Abstract

One of the most significant strategic decisions that businesses in all sectors must take is to allocate scarce investment resources amongst projects and in order to take advantage of the today’s constantly changing market opportunities, a solid defence mechanism has to be put in place among which is capital investment techniques.

However, Capital investment techniques are probably the least understood tools of management and as a result, one of the least used by small businesses. It is against this background that this research aimed at examining the effects of investment appraisal techniques on the profitability of small and medium sized farm businesses was undertaken.

The main source of data collection was primary data and the technique of data collection was closed ended questionnaire with the tool of analysis being simple descriptive tools like percentages, and tables as well as inferential tools like linearized multiple regression.

Analyzed using SPSS, demographic findings revealed that majority of the small and medium sized farm businesses operate on small scale. Besides, Small and medium sized farm businesses effectively used discounted payback, net present value and internal rate of return and as well as average rate of return and payback period appraisals techniques.

In respect to the relationship between appraisal techniques and viability, with viability captured from the farmer ability to make profit; we observed that discounted payback and average rate of return were found to have insignificant positive relationship on small and medium-sized farm business viability, while Net present value had a significant negative relationship on small and medium sized farm business viability.  Payback period and internal rate of return techniques were found to have a negative and positive insignificant relationship on small and medium sized farm business viability respectively.

Overall, investment appraisal techniques were found to have insignificant effect on the viability of small and medium sized farm businesses in the Buea municipality. More so, sophisticatedness, high cost of adoption as well as lack of proper awareness were found to be difficulties faced in adopting appropriate appraisal techniques. It was therefore concluded that farm businesses should not relent their effort in adopting appraisal techniques as the insignificant effect could have been caused by the challenges faced in adopting them.

CHAPTER ONE

INTRODUCTION

1.1 Background to the Study

In order to take advantage of the constantly changing market opportunities on our today’s economy, businesses in all sectors must have a solid defense mechanism in place against competition. One of the most significant strategic decisions that businesses must take is to know how to allocate scarce investment resources amongst projects.

Hence capital budgeting techniques has been used to evaluate and justify projects otherwise known as investment appraisal techniques. According to Jacobs (2008), investment appraisals have evolved over decades and their importance has increased over time. Overall, six discernible stages of changes in capital investment practices and systems can be identified.

The first stage is the Great Depression years during which efforts were mainly focused on designing ways to ensure economic recovery. At the time, public borrowing for financing capital outlays, except for emergencies, was not favored. In a cautious approach, Sweden introduced a capital budget that was to be funded by public borrowing and used to finance the creation of durable and self-financing assets that would contribute to an expansion of net worth equivalent to the amount of borrowing. This so-called investment budget found extended application in other Nordic countries in following years.

The second stage took place during the late 1930s when the capital budget to reduce the budget deficit by shifting some items of expenditures from the current budget was introduced in India. It was believed that the introduction of this dual budget system would provide a convenient way to reduce deficits while justifying a rationale for borrowing.

The third stage refers to the growing importance attached to capital budgets as a “vehicle” for development plans. Partly influenced by the Soviet-style planning, many low-income countries formulated comprehensive five-year plans and considered capital budgets the main impetus for economic development. The fourth stage reflects the importance of economic policy choices on the allocation of resources in government. Quantitative appraisal techniques were applied on a wider scale during the 1960s leading to more rigorous application of investment appraisal and financial planning.

In the 1960s and 1970s, it was widely believed that budget allocation, including investment expenditures, could be largely reduced to a “scientific” process by systems such as PPBS (planning, programming and budgeting system) or even ZBB (zero-base budgeting).

A fifth stage saw a revival of the debate about the need for a capital budget in government, particularly in the United States. Along with the growing application of quantitative techniques during the 1960s came the view that the introduction of a capital budget could be advantageous. But this view did not gain much support. A president’s commission in 1999 investigating budget concepts in the United States concluded that a capital budget could lead to greater outlays on bricks and mortar, and as a result, current outlays could suffer. This shift in emphasis contributed to a decline in the popularity of the use of the capital budget until the late 1980s, when it came to be revived in a different form.

During this sixth stage, partly because of the experiences of Australia and New Zealand, there was a renewed push by the professional bodies and, from the late 1990s, the international financial institutions for the introduction of accrual budgeting and accounting. These ideas found a foothold in the United States, where advocates held the view that the absence of a distinction between investment outlays and ordinary or current outlays led to unintended neglect of infrastructure or accumulated assets.

Ensuring proper asset maintenance (as important as asset creation) required a division of outlays into current and capital outlays, as a part of day-to-day budget management. In this context, capital budgeting is defined as the process of analyzing, evaluating and deciding whether resources should be allocated to a project or not (Olawale, 2010).

CIMA (2002) identified the following steps in the process of developing programs of capital investment or budgeting; identification of an investment opportunity, consideration of the alternatives to the project being evaluated, acquiring relevant information, detailed planning, and taking the investment decision.

Acquiring the relevant data to form the basis for an informed decision is one of the most important aspects in practice. This activity helps to focus manager’s mind on the reality of the projections as they are once forecasting and so weed out poor projects at an early stage before they are subjected to intensive financial scrutiny. In taking an investment decision there is need to make a clear distinction between two different types of investment which are vulnerable to different methods of treatment: The replace of or improvement in assets or groups of assets already in use and the setting-up of completely new or self-contained projects. Thanopoulas, (1965), proposed the following characteristic that makes a measure for measuring investment worth: It should summarize the merits of an investment proposal in a single figure, it should facilitate comparisons between different projects, it should be simple and easily understood by those who use it, and it should be expressed in terms compatible with firms’ long-range objectives.

CIMA (2002), (Eakins, 2002), (Lo, 2008) just to name a few, identified the principal measures employed for measuring financial characteristics of the investment proposals, these methods are: Payback period, which according to CIMA (2002) is the time it takes for the cash inflows from a capital investment project to equal the cash outflows, usually expressed in years, used when deciding between two or more competing projects, the usual decision is to accept the one with the shortest payback; Accounting rate of return (ARR) which is the ratio of the project’s average after-tax income in relation to its average book value, used to evaluate a project based on standard historical cost accounting estimates. The accounting rate of return also referred to as the book rate of return, this technique produces a percentage rate of return figure which is then used to rank the alternative investments;

Net present value refers to the present value of cash flows discounted at the cost of capital, less the investment outlay. Used to provide the investor with valuable tools for determining which projects, if any, should be accepted or rejected.

The net present value is a popular technique for investment decision because it is a financial measure that ascertains the time value of money invested in a business (Eakins, 2002); Internal rate of return (IRR) according to Copper (1999) is that rate of return which equates the present value of the future cash inflows to the present value of the cash outflows, used in order to decide on the viability of long term investments.

If the IRR is greater than the project’s cost of capital or hurdle rate, the project will add value to the company; Discounted payback period (DPP), represents the time it takes for the present value of a project’s cash flows to equal the cost of the investment.

Investment appraisal decisions are crucial to a business success for several reasons. Firstly, capital expenditure typically requires large outlays of funds. Secondly, businesses must ascertain the best way to raise and repay these funds. Thirdly, most capital budgeting decisions require a long-term commitment and finally, the timing of capital budgeting decisions is crucial (Chan, 2004).

In Cameroon the small and medium sized farmers dominate the agricultural sector which contributes greatly in reducing poverty and growth of the country. In term of employment, it employs about 70% of Cameroonians and in terms of contribution to the Gross Domestic Product (GDP) of the country; they contribute about 20.6% (CIA world fact, 2014).

However, this contribution is said to be too small given the proportion of the total population involved in this sector. To ensure that this sectors GDP increase there is the need to appraise and evaluate their agricultural projects settling down on the most profitable ones.

The best method of investment appraising and evaluating investment is capital budgeting techniques otherwise known as investment appraisal methods. Hence in this study we intended to investigate the effect of investment appraisal techniques on the viability of small and medium size farm Businesses in the Buea municipality.

1.2 Statement of Problem and Justification of Study

More accurate and reliable capital investment techniques are most needed for all small businesses including small and medium size farmers if they are to grow, remain competitive and optimize their value.

However, Capital budgeting techniques are probably one of the least understood tools of management and as a result, one of the least used by small businesses (Olowale et al. 2010), especially in Cameroon. Small and medium scale business including farmers in most developing countries are faced with the problem of inadequate capital for investment and expansion, weak bargaining power due to lack of corporative unions, technologically weak due to inadequate capital, managerial inadequacies (old and orthodox designs), high degree of obsolescence and huge number of bogus concerns, poor project planning, uneducated industries participants, etc. (Dhore, 2015).

The fact that these techniques are least used by the small and medium size businesses including agro-entrepreneurs might be partially as a result of a mix of these challenges. For example, uneducated agro-entrepreneur might not be aware of the investment appraisal techniques, not to talk of understanding and using them.

Besides, investment appraisal techniques requires the services of consultants for those who do not know how to use them and this requires that the consultancy services be paid and coupled with the fact that there is inadequate capital for expansion, agro-entrepreneurs’ who are least aware of the importance of investment appraisal techniques would prefer to invest the available capital in their business than waste it for something they are not sure would pay-off.

Furthermore, investment appraisal techniques have some strengths and some pit falls. For example the NPV is considered the best method to assess the profitability of a project because it shows the project net income after recovery of initial investment and covers all cost also including inflation as well as takes into consideration the time value of money.

However, the NPV has disadvantages that require precise calculation of cost but this is often difficult to implement for long projects, hence it is a development cost of investment discount rate (Roemer and Stern, 1995) and most at time these cost and revenues are estimated which might not reflect the real world situation. Adopting this method might lead to project failure especially when used for appraisals.

More so, Non-Discounted Techniques presents some important weaknesses: First, like the payback period, it does not take into account the time value of money. Secondly, being based on accounting earnings and not on the project’s cash flows is conceptually incorrect. Finally, there is the need to set a target rate of return as a prerequisite to apply ARR as an appraisal method (Akalu, 2001).

It is not well settled if it is the challenges faced by the small and medium sized businesses, disadvantages associated with the use of these techniques which ranges from complication of such techniques to omission of some important elements, that causes this small and medium size businesses especially the farmers not to adopt the capital investment techniques or if there are other techniques they use which are more preferable to the capital investment techniques. More so it is not well settled if they are aware of these techniques as little have been said about by scholar.

Hence it is based on this background, that the present study attempts assessing the effects of appraisals techniques on small and medium sized farmers’ viability.

The main research question is; what are the effects of investment appraisal techniques on small and medium size farm businesses profitability? The above is subdivided into a number of specific questions which are:

1.3 Research Questions

1. What are the demographic characteristics of small and medium sized farmers in the Buea municipality?
2. What appraisal techniques do small and medium size farm businesses in the Buea Municipality use?
3. What is the link between the appraisal techniques used and the viability of small and medium sized farm businesses?
4. What are the difficulties small and medium sized farm businesses in the Buea municipality faces using appropriate appraisal techniques?

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