The capital budgeting procedure

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Introduction:

The capital budgeting procedure is an important aspect of financial management. However, more effort is involved than just the selection of capital projects. Northcott [1992], establish that "capital budgeting includes both selecting long-term investments and planning for their financing. As a part of the management control cycle of a firm, capital budgeting is about the management of capital outlays and equivalent operational cash flows".

"In its simplest form, an investment decision can be described as a firm's decision to make a cash outlay in order to receive, in return, future cash inflows (Lumby, 1991)"

Multinationals enterprises (MNEs) are usually known as global, world, transnational, international, supernational, and supranational corporations (Czinkota et al., 1994). Likewise, there are numerous definitions for a MNE. The United Nations define MNE as "enterprises which own or control production or services outside the country in which they are based". Another explanation is "MNE is a firm that engages in foreign direct dealings and owns or controls value-adding activities in more than one country" (Grif?n and Pustay, 2002). Both meaning are economist oriented (Rugman, 1981). They capture together the quantitative and qualitative dimensions. Quantitatively, whether a firm to be regarded as multinational.

The number of countries of business is typically two, although the Harvard multinational enterprise project required subsidiaries in six (Vernon, 1971). Another measure is the amount of overall revenues derived from the foreign operations - 25 to 30 percent is the most often cited (Rugman, 1976). For example, Caterpillar has 114 factories extend over five continents and around half of its revenues was from overseas in 2001 (Grif?n and Pustay, 2002) and McDonald has stores in 103 foreign countries which contribute 59 percent of its total operating proceeds (Fortune, 1997). The economic power and wealth of the world's largest entities is massive.

Multinationals are extremely complex organisations, as they work across national borders. The home country headquarters, as a regulation, controls the foreign functioning divisions. In various circumstances these units are controlled according to the normal systems of business or efficient areas. According to Jan Gadella, John Hall and Wim Westerman (2002) the capital budgeting procedures of such firms engage not simply financial control of capital investments, but as well strong special liaison management, targeted towards home country strategy development and the construction of complex financial information systems.

The capital appraisal systems of multinationals are influenced by changing mind-set of exterior stakeholders (suppliers, governments, consumers and others) as well as interior stakeholders (managers, shareholders and especially employees). Though these factors may have a substantial effect at a corporate level, one issue in particular has made a great impact on systems development on the whole, namely the ever-growing body of familiarity and understanding of capital budgeting.

While the results proved a preference for sophisticated capital budgeting techniques as the key method of analysis, the present use of complicated capital budgeting techniques by foreign managers may not be as prevalent as expected by financial theorists. Though it was deduced in previous studies that some environmental and precise business factors influenced the level of complexity of capital budgeting practices used by foreign subsidiaries, there was little relationship and with merely insignificant explanatory importance. The results confirmed that overseas subsidiaries exposed to a higher level of political and financial risk were more likely to employ complicated capital budgeting strategies. Subsidiaries categorized by high levels of financial leverage and high cost of capital requirements also employed advanced capital budgeting strategies. Multinational companies have numerous alternatives accessible to them in provisions of how they administer their foreign subsidiaries.

Usually, on the whole chief strategic decisions were made at the firm's parent head office while foreign subsidiaries had little occasions to manipulate major business decisions. Nowadays, greater firms are using a flexible approach which entails implementing strategic objectives at the home office and enabling local managers to apply their personal distinct guidelines. The key problem to this study concerned with considering how successful local foreign managers were in executing their capital budgeting procedures. As MNEs kept on expanding their businesses abroad, there was a supplement endeavour to check which financial decision models were actually used by subsidiary managers to handle the augmented difficulty of spending in other countries. Unlike conventional investment appraisal examination, international analysis is a considerably more complex procedure. These complexities arise for various reasons together with complex cash flows approximation, modifications with respect to foreign exchange rates, multiple book-keeping methods, a possible locked finances, and political threat concern. To maintain a competitive advantage, MNEs should maintain using the general effective approaches accessible to them.

Capital investment assessment is of fundamental significance because:

1. It will engage the obligation of a huge amount of organizational resources which will require cautious assessment to be undertaken prior to a decision is arrived at.

2. Investment decisions are regularly associated to strategic and tactical business decisions and consequently need to attain desired long-term plans. The most typical intention is the capitalization of shareholder property.

3. It can be extremely costly and difficult to overturn an investment choice, so concern needs to be put into effect in attaining the original investment decision.

4. Projected potential benefits and costs are complicated to predict. Subsequently, the risk and insecurity of undertaking a decision to long-term investment can be high.

This study provides an in depth analysis of the capital budgeting practices that are actually being used by foreign subsidiaries MNEs based in Mauritius.

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