Capital budgeting is the process by which firms determine
how to invest their capital. Included in this process are the decisions to
invest in new project, reassess the amount of capital already invested in
existing projects, allocate and ration capital across divisions and acquire
other firms. In essence, the capital budgeting process defines the set and size
of a firm’s real assets, which in turn generate the cash flows that ultimately
determine its profitability, value and viability. In principle, a firm’s
decision to invest in a new project should be made according to whether the
project increases the wealth of its shareholders.

Efficient allocation of capital usually referred to as
capital budgeting is one of the most important functions of financial management
in modern times. This function involves the firm’s decision to commit its funds
in long- term assets and other profitable activities. The firm’s decision to
invest funds in long-term assets is of considerable significance since they
tend to influence its wealth, determine its size, set the pace and direction of
its growth and affect its business risk, Pandey (1981).

Capital budgeting addresses the question of how a company
decides to make investments in additional capacity or in new products and to
replace worn-out fixed assets. Awomewe and Ogundele, (2008), in their thesis
“The importance of the payback method in capital budgeting decision”, submitted
to the school of management, Blekinge Institute of Technology, wrote: “the
capital budgeting decision has been a very topical issue in the sustenance of a
company. Several companies have lost their identity or liquidated due to wrong
capital budgeting decision they made at one particular time or the other. Based
on these prevalent problems in industries and the effect of globalisation on
industries, it is important to use effective method to analyze investment
before decision is made. Capital budgeting is extremely important because the
decision made involves the direction and opportunity for future growth of the
organisation.”

Under conditions of global economy, the steady increase in
the variety and scale of uncertainties, competitive interactions and risks
prevail, and the difficulty to make reasonable investment decisions is growing.
The effective allocation of scarce resources can best be achieved with a
sophisticated capital investment process. The process increases the probability
of making relevant investments by ensuring that corporate strategy will be
followed, that all investment opportunities will be considered appropriately
and consistently, and that the counterproductive political aspect of informal
decision-making will be minimized.

Because capital investment decisions rank among the most
critical types of managerial decisions made in a firm and can have major
long-term implications, both positive and negative, for the success of a firm,
managers must understand how capital investment decisions are made if they are
to participate in improving corporate performance.

Researches on capital budgeting and investment decisions in
Nigeria have concentrated on the techniques used such as the payback period,
net present value, internal rate of return, accounting rate of return,
profitability index, etc. They established that Nigerian companies actually
adopted one or more of these techniques but the outcomes have not been
adequate. 

Capital budgeting is becoming increasingly more important as
a kind of managerial tool in recent years. One important responsibility of a
financial manager is to choose investments with satisfactory cash flows and
rates of return. It therefore follows that a financial manager must be able to
decide whether an investment is worth undertaking and be able to choose
intelligently among two or more alternatives. To do this, a procedure called
capital budgeting is used to compare, evaluate and select the desired project
or investment, Graham and Harvey (2001).

Making correct capital budgeting and investment decision
(e.g. whether to accept or reject a proposed project), often requires
recognising and correctly estimating the potentialities associated with
projects. Inadequate evaluations and decision tools risk the possibility of
applying scarce resources to areas which provide a return less than the cost of
capital, resulting in a destruction of value, Brigham (1992).

Most of the time, firms are attracted to any market
opportunity or projects which will increase the owners’ equity. However, due to
limitations of the new projects and availability of funds, management needs to
use capital budgeting techniques to determine which projects will achieve the
best return over an applicable period of time, Nasser (2010). He further
summarised the procedures for capital budgeting as involving the accurate
estimation of the project cost, correctly forecasting its cash flows,
evaluating the associated risks, calculating the firm’s cost of capital and
using these to determine the present and net present values of the
project. 

A given Nigerian manufacturing firm operates in an
environment where accurate and reliable data are inadequate. The
infrastructures needed to support its investments are weak and limited while
its capacity to hire and retain sufficiently qualified personnel is hampered by
lack of funds. This economic scenario poses a lot of challenges to the ability
of the firm to correctly budget for its long-term expenditure that determines
its survival and growth. It is for this reason that this study sets out to
evaluate the process of capital budgeting and investment decisions in the
selected Nigerian firms with a view to unveiling the factors that drive the
processes and making recommendations that will engender better results. 

1.2
Statement of the Problem