Table Of ContentContributions to Management Science
Baliira Kalyebara
Sardar M.N. Islam
Corporate
Governance,
Capital Markets,
and Capital
Budgeting
An Integrated Approach
Contributions to Management Science
For furthervolumes:
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Baliira Kalyebara (cid:129) Sardar M.N. Islam
Corporate Governance,
Capital Markets, and Capital
Budgeting
An Integrated Approach
BaliiraKalyebara SardarM.N.Islam
SchoolofCommerceandLaw SchoolofBusiness
CentralQueenslandUniversity VictoriaUniversity
Rockhampton,Queensland Melbourne,Victoria
Australia Australia
ISSN1431-1941
ISBN978-3-642-35906-4 ISBN978-3-642-35907-1(eBook)
DOI10.1007/978-3-642-35907-1
SpringerHeidelbergNewYorkDordrechtLondon
LibraryofCongressControlNumber:2013941870
#Springer-VerlagBerlinHeidelberg2014
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Foreword
The task of investment appraisal for efficient allocation of resources in project
selection and capital budgeting has been an enduring central theme in economics
and business for a long period of time. The objective of this book, Corporate
Governance, CapitalMarketsandCapitalBudgeting:An Integrated Approach, is
to develop a multi-disciplinary approach that integrates the impacts of multi-
dimensional factors and objectives of corporate governance, capital markets and
capital budgeting to evaluate long-term investments for appropriate investment
appraisal. The authors of this book have successfully managed to achieve this
objective through examining two case studies of Tom.com Group in Hong Kong
andWorldAirwaysintheUSrespectively.Theresultsofthestudyclearlypresent
verypracticalsolutionsaboutthecapitalbudgetingprocesswhichbothacademics
and practitioners should embrace. The approach incorporates different multiple
objectives to maximize firm value which undoubtedly improves on the existing
investmentappraisalprocess.Thedevelopedapproachcangenerallyandeasilybe
adoptedinallcapitalbudgetingprocessesandframeworks.
In this modern economy that relies on information technology to operate effi-
ciently, the traditional discounted cash flow techniques used in capital budgeting
arenolongeradequatetohandletheimpactsofmulti-dimensionalmarketforceson
capitalbudgetingdecisions.Thisbookistimelyasamulti-disciplinaryapproachto
capitalbudgetingandisnecessaryforachievingefficiencyinresourceallocationin
thecurrenteconomicenvironment.
After observing the profound impacts of Asian financial crisis in 1977 and the
GlobalFinancialCrisis(GFC)in2007ontheglobalknowledgeeconomy,ingeneral,
andtheoperationsofthee-commercesectorandtheairlineindustry,inparticular,the
authors envisaged the need for writing a book that could improve on the existing
investment appraisal techniques. The economic impact caused by the dot.com
bubbleburstin2000andtheGFConthee-commercesectorandtheairlineindustry
iswellknown.Anumberofdot.comcompaniessuchasBoo.com,Pets.com,etc.and
airlinecompaniessuchasTransWorld and American WestAirlines inthe USand
AnsettandCompassAirlinesinAustraliacollapsed.
v
vi Foreword
The new integratedapproach toinvestment appraisal developedby the authors
has a wide range of positive implications and for the e-commerce sector and the
airline industry for avoiding corporate crises and collapses. Throughout the book
the integration of the impacts of multi-dimensional factors and objectives of
corporategovernance,debtequityratio,agencycosts,riskmanagementandinterest
ratesoncapitalbudgetingdecisionmakingisfullyexploredandanalysed.Alsothe
impactofinterestratesonthechoiceofborrowing,discountrates,andthecostof
capital in investment appraisal, project selection and capital allocation is fully
explained.
This book makes a significant contribution to the literature on investment
appraisalandcapitalbudgetingdecision-making,ingeneral,andinthee-commerce
sector andtheairline industry,inparticular.Ibelievethattheauthorshave devel-
oped an excellent approach in the determination of capital budgeting decisions.
Therefore, I strongly recommend this book to all readers interested in efficient
allocationofresources,capitalinvestment,andpublicpolicyformulation.Thebook
should benefit university students, researchers, academics and practitioners in
the areas of economics, finance, banking, investment appraisal and financial
management.
ProfessorPeterDawkins
Vice-ChancellorandPresident
VictoriaUniversity,Australia;
Ex-SecretaryoftheVictorianGovernmentDepartmentofEducationand
EarlyChildhoodDevelopment,Victoria,Australia;
Ex-RonaldHendersonProfessor,andEx-DirectoroftheMelbourneInstituteof
AppliedEconomicandSocialResearch,UniversityofMelbourne,Australia.
Preface
The objective of this study is to develop a mathematical model and a conceptual
frameworkwhichintegratestheprinciplesofcorporategovernance,capitalmarkets
and capital budgeting to maximise shareholder wealth. These different principles
areappliedtotwocasestudies.Theresultsofthisstudyprovideusefulinformation
about the investment appraisal process, incorporating multiple issues in capital
budgeting decision making which cannot be achieved using the existing capital
budgeting models and framework. The proposed framework can be applied in all
capitalbudgetingexercisesandframeworks.
With information technology pervading the current global environment, the
traditional discounted cash flow techniques used in capital budgeting are not
adequate to handle the interdisciplinary impacts of corporate governance, capital
market,riskmanagement,accountingpracticesandregulationoncapitalbudgeting
decisions.Therefore,thereisaneedfordevelopinganewintegratedframeworkfor
modelling and analysing capital budgeting issues by simultaneously considering
theseimpacts.
Thepurposeofthisresearchistodevelopanewintegratedapproachorconcep-
tual framework for investment appraisal which integrates the principles of corpo-
rate governance, capital markets and risk management in a multi-criteria capital
budgetingprocess.
Thisresearchadoptsdecisionmakingandcapitalmarketresearchinanaccount-
ingperspectiveinadiscountedcashflowanalysisandmulti-objectiveoptimisation
modelling.Thisstudyusestwocasestudies.TheTom.comcasestudyisareal-life
casestudy,whiletheWorld Airways casestudyisahypotheticalone.Intermsof
datacollection,acasestudyapproachisinitiallytaken,usingareal-lifecasestudy
involving an e-commerce company, http://www.tomgroup.com/investor/report.
Data iscollectedfromthe annualreportsforthe last5yearsofitsoperations(see
alsoRayportandJaworski(2002)).Thisstudyalsousesahypotheticalcasestudy,
WorldAirways(Levary&Seitz1990),wheremultipleflightroutes,thepurchasing
of wide and narrow-body airplanes, borrowing and lending money, debt capital,
debt equity ratio and agency costs are all examined. This study uses a multiple
objectivelinearprogrammingmodel,whichisbasedonacapitalbudgetingmodel
vii
viii Preface
of Levary and Seitz (1990), and it is solved by Solver which is one of the add-in
optionsinMicrosoft’sExcelsoftwareprogram.
The results from this research provide an appropriate investment appraisal
framework and an appropriate capital budgeting model. They show an improve-
ment in NPV ranging from $1,835.11 to $1,865.35 million. The model integrates
capitalmarketinteractions,riskmanagement,agencycostsandcashflowbasedon
multiple criteria objectives as critical in an institutionalised capital budgeting
process. It provides operational processes which can be applied by any
organisationsmakingdecisionsincapitalinvestments.
This new integrated approach to investment appraisal has wide implications
for most industries, which make capital investments, in general; and for the
e-commerce sector and the airline industry; in particular. This study supports
the argument for the interdisciplinary nature of capital budgeting decisions that
theintegrationofcorporategovernance,debtequityratio,agencycostsandinterest
ratesaffectchoiceofborrowinganddiscountrate,costofcapital,projectselection
and capital allocation which in turn impact on decisions in investment appraisal.
Therefore,thereisaneedtorevisitthetheoryofcapitalbudgetingaspresentedin
textbooksandadoptanintegratedmultidisciplinaryapproachtocapitalbudgeting.
Financialmanagersshouldconsidertheimpactofmulti-criteriaobjectives,suchas
cashflow,riskmanagement,interestratesandagencycostsasthenormratherthan
theexceptioninthecurrenteconomywhichpredominatelyusesinformationtech-
nologywhenmakinginvestmentappraisaldecisions.
This study has developed a new integrated framework for modelling and
analysing capital budgeting issues. The model integrates corporate governance
principles using agency costs, capital markets interactions using interest rates,
capitalbudgetingprinciplesusingpresentvalueandriskanalysisusingsensitivity
andscenarioanalysis.Themodelconsidersmultiplecriteriaobjectivestoevaluate
capital projects in general and projects in the e-commerce sector and the airline
industryinparticular.
The authors would like to express their sincere thanks to Siti Nuryanah,
Margarita Kumnick, Gayathri Mekala, Ruchi Gupta and Neelam Maharaj for
proofreadingthisbookandprovidingtheiracademicandeditorialcomments.The
first author would liketoacknowledge the support, love andencouragement from
hiswifeWinnieandsonAlbert.ThisbookisdedicatedtoApuuli(RIP)whotaught
himthevalueofhardworkandeducation,andalsopreparedhimforthechallenges
ofthisworld–thankyouApuuli.Theauthorstakeresponsibilityforalltheerrorsin
thisbook.
Queensland,Australia Dr.BaliiraKalyebara,PhD
Melbourne,Australia Prof.SardarM.N.Islam,PhD,LL.B
Academic Acknowledgement
Theauthorsoweacknowledgementtotheauthorsandpublishersofthetwobooks
wherethetwocasestudiesusedinthisstudywereobtained.
1. The information on the use offinancial multiples and discounted cash flows in
the first case study: Tom.com Group Case was adopted from the company’s
website and a book by Rayport, J.F and Jaworski, J. J (2002), Cases in
e-Commerce,McGraw-HillHigherEducation,NewYork,NY10020.
2. The optimization model in the study is based on the second case study: World
Airways Case that was adopted from a book by Levary, R. R and Seitz, N. E
(1990),QuantitativeMethodsforCapitalBudgeting,South-WesternPublishing
Co.,Cincinnati,OH.
ix
