

2015110000272

Rakib Hasan

2014210000058

Md. Farhad Mia

2015010000021

S.M. Latiful Islam

2012010000077

Shefat Lyla Rupa

2012010000062

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Table of Contents
Topic
Name

Page
Range

Particulars
Title Page
Cover Page
Group List
Letter of Transmital
Acknowledgement
Executive Summary

1
2
3
5
6
7

Chapter 1 (Introductory Part)

1.1
1.2
1.3
1.4

Introduction of the Report

Origin of the Report
Rationale of the Study
Objective of the Report

8
8
9
9

Chapter 2 (Methodology)
2.1 Data Collection
2.2 Data Processing
2.3 Data Presentation

10
11
11

Chapter 3 (Analysis, Interpretation & Discussion)

3.1 Capital Budgeting
3.2 Techniques Used in Capital Budgeting
3.3 Capital Budgeting Decisions & Its Importance
3.4 Nature of Capital
3.5 Degree of Application of Capital Budgeting Techniques in
Bangladesh
3.6 Factors Influencing Capital Budgeting Practice in Bangladesh
3.7 Capital Budgeting & Bangladeshi Companies
3.8 Capital Budgeting in Foreign Direct Investment
3.9 Capital Budgeting in Correlation with Banking & Inflation
3.10 Indication of Capital Budgeting Practices in Bangladesh

Conclusion
References

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11
11
13
14
14
15
16
17
17
17
18
19

Letter of Transmittal
Date: 17th December, 2016.

Ms. Nasima Khatun

Lecturer
School of Business Studies
Southeast University

Dear Sir,
Attached please find the report entitled A Report on Capital Budgeting Practices in
Bangladesh. This report explains in detail about the capital budgeting, techniques of capital
budgeting, the reasons of using capital budgeting, which organizations use capital budgeting
in Bangladesh etc. This report is made and submitted by us, the Impact Group as Southeast
University students in BBA and for the assignment of the course Financial Management.
We would much appreciate if you read our report carefully and allure our internal ability, so
that we can be the perfect for completing the other reports in future and hereby.
If you have any questions or comments about this report, please notice us affluently and
continuously to make it better. It will be a great pleasure for us.

Sincerely yours
_______________________
Md. Akib Javed Khan
(On behalf of the whole study group)

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DECLARATION

I, the undersigned, Md. Akib Javed Khan, on behalf of the Impact Group, declare that this
plan is entirely our own written (MS Word) work, except where otherwise accredited, and
that it has not been submitted for any other competition, award purpose or assignment to any
other university or any other courses of the university.

____________________

Sincerely yours:
Md. Akib Javed Khan
(On behalf of the whole study group)

Date

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17th December, 2016.

Executive Summary
Capital budgeting is used to describe how managers plan significant outlays on projects those
have long-term implications such as the purchase of new equipment and the introduction of
new products. The concept of a companys cost of capital is used in capital budgeting as a
potential basic discount rate to be applied to expect future cash flows from a proposed
investment project being subjected to evaluation for acceptance or rejection. Discountedcash-flow capital budgeting techniques derive from valuation theory that determines present
value of expected future cash flows by discounting them down to the present at a discount
rate appropriate to the degree of risk involved. Conceptually, this is true with regard to both
domestic investment and foreign direct investment for any organizations of any country.
Capital budgeting practices of the companies in Bangladesh is more sophisticated than
numerous supplementary intensifying inhabitants. Factors approximating life arena of the
corporation, diligence, and magnitude calculated by paid up investment, variety of possession
and others plays a fundamental responsibility in the misjudgment of capital budget practices
in Bangladesh.

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Chapter: 01 (Introductory Part)

1.1. Introduction of the Report:
This study explores the extent of practicing sophisticated Capital Budgeting techniques &
usages in Bangladeshi companies. Capital budgeting is concerned about evaluation of long
term investment opportunities and commitments of productive resources in viable
opportunities to strengthen and renew productive capabilities. Such commitments are kind of
irreversible because reversals disturb firms economic and financial performances. Therefore,
success and growth of a company largely depends on its ability to effectively allocate capital
in productive use. Lacks in evaluation and decision tools to identify and exploit long term
investment opportunities risk survival and hinder strategic growth of companies. Due to the
importance of capital budgeting decisions, it has been a topic of research for many years.
Empirical researches of the sixties exhibited primacy of payback period. From early 1970s a
shift happened in the capital budgeting techniques used by firms. More companies not only in
developed world but also in other economies such as developing countries started using
sophisticated techniques such as NPV (net present value), IRR (internal rate of return) etc.
But most of the companies use firm risk rather than project specific risks in appraising
investment projects and besides sophisticated discounted cash flow techniques, managers still
use simple rule-of-thumb. Small companies in these economies still use payback period as the
primary tool for investment evaluation. Even larger companies in many cases use discounted
methods as a secondary technique. In terms of risk adjustment and estimation of cost of
capital companies in emerging economies like Bangladesh, lags behind US and UK firms.

1.2. Origin of the Report:

The preparation of this report is a requirement of the course on Financial Management.
Ms. Nasima Khatun, Lecturer of Finance Department at the School of Business Studies,
Southeast University, who is also the honorable course teacher of Financial Management,
has assigned us to complete a report regarding capital budgeting and work on it. The topic
of our report is Capital Budgeting Practices in Bangladesh. This report has been assigned to
the students of BBA of section 4 of the provided course.

1.3. Rationale of the Study:

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There has been almost no study on capital budgeting and/or investment evaluation techniques
and practices of the companies in Bangladesh. Therefore, this exploratory study to review
capital budgeting practices in Bangladeshi companies is likely to bring out insights from an
untapped area of corporate finance in the context of a developing economy.
1.4. Objective of the Report:
Broad objective of this research is to elaborate on the capital budgeting practices of
Bangladeshi companies. For that purpose, the following specific objectives are pursued:
Identify to what extend different capital budgeting techniques such as NPV, IRR,
Payback Period, Discounted Payback Period, Profitability Index, Sensitivity Analysis,
Scenario Analysis, Real Options Approach, and Decision Tree Analysis are used.
Identify the extent of using different discount rates, risk adjusted and other.
Identify whether companies estimate their cost of capital or use a predefined discount
rate (as prescribed by corporate headquarters of multinationals or using several rule of
thumb)
Identify the risk factors usually taken into consideration to adjust cost of capital and
cash flows.
Evaluate the influence (if any) of some factors i.e. CEO/CFO background, tenure &
age and company size (measured by annual sales revenue) on the capital budgeting
practices.

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Chapter: 02 (Methodology)
2.1.

Data Collection:

There are two ways of data collection. Those are:

0
1
2
.
Our data collection method was secondary basis. We collected information from web,
journals and various publications.
Usually published data are available in Various publications of the foreign and local governments.
Various publications of universities, international bodies and their subsidiary
organizations.
Technical and trade journals.
Report and publications of various associations connected with business and industry,
banks, stock exchange.

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2.2.

Data Processing:

Collected information is processed by the use of computer system. Detailed analysis, working
variables and working definitions are embodied in the report with the help of Microsoft
Office Applications.
2.3.

Data Presentation:
To present the data we have used Microsoft Office Applications.
We also used the graphical views and smart charts.
For preparing the presentation, PowerPoint application is used to present as slides.

Chapter: 03 (Analysis, Interpretation & Discussion)

3.1.

Capital Budgeting:

The total capital (long-term and short term) of a company is employed in fixed and current
assets of the firm. Fixed assets include those assets which are not meant for sale such as
land, building, machinery etc. it is a challenging task before the management to take
judicious regarding capital expenditures, i.e., investments in fixed assets to that the amount
should not unnecessarily be locked up in capital goods which may have far-reaching effects
on the success or failure of an enterprise. A capital asset, once acquired, cannot be disposed
of without any substantial loss and if it is acquired on long term credit basis, a continuing
liability is incurred over a long period of time, and will affect the financial obligations of the
company adversely. It, therefore, requires a long-range planning while taking decision
regarding investments in fixed assets. Such process of taking decisions regarding capital
expenditure is generally known as capital budgeting.
3.2.

Techniques

Used

in

Capital Budgeting:
The accounting rate of return that does not involve discounted cash flows. The method is also
the unadjusted rate of return, and the financial statement method. Accounting rate of return
(ARR) measures profitability from the conventional accounting standpoint by comparing the
required investment (sometimes average investment) to future annual earnings. Each
potential project's value should be estimated using a discounted cash flow (DCF) valuation,
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to find its net present value (NPV). This valuation requires estimating the size and timing of
all of the incremental cash flows from the project. The profitability index, by definition, is the
ratio of the present value of the benefits (PVB) to the present value of the cost (PVC). This
simple benefits-to-costs ratio will remove the scale effect's bias. We obviously prefer to invest
in the asset that has the higher value for the profitability index. The internal rate of return
(IRR) is defined as the discount rate that gives a net present value (NPV) of zero. It is a
commonly used measure of investment efficiency. The IRR method will result in the same
decision as the NPV method for (non-mutually exclusive) projects in an unconstrained
environment, in the usual cases where a negative cash flow occurs at the start of the project,
followed by all positive cash flows. The IRR equation generally cannot be solved analytically
but only via iterations. One shortcoming of the IRR method is that it is commonly
misunderstood to convey the actual annual profitability of an investment. The cost of capital
is a screening tool, in case of the Net Present Value Method and the cost of capital is used as
the discount rate when computing the net present value of a project. Any project with a
negative net present value is rejected unless other factors dictate its acceptance and in case of
the Internal Rate of Return Method, the cost of capital is compared to the internal rate of
return promised by a project. However, this is not the case because intermediate cash flows
are almost never reinvested at the project's IRR and therefore, the actual rate of return is
almost certainly going to be lower. Accordingly, a measure called Modified Internal Rate of
Return (MIRR) is often used. The payback is another method to evaluate an investment
project. The payback method focuses on the payback period. Payback is often used as a "first
screening method". By this, it is meant that when a capital investment project is being
considered, the first question to ask is: 'How long will it take to pay back its cost?' The bank /
company might have a target payback, and so it would reject a capital project unless its
payback period was less than a certain number of years. The payback period is the length of
time that it takes for a project to recoup its initial cost out of the cash receipts that it
generates. This period is sometimes referred to as" the time that it takes for an investment to
pay for itself." The basic premise of the payback method is that the more quickly the cost of
an investment can be recovered, the more desirable is the investment. A 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 (most often using the
weighted average cost of capital) to arrive at a present value, which is used to evaluate the
potential for investment. If the value arrived at through DCF analysis is higher than the
current cost of the investment, the opportunity may be a good one. Certainty Equivalent
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Technique is the common procedure for dealing with in capital budgeting is to reduce the
forecast of cash flows to some conservative level. Risk adjusted discount rate states that if the
time preference of money is to be recognized by discounting estimated future cash flows at
some risk free rate to their present value, then to allow for the riskiness of those future cash
flows at risk premium rate may be added to risk free discount rate such composite discount
rate.
3.3.

Capital

Budgeting

Decisions & Its Importance:

Business decisions that require capital budgeting analysis are decisions that involve in outlay
now in order to obtain some return in the future. This return may be in the form of increased
revenue or reduced costs. Capital budgeting decisions include: cost reduction decisions,
expansion decisions, equipment selection decision, lease or buy decisions and equipment
replacement decisions. Besides capital budgeting as a least cost decisions, reveals that
revenues are not directly involved in some decisions. The success of a business depends on
the capital budgeting decisions taken by the management. The management of a company
should analyze various factors before taking on a large project. Firstly, management should
always keep in mind that capital expenditures require large outlays of funds. Secondly, firms
should find modes to ascertain the best way to raise and repay the funds. The management
should also keep in mind that capital budgeting requires a long-term commitment. The
requirement for relevant information and analysis of capital budgeting has paved the way for
a series of models to assist firms in amassing the best of the allocated resources. One of the
oldest methods used is the payback model; the process determines the length of time required
for a business to recover its cash outlay. Another model, known as return on investment,
evaluates the project based on standard historical cost accounting estimates. Popular methods
of capital budgeting include net present value (NPV), discounted cash flow (DCF), internal
rate of return (IRR), and payback period. While working with capital budgeting, a firm is
involved in valuation of its business. By valuation, cash flow is identified and discounted at
the present market value. In capital budgeting, valuation techniques are undertaken to analyze
the impact of assets instead of financial assets. The importance of capital budgeting is not the
mechanics used, such as NPV and IRR, but is the varying key involved in forecasting cash
flow. William et al. (2001) state that capital budgeting decisions are crucial to a firm's success
for several reasons first, capital expenditures typically require large outlays of funds. Second,
firms must ascertain the best way to raise and repay these funds. Third, most capital
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budgeting decisions require a long-term commitment. Finally, the timing of capital budgeting
decisions is important. When large amounts of funds are raised, firms must pay close
attention to the financial markets because the cost of capital is directly related to the current
interest rate.
3.4.

Nature

of

Capital

Budgeting:
Nature of capital budgeting can be explained in brief as under:
Capital expenditure plans involve a huge investment in fixed assets.
Capital expenditure once approved represents long-term investment that cannot be reserved or
withdrawn without sustaining a loss.
Preparation of coital budget plans involve forecasting of several years profits in
advance in order to judge the profitability of projects.
It may be asserted here that decision regarding capital investment should be taken very carefully so
that the future plans of the company are not affected adversely.

3.5.

Degree of Application of
Capital Budgeting Techniques in Bangladesh:

Shakila Yasmin, International Journal of Engineering, Business and Enterprise Applications,

stated that she had found out the following degree of application of capital budgeting in
Bangladesh after running a descriptive study on 56 companies in Bangladesh.

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A large majority of firms always or often use DCF methods which are recommended as
sophisticated techniques in finance literature. Of the different DCF methods, NPV and IRR
are most frequently (always or often) used methods followed by PI. Percentage of companies
frequently using NPV and IRR are respectively 88% and 79% whereas about 67% of the
companies frequently use profitability index (PI). In fact, PI is a technique to be used to
choose among competing investment opportunities, if there is limited financial resources
(capital rationing). Capital rationing especially hard rationing is not a regular phenomena, it
thrives only in case of weak financials and/or high risk of financial distress. Therefore, less
frequent use of PI makes reasonable sense from theoretical perspective. However, other DCF
method, discounted payback period (DPBP) is not widely used technique. Nearly half of the
firms studied rarely or never uses DPBP. In contrast to the heavy use of common DCF
methods, payback period (PBP) a rudimentary non-DCF technique is quite popular among
the respondent firms. 75% of the companies seen always or often use PBP, which is very
close to the usage of IRR technique. Among the risk adjusted methods sensitivity analysis
and scenario analysis are found to be almost equally applied techniques, being frequently
used by 49% and 44% firms. But decision tree approach and real option approach are rarely
or never used by majority (62% and 70% respectively) of the local firms.
In terms of broad category DCF and non-DCF methods are almost equally used methods. In
comparison to the risk adjusted methods, DCF and non-DCF methods are more commonly
used by the most firms.

3.6.

Factors

Influencing

Capital Budgeting Applications Used in Bangladesh:

Companies have CFO/CEO with MBA/Business Masters are most frequent users of DCF and
risk adjusted methods; Companies having CFO/CEO with non-business masters are frequent
users of DCF methods but moderate users of risk adjusted methods. These two categories of
companies also use non-DCF methods but less frequently. Companies having CFO/CEO with
business or non-business undergrad degrees usually use Non-DCF.
General differences between CFO/CEOs age and tenure with the company shows that
companies with older and longer termed CFO/CEOs have a tendency to rely more on nonDCF methods compared to DCF and risk adjusted methods. Majority of large companies
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frequently use non-DCF methods, followed by DCF and risk adjusted methods respectively.
Company discount rate is most frequently used as the rate for discounting cash flows of
investment opportunities by companies with CEO/CFOs of age between 50-59; tenure above
9 years and having (business or non-business) masters degree. Majority of the companies
rarely use country specific or divisional discount rate irrespective of their CEO/CFO
background. Companies with CEO/CFOs of age between 40-59; tenure between 4-9 years
and having business masters degree frequently adjust discount rate for country, industry and
other risks.
Very few companies use different discount rates for cash flows having different risks.
Company size, measured in terms of sales revenue does not have any impact on the choice of
discount rate. CEO/CFO background or company size does not have any impact on the
frequency to taking decision contrasting to that derived by capital budgeting techniques.

3.7.

Capital

Budgeting

Practices & Bangladeshi Companies:

A large percentage of Bangladeshi companies premeditated also adjust discount rates and
cash flows for several risk factors such as inflation, exchange rate fluctuation and change in
interest rates. Therefore, it can be concluded that capital budgeting practices of the companies
in Bangladesh is more sophisticated than many other emerging economies. Firms in the USA
and other developed economies can be considered as benchmark for the capital budgeting
practices of Bangladeshi companies. In this respect Bangladeshi companies lack in the use of
risk adjusted methods namely sensitivity, scenario and decision tree analysis and other
probabilistic techniques. Majority of companies usually follow the recommendation derived
by the capital budgeting techniques, only few (less than one third) of them frequently take
investment decision in opposition to the recommendation of the capital budgeting tools. This
is sensible at the high level of sophistication in capital budgeting practices. Moreover, the
frequently cited reasons for such opposing decisions i.e. fund constraint, strategic alignment,
policy & regulation and others strengthens the conclusion that majority of the companies
seemed are sophisticated in terms of their capital budgeting practices. Capital budgeting
practices may differ from industry to industry. Even firms life cycle stage might have
influence on the practice. Practices of firms at matured or growth stage are likely to be more
sophisticated than those of new firms. Again most of the firms do not focus in detail on the
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process of estimating cost of capital, which is a crucial input in capital budgeting methods.
There are some factors like life stage of the company, industry, size measured by paid up
capital, type of ownership and others plays a vital role in the misjudgment of capital budget
practices in Bangladesh.
3.8.

Capital

Budgeting

Practices in Foreign Direct Investment:

There is recognition in the literature that capital budgeting for foreign direct
investment decisions may involve complexities but may not present in the
domestic case. These include economic, financial, and political factors, and
related risks, e.g., foreign exchange risk, blocked currencies, expropriation. On
the other hand, foreign direct investment is thought to provide diversification
benefits, so that risks that are not domestically diversifiable are internationally
diversifiable, thereby eliminating some otherwise systematic risk.

3.9.

Capital

Budgeting

in

Correlation with Banking and Inflation:

Inflation of the national economy is one of the important drives to influence the capital
budgeting decision in the banking sectors in this country. The inflation rate is adjusted with
interest rate having for the maintenance of real/ actual cash flows. Many organizations do not
pay income taxes. Not-for-profit organizations, such as hospitals and charitable foundations,
and government agencies are exempt from income taxes. The organizations that earn profit
are not exempted from income tax the Bank as the profit organizations is responsible to pay
tax to the state government at the given percent on income. Interest rate of the bank is the
required rate of return/ hurdle rate. The empirical evidence with respect to whether or not
interest rates would perfectly reflect expected inflation is strong but also controversial.
3.10

Indication of Capital
Budgeting Practices in Bangladesh:

Almost all firms in Bangladesh use several techniques in parallel. But not
all of them properly use the techniques of capital budgeting for their
organizational risk adjustment. Excluding, some of the large firms like Reckitt
Benckiser, Beximco Pharma, Grameenphone Limited etc have established a great
example of practicing capital budgeting technique. In addition, there is a very
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less existence of information of the selected topic capital budgeting in the

published journals and webs in Bangladesh

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Conclusion

Capital budgeting is a continuous process and it is carried out by different functional areas of
management such as production, marketing, engineering, financial management etc. Although
most of the firms and organizations in Bangladesh do not adequately follow the capital budgeting techniques,
we as group think that they should properly follow and practice the capital budgeting techniques in their
respective institutions. This report encompasses concise and precious review on the capital
budgeting practice and its superior correlation with monetary progress of Bangladesh and
Bangladeshi companies. Capital budgeting decision requires planning for setting up budgets
on projects expected to have long-term implication having entailed its approaches/ techniques
significantly is applied in banking sector. Now a day, the techniques of capital budgeting are
systematic. The companies or any organizations cannot control over the operation of them as
per plan beyond the meaning full capital budgeting decision and application of capital
budgeting techniques. So, capital budgeting decision and practice of capital budgeting
techniques bear the significance and importance for successful operation of corporate
business along with any other business.

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References

https://www.scribd.com/doc/29593117/Multinational-Capital-Budgeting
https://www.scribd.com/presentation/14554486/Capital-Budgeting
https://www.scribd.com/doc/17738379/Capital-Budgeting
http://www.assignmentpoint.com/business/finance/capital-budgeting-tools-and-

technique.html
http://www.termpaperwarehouse.com/essay-on/Capital-Budgeting-Practice-InBd/342082
file:///H:/SEU/production/235228517_CAPITAL_BUDGETING_FOR_FOREIGN_D
IRECT_INVESTMENT_BANGLADESH_OVERVIEW.htm
file:///H:/SEU/production/application-of-inventory-management.html
http://www.assignmentpoint.com/business/finance/capital-budgeting-tools-andtechnique.html

Mbabazizie, Peter Mbabazi. & Daniel, Twesige. Capital Budgeting Practices

in Developing Countries: A case of Rwanda. Research Journals Journal of Finance

2, no. 3 (2014) downloaded from www.researchjournal.com.
Capital Budgeting in Practice: An Explorative Study on Bangladeshi Companies
Shakila Yasmin Assistant Professor Institute of Business Administration, University of
Dhaka, downloaded from- www.iasir.net .

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