Jibola on Fin Statement

8/6/2019 Jibola on Fin Statement

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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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Documents

Jibola on Fin Statement