Investment Appraisal Thesis

Chapter 01 Introduction This chapter consists with the back ground of the study, research issue, objective of the study, significant of the study, flow of the study and the limitations which are occurred during the research.

1.1 Background of the study Rapidly changing technology, innovations and globalization are lead to make more competition in modern businesses context. The business that can compete with this competition be able to survive in the market and earn profits. Organizations which are having more flexible structure and strong financial position be able to compete with the market changes. Making capital nature expenses for unforeseen future may not be best solution to the organizations. On the other hand having zero investment also may not be the best scenario. Therefore organizations should undertake the projects which may give sustainable competitive advantage to the businesses. Capital investment decisions normally represent the most important decisions that an organization makes, since they commit a substantial proportion of a firms resources to actions that are irreversible. Expansion of business operations, acquisitions, modernization and replacement of long term assets and sale of a division or business can be identified as investment. Normally such investment will take more than one year period and those includes investments in plant and machinery, research and development, advertising and warehousing facilities. These types of investments carry huge cash inflows and outflows as well as risk associated with; therefore managers are evaluating the project before it is accepted. In

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this case, managers apply different criterion to evaluate investment decisions in which maximize the wealth of the shareholder’s. In current practice, managers use Traditional method and Discounted Cash flow (DCF) analysis to evaluate the investment in financial terms. In which traditional Method includes Payback method and Accounting Rate of Return (ARR) which make no adjustment for the time value of money. But in DCF method considers the time value of money in which reduces the time value of money progressively and it consist with Net Present Value (NPV) approach and Internal Rate of Return (IRR) method. This could lead to more popularize investment appraisal techniques among the managers. In theory would suggest that DCF method is more superior than the traditional method, on that NPV is superior than to IRR. Even though in theoretically NPV technique of investment appraisal is superior in pragmatic ground its rivals are over. It is proved that survey conducted by Arnold & Hatzopoulos (2000) and Graham & Harvey (2001). These surveys done in UK and more generally and they have revealed that techniques less behind for it rivals. In addition to that Koller (2006) have identified most frequent ten errors in application of DCF model. He also stated that DCF model should be economically sound and transparent. Therefore Koller has strongly emphasized without looking at those issues managers may not be able to end up with good decisions. In this case he suggests that application of DCF method need to be adjusted and assumptions to be made accurately. Because accuracy of the decision is relies on such assumptions. Surveys of capital budgeting practices in the UK and USA reveal a trend towards the increased use of more sophisticated investment appraisals requiring the application of DCF techniques. Several writers, however, have claimed that companies are under

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investing because they misapply or misinterpret DCF techniques. Such claims have been made on the basis of observations in only a few companies, or anecdotal evidence, without any supporting statistical evidence. Reports on a recent survey conducted by the Drury C. & Tayles M. (1997) suggest that many UK firms are guilty of misapplying DCF techniques. On this survey they have tested the three areas where misapplication could be taken place. They are selection of investment appraisal techniques, treatment of Inflation and Uses of discount rate. In addition to that they have tested the major reason that is cited to explain why the financial appraisal often fails to justify investment in Advanced Manufacturing Technology’s (AMT). It is because those benefits which are difficult to quantify are either understated, or frequently omitted from the financial appraisal. Because of that UK organizations may be rejecting the profitable investment. On the other hand, when we are considering the appraisal of AMT project different researchers established diverse arguments. Kaplan (1986) argued that conventional DCF method to be used based on the financial data available to appraise the AMT projects. Meredith & Suresh (1986) also developed the new approach consist with flexibility, high level of risk and the synergy of Flexible Manufacturing Systems (FMS) when linked together with other systems. These three levels tested on different appraisal techniques and try to overcome the problems associate with Kaplan’s Model. But later Browmich & Bhimami (1991) developed the model in which quantify all the benefits either financial terms or score value terms. However DCF approach is still widely used investment appraisal techniques. It is prove according to the surveys carried out by Lawrance, Gary & Williams (1978) 65% and 56% respondent of Large US firms were applied IRR and NPV respectively and recent survey carried out by the Pike (1996) reported 75% and 81% UK firms are

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applying NPV and IRR respectively. According to the study carried out by the McIntosh (1993) among major valuation firms in Australia and the Sangster (1993) among largest 500 Scottish companies they have revealed that more than 75% firms are currently practicing the DCF method.

1.2 Research Issue According to the literature survey we can see that there is an ongoing debate among the managers of all industries whether to use DCF analysis or any other method in capital investment evaluation process. However it was found that DCF analysis is the more accurate and flexible decision making technique that can be used. But as far as practical application is concern DCF models cannot be applied as it is. It has to be developed and to be made the necessary adjustments to minimize errors that can be occurred in decision making process. Therefore validity of the DCF analysis is susceptible. So that researcher undertakes research on following issue. Whether DCF analysis is validated by the Managers of Milk Food industry as an Investment Decision making Tool

1.3 objectives of the study To identify, whether DCF analysis is validated by the managers of milk food industry as an investment decision making tool

1.4 Significance of the study Investments are the most critical aspect for the success of an organization. So that it has given the highest importance in financial management. It is because it’s impact upon the long term future of the business, the amount of scare resources utilized and

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degree of irreversibility. Misguided decisions can endanger the survival of the business and cause difficulties in obtaining additional finance from more costly sources. On the other hand it showed that investment decision is at a high risk. Therefore investment must be carefully analyzed in a systematic and logical way. All of the projects will generate financial or non financial benefits to the organization. To evaluate the financial benefit pre determined appraisal techniques are developed and existed. But in case of appraising non financial benefits there is no specified method is developed. Therefore organizations evaluate the non financial benefits based on the judgments of the specialized persons and their experiences. When managers are evaluating the financial benefits of the generally accepted techniques such as Pay back, NPV or IRR most of the calculations based on the assumptions. Therefore validity and acceptability of such techniques is in doubt. According to the Sri Lankan context it is a collection of different industries like Transportation, Telecommunication, Garment, Milk food, Construction, Paddy etc. Considering the milk food industry it is more competitive and widely spread their activities all over the country. Therefore organizations which are currently running in milk food industry make frequent investments to keep their market by way of doing innovations. In addition to that major organizations which acquired majority of the market is foreign own companies. They make frequent investment according to the changes in technology, consumer preference all over the world. Therefore it is significant to study the decision making process of the milk food industry and there validity of the decision making techniques.

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1.5 Flow of the study Chapter 1 Introduction This chapter includes the background of the study, research issue, objective of the study, significant of the study, flow of the study and limitation of the study. Chapter 2 Literature Review This includes the literature review of the study. Chapter 3 Conceptual Frame work and Research Methodology This chapter consists with conceptual frame work and research methodology. Under the research methodology empirical setting of the study and the data collection method is included. Chapter 4 Data Presentation and Analysis This chapter consists with profile of the respondents, discussion with the managers and analysis of data. Chapter 5 Conclusion This chapter comprises the conclusion of the study and directions for further researches.

1.6 Limitation of the study •

Quantitative information is more confidential and more prices sensitive therefore companies are reluctant to give that information to outsiders

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Milk food industry is comprised with large organizations as well as small scale organizations such as yoghurt manufactures. Due to the insignificant capacity and unable to make more financial investment they are dismissed from the research.

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Chapter 02 Literature Review Capital budgeting define, Drury (2000) stated, “ The theory of capital budgeting reconciles the goals of survival and profitability by assuming that management takes as its goal the maximization of the market value of the shareholders’ wealth via the maximization of the market value of ordinary share”. Capital budgeting decisions may be defined as “the firm’s decision to invest its current funds most efficiently in the long term assets in anticipation of an expected flow benefits over a series of years”. (Pandy, 2005) According to the above definitions of capital budgeting, following features can be identified, I. Exchange current funds for future benefits II. Funds are invested in long term assets and III. Benefit will occur to the firm over a series of years. Therefore main objective of the capital budgeting decisions are to maximize the wealth of the shareholders by, •

Determining which specific investment projects to be undertaken

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Determining the total amount of capital expenditure which the firm should be obtained

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Determining how this portfolio of projects should be financed.

In capital budgeting process different investment appraisal techniques are used to evaluate the investments. They are mainly traditional and Discounting Factor (DCF) methods. In traditional method consist of Payback and Accounting Rate of Return (ARR) which don’t have the time value adjustment. But in DCF method Net Present 7

Value (NPV) and Internal Rate of Return (IRR) are included and they are adjusting the time value of money to the cash flows. These techniques give different benefits and limitations in investment evaluation process, although as per the theoretical view DCF analysis may give more benefit to the organization. However successful completion of a project mainly depends on the selection criteria adopted while choosing the project in the initial phases itself and the choice of a project must be based on a sound financial assessment and not based on impression. DCF techniques are being widely used in both public and private sector. This is the method recommended for evaluating investment proposals. In this method, the incremental cost and benefits of proposals are discounted by a required rate of return in order to obtain the net present value of the proposal. Discounted cashflow (DCF) DCF focuses on the time value of money, Rs.1 is worth more today than Rs.1 in the future. The reason being that it could be invested and make a return (yes, even in times of low interest, so long as interest rates are positive). So that's the discounting methodology, DCF has two methods. Net Present Value (NPV) The annual cash flows are discounted and totaled and then the initial capital cost of the project is deducted. The excess or deficit is the NPV of the project, it goes without saying that for the project to be worthwhile the NPV must be positive and the higher the NPV the more attractive is the investment in the project.

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Internal Rate of Return (IRR) The IRR or yield of a project is the rate of return at which the present value of the net cash inflows equals the initial cost, which is the same as the discount rate which produces a NPV of zero. For an investment to be worthwhile the IRR must be greater than the cost of capital. Due to the following reasons, DCF method is identified as a best method for investment appraisal processes, •

They give due weight to timing and size of cash flow

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Thy take the whole life of the project in to irregular cash flows do not invalidate the result obtained.

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Estimate of risk and uncertainty can be incorporated

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Use of discounting methods may lead to move accurate estimating and

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They rank projects correctly in order of profitability and give better criteria for acceptance or rejection of projects than other method.

Because of that in theoretically said that DCF analysis is best method to evaluate the investment over its rivals. A survey carried out by the Arnold & Hatzopolous (2000) and Graham & Harvey (2000) to identify the practical usage of investment appraisal techniques among the large manufacturing firms of UK had revealed that NPV and IRR are less behind its rivals in practically. Therefore they have commented that there is a gap between usages of appraisal techniques in practically and theoretically. But according to the Koller (2006) have identified the errors which may occur frequently while application of DCF techniques. He also commented that DCF model should be economically sound and transparent to get the expected output. Economically sound means the company’s return and growth are consistent with the 9

company’s positioning and the ample empirical records. Transparent means you understand the economic implications of the method and assumptions you choose. As per his comment most DCF models fail to meet the standards of economic soundness and transparency.

Following are the frequent errors identified by Koller, •

Forecast horizon that is too short. One of the most criticisms is that any forecast beyond a couple of years is suspect.

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Uneconomic continuing value. The continuing value component of a DCF model captures the firm’s value for the time beyond the explicit forecast period which can theoretically extend in to perpetuity.

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Cost of capital. You will rarely see a grate equity investor point to an ability to judge the cost of capital better than others as the source of meaningful edge. But you do see many DCF models debilitated by non sensible cost of capital estimates.

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Mismatch between assumed investment and earnings growth. Companies invariably must invest in the business in order to grow over and extended period. Return on investment (ROI) determines how efficiently a company translates its investments into earnings growth. So that investor must treat the relationship between investment and growth carefully.

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DCF models commonly underestimate the investment necessary to achieve an assumed growth rate.

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Improper reflection of other liabilities. Most liabilities, including debt and many pension programs are relatively straightforward to determine and reflect in the model. Some other liabilities like employee stock option are trickier to

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capture. Not surprisingly most analysts do a very poor job capturing these liabilities in an economically sound way. •

Discount to private market value. The discount to private market value model lacks sufficient transparency because it conflates the base and synergy cash flows.

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Double counting. Models should not count a rupee of value more than once. Unwittingly, DCF models often double count the same source of value.

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Scenarios. Probably the most often cited criticism of a DCF model is that small changes in assumptions can lead to large changes in the value.

Because of such errors, they have commented that an investor must ensure the models are economically sound and transparent to apply DCF models to the real world. Drury and Tayles (1997) argued uses and limitations of DCF analysis in different view. They have done a survey on application of DCF method based on 886 UK manufacturing organizations. On that survey they have identified companies are under investing because of the misapplication and misinterpretation of DCF techniques. That survey showed smaller organizations place less emphasis on formal appraisal techniques and staff responsible for making capital investment decisions are likely to be involved in the invitation process. Hence they will have detailed “knowledge of the business” and intuitive managerial judgment. The survey findings also indicated that non-discounting methods continue to be used by both smaller and large organizations. Firms are guilty of rejecting worthwhile investment because of the improper treatment of inflation in the financial appraisal. Inflation affects both future cash flows and the cost of capital that is used to discount the cash flows.

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It must be noted also that inflation is likely to affect different components of cash flows in different ways. Inflation also affects the cost of capital because investors require higher monetary returns to compensate for inflation. The correct treatment of inflation requires that we compare like with like in the financial appraisal. Thus real cash flows should be discounted at a real discount rate or nominal rate. In order to ascertain how inflation was dealt with in financial appraisal they asked from the respondent to specify whether real or money discount rate used to discount the cash flows. In that case 49% of respondent were understating the IRR by using current or real cash flow estimates to compute the IRR and then comparing the resulting return with a normal discount rate. Results were almost similar to largest and smallest organizations. Therefore it is important to ensure that inflation is dealt with correctly in financial appraisals. Another misapplication of DCF analysis is uses of excessive discount rate uses for investment appraisal. During that period there was a debate on UK companies for using high discount rates to appraise investment and as a result these companies in danger of under investing. According to their survey, they have identified approximately 50% of respondents are using nominal and real discount rate more than 19%. It showed majority of respondents use rate significantly in excess of those calculated above for average risk projects. These findings show that many companies in UK were using excessively high discount rates. In case of Advanced Manufacturing Technological (AMT) investments, different researchers are having various ideas. Because AMT investments generate more benefits on financial and non financial terms as well. Benefits like quality improvement, manufacturing flexibility, higher level of customer service and delivery, shorter lead times and greater product innovations cannot be quantify are distorted by

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the DFC analysis. It means that investment in AMT projects are often fails because of non financial benefits which are difficult to quantify or either understated or frequently omitted. Kaplan (1986) argued that conventional DCF method should be used to evaluate investments based on the financial data available. He also stated that if the net results of the cash flows results in a negative NPV, then it becomes necessary to estimate how much the annual cash flows must increase before the investment does give a positive net present value. Kaplan goes on to argue that the management must then decide if the value of the intangible benefit will be greater than this figure. If the answer is yes, then he project would meet the criteria for acceptance. But Meredith & Suresh’s (1986) argument was financial appraisal methods used by industry to evaluate investments may be inappropriate on their own for today’s high technology business environment, since they fail to capture many of the strategical benefits from important AMT projects. Therefore he suggested three stages appraisal techniques. It can be identified as 1. Flexibility, 2. High level of risk and 3. Synergy of Flexible Manufacturing Systems. Flexibility can be identified by way of conventional investment appraisal techniques and at the second stage company must sue techniques such as value analysis, portfolio analysis and risk analysis. Final stage requires a more strategic justification. Bromwich & Bhimami (1991) had a different approach for the appraisal of AMT projects. In their approach, they attempted to quantify either financial terms or score values of benefits of investing in AMT. Still there is no specifically developed technique to appraise AMT projects.

Different researchers have been developed

different models for appraising AMT projects.

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Even though there are different models, different arguments still managers are compel to use DCF analysis for their investment decisions. According to the past survey carried out by Lawrence, Gary & Williams (1978) inquired about the capital budgeting techniques employed by large US firms and computation of the discount rate and cash flows. Of those responding firms indicating that a discount rate is applied. 65% of the respondents were applied IRR and 56% uses NPV method. Over 86% of the respondents use either IRR or NPV or both. Another survey carried out by Pike (1996) on capital budgeting practices of large UK companies between 1975 and 1992 reported a substantial increase in the usage of discounted cash flow. According to survey he has identified 75% and 81% UK firms are applying NPV and IRR respectively. In a recent study carried out by the McIntosh (1993) to ascertain whether or not DCF technique is used by property investors as an investment decision making tool among the major property investors in Australia. It was reported that 75% of the respondents always use DCF and 25% usually use DCF analysis in the valuation of properties over $25 million. The survey carried out by the Sangster (1993) among the 500 largest Scottish companies to ascertain currently used techniques for capital investment appraisal. His findings indicated that companies are using several appraisal methods together, and application of discounted cash flow techniques is becoming more sophisticated. Although the survey does not directly indicate the use of DCF techniques for valuing property investments, it does suggest that the DCF technique of appraising investment is an accepted and widely used method by investment appraisers.

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Due to these research findings we can identify there is an ongoing debate among managers for using DCF analysis for their investment decisions. And there is an unfilled gap for the uses of DCF analysis.

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Chapter 03 Conceptual Framework and Research Methodology Introduction This chapter mainly describes under two parts, the conceptual framework of this research and research methodology.

Methodology part explains methodology

followed by the researcher, analysis methods, empirical settings of study, sample of study and data collection methods.

3.1 Conceptual framework

Nature of capital Expenditure

Share holders Expectation

Human Factors

Company Policies

Validity of DCF Analysis

Reliability of Investment appraisal Techniques

Managers Perceptio n

Benefits of the project

As shown in above, researcher has developed a frame work to identify the factors which affect to the validity of the DCF analysis techniques. Factors such as company policy and the manager’s perception are directly affected to the manager’s validity to the techniques. There is overwhelming evidence that the importance of these factors vary among each managers and shareholders. Researcher found out that preference to

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each factor varies with the demographic factors such as age, gender type of employment, marital status, and educational level and companies policy requirements of managers and shareholders.

Working Definitions •

Company policies

Most of the large companies follow the predetermined procedures for each and ever activity. In case of decision making process also they have practicing proper procedure manual. Therefore it will restrict the decision making power of the managers to some extent. According to the return requirement of shareholders and the reliability of DCF analysis owners may set the company policies. In addition to that nature of the expense such as adding new spare parts to the vehicle may not apply the Investment appraisal techniques. Based on such things top management of a company is set the selected techniques and the decisions which need to be analyze through the appraisal techniques. Therefore researcher has highlighted company policies are directly influence the validity of the DCF techniques According to the nature of the capital expenditure company may formulate their policies and procedures. Normally asset repairs, purchase of new car are not evaluated through investment appraisal techniques. On the other hand based on the expectation of share holders or owners they may set the discount factor or the method should be used to evaluate the projects. And also reliability of the answer must be more to accept the project otherwise project may not be accepted. Because of such instances validity of an investment appraisal technique is lost.

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Managers perception

Different persons perceive different character. This is a human factor therefore it won’t be fixed it is varying with the personal Characteristics. Personnel characteristics are depend on the demographic factors such as age, gender, education qualification, experience, attitudes and so on. There is no stipulated format is developed to measure the non financial benefits of an investment. Therefore it is measured based on the judgments of managers. Before accepting the projects company may analyze those benefits according to the manager’s knowledge and skill. Because of that accepting or rejecting investment appraisal techniques is depend on the manager’s perception. This will lead to eliminate another factor which directly influence validity of the decision making process. In these instances in a same organization Engineer and Accountant may have different ideas. If a project is financially not viable but its non financial benefits are better, Engineer will accept the project. In addition to that personal characteristic such as risk averse managers, lack of knowledge of investment appraisal techniques may lead to loose the validity of the DCF techniques.

3.2 Research Methodology Reseacher has identified this study as the qulitative study. Qualitative research is one of the two major approaches to research methodology in social sciences. In the social sciences, qualitative research is a broad term that describes research that focuses on how individuals and groups view and understand the world and construct meaning out of their experiences. Further Qualitative research involves an indepth understanding of human behaviour and the reasons that govern human behaviour and relies on

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reasons behind various aspects of behaviour. Simply put, it investigates the why and how of decision making. In this study the main reason for identifying this research as a qualitative is that, this study mainly address the problem that “whether DCF analysis is validated by the managers of Milk food industry”. Validity can be defined as "An account is valid or true if it represents accurately those features of the phenomena, that it is intended to describe, explain or theories.” Therefore researcher has tested validity of the DCF analysis according to the above mention conceptual frame work by collecting qualitative data from an interview method.

3.2.1 Empirical Settings of the Study In this study researcher has identified three large milk food manufacturing firms for the research context. Following figure 3.1 shows the Island wide milk intakes by the milk food manufacturers in 2005.

When selecting those firms to the sample

researcher has concentrated on the firms in this represents the large portion of the market and the type of the organization. According to the organization type researcher chosen private, public sector and Quoted company namely Fonterra Brands Lanka (Pvt) Ltd, Milco (Pvt) Ltd and Nestle Lanka Ltd respectively. Throughout this research researcher noted the three respondents. Accountant of Fonterra Brands Lanka Ltd, Finance Manager of Milco (Pvt) Ltd and Accountant of Nestle Lanka Ltd are recognized as respondent 1, 2 and 3 respectively. Investments made of these three companies during the last 5 year period are shown in the figure 3.2.

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Figure 3.1 Island wide milk intakes

Othres & Small Manufactures, 5.9

Islandwide Milk Intake ,

Maliban, 0 Strassen , 12.3

Milco (Pvt) Ltd, 33.8

Kothmale Holdings, 13.1 Fonterra Brands Lanka (Pvt) Ltd, 11.2

Nestle Lanka (Pvt), 23.7

Figure 3.2 Investment values of sample selected Investments of Selected Sample 800,000

700,000

Values in Rs.'000

600,000

500,000

Nestle Lanka (Pvt) Fonterra Brands Lanka (Pvt) Ltd Milco (Pvt) Ltd

400,000

300,000

200,000

100,000

0 2001

2002

2003 Years

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2004

2005

Fonterra Brands Lanka (Pvt) Ltd Fonterra is a fully own subsidiary of the Fonterra Group of Companies in New Zealand. Fonterra is the world’s largest manufacturer and exporter of diary products in New Zealand. This company was established in 1985 under a joint venture in Sri Lanka and in December 2000 become a wholly owned subsidiary of New Zealand Dairy Board. The company’s vision statement stated that their vision is “To lead in Diary” and mission is “Delighting consumers through diary products that are notorious, innovative and taste great”. This company is in business of importing, manufacturing and marketing diary based products in the country. The company employs 600 people who are mostly located at the Biyagama office. Company is the owners of different types of products there product range is Anchor, Anmum, Anlene, Ratthi full cream milk powder, Newdale

Ratthi yourghts, Wam, Curd, Cheese,

Butter etc with different quantities.

Milco (Pvt) Ltd The company was incorporated on 9th May, 1996 under the name “ Kiriya Milk Industries of Lanka (Pvt) Limited. The name of the company was changed as Milco (pvt) limited with effect from 23rd July, 2001 as per the agreement entered into between the Government of Sri Lanka and the National Dairy Board of India. Milco is a fully government owned company. The principal activities of the company is collecting, packing, distributing and dealing in milk powder, yogurt, ice cream, cheese and butter. It employs nearly 1000 people and it’s products are targeted to the South Asian market. During the last few years they have carried out under mention massive activities with the expectation of increasing the production, quality and the market share.

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Opened 5 new milk chilling centers in 2002

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Adding 6 new bousers to the existing fleet

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Established new weigh bridges at Polgahawela cattle feed plant and Digana milk factory

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Formulate and implement a “clean milk” program in collaboration with JICA.

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Installation of a new instant soluble milk powder plant at Ambewela.

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Installation of new powder packing machines and 2 ice cream making machie.

Nestle Lanka (Pvt) Ltd This is a quoted company in Colombo Stock Exchange. This also a multinational company and nearly 91% is owned by the Nestle S.A. of Switzerland. The company produces high quality products at its’ factory in Kurunegala under exclusive permission from the Trade mark owner, Societe de produits Nestle S.A. Vevey, Switzerland. World renowned brands such as Nespray, Nestomalt, Cereal, Milo and Maggi range of products maggi bouillon cubes and Maggi Noodles are manufactured in Sri Lanka. Currently nestle employes nearly 750 employees in factory at Kurunegala and office at Colombo 10.

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3.2.2 Data Collection Method In this study researcher has adopted interview method to collect information. Because this is a qualitative research and also to obtain more accurate and deep information about companies it is necessary to make interviews with the persons who is handling the capital budgeting of an organization. Size of the sample is too small and it makes easier to apply the interview method for data collection purpose. By using interview method researcher ca identify the clear idea of managers and it will not make struggle with understanding the questions and researcher can obtain more qualitative information as they want. In this study researcher uses the questionnaire to interview with managers. This is developed mainly to gather data about the decision making process and techniques they are currently practicing.

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Chapter 04 Data presentation and analysis Introduction This chapter explains the information collected for this regards. On this earlier part is consisting with the data extracted from the selected respondent and their personal characteristics. Latter part of this chapter included the analysis part of the data gathers during the research.

4.1 profile of the respondents First respondent is an accountant of the company and he is responsible for capital budgeting of the company. He is a young character and he is having BBA degree in University of Colombo. In his professional career he is a qualified chartered accountant and also he is doing finals of CIMA. Researcher had a nearly two hour discussion with the him and he is identified he is a risk averse character because he is not willing take any risk. In addition researcher has observed that he is the person who strictly adheres to the company policies and procedures. Because, he has only one year experience in this firm as an accountant. The second respondent is a government servant and he is newly promoted as a finance manager of the Milco (Pvt) Ltd. He is 45years old and he is having BSc degree in University of Sri Jayewardenepura. He is having experience in 15 years in this company. He said that he is decision making power is limited to some extent because of the complicated government rules and regulations. He also noted that big projects like restructuring organization, establishing new plants require approval for the parliament.

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Last respondent of the research is a treasure manager of Nestle (Pvt) Ltd. He is also 43 years old and he a graduated from the foreign university. He is a member of the CIMA. He is very corporative character and he is having more experience in capital budgeting area. Since 1988 he is working in this organization in different levels. However their decisions are taken by the board of executives including Managing Director, Finance Director, and other functional level directors.

4.2 Discussion with Managers According to the first question of the questionnaire respondent 1 said they are classify their expenses mainly capital and revenue expenses. Capital expenses further divided into two parts called capital expenditure and operative expenditure. Out of this capital expenditure they are identified as investments which are needed to evaluate by using investment appraisal techniques. Respondent two and three also have the same classification of expenses and they also not recognize the capitol nature operational expenditure to the investment decision making process. Because they said such expenditure must be incurred to carryout the continuous production. As per the second question there were no restriction is made for application of investment appraisal techniques as a percentage of total corporate capital investment expenditure. But respondent 1 said their MD has the approval limit of $20million and respondent 3 said their MD has a $50 million approval level. If we look at the application of appraisal methods respondent 1 should apply the Payback method, NPV and IRR method for investment evaluation process as per the group decision making process. But they haven’t calculated the ARR for the projects in case of that they calculate the EBIT and GP margin. In addition he stated that they are calculating payback method for discounted cash flows also. But the respondent

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two applies the NPV and ARR for their capital decision making. It is a must and this is imposed by the National Livestock and development board.. Application of investment appraisal techniques of respondent 3 is more similar to the respondent 1.They are also apply the NPV, IRR and discounted payback method to evaluate the investment in financially. This is the requirement of its parent company. According to the next question to identify the techniques which are currently used for the evaluation of non financial benefits, respondent 1 said “when we are going to new project, project initiator must be identified the benefits generated from such projects”. It shows that project initiator should be included the non financial benefits generated from the project in the project report. Improvement of efficiency, reduction of wastage etc should be quantified by the project initiator. He also stated that if a project has marginally negative NPV and more non financial benefits they are accepting such projects. But the respondent 2 had a different view for evaluating non financial benefits of a project. He said that his organization is paying more attention on non financial benefits rather than financial benefits. He is more emphasizing the importance of non financial benefits to a government organization. Likewise other governmental organization his organizations also have the political influence. Ultimate decision is taken by the minister. As per the discussion with respondent 2, researcher has revealed that personal characteristic of Minister’s also effect to their organization decisions. Unless the project is not financial viable with the approval from the Minister company will accept those. But if it is a large scale projects such as restructuring the organization in which people loose their employment, they must obtain the approval from the parliament. Chairman should passed the sanction from the parliament.

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Respondent 3 has the similar opinion as respondent 1 has in this manner. Here also MD of the company has given the approval limit of Rs 2500million. But the company may not accept any projects which are not financially viable. It means that they have accepted the project which carries positive NPV value. According to the question No 5 all respondents said that they are going for such techniques to comply with the company policies and procedures which are developed by the top management to maximize the wealth of the owners or share holders. Fonterra and Nestle has the group policy for their subsidiaries all over the world. MD should adhere to practice such policies with in their organization. Normally when they are going to evaluate the investment in DCF models they are always concern the inflation and the cost of capital. All respondents are considering the WACC as the cost of capital of such project. Three respondents are concerned different time period for the investment appraisal process. Respondent 1, 2 and 3 consider the 5years, 6years and 10 years time periods for investment appraisal process respectively. While analyzing the project through investment appraisal models, all respondents are made similar assumptions for prices, usage of materials, inflation etc. In addition to that respondent 1 ignores the cash flows after 5 years and growth rate is considered as 10% over and year. When considering the Advance Manufacturing Technological projects respondent 1 and 3 has complied with the stated procedures. But in case of respondent 2, parliament may decide the investment by considering the social as well as company non financial benefits.

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4.3 Analysis of data According to the findings researcher has noted that decision making of an organization is influence by the type of organization. If an organization is private or public their decision making process is little different. It is because most of the public organizations are focus on welfare rather than earning profits. Therefore such organizations more concern on non financial benefits rather than financial benefits. But in the other hand private sector organizations are profit oriented therefore owners are set the standard procedures or benchmark to follow the managers of an organizations at a minimum risk and high level of profit margins. In case of investment evaluation process most of the organizations are applying DCF techniques to appraise the financial viability of the project. It also confirmed by the different surveys conducted in the different countries. Therefore it proves that milk food industry in Sri Lanka is also practicing the DCF techniques for investment appraisal techniques. In literature review shows that most frequent errors identified by the Koller (2006) and to over come such errors happening in the decision making process companies make assumptions and forecast the significantly less time period. And also minimize the effect of misinterpretation and misapplication of investment appraisal techniques these companies adopted the inflation adjusted discount rate and make use of WACC to recognize the company’s cost of capital. When we consider the validity of investment appraisal techniques it is depend on whether they are using and identifying DCF technique. If managers are relying on the result of the DCF method, it will make validity of the DCF techniques. But when we look at the research findings non governmental organizations pay more attention on financial appraisal techniques such as NPV, IRR and Payback method but it can’t say

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with full assurance because respondent 1 said they are accepting projects which are having marginal negative NPV. In such instances validity of the investment appraisal is lost. When we look at the decision making process of a governmental organization it is influence by the political leaders and employee unions in Sri Lankan context. Therefore we can see that application of formal procedure is exists but it may not be workout as it is. Therefore in such instances also lost the validity of investment appraisal techniques. But as argument made by the Kaplan (1986) is may not be valid. In practically organizations considers the financial and non financial benefits as well. According to the research finding it is noted that major manufacturers of milk food in Sri Lanka show that not only financial benefits but also non financial aspects are considered. When we look at the effects of the company policies and managers perception for the validity of the DCF technique as per the conceptual frame work we can see that decision making process in milk food industry in Sri Lanka is largely affected by the company policies. Up to certain level managers has empowered to make decisions within the stipulated frame work. And also company policies are affected by the share holder’s preference, nature of capital expenditure and generally accepted reliable investment appraisal techniques. As mention in the conceptual frame work managers perception is affected by their personal characteristics but in this context it has no impact to the validity of a DCF techniques. On the other hand researcher has observed that benefits of organizations also have significant influence to loose the validity of the DCF model.

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Chapter 5 Conclusion This research is mainly focus by the researcher to identify whether DCF techniques are validated by the managers of the milk food industry. According to this research also researcher recognized that discounted cash flow is a powerful devise for appraising investment projects. And still DCF model is excessively used by the managers of milk food industry in Sri Lanka. This research also eliminated that selection of capital investment appraisal techniques in Milk food industry is affected by policies of multinational companies to the private sector. Political interference is affected to the public sector investment decision making in milk food industry in Sri Lanka. It is a new variable identified in this research. Therefore research finding showed that most of the organizations are using DCF techniques for evaluating in investment on its financial perspective. Because it is the more appropriate technique developed for investment appraisal. Therefore managers of milk food industry of Sri Lanka also apply and validate this approach as a decision making tool. In some instances managers are not rely on the DCF methods in decision making process. But it is insignificant when compared to overall decisions taken by the managers of milk food industry. It ensures the managers by making adjustment to the DCF model to overcome problems of misinterpretation and misapplication. To obtain reliable answer managers make assumptions. The various models and approaches highlighted and discussed in this paper to appraise the investment in AMT all attempt to take into account and the strategic benefits from the introduction of AMT. However, no single model that has been

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universally accepted and it is to the decision maker to adopt whichever approach is preferred. In this research has not covered the all the sectors of the manufacturing industry and all the areas of investment appraisal techniques. There is lot of further investigation can be done in this area also.

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