University of Dhaka

A Report On
Managerial Finance Practice on
Beximco Pharmaceuticals Limited.

Date of Submission: August 21, 2017

Course code: F-508

Course Title: Managerial Finance

Report: Managerial Finance Practice on Beximco Pharmaceuticals
Limited.

Submitted To:

Professor Kismatul Ahsan

Department Of Finance

Faculty of Business Studies

University Of Dhaka

Submitted By:

Name Id
Mohammad Arman Reza 34003

Sec: B

Department Of Finance

University Of Dhaka

Date of Submission: August 21, 2017

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 Acknowledgement

Our group expresses our gratitude to our honorable course teacher Professor Md. Kismatul
Ahsan, department of Finance, University of Dhaka, who has given us the opportunity to
work on this report.
We are very much grateful to our honorable course teacher for assigning us such an
important course which is very much beneficial for our later part of life.

We also want to thank all who have helped us in preparing this report and worked hard to
make this report happen.

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 Table of Contents
Table of Contents ...................................................................................................................................... 4
EXECUTIVE SUMMARY .............................................................................................................................. 5
Chapter1 INTRODUCTION ................................................................................................................ 6
1.1 Introduction ............................................................................................................................................ 6
1.2 Limitations............................................................................................................................................... 6
Chapter2 OVERVIEW OF BEXIMCO ....................................................................................................... 7
2.1 Introduction ........................................................................................................................................ 7
2.2 About the company ............................................................................................................................ 7
2.3 Mission of BPL ..................................................................................................................................... 8
2.4 Vision of BPL........................................................................................................................................ 9
Chapter3 DUTIES of ................................................................................................................................ 9
FINANCIAL MANAGER ............................................................................................................................... 9
3.1 Introduction ........................................................................................................................................ 9
3.2 Duties of Financial Manager ............................................................................................................... 9
3.2.1 Financing Decision ..................................................................................................................... 10
Investment Decision: .............................................................................................................................. 12
Research & Development ................................................................................................................... 14
Plant and Machinery ........................................................................................................................... 14
Investment in shares and short term investment .............................................................................. 14
Working Capital management ................................................................................................................ 14
WC Cycle of BPL .................................................................................................................................. 15
Inventory ............................................................................................................................................. 16
Inventory Stock ................................................................................................................................... 16
Dividend Decision ................................................................................................................................... 16
Dividend Policy ....................................................................................... Error! Bookmark not defined.
Why dividend ......................................................................................... Error! Bookmark not defined.
Risks of paying dividend ......................................................................... Error! Bookmark not defined.
Chapter4 COST of CAPITAL ................................................................................................................... 19
Chapter5 CAPITAL BUDGETING ........................................................................................................... 22

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 EXECUTIVE SUMMARY

The report presented here under the title Managerial Finance Practice on Beximco
Pharmaceuticals Limited. was assigned to us as a part of semester works.

This report is based on our experience, academic knowledge and mostly based on the
secondary data. It was a great opportunity to experience and gather knowledge about
different aspects of an organization, specially the tasks related to a financial Manager.
Based on the suggestion of our academic supervisor, we have chosen the topic Managerial
Practice on Beximco Pharmaceuticals Limited. At the beginning of the report, an overview
of Beximco Pharmaceuticals Limited including their mission, vision has been given. After
the overview, the role of financial manager of Beximco Pharmaceuticals Limited and the
functions performed by financial manager have been discussed. The decisions that a
financial managers undertakes includes investment decision, financing decision and
dividend decision. How the financial managers take those decisions and what factors affect
their decision making are also included. We have also tried to find out the cost of capital of
Beximco Pharmaceuticals Limited by information provided their Annual Report. A short
discussion on Capital Budgeting has also done in this report. compared it with its two (02)
of the strongest competitors, Square Pharmaceuticals Limited and Renata Limited. we
have also came up with some reasons behind the fluctuations of BPLs ratios. Later on the
financial analysis part, we have made an equity analysis where we have mentioned the
calculating procedure of Operating Cash Flow (OCF), Project Cash Flow and Net Present
Value (NPV). After that, we have calculated the intrinsic and market price of the shares of
BPL for the sake of comparison and later on came up with the reasons behind the
overvaluation of shares of BPL

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Chapter 1 INTRODUCTION

1.1 Introduction
Management is the art of making effective use of resources to achieve goals. It concerns planning,
coordinating and implementing all aspects of an organizations operation in a manner which fulfills
the organizations aims. In other words, once a museum identifies its purpose, good management
helps to achieve it. As different processes are needed to achieve various aims, we tend to discuss
management practices in terms of particular functions.

Management is the sole of an organization. An organization cant run without management.

Management is necessary in every steps of an organization. Management Practice is using
managerial process to run an organization. Every organization has a goal & objective, management
set this goal and it says how an organization can achieve this goal. The basic operations of an
organization (Planning, Organizing, Staffing, Leading and Controlling) are performed by different
levels of managers. So we can say that every organization should practice management in proper
way.

Managing the finance is undoubtedly a mammoth task to accomplish. An organization put topmost
emphasize on managing its finance, as the growth and prosperity of an organization depend
significantly on how it manages it finance and how appropriately and efficiently it uses its assets.
On the contrary, improper management of finance can lead a company to a situation from where it
is difficult to recover and chance of lagging behind in the competition.

1.2 Limitations
There are a number of limitations while making this report. A time limitation is the biggest of them. . With
this short time making such a report is really difficult. The most difficult part of the report was to get

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appropriate information regarding the practice of managerial practice. Some crucial information which
was essential to represent the current market situation was not easily available such as. Market share of
different companies, growth of income and expenditure related information. The absence of clear idea
regarding leasing is also a problem. Despite having those limitations, we have tried our best to make this
report successful.

Unable to collect specific information of BPL.

To protect the organizational confidentiality some parts of the report are not in depth.

Chapter 2 OVERVIEW OF BEXIMCO

PHARMACEUTICALS

2.1 Introduction

In this chapter an overview of Beximco Pharmaceuticals has been given. The history of the company,
their evolution, mission, vision and their current market position in the pharmaceuticals market are also
included.

2.2 About the company

Beximco Pharmaceutical Ltd. is a leading edge pharmaceutical company based in Dhaka,

Bangladesh and is a member of the Beximco Group. The history of pharmaceutical business of the
company dates back to the early 70s, when it started to import market and distribute medicines
from world renowned companies like Upjohn Inc. of USA and Bayer AG of Germany. Since the very

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beginning, the company was highly successful in generating increased demand for its products
which eventually justified local production. It completed its registration in 1976 and started its
operation in 1980 by manufacturing and marketing licensee products of Bayer AG of Germany and
Upjohn Inc. of USA. After its initial years of struggle it broke ground with the launching of its own
products in 1983. In 1985 BPL was listed in Dhaka Stock Exchange (DSE) as a Public Limited
Company. The journey continued and barrier after barrier were crossed, challenges were faced and
overcome to transform BPL into what it is at present. Now it has grown to become nation's one of
the leading pharmaceutical companies, supplying more than 10% of the country's total medicine
need. In the process, it was enlisted in Chittagong and London Stock Exchange. Today Beximco
manufactures and markets its own `branded generics' for almost all diseases from AIDS to cancer,
from infection to asthma, from hypertension to diabetes for both national and international
markets. It manufactures a range of dosage forms including tablets, capsules, dry syrup, powder,
cream, ointment, suppositories, large volume intravenous fluids, metered dose inhalers etc. in
several world-class manufacturing plants, ensuring high quality standards complying with the
World Health Organization (WHO) approved current Good Manufacturing Practices (cGMP).
Beximco also contract manufactures for major international brands of leading multinational
companies. Beximco has a strong market focus and is anticipating continued future growth by
leveraging business capabilities and developing superior product brands and markets. In particular
it is very interested in developing a strong export market in USA and Europe. To meet the future
demand it has invested over US 50 million dollar to build a new state-of-the-art manufacturing
plant, confirming to USFDA and UK MHRA standards. This new plant will also offer contract-
manufacturing facility to leading pharmaceutical companies, especially from Europe and US.

2.3 Mission of BPL

BPL has a remarkable mission statement, which is being seriously pursued in its thoughts and
actions. An increasing amount of contribution is ploughed back into social causes BPLs
commitment, duties and responsibilities to the human society and nation.

Organization mission refers managements viewpoint towards is our business. A mission statement
broadly outlines the organizations future direction and serves as a guiding concept for what the
organization is to do and to become.

Each of our activities must benefit and add value to the common wealth of our society. we firmly
believe that in the final analysis we are accountable to each of the constituents with whom we
interact, namely our employees, our customers, our business associates, our fellow citizens and
shareholders.

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2.4 Vision of BPL
Vision is the long-term outlook i.e. over the years, the company is growing from strength to
strength, and consistently delivering on its promise of performance. In 2014 it achieved sales
growth of more than 21% outperforming the industry growth an consolidated its position in the
domestic market.

we strongly believe our investments in expanding capacity and upgrading our facility will provide
the necessary impetus for sustainable growth. Our major focus currently remains on development of
international markets and now we are aggressively pressing ahead with our strategy which is crucial
to the companys future-particularly for building presence in developed markets.

Chapter 3 DUTIES of

FINANCIAL MANAGER

3.1 Introduction
This chapter will describe the duties and responsibilities that the financial manager of BPL performs.

3.2 Duties of Financial Manager

As we came to know the financial manager has to play a various role, all the responsibilities
can be divided into four broad categories:

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 FINANCING INVESTMENT
DECISION DECISION

WORKING DIVIDEND
CAPTIAL
MANAGEMENT DECISION

3.2.1 Financing Decision

The Financial Manager (FM) always keeps an eye to its Capital structure before taking any
financing decision. Failing to do this will result in various risks. If capital structure does not
make sense, the cost of capital will be increased and it will deteriorate the company profit.

The second important decision which finance manager has to take is deciding source of
finance. Deciding how much to raise from which source is concern of financing decision.
The FM should oversee the capital structure of the company, determining the best mix of
debt, equity and internal financing. All functions of a company need to be paid for one way
or another. It is up to the finance department to figure out how to pay for them through the
process of financing.

There are two ways to raise money from external funders: by taking on debt or selling
equity. Taking on debt is the same as taking on a loan. The loan has to be paid back with
interest, which is the cost of borrowing. Selling equity is essentially selling part of your
company . When a company goes public, for example, they decide to sell their company to
the public instead of to private investor. Going public entails selling stock which represent
owning a small part of the company. The company is selling itself to the public in return for
money.

A firm tends to benefit most when the market value of a companys share maximizes this
not only is a sign of growth for the firm but also maximizes shareholders wealth. On the

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other hand the use of debt affects the risk and return of a shareholder. It is more risky
though it may increase the return on equity funds.

A sound financial structure is said to be one which aims at maximizing shareholders return
with minimum risk. In such a scenario the market value of the firm will maximize and
hence an optimum capital structure would be achieved. Other than equity and debt there
are several other tools which are used in deciding a firm capital structure.

Major task of financing can be included:

Maintaining liquidity

Optimizing cash resources

Establishing and maintaining access to short-term financing

Managing risk

Coordinating financial functions and sharing financial information

3.2.1.1 Financial Source to meet crisis

3.2.1.1.1 Revenue
BPL manages their daily expenses from mostly revenue short term credit from bank. The
most important thing they do consider in financing decision is BPL always seeks for
optimal capital structure so that ultimately it helps to minimize the capital expenditure.
Risk involved with the revenues are as follows:

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 Bounced check creates a bad reputation about the firm. To overcome this problem
the BP always follow-up to ensure minimum balance available.
Accounts receivables may remain uncollected. To overcome this, they do not make
credit sale unless a trusted client.
To pay to its supplier they have more accounts in different banks so that shortage in
one could backup by others.

3.2.1.1.2 Reserve Fund

Reserve fund is only used when there is a handsome payment to be made. Short and
medium expenses are paid by the revenues collected but in case of big disbursement
needed such as expenditures at Research and Development (R&D) department; purchasing
a major asset etc. these are the internal source of fund.

The risk involved using retained earnings as financial source is,

The retained earnings is a part of equity, it may create confusion at companys
balance sheet.
It takes a bit lengthy process and time to get the amount. Because to raise fund
from retained earnings, BPL need to take permission of corporate office.

3.2.1.1.3 Short Term Loan

A loan that is set to be paid back in a short period of timetypically within a year, though
in some cases, short-term loans can have longer terms .Sometimes BPL borrows money
from bank. The major advantage of borrowing loan is it reduces the tax expenditures. But
as long as they want to keep the optimal capital structure, short term loan contributes to
form a good capital mix.

Short term loan has always risk of paying higher interest. But they deal this problem by
very limited term borrowings. They always maintain a certain maximum amount of credit
so that the interest expenses remain minimum.

3.2.2 Investment Decision

An investment decision revolves around spending capital on asset that will yield the
highest return for the company over a desired time period. In other words, the decision is
about what to buy so that the company will gain the most value.

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To do so, the company needs to find a balance between its short-term and long-term goals.
In the very short-term, a company needs money to pay its bills, but keeping its entire cash
means that it isn't investing in things that will help it grow in the future. Companies need to
find the right mix between long-term and short-term investment.

The investments must meet three main criteria:

It must maximize the value of the firm, after considering the amount of risk the
company is comfortable with (risk aversion).

It must be financed appropriately (we will talk more about this shortly).

If there is no investment opportunity that fills (1) and (2), the cash must be
returned to shareholder in order to maximize shareholder value.

As Beximco Pharmaceuticals Ltd. is a leading edge pharmaceutical company so their

investment area is so vast. They handle their investment decision seriously.

Their major areas of investment are

Research & Development

Raw materials (working capital)
Plant and Machinery
Investment in shares and short term investment

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3.2.2.1 Research & Development
BP invests a handsome portion of their total investment at Research & Development
department. Thus they always emphasize on developing new products. They want to
innovate medicine for the treatment of some demise diseases such as cancer, swine flu,
Bird-flu, HIV etc. They have already invested massive amount of money to develop anti-
medicine of these disease. The major risk in investing research and development is, there
might not come any satisfactory result after a rigorous research. And even they might fail to
implement the newly innovated product. To overcome this risk, BPL does some feasibility
test, estimated cash flow to measure NPV. The projected cash flow is hardly maintained
.How effective the total estimated expenditure is verified by producing in a small scale, just
like to make pilot project.

3.2.2.2 Plant and Machinery

As current asset does not generate income, we need to be very sensitive in investing at
fixed asset, said the manager of BPL. This is why another huge investment area of BPL is
plant and machinery or fixed asset. Every time they get a new investment opportunity of
developing a new product, BPL emphasizes most on it. They always try to keep around
80% of their total investment in fixed asset. Risks associated with machineries are:

Machinery may be less effective than estimated.

Maintenance cost may be high.
Import cost of Machinery may become costly.

3.2.2.3 Investment in shares and short term investment

BPL invests a certain portion of their retained earnings at share capital and some short
term investment. It is really a good sign for a firm manager said. It ensures the money
doesnt treat as idle as well as it is a current asset so they can convert it as cash if they
needed. Risks associated with this are:
Share market may decline badly.
Wrong security investment

3.2.2.4 Working Capital management

The term working capital (WC) refers to the amount of capital which is readily available to
an organization.

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BPLs components of WC are:
Liquid Assets (cash and bank deposits):
Inventory
Receivables
Current Liabilities:
Bank Overdraft
Creditors and Payables
Other Short Term Liabilities

Liquid Assets Inventory

(cash and
bank Receivables
deposits)

Current
Liabilities Bank Overdraft

Creditors and Payables

Other Short Term Liabilities

WC Cycle of BPL

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3.2.2.4.1 Inventory
As the raw materials are 80% comes from outside of country, they needed a handsome
amount of investment in this side. BPL always focuses on ensuring the quality, they make a
very strong relationship with their suppliers. In this case, they select an ultra-reliable
supplier who supplies quality product to deal with rather than purchasing raw material
from different ways.

3.2.2.4.2 Inventory Stock

The more efficient the WC management is, less the maintenance cost and more the
turnover. The manager said they do update the working capital day to day, it helps them to
get the real idea how much should be their optimum level of WC. As per their experiment
study they keep inventory a stock of 2 months and finished product for one month. As
they collect raw materials from single suppliers, there might be a chance of defective
products. There might be a crisis of raw materials if the demand rises suddenly. Sudden
decline in demand could cause the higher maintenance expense. Thus they reduce Risk as
they could still supply for at least one month even their production hampers.

3.2.3 Dividend Decision

This decision is concerned with distribution of surplus funds. The FM has to decide how
much surplus profit is to be distributed to equity shareholders in the form of dividend or
kept aside in the form of retained earnings based on the growth plans and investment
opportunities. Earning profit or a positive return is a common aim of all the businesses. But
the key function a financial manger performs in case of profitability is to decide whether to
distribute all the profits to the shareholder or retain all the profits or distribute part of the
profits to the shareholder and retain the other half in the business. Its the financial
managers responsibility to decide an optimum dividend policy which maximizes the
market value of the firm. Hence an optimum dividend payout ratio is calculated. It is a
common practice to pay regular dividends in case of profitability. Another way is to issue
bonus shares to existing shareholder.
Risks associated with paying dividend including:
Shareholders may not be happy.
Wrong dividend decision could cause share price fall.
Reserve fund crisis.
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 Authorized capital may be fully raised (in case of stock dividend)

3.2.3.1 Dividend declaration of BPL

After analyzing percentage dividend of the years from 2010 to 2014, we have found out
that Beximco Pharmaceuticals Limited had declared only Stock dividend in 2010-12 and both Cash
dividend & Stock dividend 2013-14 to its shareholders. Details are as follows-

1. Cash Dividend

Year Dividend
(%)
2010 0
2011 0
2012 0
2013 10
2014 10

Cash Dividend declared from 2010 to 2014

Beximco Pharmaceuticals Limited has declared 10% cash dividend in the year 2013 and 2014 on the face
value for their shareholders and previous to that no cash dividend was paid. They give stock dividend to
their shareholders on a consistent basis through which they spread good news in the market that its a
good prospect company.
2. Stock Dividend:
Considering the market consideration factor, Beximco Pharmaceuticals Limited is providing mostly stock
dividend as well as some cash dividend in order to satisfy both types of investors considered under
cliental effect- short term and long term investor. by looking at the dividend trend it can also be said that

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they are more focused on stock as it helps the company to provide dividend without transfer of cash and
also a tool to increase number of common stock/ paid up capital.

From the above table we can say that Beximco Pharma declared at least 5 percent stock dividend every
year. Is had declared highest 21 percent stock dividend in the year 2011. From the above table it is also
clear that, this company has a position in between growing and maturity stage, though it has more
internal and external sources to raise fund for future expansion but it mainly focus on internal sources. It
also helps the company by provide dividend without transfer of cash and also a tool to increase number of
common stock/ paid up capital.

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Beximco Pharmaceuticals Limited does not follow any specific dividend policy. we also see that the
percentage of stock dividend was not similar as well as they also declare cash dividend in recent two
years and the percentage of stock dividend was not same. Finally the percentage of total dividend is
fluctuated from 15% to 21%.

Chapter 4 COST of CAPITAL

4.1 Introduction
This chapter will discuss about the concept of cost of capital and how Beximco
Pharmaceutical calculates their cost of capital. Based on the Annual Report 2014 their cost
of capital has been calculated here.

4.2 Cost of Capital Analysis

The cost of capital is the companies cost of using funds provided by creditors and
shareholders. The cost of capital of a company is the cost of its long time sources of fund:
common share holder equity, debt and preferred equity. The cost of each sources reflect
the risk of the invested in. A company that invested in assets having little risk in producing

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income will be able to bear lower costs of capital then a company that invests in assets
having a higher risk of producing income.
There are two methods of calculating Cost of Capital.
1. Capital Assets Pricing Model ( CAPM)
2. Dividend Growth Model

4.2.1 The Capital Asset Pricing Model (CAPM)

The process of estimating cost of capital

Determine the proportion of each sources of the capital that

will be raised
Determine the proportion of each sources of the capital that will be raised.
Estimate the marginal cost of each sources of capitale marginal cost
of each sources of capital.

Calculate the weighted avg. cost of capital

Calculate the weighted avg. cost of capital..
Determine the proportion of each sources of the capital that will be raised.

4.2.1.1 Cost of Debt

By definition cost of debt is the amount of interest being paid by a company on all of the
debts that it has incurred. Company will use various bonds, loans and other forms of debt,
so this measure is useful for giving an idea as to the overall rate being paid by the company
to use debt financing. The measure can also give investors an idea as to the riskiness of the
company compared to others, because riskier companies generally have a higher cost of
debt.

Formula: Kd = kd (1-T)
Here, Kd = Cost of debt
kd = Before tax % cost of debt
T = Tax rate
To calculate cost of debt of Beximco Pharmaceuticals we analyzed its annual report of
2014. Here I found that BPL has two secured long terms borrowings- (a) Project Loan; (b)
Obligation under Finance Leases. Those Loans carrying interest at 13% to 15.50% per
annum, is repayable in quarterly installments ending by 2017. For my own calculation I

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assume, kd = 15.50%. As we know that Beximco is a publicly traded company hence the
applicable Tax Rate is 27.50%.
Cost of Debt of BPL; Kd = 15.50 %( 1 27.50%) = 11%
Cost of preference share:
Kp = /

For BPL perspective,

Dividend = 5% of Tk.100 = Tk. 5

Price of share = Tk. 100

Cost of preference share; Kp = 5/100 = 5%.

Capital Structure of 2014

Capital Amount Weight

Share capital 3,678,516,520 42%
Long term debt 901,709,327 11%
Preference share 4,100,000,000 47%
Total 8680225847 100%

Wd = Weighted of debt

Wp = Weighted of preference share

For BPLs WACC = 30%*0.09%* + 22%*11% + 48%*5% = 4.9%

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Chapter 5 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.

3.1.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, 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.
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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 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.

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3.2.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 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.

3.3.Nature of Capital Budgeting:

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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.

3.4. 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.

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

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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.

3.5.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 non-DCF methods
compared to DCF and risk adjusted methods. Majority of large companies 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

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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.

3.6.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 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.

3.7.Capital Budgeting Practices in Foreign Direct Investment:

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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.

3.8.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 less existence of
information of the selected topic capital budgeting in the published journals and webs in Bangladesh

References:

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Hamilton, J.J. (1992), Financial Decision Making: Concepts, Problems and Cases. Prentice Hall
of India Pvt. Ltd., New Delhi: 486-487.
IFC (2003), OEG Leasing Brief, International Finance Corporation, Washington, DC.
Islam, M.A. (1999), Growth and Development of Leasing Business in Bangladesh: An
Evaluation, Khulna University Studies, Bangladesh, 1(2): 311-317.
John, H.M. (1964), Reporting of Leases in Financial Statements, Accounting Research Study
No.4, New York: 10-11.

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