jibola on fin statement
TRANSCRIPT
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CHAPTER 1
1.1 BACKGROUND OF THE STUDY
Accounting information Statement has been prepared over the centuries to serve as
a means of communicating the transaction of business entities to users.
Stewardship accounting requires that the management of any organization to
prepare financial statement or annual report at the end of each trading period in
order to further convince the FUND PROVIDERS that the fund provided has been
properly and adequately utilized.
Financial Statement in no doubt must have been prepared over the ages and in fact,
theres no business entity that does not prepare Financial Statement. Its a means of
conveying concise picture of the profitability and financial position of an
organization. Also, it is a language of business used in communicating financial and
other information for decision making.
Companies invest capital in a variety of business opportunities. These investments
are meant to provide the company with passive income streams or future returns on
the growth of the investment. Hence, companies make these decisions using
accounting information and measurement for finding the best investment possible.
Since future benefit associated with capital projects are not known with certainty,
theres need to utilize the companys fund profitably.
However, in order to bargain more effectively for external funds, the management
of an organization would be interested in all aspect of the financial statement and
considering the retrospective nature of the financial statement, theyll never want to
look at only a single statistic or metric in making investment decision.
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Investment decision in this context refers to both short term and long term
reallocation of corporate funds. Short Term Investment decision include the level of
current asset( cash, debtors and inventories) necessary for day to day operations
whereas long term investment decision refers to fixed asset purchase, mergers,
acquisition and corporate re- organization.
Capital Investment is a major aspect of investment decision in terms of allocations
of capital to investment proposal that will realize benefits in the future. Investment
proposal necessarily involves risk because future benefits are uncertain
Consequently, investment proposal should be evaluated both for their expected
return and for the risk of the company. The evaluation of capital investment
proposal involves a number of different techniques and types of financial analysis
all of which are interrelated.
Financial Statement Analysis uses ratios calculated from a companys income
statement and balance sheet to evaluate the company. These ratios are compared
with the ratios from previous years to assess trends in the performance of the
company. Ratios are also compared to those of other firms and the overall industry
and economy-wide averages to assess the relative performance of the company.
1.2 STATEMENT OF RESEARCH PROBLEM:
It has been observed that as a result of peoples inability to analyze a companys
financial statement; they more often than not invest blindly. In efffect, people buy
into companies not knowing its going concern ability . This is largely due to poor
understanding and interpretation of financial records. In most cases also, people that
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can analyze financial statement do not take the pain to do the necessary home work
before investing. They use various techniques which cannot be proved to take
investment decision and loose their investment afterwards
The banking industry however has experienced various decree which had hindered
investors from undertaking capital investment , the introduction of indigenization
decree to encourage investors in investing is not justfied,while fluctuation in the
interest rate has endangered the investment decision . This research work is
expected to tackle the afoementioned problem.
1.3 PURPOSE OF THE STUDY
The main objective of this study is to examine the impact of financial statement
analysis on decision making while the specific objectives are:
1. To establish the relevance of financial statement analysis in making sound
investment decision
2. To examine the relationship between financial statement analysis andinvestment decision
3. To examine factors to be considered before choice of investment
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4. To examine the importance of financial statement analysis in evaluating
projects/investment
5. To conduct measurement and evaluations on financial information toward
providing answers to the research questions.
1.3 RESEARCH QUESTION
There are questions of the problem relating to the study of which the study would
provide answers to in the conclusion. In other words, the project work is to provide
answers to these questions;
1. What is Financial Statement?
2. Does the financial statement provide information to guide investment
decision?
3. How does the analysis of financial statement influence investment decision?
4. Does the accounting ratio show the financial performance of a company?
5. What are the factors that mitigate against investment decision in Nigeria?
6. How can funds be invested profitably through the analysis of the financial
statement?
7. Does the bank put into consideration other relevant statutory regulation in
preparing the financial statement
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1.5 METHODOLOGY
Both primary and secondary data shall be the basis of this research work. The
primary data shall be generated by means of a well-structured questionnaire
instrument. The first section of the questionnaire shall be based on the personal data
of the responses while the second section shall seek to ask questions that relate to
the subject on the basis of the research questions. The questions in the questionnaire
shall focus on the relationship between the financial statement and investment
decision
The questionnaire to be used shall be carefully administered and a total of fifty (30)
potential investors and professional analyst. The sampling shall be done randomly
such that the respondents shall cut across various users of the financial statement.
This could to some extent give a basis for generalization.
The questionnaire, which contains twenty (20) items, shall be distributed to the
respondents in their offices and the researcher shall collect the filled questionnaire.
The data, which would be collected from the questionnaire, will be analyzed using
the simple percentage method and chi-square, goodness of fit. The hypothesis
testing shall be done at one per cent level of significance. This would make the
analysis of the data more concise and simple.
The secondary data shall be collected from the statement of accounts and annual
reports of Zenith Bank Plc for various years. Relevant financial ratios shall be
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computed to measure the performance of the company. The financial ratios to be
computed shall include: Net profit margin, Return on asset , Return on Equity
1.6 STATEMENT OF HYPOTHESIS
Research Hypothesis is a tentative statement that is meant to specify the
relationship between financial statement and investment decision. This happens to
be the nucleus of this research work as all effort is simply geared towards
determining whether the hypothesis are true or false.
I have chosen to present my hypothesis in form of Null Hypothesis (Ho) and
Alternative Hypothesis (H1). Below is the Hypothesis to be tested for the purpose
of this study:
Hypothesis I
1. Ho: - Financial Statement does not provide useful information to
guide investment decision.
2. H1: - Financial Statement provide useful information to guide
investment decision
Hypothesis II
3. Ho :- Ratio Analysis does not help in discovering the strength and
weakness of a company
4. H1 :- Ratio analysis help in discovering the strength and weakness of
a company
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1.7 SIGNIFICANCE OF THE STUDY
This study is carried out to show whether or not the financial statement provides
useful information for decision making. It will be of importance to the organization
in the method of evaluating projects or investment and also safeguard potential
investors from investing in any organization where the yield or returns is not
encouraging. The method of evaluating can either be the use of Accounting Rate of
Return (ARR), Net Present Value (NPV) and Cost of Capital.
Furthermore, its usefulness to investors in the interpretation of financial statement
will provide increased investment and capital employed thus enhance employment
to the generality of the public.
1.8 SCOPE OF THE STUDY
The research will attempt to give insight into financial statement in the financial
institution (Zenith Bank Nig. Plc as a case study) and it will discuss the impact of
financial statement on investment decision.
More so, it will analyze the use of accounting ratio for investment purpose and
computation of the financial Statement.
1.9 OPERATIONAL DEFINITION OF TERMS
A. FUND PROVIDERS
These are the people who provide capital for business. It may be internal or
external
B. ORGANIZATION
It is a business unit established to provide goods and services or both with a
view of making profit.
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C. CASH FLOW
A cash flow stream is a series of cash receipt and payment over the life of an
investment.
D. PROFITABILITY INDEX
It is a time adjusted method of evaluating the investment proposal.
E. STEWARDSHIP ACCOUNTING
This is the process whereby the manager of a business account or report to
the owners of a business.
F. MANAGEMENT
This defined as direction of the enterprise through or by skill full set of
people, who are interested in the general performance of the organization.
G. ORGANISATION
It is a business unit established to provide goods and services or both with a
view of making profit.
H. PAYBACK PERIOD
This technique is defined as the period which the cash outflow will equate the
cash inflow from the project
I. ACCOUNTING RATIO
This is a proportion or percentage expressing the relationship between one
item and another item in the financial statement
J. ACCOUNTING RATE OF RETURN
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This is a method of using accounting information as reviewed by the
financial statement to measure the profitability of the business.
K. COST OF CAPITAL
The projects cost of capital is the minimum acceptable rate of return on
funds committed to the project
L. NET PRESENT VALUE
This is the classic economic method of evaluating the investment proposal. It
recognized time value of money
1.10 REFERENCES
White, Sondhi, & Fried, Chapter 2, Addendum
Olowe P.A (1997): Financial Management :Concept and Analysis and
Capital Investment, Briely Zones Nig. Ltd, Lagos
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Taylor P. (2003) Bookkeeping and Accounting for Small Business and
Economic Prentice Mall Inc, London
Foster G.(1986): Financial Statement Analysis 2nd Edition Mall Publication
Ltd. New York
Omitogun(2000): Statistics for Social and Magement Science, Higher
Education Book Publishers Lagos
Robert O.Igben (2004) : Financial Accounting made simple ROI Publication,
Lagos
Lucey T. (1992): Management Accounting 3rd Edition D.P Publication Ltd
London
Asika O. (1991): Research Methodology in Behavioral Science, Longman
Plc, Lagos
Fraser L.M (1998): Understanding Financial Statement 2nd
Edition Prentice
Mall Publication Ltd New York
Oyerinde D.T.,(2009), Value relevance of accounting information in
emerging stock market in Nigeria, Proceedings of the 10th Annual
International Conference. International Academy of African Business and
Development (IAABD), Uganda
Presentation of Financial Statement IAS 1, June 2007
www.zenithbank.com
Zenith Bank Audited Financial Report 2010
http://www.zenithbank.com/http://www.zenithbank.com/ -
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CHAPTER ORGANIZATION
In this research, chapter 2 and 3 will cover the first 3 objectives. Also, chapter 4 and
5 will cover objectives 4 and 5 respectively.
CHAPTER 2
LITERATURE REVIEW
2.1 INTRODUCTION
The financial manager plays a dynamic role in a modern company's development.
With growing influence that now extends far beyond records, reports, the firm's
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cash position [liquidity], bills and obtaining funds, the financial manager is
concerned with:
1. Investing funds in assets and
2. Obtaining the best maximum of financing and dividends in relation to the
overall valuation of the firm.
In the process of making optimal decisions, the financial manager makes use of
certain analytical tools in the analysis, planning and control activities of the firm.
Financial statement analysis is a necessary condition or prerequisite for making
sound financial decision.
Financial statement analysis involves a critical evaluation of the financial condition
and performance of a firm with a view to making rational decisions in keeping with
the financial and corporate objectives of the firm. The financial manager/analyst
needs certain yardsticks for his evaluation and one of these tools frequently used, is
a ratio or index, relating two pieces of financial data compare to each other.
Analysis and proper interpretation of various ratios should give informed users of
accounting information a better understanding of the financial condition and
performance of the firm than they would obtain from raw financial data alone.
Financial Statements of a company are documents that reflect the historical
financial information of an entity. This includes a detailed and accurate record of
the assets and liabilities as well as the income and expenses and the cash flow of the
entity. These documents are written records that quantitatively explain the health of
each unit represented in the statement.
Financial Statement is a concise picture of the profitability and financial position of
a business entity. According to Taylor (2003), Financial Statements are written
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records of a business financial situation. They include standard report like balance
sheet, income statement and cash flow statement, Foster (1986) defined financial
statement as a means of accounting information about the financial position of an
enterprise which is utilized by a wide range of users of the information in making
investment decision.
According to Akintoye (2006) Financial Statement deals with the presentation of
financial and other relevant statement to show the extent to which the objective of
the organization has been achieved
Hence it has been described as a way or manner of documenting the day to day
financial or other transaction of an enterprise for a given accounting period.
It is therefore regarded as the basic source of information in economic and business
statement as any information which keeps users informed about the financial status
of the reporting entity and which guides in making a better financial decision.
However, financial statement becomes necessary as a result of various groups
having direct or indirect interest in a particular company. Examples of such groups
are shareholder, management, creditors, employee and investment analyst (Ross
1999)
The analysis of financial ratios involves two types of comparison. First, the analyst
can compare a present ratio with past and expected future ratios for the same
company. For instance, the current ratio for the present year end could be
compared with the current ratio of the proceeding year end. When financial ratios
are arrayed on a spread sheet over a period of years, the analyst can study the
composition of change and determine whether there has been an improvement or
deterioration in the financial condition and performance of the firm over time.
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Financial ratios can also be computed for projected, or proforma-statements and
compared with past and present ratios, the second method of comparison involves
comparing the ratios of one firm with those of similar firms or with industry
averages at the same point in time. Proper analysis of some financial ratios could
reveal a firm's financial condition and corporate performance in the areas relating to
level of profitability, short-term solvency, long term stability, returns on
investment, management efficiency in the use of available resources, level of
activity, loan safety, to mention a few. The appropriate ratios shall be considered in
details in chapter four.
However, in relation to investment decisions in both real and financial assets,
financial analysis implies a comparison of the financial benefits of a project with
the costs of its implementation. This would entail the translation of the estimated
capital and operating requirements into financial costs, and the estimated benefits
into financial revenue. The completed financial analysis of a firm would
theoretically reduce the project to a stream of cash flows (cash inflows and
outflows); on the basis of which a final viability (self- liquidity) test can beconducted.
Financial statements, also known as financial reports, record the financial activities
of a business in short and long term. The four financial statements are: balance
sheet, income statement, statement of retained earnings, and statement of cash
flows. A balance sheet reports the assets, liabilities, and net equity on a company.
An income statement reports income, expenses, and profits on a company. Astatement of retained earnings shows a company's changed retained earnings. The
statement of cash flows shows a company's cash flow activities, such as operating
investing, and financing activities (Financial statements, 2007, para.1).
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There are major purposes of financial statements and the type of information they
provide is very important. According to Financial statements, the objective of
financial statements is to provide information about the financial strength,
performance and changes in financial position of an enterprise that is useful to a
wide range of users in making economic decisions. Financial statements should be
understandable, relevant, reliable, and comparable. They are directed towards
people who understand business and economic activities and accounting Owners
and managers require financial statements to make important business decisions
that affect its continued operations. These statements are also used as part of
management's annual report to the stockholders. However, employees also need
these reports in making collective bargaining agreements (CBA) with the
management, in the case of labor unions or for individuals. (Financial statements,
2007, Purpose of financial statements, para.2).
"The objective of financial statements is to provide information about the financial
position, performance and changes in financial position of an enterprise that is
useful to a wide range of users in making economic decisions. Financial should be
understandable, relevant, reliable and comparable. Reported assets, liabilities,
equity, income and expenses are directly related to an organization's financial
position.
According to Foster G(1986), financial statements are intended to be
understandable by readers who have "a reasonable knowledge of business and
economic activities and accounting and who are willing to study the information
diligently. Financial statements may be used by users for different purposes:
Owners and managers require financial statements to make important
business decisions that affect its continued operations. Financial statement is
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then performed on these statements to provide management with a more
detailed understanding of the figures. These statements are also used as part
of management's annual report to the stockholders.
Employees also need these reports in making collective bargaining
agreements (CBA) with the management, in the case of labor unions or for
individuals in discussing their compensation, promotion and rankings.
Prospective investors make use of financial statements to assess the viability
of investing in a business. Financial analyses are often used by investors and
are prepared by professionals (financial analysts), thus providing them withthe basis for making investment decisions.
Financial institutions (banks and other lending companies) use them to decide
whether to grant a company with fresh working capital or extend debt
securities (such as a long-term bank loan or debentures) to finance expansion
and other significant expenditures.
Government entities (tax authorities) need financial statements to ascertain
the propriety and accuracy of taxes and other duties declared and paid by a
company.
Vendors who extend credit to a business require financial statements to
assess the creditworthiness of the business.
Media and the general public are also interested in financial statements for a
variety of reasons.
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Elements of financial statements
The financial position of an enterprise is primarily provided in the Statement of
Financial Report. The elements include:
Asset: An asset is a resource controlled by the enterprise as a result of past events
from which future economic benefits are expected to flow to the enterprise.
Liability: A liability is a present obligation of the enterprise arising from the past
events, the settlement of which is expected to result in an outflow from the
enterprise' resources, i.e., assets.
Equity: Equity is the residual interest in the assets of the enterprise after deducting
all the liabilities under the Historical Cost Accounting model. Equity is also knownas owner's equity. Under the units of constant purchasing power model equity is the
constant real value of shareholders equity.
Measurement of the Elements of Financial Statements
Measurement is the process of determining the monetary amounts at which the
elements of the financial statements are to be recognized and carried in the balance
sheet and income statement. This involves the selection of the particular basis of
measurement.( Par. 99 IASB)
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A number of different measurement bases are employed to different degrees and in
varying combinations in financial statements (Par. 100 IASB). They include the
following:
(a) Historical cost. Assets are recorded at the amount of cash or cash equivalents
paid or the fair value of the consideration given to acquire them at the time of their
acquisition. Liabilities are recorded at the amount of proceeds received in exchange
for the obligation, or in some circumstances (for example, income taxes), at the
amounts of cash or cash equivalents expected to be paid to satisfy the liability in the
normal course of business.
(b) Current cost: Assets are carried at the amount of cash or cash equivalents that
would have to be paid if the same or an equivalent asset was acquired currently.
Liabilities are carried at the undiscounted amount of cash or cash equivalents that
would be required to settle the obligation currently.
(c) Realizable value: Assets are carried at the amount of cash or cash equivalents
that could currently be obtained by selling the asset in an orderly disposal. Assetsare carried at the present discounted value of the future net cash inflows that the
item is expected to generate in the normal course of business. Liabilities are carried
at the present discounted value of the future net cash outflows that are expected to
be required to settle the liabilities in the normal course of business.
The measurement basis most commonly adopted by entities in preparing their
financial statements is historical cost. This is usually combined with other
measurement bases. For example, inventories are usually carried at the lower of
cost and net realizable value, marketable securities may be carried at market value
and pension liabilities are carried at their present value. Furthermore, some entities
use the current cost basis as a response to the inability of the historical cost
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accounting model to deal with the effects of changing prices of non-monetary
assets. Par. 101 IASB
2.2 REGULATORY FRAMEWORK OF THE FINANCIAL STATEMENT
Financial Statement published by companies in Nigeria are product of several
regulatory framework in addition to accounting concept, assumptions and
convention.
The Nigerian Accounting Standards Board (NASB) is the only recognized
independent body in Nigeria responsible for the development and issuance of
Statements of Accounting Standards (SASs) in the preparation of financial
statement using the Generally Acceptable Accounting Principle (GAAP) which
means statements are useful, reliable and comparable across companies.
Financial Statement as a communication medium to investors provides a valuable
summary of the entities economic history. To the informed, these are useful tools to
establish the historic performance as well as future potential of the entity.
The Financial Statement that will be discussed in this article are:
1. The Balance Sheet: this document is a quantitative summary of assets,
liabilities and net worth of the entity at a specific point in time.
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2. The Income Statement: This document provides an accurate accounting
record of the sales, income and expenses resulting in the net profit for the
reporting period
3. The Cash Flow Statement: this is a record of the sources and application of
funds that includes operating, investing and financing activities and how they
impacted on the cash position during the reporting period.
The primary purpose of the financial statement is to provide information about a
company in order to make better decisions for users particularly the investors
(Germon and Meek 2001). It should also increase the knowledge of the users and
give a decision maker the capability to predict future actions. Therefore relevance
of accounting information can be described as an essential pre requisite for both
stock market growth and investment (Oyerinde D.T 2009)
Investment
Foster (1986) defined investment as assets accrued as a result of long term savings.
It should be noted that savings and investment are not the same but nearly the same.
Investments are buying securities or other monetary on paper assets in the money
market or in a fairly liquid real asset such as gold, real estate or collectibles.
Valuations are the method to know whether a potential investment is worth its
price.
2.3 INVESTMENT ANALYSIS
One of the most important functions of a financial management in modern times,
involves investment decisions, capital investment, a major aspect of this decision, is
the allocation of capital to investment proposals whose benefits are to be realized in
the future. Because the future benefits are not known with certainty, investment
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proposals necessarily involves risk. Consequently, the investment should be
evaluated in relation to their expected returns and risks. This decision to invest on
long term assets is very important because it influences the firm's wealth, its size, its
growth and its business risk. Long-term investment or capital budgeting can be
defined as the investment of current funds most efficiently in long-term assets in
anticipation of expected flow of future benefits over a number of years.
More so, capital budgeting is very crucial and critical in business operations
because they have long-term implications for the firm, involves commitment of
large amount of funds, they are irreversible and are among the most difficult
decisions to make. A wrong decision can prove disastrous for the long-term survival
of the firm in the same way, as unwanted expansion of assets will result in
unnecessary heavy operating costs. Consequently, before a firm commits its scarce
fund on any project there is the need for a pre-investment evaluation
studies-feasibility study.
Subsequently, a feasibility study is directed at two major objectives of the firm.
Simply put, a feasibility study is an attempt by a potential investor to establish the
viability and profitability of an investment or their absence. Viability, operationally
defined is financial viability which is an attempt to establish whether the project as
envisaged has the potentials of being self-liquidating. For a project, however, to be
self liquidating, it should be capable of generating enough cash inflows with which
to retire its cost. The most important steps involved in capital budgeting are project
generation, project evaluation, project selection and project execution.
This is because, the firm's supply of fund is limited, and a firm may generate a
given number of projects that are profitable or otherwise. The firm should choose
among the profitable, the most profitable projects as much as its budget could
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accommodate. But before the firm commits fund into any of these projects, it has to
evaluate them using some criteria to enable it select the project or projects with
more economic worth than the others.
In evaluating a project to determine its viability that is in conducting feasibility
study many procedures are involved. In this study however, the emphasis will be on
financial evaluation. In this evaluation, the basic information needed includes those
disclosed in the balance sheet of the firm; for those already in existence, and income
statement and balance sheet for businesses starting operations newly. Other
information includes the initial cost of the project, the projected cash inflows from
the project, the scrap value of the project at the end of its useful life, the discount
rate for the firm and the gestation period of the project (Andrew D. & others 2006).
2.4 INVESTMENT APPRAISAL TECHNIQUES
In evaluating a project proposal according to Geoffrey A. Hirt and Stanly Black
2004, a good number of techniques are employed. These techniques are called
investment criteria. Any criterion to be used should possess some qualities among
which are:
a. It should provide a means of distinguishing between acceptable and
unacceptable projects.
b. It should provide a ranking of projects in order of their desirability.
c. It should solve the problem of choosing among alternative projects.
d. It should be applicable to any conceivable investment projects.
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e. It should recognize the fact that bigger benefits are preferred to smaller ones
and that early benefit are also preferred to latter ones. These investment
criteria are grouped into the following categories:
A. ON - DISCOUNTING CRITERIA:
a. Capital recovery or payback period.
b. Visual selection method.
c. Accounting rate of return.
B. DISCOUNTED CASH FLOW CRITERIS:
a. Net present value (NPV)
b. Profitability Index (PI)
c. Internal Rate of Return (IRR)
It should be noted that the choice of any criteria depends on the firm using them and
a firm can employ different methods to different projects.
2.4.1 NON - DISCOUNTING TECHNIQUES - VISUAL SELECTION
METHOD
One easily gets the impression that visual selection is subjective. This is not the
case. Visual selection is based on expected project cash flows. However, the
expected cash flows are not subjected to any rigour (thoroughness) of processing
before selection is made. Rather, the cash flow of each project is examined visually
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relative to its cash outflow, and the project, which seems to have the highest net
cash inflow, is selected.
This approach is illustrated below in table 2.1.
Periods Project A (N) Project B (N) Project C (N)
0 -250,000 -250,000 -250, 000
1 100,000 100,000 100,000
2 110,000 110,000 110,000
3 95,000 95, 000 95, 000
4 60,000 -20,000
The three projects in table 2.1 can easily be ranked by visual inspection. It is
obvious that b is preferable to A, since it has an additional net flow of N60, 000 in
the fourth year. Where, however, negative; the investment with a shorter life would
be preferable. On that basis, project A is preferable to C.
The other situation, which lends itself to visual selection, occurs when alternatives
projects have equal lives, equal initial cost and equal nominal net cash inflows.
However, one of the projects records a higher inflow in one period, before others
make up difference in later periods. Such case is illustrated in the table below:
TABLE 2.2 VISUAL SELECTIONS OF PROJECTS
Periods Project A (N) Project B (N) Project C (N)
0 -250,000 -250,000 -250, 000
1 110,000 110,000 95,000
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2 110,000 95,000 100,000
3 100,000 110, 000 110, 000
The three projects in the table above have the same nominal net cash flow. It is
obvious however, that A is preferable to B and C, and B is preferable to C. This is
so because project A earned highest cash inflow in earlier periods than projects B
and C even though the total and the net cash inflows are the same.
B. PAYBACK OR CAPITAL RECOVERY PERIODCapital recovery or payback period is the number of years required to recover the
original cash outlay invested in a project. Assuming an investment generates
constant annual cash inflows, the payback can be computed thus:
PBP = C
A
Where C = Initial cash outlay
B = Annual equal cash inflow
But were the cash inflows are unequal, the PBP is found by adding up the cash
inflows until the total is equal to the initial cash outlay. The PBP can be used as an
accepted or rejected criterion and also for ranking projects. If the calculated PBP is
higher than the one set up by the management, the project is rejected otherwise it is
accepted. The PBP gives highest ranking to project with shortest PBP and vice
versa. It also gives preference to projects that promise higher returns in earlier years
than in later years.
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ADVANTAGES
Payback period is simple and easy to calculate. It requires less of managements
time and less cost. It does not necessarily require the elaborate use of the computer.
DISADVANTAGES
Payback period fails to recognize cash inflows earned after the PBP. This is because
some projects are such that they generate higher cash inflows after their payback
periods. Using this criterion, the tendency is to reject such projects, which can
prove to be more profitable.
The second setback of this method is that it does not measure profit appropriately
since it fails to consider all the cash inflows arising from the project. It does not
consider the pattern of cash inflows that is, the magnitude and timing. In other
words, it does not take into consideration the time value of money.
B. ACCOUNTING RATE FO RETURN (ARR)
Accounting rate of return method uses accounting information to measure
profitability of the investment proposals. The formula is denoted thus:
ARR = AY
A1
Where: AY = Average Income after taxes
A1 = Average Investment
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ARR will accept projects whose ARR is higher than the minimum rate established
by management and reject those projects which have ARR less than the minimum
rate. Projects with high ARR are ranked higher than those with lower ARR.
The ARR is not very popular in use by firms despite its various advantages which
includes its simplicity, ease of calculating the accounting data. However, it has the
following disadvantages; it uses accounting profits instead of cash flows, it fails to
recognize the time value of money and it does not consider the entire life of the
project. It also fails to recognize that profit can be ploughed back.
Consequently, there is one problem associated with both the PBP and the ARR is
their total neglect of the time value of money which is essential in comparing
values of money received at different time periods. Giving price changes, a
given quantity of money received three (3) years to come. Before comparing
them, the two quantities should be made time equivalent. On this basis,
therefore the discounted cash flow methods of evaluating projects are better
than three (3) methods earlier discussed. These methods consciously take the
time value of money into consideration.
2.4.1 THE DISCOUNTED CASH FLOW METHODS
i. Net Present Value [NPV] method:
One good quality of NPV is that it recognizes the time value of money, postulating
that cash flows arising at different time periods differ in value and are comparable
only when their equivalents are found. The NPV is a process of comparing or
calculating the present value of cash flows [inflows and outflows] of an investment
proposals, using the cost of capital as the appropriate discounting rate and finding
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out the net present value by subtracting present value of cash outflows from the
present value of cash inflows. The formula is denoted as:
n AT
NPV = 1+ke
(n)
Where At = Cash inflows
t = time period usually years
ke = cost of capital
c = initial cost outlay.
It will only be meaningful to invest in a project if the present value of the cash
inflow is more than the present value of the cash outflows. At worst, the time
should be equal for the firm to break-even, because a firm can still exist if it breaks
even. The ability to break even depicts that at least the firm can cover its cost of
operations. The decision rule for NPV is as follows:
1. If NPV > 0 accept; this implies that the project is profitable or at worst, can
break even.
2. If NPV < 0 reject; this implies that the project is not profitable; rather it will
lead to losses.
Where there are many projects, they are ranked according to the magnitude of the
Net present values. Projects with higher NPV are more profitable and are so
ranked higher than those with lower NPVs. But where a firm is faced with
t - c
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the problem of choosing between two mutually exclusive projects, the firm
with higher NPV will be chosen.
NPV has the following advantages:
It considers the time value of money; it takes into account all cash flows over the
entire life of the project. It is consistent with the firm's objective of maximizing
shareholders wealth. The following are however, the problems encountered in using
NPV:
INVESTMENT CRITERION:
It is difficult to use, it assumes wrongly that the discount rate is known, if the
projects being considered do not have the same capital outlay, it may not give a
satisfactory result.
ii. PROFITABILITY INDEX (PI)
Profitability index is the ratio of present value of future cash benefits at the required
rate of return to the initial cash outflow of the investment.
PI = PV of cash inflows
PV of initial cash outflows
This is denoted as: PI= n AT
NPV = 1+ke
t
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t=1
Where At = Cash inflows
T = time periods usually in years
Ke = required rate of return C initial cost of investment.
If a project has PI greater than one, it is accepted, otherwise it is rejected.
iii. INTERNAL RATE OF RETURN (IRR)
The IRR can be defined as the rate which equates the present value of cash inflows
with the present value of cash outflows of an investment. It is the rate at which the
NPV is equal to zero. In other words, it is the break even rate of borrowing. Internal
rate of return takes into account the magnitude and timing of cash flows. This can
be referred to as the yield of an investment, marginal efficiency of capital, rate of
return over cost, etc.
By formula, it is given as:
C = such that
t=1 (1+r)t
n AT
n AT
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t-c=0
t=1 (1+r)
Where At = Cash inflows over the periods
t = Time periods usually in years
r = The internal rate of return c Initial
c = Initial cost of investment.
In the equation above, the r is found by trial and error method and by means of
interpolation. The use of trial and error method could involve the use of many rates
before arriving at the correct IRR. This could be time consuming to management.
Therefore, an improved method could be employed by using formula as shown
below.
IRR = ri + (r2 - ri) x V1
(VI - V2)
Where ri = The rate that gives positive NPV
vi = Positive NPV
r2 = the rate that gives negative NPV
V2 = the negative NPV.
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Applying this to solve a problem would involve first of all using a high rate of
return to find a negative NPV and then trying a lower rate that will give a positive
NPV. Having got this, you then interpolate to get the accurate rate.
If the calculated IRR is higher than or equal to the minimum required rate of return
such that (r > k) we accept the project but if (r < k) we reject the project. The IRR
represents the highest rate of interest the firm would be willing to pay on the fund
borrowed to finance the project without being financially worse-off.
2.5 RISK ANALYSIS AND MEASUREMENT
2.5.1 RISK ANALYSIS
Every firm that is engaged in investment projects is exposed to different degrees of
risk. Risk exists because of the inability of the decision maker to make perfect
forecast. The inability to make perfect decision arises from uncertainty of future
events. If it were possible for an investor to forecast with certainty a unique
sequence of cash flow returns, then investment would not be risky. In reality
however, cash flows cannot be forecast accurately. Therefore, risk arises in
investment decision because it is difficult to anticipate the occurrence of the
possible future events with certainty and consequently, one cannot make any correct
prediction about the cash flow return sequence.
Risk associated with a project can be defined as the variability that is likely to occur
in the future returns from the project. The greater the variability of the expected
returns, the riskier the project. In this context also, risk refers to the probabilities
that the future returns and therefore the values of an asset or security may have
alternative outcomes.
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It is because of the variability of cash flows from projects that risk analysis
becomes relevant to investment decisions. A wrong expectation of cash flow returns
in future could be dangerous to the financial well- being of a firm. Risk analysis
helps an investor to reduce the effect of variability in cash flows.
2.5.2 MEASUREMENT OF RISK
The financial manager must make decision under condition of uncertainty. Investors
require compensation to invest their funds in ventures where returns are not certain
and the required compensation to include investors to enter into these risky
investments should be over and above the compensation they require for time value
of money and their risk aversion. From the foregoing analysis therefore, two
important factors should be noted.
a. Some risk is present in any investment decision. The risk may be smaller, for
example, in a decision to invest N20,000 in an asset. This is similar in also
taking a decision to invest N20,000,000 in a test-process for extracting oil
from the soil.
b. Since risk cannot be avoided completely, best strategy is to recognize it
formally, measuring it as we can, then make choices based on decision rules
that incorporate the measure of risk. The best measure of risk is to measure
the level of dispensation in the rate of return because it is the rate of return
that enables one to determine the level of risk in an investment that is, the
presence or absence of profitability.
Risk is sometimes distinguished from uncertainty. Risk is referred to as a situation
where the probability distribution of the cash flow of an investment proposal is
known. But where there is no information to formulate a probability distribution of
the cash flows, the situation is known as uncertainty. This suggests that probability
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is a very important tool in measuring risk of investment. Forecast of future cash
flows is the most crucial information for capital budgeting decision.
Probability may be described as a measure of someone's opinion about the
likelihood that an event will occur. This implies that cash flows. Forecasts from an
investment should be associated with probability of occurrence. In measuring the
level of dispersion in any investment, profitability, plays an important role in our
analysis. In this case, we are concerned with the profitability that, the expected
returns will materialize, from which we can determine the variance and the standard
deviation of the investment.
Therefore, the first step in measuring risk in any investment proposal is to estimate
the returns and with experience, determine the probability of occurrence of such
returns.
Illustration 2:1 Assume the following cash inflows with their corresponding
Probability are expected from an investment project A.
YEAR CASH-
INFLOWS
PROFITABILITY EXPECTED
VALUE
1 600 0.15 90
2 800 0.25 200
3 1,200 0.35 360
4 1,000 0.20 200
5 1,600 0.10 160
Total 1.00 N1,010
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With the probabilities attached to the cash flow returns, the expected value can be
found By multiplying each project cash inflow with its corresponding probability
and then summing up. The formula is denoted as thus:
A = AiPi
Where A = the expected value
Ai = Individual cash inflows
Pi = Probabilities of occurrence.
From the above illustration, the expected value of the project is N1, 010. If theinvestor is satisfied with their expected values, he may go ahead and invest. But the
rule or concept is that the higher the expected value the lesser the risk on project
investment. Where there are many projects for the investor to choose from, he
would prefer projects with higher expected values.
ILLUSTRATION 2.2
Let us consider another project B, with the following cash inflows and their
probabilities.
YEA
R
CASH-
INFLOW
S
PROFITABILITIE
S
EXPECTE
D VALUE
1 2400 0.10 240
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2 1600 0.25 240
3 2,000 0.50 1,000
4 1,200 0.15 180
5 800 0.10 80
Total 100 N1,740
From the above illustration, project B has a higher expected value and hence would
be less risky to the firm than project A. Therefore, the concept stated above is that
projects with higher expected values are generally preferable to projects with lower
expected values.
In their own contributions, Geoffrey A. Hirt and Stanly Black, stated that though
expected value method incorporates risk explicitly into capital budgeting analysis, it
does not accurately measure the risk of an investment. According to them, a better
insight into the risk analysis will be obtained if the dispersion of cash flows is foundby calculating the variance of the investment project, which measures the variability
of the individual cash inflows from the expected value. They stated that high
variance depicts high variability of cash flows and hence high risk while low
variance signifies less variability of cash inflows and hence low risk. In other
words, projects with greater variances are riskier than those with lower variances.
Formula for calculating variance:
R2 = (Al-Al)2Pi
Where Ai = expected value of project A.
Al = Expected cash inflows per period.
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Pi = Probabilities of individual cash flow.
Consequently from the illustration above project A variance 81900 and project Bvariance of 21240O.Therefore project A would be preferable to project B. This
represents a contradiction with the expected value criterion which favour project B
Isu, H.O., preferred solution to the above problem. He opined that when such
situation arises, the projects should be subjected to further analysis by computing
the standard deviation simply as the square root of the variance. He said that the SD
(standard Deviation) also measures the variability of cash inflows from the expected
value but with improved result, and that the decision rule is that for two mutually
exclusive projects, the one with lower standard deviation is less risky and hence
preferable to the one with higher standard deviation. He gave the formula as:
SD = r2orSD = (A1-Al)2 Pl
Where SD = Standard Deviation
Al = expected value of project
Al = Expected Cash inflow per period
P1 = Probability of each cash inflow
R2 = Variance
Therefore, for our hypothetical projects A and B above, their standard deviations
will be as follows:
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Project A SD 81900 = 286.18
Project B SD = 212400 = 460.86
However, one will discover from the above results, that there is still a contradiction.
In terms of expected value, project B is preferable while in terms of standard
deviation and variance project A should be chosen. The above criteria however,
measure risk in absolute terms.
To resolve the problem therefore, it is better to measure risk in relative terms and
this is done by computing the coefficient of variation which is defined as the
standard deviation of the probability distribution divided by its expected value.
Coefficient of variation is particularly useful where we are comparing projects
which have the following in common:-
i. Same standard deviation but different Evs.
ii Different standard deviation but same Evs.
ii. Different standard deviation and different Evs.
Therefore, for project A, the coefficient of variation will be
CV 286.18
1, 010 = 0.28
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For project B
CV = 460.86
1740 = 0.26
The decision rule is to accept a project with power coefficient of variation. This
project would however have lower returns and lower risk. Projects with higher
coefficient of variation have higher returns associated with higher risk. The choice
will now depend on the investor's attitude to risk. The results of our computation of
the coefficient of variation of the two projects shows that project B has lower
coefficient of variation and therefore should be preferred to project A.
2.5.3 RISK - RETURN RULE
Investors have conflicting attitudes towards investment risks and returns. In general,
investors have a strong preference for investments and most investors have strong
aversion to risks. Both attitudes are conflicting because risky investments generally
attract high expected rates of returns and conversely. The attractiveness of a given
investment opportunity must therefore be assessed on a two-parameter model which
incorporates its expected rate of return and its index of risk. The risk-return rule
according to Prof. Okafor implies that two mutually exclusive investments, A and
B, A will be preferred if one of these two conditions holds:
a. Project A has a higher rate of return than B, but has the same or a lower
standard deviation of possible return (risk).
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b. Project A has a lower risk than B but has as much as or a higher
expected rate of return.
He concluded that the rule implied an inevitable trade off between investors' desire
for high-expected rates of return and their preparedness to assume investment risks.
2.6 THE CONCEPT OF VALUATION
A. A. Ring states, "it is important to remember that the value is the heart of
economics, more important still is the indisputable fact that only people can make
value. It is also stated that variation is the heart of all economic activities.
Everything we do as individuals or as a group of individuals are business or as
members of the society evolves about or is influenced by the concept of value.
Whenever one is buying, selling, investing, developing, lending, exchanging,
renting, assessing, acquiring etc; a work of knowledge of sound valuation is
essential.
Meanwhile, from a financial point of view, the basis for valuation of any asset
whether real or financial is the expected future cash benefits that would be paid to
the owner during the life of the asset. The traditional theory of value suggests that
the amount an investor is willing to invest is determined by the amount he expects
to receive in future. The returns from an investment are spread over time. The
discounted value of these returns represents the value of the asset to the investor
presently. Consequently, the value of an investment is derived from the discounted
expected cash-flows that the asset is expected to earn. One of the financial
managers principal goal is to maximize the value of the firm. Accordingly, an
understanding of the way the market value securities is essential to sound financial
management. The first point to note is that it is the prospective income from
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business assets that gave them value. There are different concepts of values
liquidating value, going concern value, book value, market value and fair or
redeemable value. Hirt Geofferey A. and Block Stanley(2004): Fundamental of
Investment and Strategy 4th Edition.
Investment Climate
Investment Climate in Nigeria refers to all the things put in place to motivate
investors and others with money to invest. A number of factors that contribute to
investment climate of a country are:
1. Government
2. Availability of data/ information to make sound decision
3. Availability of infrastructural facilities e.g. power supplies and good
telephone system
FACTORS THAT MILITATE AGAINST INVESTMENT IN NIGERIA
The following are the factors mitigate against investment in Nigeria:
1. Poor or absence of indigenous technological bases
2. Inadequate supply of raw materials and spare parts
3. Expensive and relatively unproductive policies
4. Confusing and sometimes contradictory government policies
5. Lack of Credit Facilities
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FACTORS TO CONSIDER BEFORE CHOICE OF INVESTMENT
There are four major factors to be considered when choosing an investment
according to Foster (1986)
1. Security: The most important is the security of the capital invested.
Investment should at least maintain their capital value
2. Liquidity: Where the investment are made with short term funds, they should
be converted back into cash at short notice
3. Spreading Risk: An investor who put all his funds into a type of security risks
everything on the future of that security. If it performs badly, his entire
investment will be lost. A betters and more secure policy is to spread the
investment over several types of securities so that in the case of possible loss
with one may be off set by gain in other. A planned spread of investment is
known as portfolio
INVESTMENT DECISION
Investment decision also known as capital budgeting is one of the fundamental
decisions of business management. Managers determine the assets that business
enterprise obtains. These assets may be tangible or intangible
Fraser (1988) investment decision involves the profitability utilization of company
funds especially in long term projects or capital projects because future benefits
associated projects are not known with certainty and investment decision involves
risk.
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This research work is therefore evaluated in relation to their expected return and
risks. The company will be interested in those projects with maximum returns and
minimum risk, an understanding of cost of capital, replacement theory and capital
structure theory is very important in this aspect
RELATIONSHIP BETWEEN FINANCIAL STATEMENT ANALYSIS AND
INVESTMENT DECISION
While the financial statement analysis describes the occurrences of past economic
event showing the profitability and expected return Investment decision however,enables the analyses of the risk
HISTORICAL BACKGROUND OF ZENITH BANK PLC
Zenith Bank was incorporated as Zenith International Bank Ltd on 30th May 1990, a
private limited liability company and was licensed to carry on business of banking
in June 1990. The name of the bank was changed to Zenith Bank Plc on May 20,
2004, to reflect its status as a public limited liability company.
The banks shares were listed on the Nigerian Stock Exchange on 21st October
2004, following a highly successful initial public offer (IPO). Nigerian individuals
and institutions numbering over 700,000 shareholders currently own the bank.
Within the first decade of commencing operations, the bank made its mark in
profitability and all other performance indices in Nigeria and has maintained its
prime position till date.
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