Literature Review on Capital Budgeting and Price Volatility
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This literature review analyzes the research on capital budgeting techniques and their limitations in the face of price volatility. It explores theories, models, and recent research in this area.
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Literature Review Introduction In this section, the literature related to the study question will be analyzed to find out what other researchers have done in the past and how they concluded their researches. The topic on the capital budgeting has been researched by many researchers because many industries usually have a problem in choosing the most capital budgeting techniques because all the developed model have limitations (Abor,2017). the case becomes more difficult especially when the company is dealing with the volatility of the price. The crude oil companies are the most affected by the price volatility because there are very many factors which comes into play and which determines the price of the crude oil. These factors are not fixed and the change quacking making the capital budgeting of the crude oil companies to be difficult. Some researchers who will be reviewed this section have conducted the research on the best capital budgeting techniques which the crude oil companies can use taking the price volatility of the crude oil into account. However, the problem persists because even after companies applying those techniques, the crude oil companies still venture into projects which prove unprofitable and, in some cases, put the companies in the risk of been bankruptcy (Aldaarmi et al, 2015). This section will focus on the theories of capital budgeting as well as review different capital budgeting model and where they have been used. This will enable us to discover the strength and the weakness of those model and then hence find the gap which exists in the body of knowledge. Research Background Capital budgeting is important to managers because it helps them to make the informed and proper decision so that they can venture into certain investment. The process has to take into consideration the future cash inflow and outflow of the business for the technique to be
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considered as reliable and quite accurate. The main problem arises where the volatility of the price experiences to the extent that it becomes impossible to predict the future price of the product. The price volatility makes it had for the company accountants to determine the future cashinflowofthebusiness(Ahmad,2017).Theworstcaseoccurswhenthecompany accountants assume that the price of the product will increase and the end up predicting the future cash inflow which is higher that which will be generated. this cause the company to be unprofitable to the extent which the investors fail to get the equity returns. The investors are the most important stakeholders in the company and hence the managers have to ensure that their wishes and expectations are met. most of the managers use the payback period capital budgeting technique because it is the easiest method (Al Hudithi,2017). However, this method is never accurate because it is based on many assumptions which can be applied in the crude oil companies like Armco Saudi where the price is highly volatile. The throughput analysis has been used in a few companies and has proven to be the best technique of capital budgeting. Nevertheless, most of the companies do not use this technique because it is complex and considers every aspect of the company. This method is very accurate because all it considers the cost as the operating cost and the profit has to be maximized to pay for these expenses (Su et al., 2018). The Armco Saudi has vision 2020 which is aiming at ensuring that the shareholders are satisfied by the performance of the company and how the management of the company id managing resources. This vision might fail to be achieved considering the danger which Armco company in the aspect of the crude oil price volatility (Alkhamis et al., 2017). The sad part of the story is that the price of crude oil in most cases is fluctuating downward meaning that there is a probability that the price of crude oil will go down.
Historical Development of Research in the Area The research on capital budgeting has been conducted for the last 80 years (1940-2019) through various methods. In most of the studies, the empirical method was used to analyze the data. Some of the researchers were conducted by the government researcher while most of them were done by the scholar. In more than 50% of the researcher were case studies where only the secondary data was used in the study without having primary data to confirm the secondary data. The government researchers used the companies’ financial data of about 20 years to study the capital budgeting techniques which those companies have been using. Most of the scholar-researchers were carrying out primary data collection to find out whether the secondary data is consistent with the reality on the ground. However, the studies concerning the impact which the volatility in price has on capital budgeting have a history of about 20 years because most of the researches in the past have not been so keen on the effect which price volatility has. Since the start of the 21st century, the volatility of the prices of good hasbeenexperiencedinmanycountriesbecauseofglobalizationwhichhasexpanded international trade (AlMotairy, 2016). It is no longer the case where the price of good was determined by the market forces within countries but with the advancement of technology, an action happening in one country can affect the price of products in far distance country ibn short period of time. This has brought a difficult time for the managers and hence a few researchers have conducted studies on the impact of volatility on the capital budgeting. The study on the volatility of the price of crude oil impacting the capital budget is scarce and has only been done for the last 10 years (Al-Maamary et al., 2017). This is because the price of crude oil had for a long period of the time constant until there was great economic depression in the year 2008 (Al Hudithi,2017). After many countries recovered from the great depression, the price of crude oil
has been fluctuating greatly making it very difficult for the managers to determine which is the best method they can use for capital budgeting. Relevant Theories in the Research When it comes to the capital budgeting there are many theories which are developed by the researchers. The most important of them is that the main aim of the company is to make a profit so that to create as much wealth as possible for the shareholders. For the company to make profit then project which will be profitable to the company have to be selected (Al-Mutairi et al., 2018). For this reason, the capital budget has to be used to select the appropriate project which the company has to invest in so as to meet the expectation of the shareholder who is the owners of the company. The capital budgeting process is quite complex because the managers have to ensure that the future uncertainties are covered in the capital budgeting techniques. In case the managers ignore future uncertainty, then the investment appraisal is unreliable and will not be a true reflection of indicating the profitability of the company (Adam et al., 2017). There are many techniques which the managers have been utilizing in capital budgeting which include, throughput analysis, discounted cash flow method, net present value (NPV), internal rate of return and payback period. These techniques have different complexities and the more complex certain techniques are, the more it is likely to be accurate. In most cases, the net present value and the internal rate of return (IRR) are used together but the NPV is considered paramount even which the IRR seems to give contradicting conclusion (Araujo et al., 2016). When the net present value of the project is found to be positive then it means that the company will be profitable. However, this model cannot be fit in cases where the price is volatile since the model is not flexible. Basically, the capital budgeting models are not fully capable of appraising theinvestmentforthemanagerstomakethemostinformeddecisions(Aregbeyen&
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Fasanyan,2017). Despite which method is used in capital budgeting the crude oil price volatility has to affect it because the volatility in the prices affect the revenue which the company is expecting in the future and which is subject to price fluctuations (Benramdane, 2017). The capital budgeting of the company is usually governed by the budgetary policy which governs the allocation of the resources in the company. Review of Recent Research in the Area Capital budgeting Capital budgeting can be affected by changes in demands over the time horizon. Capital budgeting using issuing new equity as a source of finance, Implies that industries anticipating positive shifts in demand in the near future, as a result issuing more equity is the appropriate financing method to cater for such demand shift (Buller& McEvoy,2016). Market timing implies that industries anticipating positive demand shifts in the distant future should issue less equity, to avoidexposuretoundervaluation(Chittenden&Derregia,2015).Therelationshipbetween demand shifts and stock issuance has been found to be: new listings and equity issuance respond positively to demand shifts up to 5 years ahead, and negatively to demand shifts 5 to 10 years ahead.(DellaVigna & Pollet, 2007) In the context of project appraisal, Ross et al. demonstrate a generic discount rate should be discouraged in practice. In theory, however, a generic discount rate is justified through M&M proposition III. Dayala (2010) has investigated the discrepancy and finds that consistently selecting positive NPV projects with individual risk-adjusted discount rates will always result in an excess return over the generic hurdle rate, hence value creation. Yet, a generic discount rate for individual project appraisal can only be justified if and when the generic discount rate is identical to the individual discount rate; that is in a context of projects being perfectly correlated
and of an identical risk class only (Araujo et al., 2016). In all other cases, a generic discount rate could lead to value destruction. M&M Proposition III is misguided (Dayala, 2010). Budgeting is considered to be one of the most important management tools to steer the organization, evaluate its performance and motivate its people. Capital budgeting decisions affect the profitability of a business organization. The paper focused on the efficiency of capital budgeting. Over-investment or under-investment is inefficiency (Crossman & Fischer, 2016). Using Chinese listed company's data, when the majority stockholder has more stock, the more inefficiency of capital budgeting has been concluded. Also, the negative relationship between leverage and the inefficiency of capital budgeting has been established (Davoudi, 2018). The inefficiency of capital budgeting decreases as the number of independent director increases (Wu, 2011). Capital asset pricing model (CAPM) The empirical evidence presented by Da, Guo, & Jagannathan (2012) against the capital asset pricing model (CAPM) based on stock returns, proposed that using CAPM for estimating the cost of capital does not invalidate its use as capital budgeting model for projects in the making. It can be attributed to the fact that stocks are backed not only by projects in place (Decisions,2015). The presence of options to modify current projects and undertake new ones, the expected returns on stocks does not have to satisfy the CAPM even when expected returns of projects pass CAPM criteria for financing the specific project. Our findings justify the continued use of the CAPM by firms in spite of the mounting evidence against it based on the cross-section of stock returns. (Da et al., 2012)
Net Present Value Net present value: is defined as the sum of the present values (PVs) of the individual cash flows. In the case when all future cash flows are incoming (such as coupons and principal of a bond) and the only outflow of cash is the purchase price, the NPV is simply the PV of future cash flows minus the purchase price (which is its own PV) (de Andrés et al., 2015). NPV is a central tool in discounted cash flow analysis and is a standard method for using the time value of money to appraise long-term projects (Domanski et al., 2015). Used for capital budgeting, and widely throughout economics, finance, and accounting, it measures the excess or shortfall of cash flows, in present value terms, once financing charges are met. ( Lin et al., 2000). Advantages: the time value of money, easy to calculate, and Shows the risk associated with all future cash flows. Disadvantage: it assumes that interim payments received during the life of the project can be invested at the discount rate used in the calculation (Donovan & Corbishley, 2016). For determining expected annual cash flows and the expected period of benefit, subjective data is used. The outcome is shown as a rand value and not as a percentage; which are usually easier to understand (Feibel, 2003). Net Present value for Foreign Investment The usage of the theoretically correct net present value method decreases with the political risk in the host country, and that the use of the Payback method increases with the political risk (Chittenden& Derregia,2015). also in the presence of capital market imperfections, unsystematic and country-specific political risks are important (Ghenimi et al., 2018). Due to the fact that these risks are difficult to estimate (rendering high deliberation costs) managers are inclined to use simple rules of thumb for their capital budgeting decisions (Araujo et al., 2016).
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Research results partly explain why surveys find that alternative methods such as the Payback method are frequently used despite their theoretical drawbacks (Holmén & Pramborg, 2009). The traditional methodology for determining whether or not such an investment should be made is known as the discounted cash flow method (Al Hudithi,2017). This method, unfortunately, does not capture efficiently the benefits of flexibility that often accompany capital budgetingdecisions(Graham&Harvey,2002). Using theframeworkof financialtheory, employing real options modeling in public sector capital decision-making has been found to improve the efficacy of capital budgeting decisions.(Schubert & Barenbaum, 2007b) The standard textbook formula for computing the present value of future random cash flow - the discounted expected value – has been found to be formally incorrect and can generate significant errors when used to compute present values. The standard error found in the standard text PV formula has been theorized to be more severe for projects that run beyond 5 years (Jarrow, 2014). Including real options for decision makers for capital budgeting, empowered the decision makers to eliminate projects that didn’t perform up to standards at an early stage (Guerrero- Baenaet al., 2015). The study by Denison (2009) Using experimental methods to explore whether incorporating real options into net present value analysis can reduce escalation of commitment, or the tendency of decision makers to continue to commit resources to a project after receiving negative feedback (Jahfer & Mulafara,2016). Findings indicated that users of real options display less escalation of commitment than do users of net present value analysis alone. The main result demonstrates that the use of real options in capital budgeting can affect the behavior and
decisions of the user even in an experimental setting that controls for the informational advantage of using real options(Denison, 2009). Budgetary policies The impact of the institutionalization of governance and budgetary policies on the accountability of organizational actors from an institutional and critical realism perspective has been studied by Mutiganda (2013). The study has been based on the framework developed by Burns and Scapens (2000) to critical realism. Accountability practices have been reported to be dependent on whether the institutionalized policies have reduced or increased the gaps between the real, the actual, and the empirical domains of the reality of the organizational actors involved (Kengatharan,2016). The governance policy that prevails at a given domain of reality, has been reported to be a factor to affect the accountability practices (Araujo et al., 2016). The application of budgetary information as a tool of governance and accountability in the empirical field of the study, cannot be taken for granted (Mutiganda, 2013). The nature of the prescreening process has not been thoroughly investigated. However, evidencesuggeststhatsomescreeningtakesplaceduringproposalbudgetdevelopment. Researchers have identified departments responsible for the budget, 39 percent of the budgets were prepared by engineering, 33 percent by accounting, 17 percent by finance or budget committees, while 11 percent were considered divisional responsibilities (Kristjanpoller & Concha,2016). It may be inferred from this finding that engineers and accountants are more involved in the prescreening process than personnel in the finance department (Araujo et al., 2016). An important analytical issue is the estimation of cost-benefit data. It has been found that firms typically classified projects, and user acceptance and selection criteria that depended upon these classifications (Lee et al., 2017). Generally, the finance department is not responsible for
budget development during the screening process. Finance, however, appears to control selection (Muksherjee & Henderson, 1987). Uncertainty is defined as the gap between the information currently available and the information required to make the decision (Galbraith, 1973). A condition of uncertainty usually exists in capital budgeting because investment decisions, by definition, involve uncertain outcomes that in the long run are important to firm survival and about which complete information is unavailable (Zhu and Weyant, 2003; Simerly and Li, 2000; Smit and Ankum, 1993). Also consistent with previous research is that industry has an impact on capital budgeting practices. More specifically, firms in the financial services industry and, to a lesser extent, the building, construction, and utility industries appear to find sophisticated capital budgeting practices (SCBP) more important and useful than the extraction, manufacturing and non- financial services industries (Masri & Abdulla,2018). The results indicate that it is more than the sole uncertainty that affects the importance and use of sophisticated capital budgeting practices (SCBP). One reason may be that some industries have characteristics (that make administrative innovations like GT and/or ROR more suitable to implement (Mukherjee et al., 2016). Another reason may be that these industries are used to dealing with uncertainty through option-like analyses (Verbeeten, 2006). Participative budgeting The process by which managers have an influence on the setting of their budget goals, participative budgeting (PB), has been researched extensively since the 1960s. The empirical PB studies identified (1) the antecedents or determinants of PB, (2) the impact PB has on mental states and performance and (3) PB's effects on the existence of budgetary slack (Myers,1974). Summing up the findings, it has to be noted that while the informational role of PB in enhancing
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subordinate performance is generally established, the results relating to reductions in information asymmetry as well as PB's motivational effects remain ambiguous (Prümmer, Frey, Schentler, Williams, & Motwani, 2011). Beyond budgeting Beyond Budgeting has been proposed as an influential idea that will reinvigorate management accounting contribution in business operation and performance. It is claimed that the traditional system has lost relevance with the modern business environment and is no longer satisfying the needs of managers (Nobanee,2017). Budgets have been ingrained in the culture of business since their inception in the 1920s and managers will find it extremely difficult to radically shift to a system without budgets. The implications of a Beyond Budgeting system are; performancemeasuresrelativetocompetitorsandadecentralizedorganizationstructure (Nurullah& Kengatharan,2015). Alternatives such as the Better Budgeting techniques may be more favorable to management who desires a formal planning and control system. The Beyond Budgetingconceptisstillinitsinfancyandrequiresfurtherdevelopmentandpractical implementation. (Goode & Malik, 2011) Capital budgeting forlong-terminfrastructures projects Anew empirical insight on the capital structure of project-financed Liquefied Natural Gas (LNG) infrastructures and gas pipeline projects has been provided, by using data relating to projects whose financial close occurred between June 2004 and March 2011. Most results are consistent with the basic view of risk-averse funds suppliers (Prasad,2018). Especially, the projects located in risky countries and larger projects tend to exhibit lower debt ratios and less-
concentrated equity ownership. In addition, regasification projects appear to have more diluted equity ownership. Methodological issues raised by the financing of these projects are also examined from a capital-budgeting perspective (Rahma et al., 2016). In particular, the equity residual method, usually used by industrial practitioners to value these projects, should be adjusted (Pierru, Roussanaly, & Sabathier, 2013). Liquefied Natural Gas projects are the current new strategic venture by Aramco (Aramco,2014). Understanding the applied method for LNG projects capital budgeting is important because Natural Gas considered to the more efficient alternative source of energy for crude oil. Risk budgeting The impacts of risk budgeting on managers' optimal effort decision and on investors' contract design has been studied by Zhong &Jiang( 2011 ). The results indicate that managers spend a low level of effort when they are constrained than when they are unconstrained regardless of whether the effort is observable or not, and the effort managers spend decreases as the constraint becomes tighter (Riley et al., 2017). However, active risk budgeting has negligible impacts on investors' contract design. In addition, the contract sharing coefficient without risk budgeting restrictions is still optimal in the scenario where the active risk budgeting is present and the effort is observable (Rossi, 2015). Throughput analysis Throughput analysis is one of the methods that is used in capital budgeting. The technique is so complex that many managers prefer not to use it but many economics have proposed it as the best capital budgeting technique(Ruiz & Zuniga-Jara, 2018). Unlike many other techniques like the net present value the technique does not consider the cash flow of each separate project but it analysis the total throughput of the company. throughput is a word which
is used to represent the value which one gets after subtracting the operation cost from the revenue generated by all the projects of the company (Sari & Kahraman,2015). This technique is more reliable because in most cases the companies have a different project which are related and throughput analysis considers them all as one entity which gives a clearer picture of how the future will be (Ahmad,2017). The bottleneck operation is enhanced such that to increase the value of the total throughput the projects have to pass through the bottleneck which us the resource that the company has (Saidu, & Musa, 2017). It is not in all cases that the bottleneck operations have to increase the value of total throughput but ins some cases it is applied to reduce the operating expenses of the company which indirectly increase the through. In other cases, the operation is done to mitigate the risks which the company is likely to face especially the risks which are associated with the fluctuation of the market prices of the products (Shivaani et al. 2017). There are some companies which apply the throughput analysis for the purpose of fulfilling the legal requirement of the company by the state, shareholders and even the lenders (Solomon, 1956). Throughput analysis can be used by the management in the cases where the price of the products is volatile (Ghenimi et al., 2018). The model is fit because it takes into account all the operation of the company instead of reviewing just the project which is experiencing the price volatility of the products or services. Discounted Cash Flow Discounted cash flow is another model which is used in the capital budgeting. The model is used to find out the amount of money which the investor would receive from a project based on the presents value of the money (Su et al., 2018). The idea is that the dollar is weaker tomorrow than today and for that reason, the discount rate is applied to find the amount of money if it was equated to the present values (Sari & Kahraman,2015). The main challenges which the
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discounted cash flow encounters are to determine which cash flow in the project to be discounted (Saidu, & Musa, 2017). This challenge occurs especially when the project is complex and dividends are expected to be paid to the shareholders. In the case when the discounted cash flow analysis is based on the dividends paid to the investors especially the minority shareholders, it becomes easy for the manager to know that the value of the stock is low (Tahir & Anuar,2016). The model is not fit for the complex investments and it becomes even more challenging when the price of the products is volatile (Ghenimi et al., 2018). The volatility makes it hard for the manager to know which will be the future cash flow of the project because the revenue generated in the future can hardly be determined by the current revenue generated (Zhao et al., 2016). For these reasons, the model is fit when used in a private company where the investment is less complex and the price of the products is stable. Internal Rate of Return Internal rate of return is not quite a model but a metric used in capital budgeting. This is the return rate by which the net present value of the company is equal to zero (Ghenimi et al., 2018). The NPV formula is used to calculate the internal rate of return and by the nature of the formula, it is hard to make the IRR as the subject of the formula and hence the method of trial and error is used. The higher the internal rate of return is the higher the present value of the company is expected to be and hence the more desirable it is to venture into that project (Zhang et al., 2016). When the company has several projects which it has to choose from, then the internal rate of return can be used to consider which of the investment is the best (Saidu, & Musa, 2017). This is done especially when the cost of the investment is the same and the company is not willing to complex model to analyses all the investments. However, the managers decide to look into the net present value then the outcome of the NPV is taken as
paramount (Zhang, 2017). This is because the managers can analyze several investments’’ internal rate return and net present value and find that the investment with the highest IRR has negative NPV while the one with a lower IRR had highest positive NPV (Lee et al., 2017). In such a case, the investment with the highest positive prevent values is considered the most desirable even if the NPV is not the highest (Zhu & Singh,2016). The advantage of the internal rate of returns is that it can be used to analyze the projects even when the price of the products is highly volatile. Payback period The main aspect which the managers are always willing to know is the amount of time which the investment will take to cover the cost of investments (Saidu, & Musa, 2017). This is sometimes called the breakpoint of the company beyond which the company starts making a profit. The less the payback time the investment is, the more desirable the investment is because it will soon start making a profit and the vice versa (Zhang et al., 2016). Basically, the payback time is given by the cost of the investment divided by the annual cash flows (Waheed et al., 2018). The main challenge which this method has is that unlike other models like the net present value, discounted cash flow and the internal rate of returns the model does not consider the present value of the future cash flow. This results in giving an unreliable figure because the revenue which will be generated in the future will be weaker than the revenue generated today (Zhang et al., 2016). The model completely unreliable when it comes to the economies where the price of the good is highly volatile because it becomes hard to predict future cash flows (Weingartner,1969).
Crude oilprice volatility in Saudi Arabia The crude oil price volatility is not something new because it started around 1973 when the non-OPEC suppliers started supplying crude oil and this resulted in the moderation of prices. The price of the crude oil before then was quite higher because the OPEC cartels were cutting production so as to create high demand rising and keeping the price of the crude oil high (Zhao et al., 2016). The supplies by the non-OPEC suppliers was a good step since they moderated the price of the crude oil for a long time until these suppliers started declining. The price of crude oil in 2001 in Saudi Arabia was $20 while by just before the time of the economic depression in 2008, the price rose to $140 dollar (Chittenden& Derregia,2015). After the economic depression, the price dropped to $40 per barrel and this was huge fluctuation in just a short period of time (Sari & Kahraman,2015). After the economic recession, the price went down to $120 in the year 2014 when the economy of the world was recovering. The price of the crude oil Saudi Arabia has never again been stable, not because of the collapse of the economy but because of crude oil been generated from various source (Su et al., 2018). This makes it hard for the OPEC to control the price of the crude oil because when they cut the production with the intention of increasing the price of the crude oil, they find that other sources are meeting the market demand (Zhang et al., 2016). Another aspect which is bringing about the volatility of the crude oil prices is the decision of the client governments like the US. In 2018, the US president, Donald Trump, declared that the US will not be purchasing the crude oil from Iran (Waheed et al., 2018). This was great news for Russia and Saudi Arabia who met to decide how the supply of the crude oil will be like in 2019 with Iran been limited to the market. This cause the price of the crude oil to rise while Iran lowered the price so as to attract more clients to cover the sale, they would lose by
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not supplying in the US. However, the most important thing that President Trump was hoping is that Saudi Arabia and Russia will not cut down the supplies (Waheed et al., 2018). The volatility of the crude oil prices in Saudi Arabia have caused the companies to restructure their capital budgeting such that they can be flexible to consider the fluctuation. In the past, the crude oil supplying companies in Saudi have been using a simple model of capital budgeting like the net present value to find out if the investment is desirable to invest in (Su et al., 2018). However, it is no longer possible to use the simple model because the determination of the future cash flows is difficult considering how the prices are unpredictable. AuthorsYea r Research objectives Research methods Research Findings Suggested future research Waheed,R., Wei, C., Sarwar, S., & Lv, Y 2018Tofindthe impactof crudeoil priceonthe stock market Questionnaires and interviews Thecrudeoil price has effect on stock market of crude oil Studyonthe impactof crude oil price oninvestment decision making Zhu, Q., & Singh2016Tofindout theimpact whichthe crudeoil price volatilityhas Secondary sourcedata and interviews Thecrudeoil pricevolatility hasgreat impacton investment strategies Studyonthe impactsof crudeoil volatilityon thesamein Europe
onstrategies of investments in crude oil in thenorthern partof American Zhang,W.,Li, X., Shen, D., & Teglio, A. 2016Tofindthe impacts of the price volatilityon investment returns Secondary data collection andrandom questionnaire Pricevolatility affectthe returns dependingon the direction of price fluctuation The impact of pricevolatility onimportant productslike crude oil. Zhao, L., Zhang, X., Wang, S., & Xu, S. 2016Tofindthe effectofthe crudeoil priceon inflationin china InterviewsThe inflation is determinedby thecrudeoil pricebecause economy dependon transportation. Studyonthe impactof crude oil price volatilityon the performance of other companies Tahir,M.,&2016TheRandomPricevolatilityStudy
Anuar, M. B. A.determinants of the capital budgetingin Pakistan questionnaires and secondary source was considered asthemajor determinateof capital budgeting techniques determinants ofcapital budget techniquesin highlyvolatile companies. Shivaani, M. V., Jain,P.K.,& Yadav, S. S. 2017Tofindout themost commonly usedcapital budgeting techniquein India Interviews and secondary source data Themost commonlyuse techniquesin India is CAPM Studyofthe capital budgeting techniquesin crudeoil- dependent economies Rahma,E., Perera,N.,& Tan, K. 2016The impact of the crude oil price volatilityon the budget of the government of Sudan Secondary source data Crude oil shock prices cause the budgetofthe Sudan government less reliable. Study on crude oil price shock onthecrude oilproducing companies. Nobanee, H.2017Tofindout themost Interviewand secondary Allthe techniques have Studyonthe best techniques
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efficient capital budgeting techniquesto be used in the crudeoil- dependent economies sourceweaknesses and hencemore thanon techniqueneed to be applied. forthecrude oil companies. Kristjanpoller, W.D.,& Concha, D. 2016Theimpact whichthe fluctuation in the crude oil price have on airline stock QuestionnairesStockpriceof theairlines drops as result of the crude oil price volatility Effect of crude oilprice fluctuationon thecapital budgetingon theairline companies. Aldaarmi,A., Abbod,M.,& Salameh, H.). 2015Tofindout the fitness of CAPMin SaudiArabia stock InterviewsTheCAPMis the best model forthecrude oil-dependent economy. The impact of crude oil price volatilityon capital budgeting techniques.
Research gaps identification and deliberation The research on the effect which the crude oil price volatility on the crude oil stock market and the public investments have been conducted previously. However, there are no studies of the crude oil price volatility impact on the capital budgeting of the crude oil companies in Saudi Arabia. The impact which the crude oil price volatility has on the crude oil stock market and the public investments decision-making conducted elsewhere is totally different from the impact which price volatility has on the crude oil companies in Saudi Arabia. The previous research on the impact of crude oil price volatility on the public investment decision making was not based on case studies and hence there is the possibility of ignoring the details which is crucial in capital budgeting. By the reviewing of literature, it is very clear that there is a gap in the body of knowledge because there are no studies which are addressing specifically the effect on the capital budgeting in Saudi Arabia. Conceptual Model Development The capital budgeting is done using various conceptual models. These conceptual models include the internal rate of returns, discounted cash flow, the net present value, the payback period and the throughput analysis (Zhang et al., 2016). Most of these models have been analyzed in the literature review but in this section, how the models were developed will be discussed. The payback period is the simple model of capital budgeting and was developed by the idea of finding the length of time it would take to cover the cost of the investment. This is done by dividing the cost of the investment and the annual cash flow (Sari & Kahraman,2015). The internal rate of return was developed to find out the return rate at which the net present value will be zero. The net present value formula is used where the NPV is equated to zero (Saidu, & Musa, 2017). The throughput analysis was developed through the consideration of the all the
project or investment which the company is undertaking as one entity and the revenue which the investments are likely to generate subtracts the operating costs of all the investments. The net present value was developed through the consideration of the revenue which the project is likely to develop in the future based on the present value of the dollar (Sari & Kahraman,2015). The discounted cash flow model was developed by applying a certain discount rate so as to get the present value of the future cash flows so as to find out the amount which investor will accrue from the investment. Hypothesis Development The hypothesis development requires the consideration of all the possibilities. This was done through thinking wide and brainstorming so as to have a wide perspective of the matter in the study. Through the reviewing of the literature, the gap in the body of knowledge was identified and hence it was easy to develop the hypothesis to cover the gaps. Both the divergent and the convergence thinking were used in the development of the hypothesis (Lee et al., 2017). The divergent thinking was used to incorporate all the hypothesis which can be addressed in the study and the convergent thinking was used to eliminate the redundant hypothesis. This process resulted in the development of other hypotheses which will cover the research question in totality. Chapter's Summary This chapter has reviewed the previous studies which were conducted by the researchers in the past on the aspects of the capital budgeting and the crude oil price volatility. The many things that stood clear were that the volatility of the crude oil price affects the company decision in terms of capital allocation and the financing of the projects. The simple capital budgeting model is not fit to handle the project which has high volatility in the price of the products and
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service. The hypothesis of the study was deep through a deep review of the literature to analyze all the possibilities such that the hypothesis can be addressing the areas where there is a gap in the body of knowledge. The models used in the capital budget were developed based on different aspect but all of them considers the total cost of the project and the total revenue which will be generated from the investment. References Abor, J. Y. (2017). Evaluating Capital Investment Decisions: Capital Bud Aldaarmi, A., Abbod, M., & Salameh, H. (2015). Implement Fama and French and capital asset pricing models in Saudi Arabia stock market. The Journal of Applied Business Research, 31(3). Ahmad, K. (2017). The implementation of management accounting practice and its relationship with performance in Small and Medium Enterprises sector. International Review of Management and Marketing, 7(1). Al Hudithi, F. A. S. (2017). Social capital and participative budgeting: a process thinking perspective (Doctoral dissertation, University of Hull). Alkhamis, N., Noreen, U., Ghonaim, L., Alghonaim, S., Ibrahim, S., & Alturki, R. A. A. (2017). Capital Budgeting and Capital Structure Decisions in Saudi Arabia. Advanced Science Letters, 23(1), 330-332. AlMotairy, O. S. (2016). Measuring the Learning Outcomes and Critical Thinking: The Case of Saudi Accounting Students. Journal of Accounting, 6(2).
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