The Effectiveness of Capital Budgeting Techniques in Evaluating Projects’ Profitability

Abstract

This study was conducted to examine the effectiveness of capital budgeting techniques on the evaluation of projects’ profitability. To achieve this objective, research questions were raised, hypotheses were formulated and tested with the chi-square (X2) statistical test; and relevant literature was reviewed. The accessible population for this study was all the sixty-five (65) quoted companies in Rivers State with a sample size of fifty-six (56) companies. A simple random sampling technique was used to select members of the sample frame. The questionnaire, which was administered on the General Managers of the selected companies, was the major data collection instrument employed in this study. From the results of our analysis, the following findings were made: (i) the various capital budgeting techniques used in evaluating the profitability of a project are- pay-back, accounting rate of return, net present value, internal rare of returns, profitability index, and net terminal value (ii) the most significant factor influencing the choice of capital budgeting techniques is the wealth maximization factor, (iii) the capital budgeting technique lacks relevance in evaluating projects under conditions of risk and uncertainty, (vi) the most effective capital budgeting technique for evaluating the profitability of risk-free projects is the net present value (v) taxation has no significant effect on project evaluation. It was therefore recommended that in an environment of risk and uncertainty as we are today, the traditional capital budgeting techniques are not effective in evaluating the profitability of a project; therefore the risk-adjusted discount rate and the certainty equivalent techniques are to be adopted.

Key words: Capital budgeting Techniques, Project Profitability