March 5, 2009

Sample Research Proposal on Re-thinking Business Leaders’ Decision-Making on Capital Budgeting & Capital Structure


            Capital budgeting and capital structure comprises key decision spheres for all business firms. This is because of the need for firms to maximise returns to its different constituencies holding varying levels and characteristics of interest in the financial viability of the organisation. Moreover, decisions on these financial aspects holds a great impact on the ability of the organisation to effectively deal or even influence the existing competitive environment towards its benefit. Decision-making over these financial issues rely upon existing models defining the factors that should be considered, the process to be followed, and the outcomes to be expected from the decision. While decision-making comprise a conscious judgement from business leaders, the ability of these models to provide a sound theoretical basis for judgments and encompass actual business conditions determines the workability of model and the success of the decision-making process. This implies that business leaders need to consider the models they use as guides in decision-making in order to determine a model or a combination of models that suits their experience and able to provide appropriate guidance in decision-making on capital budgeting and capital structures. This further implies that the chosen business model should also be utilised appropriately in the context of the business organisation to arrive at a sound decision that works towards the achievement of the financial and competitive objectives of the company.

Statement of the Problem

            In light of the complexities in the decision-making process that business leaders go through in considering capital budgeting and capital structures, the research seeks to identify the models used by manufacturing companies in decision-making over these financial factors and assess the extent that their chosen model/s contribute to the expediency of the decision-making process as well as the viability of the decision in supporting the achievement of the financial objectives of the company.


Research Objectives

            The research proceeds through the guidance of the following objectives:

  1. Identify the different models or theoretical concepts utilised by manufacturing companies in the decision-making process over capital budgeting and capital structure.
  2. Determine the nature, extent and characteristics of the usage of these theories by manufacturing business firms.
  3. Investigate the strength of the relationship arising between the preferred models or theoretical concepts adhered to by business leaders and expeditious decision-making on capital budgeting and capital structure.
  4. Investigate the link between model-based decision and the achievement of the common financial objectives of manufacturing companies.
  5. Determine best practices for manufacturing companies in the utilisation of models or theoretical constructs as guides in decision-making over capital budgeting and capital structure.


Significance/Rationale of the Study

The completion of this research will help reinforce the importance of the foundational support for the decision-making process over capital budgeting and capital structure because of the recognised influence of the decision towards the financial viability as well as competitiveness of the business organisation.

In addition, the results of this research will ascertain the advantages and disadvantages of the different models or theoretical constructs utilised by companies in the decision-making process over these financial factors. This would help organisations in evaluating their decision-making processes to determine the appropriateness of the models adhered to or the effectiveness of the usage of these models in arriving at decisions intended to make-way for the achievement of the financial and competitive objectives of the companies.

Moreover, the investigation into the advantages and disadvantages of the utilisation of existing models in the decision-making process over capital budgeting and capital structure would enable the research to draw conclusions on best practices applicable to manufacturing companies that may be adopted by manufacturing firms to improve their decision-making process in order to optimize the achievement of their financial and competitive objectives.


Definition of Terms

Capital budgeting refers to the aggregate process involving the generation, evaluation, selection and follow-up on capital expenditures expected to benefit the company long term in terms of replacement, expansion, modernisation or strategic development. Capital budgeting also deals with real asset valuation, which depends upon the value of cash flows at a discounted rate over a relevant period. The process of capital budgeting considers cash flows at base period or time 0 together with cash flows over the length of the duration of the specified period being considered. Capital budgeting constitutes a salient aspect of financial management of business organisations. Even if capital assets commonly constitutes smaller percentages of the total assets of companies relative to current assets, the implications of managing capital assets reflect in the long term operation of the company. (Higgins 2000) This means that the consequences of decisional mistakes on capital budgeting would have dire implications accruing throughout the future operations of the company.  

Capital structure pertains to the manner that a business organisation finances itself through the determined combination of loans, bonds, equity sales and equity options. Businesses incur debts through bond issues or long-term notes payable and equity as retained earnings, common stock or preferred stock.  This also refers to the permanent or long term financing of business firms. (Higgins 2000) This implies that capital structure encompasses the way that business organisations finance their overall operations towards growth through the utilisation of various sources of funds. In decision-making over capital structure, business leaders look into short and long-term debt so that capital structure usually relates to the debt-to-equity measure, which in turn indicates how risky the company is. Commonly, a company financed heavily by debt poses greater risk because the firm is highly levered relative to firms with lower debt-based capital structure.

Decision-making refers to the cognitive process concluding with the selection of a particular course of action based on alternatives. The process starts with the assessment of the situation followed by the identification of the choices possibly constituting alternative decision, selection of an option through elimination and critical analysis, and ending with the reflection on the results of the decision. Decision-making may be rational or irrational depending upon the situational context and the foundational basis of the decision-making process. Brauner et al. 2000)


Review of Literature

Capital Budgeting Constructs

            Capital budgeting decisions stem from the major rule in modern finance of considering the value of a particular asset or the entire company as equal to the discounted present value of expected cash flows in the future (Dayananda et al. 2002). This implies that business organisations considering placing investments into capital projects are inclined to utilise the rule on net present value to push through with the investment if the net present value is zero or positive and reject the investment proposal if the net present value is negative. This is the dominant model taught in business schools used in decision-making on capital budgeting.

            However, there are other models that companies uses in deciding over capital budgeting including internal rate of return, hurdle rate, payback, sensitivity analysis, P/E multiples, discounted payback, real options, book rate of return, simulation analysis/VAR, profitability index and APV.

            Internal rate of return constitutes a decisional model on capital budgeting that involves the consideration of discount rate equals present value of the future cash flow to the initial investment. As a measure, the internal rate of return is akin to the rate of return per annum of investments based on calculations on compound interest rates. (Graham & Harvey 2002) This serves an important purpose in situations where there are several future case flows requiring calculations relative to interest rates. In decision-making, higher internal rate of return supports investments.

            Hurdle rate is another decisional construct for capital budgeting. This pertains to the consideration of the minimum investment rate acceptable to the investor. This mostly depends upon the common business practice as well as the return expectations of investors on a particular endeavour. Hurdle rate also proves useful in the achievement of a certain investment rate prior to the occurrence of certain events such as the achievement by the fund manager of a specific hurdle rate expected by investors before receiving a bonus or the achievement of a particular hurdle rate to obtain or retain investments. (Marino & Matsusaka 2005)

            Payback as another decisional construct refers to the period needed to recover the preliminary cost of a particular project if the time value of money is not considered. This implies that the capital budgeting decision depends on the period for recovering the costs incurred in a project. The acceptability of the payback period lies upon the expected payback period of the company with a shorter or equivalent period of payback relative to expectations accruing greater favour while longer payback periods may support the decision to forfeit incurring costs for a project. (Marino & Matsusaka 2005)

            A variation of payback is the discounted payback decisional construct. This is similar to payback in terms of the purpose underlying the construct except that discounted payback involves the initial discounting of cash flows prior to the determination of the payback period. This is because money to be received in the future will be likely to be less in value than if the money is received today. (Marino & Matsusaka 2005) This constitutes a more realistic construct because it considers the recognition of monetary devaluation in the long term.  

            Sensitivity analysis constitutes another capital budgeting decisional construct. This pertains to the analysis made over the effect over the profitability of the project of changes or shifts in sales, costs and other financial factors. The appeal of the result of the analysis to decision-makers depends upon the actual and projected direction of the shifts. Positive shifts in sales, costs and other financial factors supports capital budgeting decision favouring the project while negative shifts would likely lead to the abandonment or reassessment of the project. There are instances where positive shifts occur for certain financial factors while negative shifts characterise the other elements. In this instance, the decision depends upon the weighing of the positive and negative shifts with positive changes able to offset the negative shifts to support a decision favourable for the pursuance of the project. (Graham & Harvey 2002)

            P/E multiples comprise another capital budgeting decisional construct. This term commonly occurring in the equity market is actualised by dividing market value per share with earnings per share where market value is the current market price per share and earnings per share pertains to the earnings of the company. The value shows the times during which the market becomes willing to pay based on the current company earnings. Mathematically speaking, a higher P/E multiple means that the market is willing to pay an exponential price for the current earnings of the firm. This implies that the higher P/E multiple of a company, the higher is its growth rate. However, P/E multiples to reflect upon competitiveness should be compared to the performance of other similar companies. Moreover, the values are susceptible to manipulation so that the multiple should not be considered as a sole construct in capital budgeting decisions. (Dayanandra et al. 2002)

             Real option comprises another capital budgeting decision-making construct. This refers to the decision-making process involving real assets such as land and machinery. This also pertains to the alternative option becoming available in line with business investments opportunities. This means that if a company decides to pursue a project, the actualisation of the decision opens real options for expansion or divestment of previous investments in favour of the new investment opportunity. This construct is closely linked to the decision-making process because utilising this model actually leads to determination of actual options for consideration. (Mayers 2001; Triantis & Borison 2001)

            Book rate of return constitutes another decisional construct in capital budgeting computed by dividing the average profits based on predicted cash flows with the average net book value of the investment. The acceptability of the value depends upon the book rate of return targeted by the internal analysts of the company or by industry analysts. This is insensitive to variable cash flow patterns and the choice of target is subjective. Expected returns at par or greater than the targeted book rate of return indicates a positive point favouring the pursuance of a project. (Graham & Harvey 2002)

            Simulation analysis comprises another capital budgeting decision construct. This method involves the utilisation of a selected mathematical model for a number of times to derive an estimation of the probability of arriving at certain possible outcomes. This constitutes more of a procedural construct rather than a measure indicating a suggested guide for the decision-making process instead of a measurable consideration in the decision-making process. Consistency in the result of the simulation indicates greater support for the capital budget decision relative to particular project while inconsistent results indicates the need to asses the utilisation of simulation or the evaluation of the elements considered in the model. (Dayanandra et al. 2002)  

Profitability index constitutes another capital budgeting decision construct. This decision construct considers the benefit cost ratio computed by taking the present value of future cash flows and dividing this by the amount of the initial investment in deciding over the utilisation of funds for a particular project. A decision-maker utilises this construct by weighing the factors derivable from the investment with the cash flow. The greater the result obtained from the measure, the better the support provided for the decision to push through with the capital budgeting decision. (Modigliani & Miller 1958)

Adjusted present value (APV) constitutes another construct for the capital budgeting decision. The utilisation of the construct considers the results of the analysis on the net present value of a particular asset with the consideration that this is financed solely by equity together with the present value of other financing decisions such as levered cash flows. (Dyanandra et al. 2000) This means that the decision-maker looks into and calculates separately the different tax shields contributed by interest deductibility as well as the benefits from other investment-related tax credits.      

Capital Budgeting Construct in Decision-Making among Business Firms

            Corporations utilise different processes or methods in allocating capital, with the respective methods offering unique benefits and costs. The capital budgeting decision using one or a combination of these methods depends upon the business context and the objectives vied by decision-makers. (Marino & Matsusaka 2005) Looking into the actual capital budgeting techniques of companies leads to an empirical-based knowledge of the trends in the theoretical constructs supporting capital budgeting decisions. This implies that the gap between theory and practice in the area of capital budgeting has decreased. (Arnold & Hatzopoulos 2000)   

            According to the survey conducted by Graham and Harvey (2002) over the theoretical constructs used by companies in the capital budgeting decision indicates that majority of the respondent companies answered using internal rate of return and net present value as their basis for capital budgeting decision. These constructs comprise the traditional, textbook measures used in capital budgeting. However, there are also significant responses for other theoretical constructs. Next to the IRR, NPV and hurdle rate, the payback method was the next commonly used construct to support capital budgeting decisions despite the stressed limitations of this method when utilised on its own. This is more pronounced in small firms and firms with older business leaders without currently achieved educational degrees. The theoretical constructs minimally used are simulation analysis, profitability index and adjusted present value. The study shows that companies are more inclined to use traditional constructs despite the presence of other constructs and the possibility of combining constructs to achieve more accurate and comprehensive information for decision-making.

Capital Structure Constructs

            The capital structure decision may be based on two major theoretical constructs, which are the trade-off theory and the pecking-order theory each having their unique features resulting to the consideration of these theoretical constructs as contenders.

            According to the trade-off theory, business firms hold optimal debt-to-equity ratios determined by the process of trading-off benefits of debt with its costs. This theoretical construct has undergone changes resulting to different versions. The original version of the trade-off theory provides that the primary benefit derived from debt is comprised of the tax advantage constituted by interest deductibility. Developments on this theoretical constructs still recognise the valuable role that debt plays due to its ability to discourage the tendency of managers to overinvest but considers the primary costs of debt financing as revolving around financial distress such as underinvestment together with defections by company customers and suppliers. (Champion 1999; Graham 2001)

            In application, the theory implies that large and mature business firms should go with the capital structure decision to take advantage of the tax deductibility of debt and their lesser financial distress cost. This decision is strengthened in instances where mature companies have stable cash flows together with limited investment opportunities. This is exemplified by high-tech companies often incurring negative leverage or their cash balances exceeding their outstanding debts to experience the trade-off benefits.  

            The other construct that could be preferred as the basis for the capital construct decision is the pecking-order theory. This theory serves as the contender of the trade-off theory because it provides that corporate leverage ratios normally are not reflective of capital structure targets because these are better reflected by the practice of using internal funds to finance new investments as much as possible and the issuance of debt instead of equity in case external funds are needed. In this model, equity is considered as the last resort. The underlying premise behind this theory is that the company decision-makers avoid the issuance of securities, especially equity, if the company is determined as undervalued. Moreover, even if the company were deemed as fairly valued, announcing the offering of new equity would lead to a market reaction that would cause stock prices to decrease below the fair level value. The reaction stems from the recognition that companies would either offer fairly or over priced equity and investors assume that good business sense would drive companies to over price equity. The effect on the company depends upon whether it has fairly priced or over priced its equity offering. If the company has fairly priced equity, the price drop results to the undervaluation on the part of shareholders but if the company over priced equity, the decrease in price as long as this is not too big constitutes a correction in value rather than real economic cost to the shareholders. (Barclay & Smith 2000, Simerly & Li 2000)

This highlights the importance of minimising the information gap between the company decision-makers and investors. 

Capital Structure Constructs in Decision-Making among Business Firms

            In practice, the survey conducted by Graham and Harvey (2002) on the theoretical constructs preferred by decision-makers in making the capital structure shows that the consideration of tax advantage of debt covered by the trade-off theory was deemed as moderately important in the capital structure decision. However, the results also showed that among companies of different scale and financial status, the tax advantage of debts still accrued great importance among large companies that are more leveraged, incurring lesser risks, engaged in manufacturing, highly regulated and dividend-paying. This means that companies likely to experience high marginal corporate tax rates hold stronger incentives to obtain the tax advantage from debt consistent with the trade-off theory.



This research requires appropriate organised data gathering and analysis procedures to meet the identified objectives.

The study applies the positivist research approach. This is because the research involves the accomplishment of these stages of the positivist approach: 1) formulation of hypothesis; 2) testing the hypothesis; 3) showing the falsity of the hypothesis; and 4) formulating predictive principles (Morris 2006). The hypothesis in the current research is the making of capital budgeting and capital structure decisions as supported by the existing models or theoretical constructs but the nature and extent of support derived from these constructs is yet to be determined. The present research also seeks to capture reliable data and the positivist approach focuses on data measurement precision and reliability (Collis & Hussey 2003). Although the research covers the decision-making process, which is a cognitive undertaking indicating a phenomenological bearing, the bulk of financial data are measurable so that the primary research approach becomes more positivist than phenomenological.

In relation to research perspective, the study utilises the objective approach. This is because the researcher is not a member of the business organisations subject of the study. As a non-member of these organisations, the researcher seeks to explore the nature and extent of the relationship between theoretical constructs and decision-making on capital budgeting and capital structure relative to their achievement of financial as well as competitive objectives. Although certain degrees of bias on the part of the researcher is inevitable in understanding and interpreting data derived from the research participants, objectivity or fact-based approach is maintained through the utilisation of a uniform measurement and analysis criteria for all the business firms being studied and the answers given by the research participants. (Chatman 1984; Mellon 1990; Fidel 1993; Sutton 1993; Westbrook 1994)

With regard to data treatment, the study utilises both qualitative and quantitative research methods.

Qualitative research is a method used to elicit detailed verbal and written descriptions or accounts of characteristics, cases and situations. (Rubin & Rubin 1995; Alasuutari 1998; Stringer 1999) This approach is appropriate for the study because the research objectives involve an investigation into the cognitive process underlying the decision to utilise theoretical constructs to support the decision-making process over capital budgeting and capital structures. This supports the derivation of comprehensive research data by covering the immeasurable aspects of the research particularly the perceptions of decision-makers themselves over the preferential relationship between constructs and decision-making in the business context.

Quantitative research is geared towards deduction since it tests and develops theory. This means that this type of research method leads to generalised results. Apart from this, quantitative research method also involves the treatment of measurable or quantifiable data. (Kervin 1992; Gill & Johnson 1997; Blaxter, Hughes & Tight 1998) The present research applies the quantitative research method because the goal of the study is to test the research hypothesis. Apart from this, a research objective is to achieve reliable data as bases for generalisations or theory. Moreover, primary data will be tabulated and analyzed through statistical measures to determine improvements in performance as well as frequencies, averages and variances in the answers provided by the research participants in order to support the generalisations regarding the preferred use and the extent of use of constructs to support decision making in the financial management areas of capital budgeting and capital structure.

With the use of the combination of the positivist approach, the objective research perspective and the qualitative and quantitative data treatment methodologies, the study seeks to achieve the predefined research objectives as well as to achieve credibility by recognizing the inevitable existence of bias but ensuring that data and data gathering methods work towards the achievement of overall dependability and confirmability of the study.        

In terms of data collection, the study constitutes a descriptive research, particularly utilising the survey method.

A descriptive research is a type of study that tries to explore the causes of a particular phenomenon, present facts concerning the nature and status of a situation, as it exists at the time of the study, and portray an accurate profile of persons, events or situations (Creswell 1994; Robson 2002). The purpose of employing the descriptive method is to capture the nature of a situation, as it exists at the time of the study and to explore the cause/s of particular phenomena.. The approach undertaken for such type of study is appropriate for a number of reasons. The descriptive approach is quick and flexible giving rise to three advantages: first, when new issues and questions arise during the duration of the study, this approach allows a further investigation. Secondly, when there are unproductive areas from the original plan of the study, the researcher can drop them; and thirdly, the approach is more practical in terms of time and money.

A descriptive research uses observations and interviews. For this reason, the researcher chose this approach because it is the intention of the researcher to gather first hand data from the key decision-makers of manufacturing companies to obtain their perceptions over the dynamics of the relationship between the preferred theoretical construct and decision-making. With the help of the descriptive approach, a clear picture of this phenomenon may be provided (Saunders et al. 2003). This type of study may serve as an extension or a forerunner to a piece of exploratory research, a valuable research approach employed to: discover what is happening; seek new insights; ask questions; and/or evaluate a phenomenon in a new light.

To accomplish the research objectives and obtain necessary information, the survey method appropriately supports data collection to address the research objectives. The survey method is a descriptive and non-experimental research method used to collect data of a particular phenomenon. This method is effective in studies involving the determination and assessment of the nature and extent of influence of a variable/s to other research variables.  

The survey method allows the researcher to obtain unbiased, accurate and generalisable data. This data gathering method has advantages and disadvantages that should be considered in the application of the method so that disadvantages are as much as possible addressed. First, the method established the existence of a relationship between the variables but it does not determine the direction of the relationship. This issue is addressed in the research through the application of the qualitative method where the perceptions of the research participants are obtained to fill the weakness of the survey method. Second is the reliance of survey method on self-reported data implying great dependence on the truthfulness and accuracy of information given by the participants opening the research to the risk of obtaining unreliable data. The risk is arrested by the use of measurement tools in determining performance so that quantitative data addresses the limitations of qualitative data and vice versa. Third is the tedious research planning required by the survey method necessitating a minimum period of at least seven weeks for the completion of the survey. The current research meets the minimum survey period requirement as indicated in the timetable for the completion of the research.

The method will be applied through a survey questionnaire floated to key decision-makers in manufacturing companies. Apart from knowledge and experience over capital budgeting and capital structure decision-making, other selection criteria include participant ages to be consistent with those ordinarily found in the workforce, ages 25 through 60. Age and gender does not comprise selection criteria for research participants.

Initially, the research will utilize purposive sampling to determine the number of manufacturing companies and random sampling to choose a representative sample for the manufacturing industry. Again, purposive sampling will be utilised to determine the key decision-makers with knowledge and experience of the decision-making over capital budgeting and capital structure and out this number, random sampling will be applied to determine a representative sample as needed. The research applies the simple random sampling method through the formula n/N x 100 = 10% to obtain a representative sample from each business firm. The formula affords sufficient representation of employees in every organization to support data integrity.

Data requirement for the research covers both primary and secondary sources.  Secondary data comprised of concepts, definitions, past statistics, and research results contained in raw data and published summaries to serve as the foundation and context for the research. Secondary data fall into three main subgroups: documentary data, interview-based data, and those compiled from different sources. Documentary secondary data are derived from primary data collection methods to be while interview-based secondary data are collected through questionnaires that have already been analysed for their original purpose. Primary data comes from the results of the survey conducted covering key decision-maker of manufacturing companies. Secondary data works as foundational support for the research while primary data serves to confirm the validity of a theory, invalidate existing theories, and confirm some aspects but invalidate other separable aspects of theories based on the context of the actual experiences of manufacturing companies in utilising constructs to support the decision-making process.  

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