Capital Budgeting – Cheap Research Essays

Scope of research: Modern management accounting systems, improve efficiency and effectiveness
Bottom Line Effectiveness Measured with Capital Budgeting

Table of Contents
1 Introduction 1
2 Problem Indication 1
4 Research methods 3
5 Analysis 3
6 Proposed Timeline 4
Literature 5

1 Introduction

Technological advances, shorter product life cycles, changing consumer demands and sophisticated competition make strategic capital investment decisions crucial to the success of a firm. Management accountants are responsible for analyzing the effectiveness of capital expenditures. Errors could be costly and affect the firm’s performance and future direction.

With revenues over $6 billion, 13,000 employees and locations in over a 100 countries worldwide, IGT is the global leader in the gaming industry. The mission statement of IGT is: “We create value by adhering to the highest standards of service, integrity, and responsibility”. Leveraging a wealth of knowledge, substantial investments in innovation, in-depth customer intelligence, operational expertise, and leading-edge technology, IGT expects to achieve its strategic objectives and maximize shareholder value.

One of IGT’s business units, Lottery Management Services, is responsible for managing public lotteries under a private management agreement. IGT established a subsidiary, Northstar Lottery group, in 2010 in which it holds an 80% controlling interest. In January of 2011, Northstar entered into a 10-year agreement with the states of Illinois, Indiana and New Jersey acting through the Department of the Lottery. Northstar guaranteed the State of Illinois a minimum profit level for each fiscal year of the agreement. $851 million in FY2012 and by FY2016 it is expected to hit the $1 billion milestone (Illinois Lottery, 2010). Northstar is responsible for day to day operations and marketing activities of these three state lotteries. IGT itself supplies the lotteries with lottery tickets and point of sale systems. Both Northstar and IGT receive a management fee based on either net income or sales, depending on the service.

In August of 2014 the State of Illinois terminated the private agreement with IGT’s subsidiary Northstar as net income targets fell short three years in a row. However, Northstar didn’t agree with the termination as it always adhered to its agreement with the State of Illinois. Northstar paid penalties for net income shortfalls. The case continued in court and the judge ruled in Northstar’s favor. The contract was terminated under a clause of convenience. This means that the State only could terminate the contract if it would pay enormous fees to Northstar (approximately $200 million). Democratic governor, Pat Quinn, at the time, decided to move forward and terminate the contract under political pressure as elections were occurring in autumn of 2014. Pat Quinn lost the election and was succeeded by Republican Bruce Rauner. The Rauner administration took over in January of 2015 and had a dissenting view on the escalated lottery situation. Currently, Northstar is still active in Illinois and is trying to resolve the matter of not reaching the net income targets. One way is a downward adjustment of net income targets as jackpots are unpredictable. Another way is to generate more net income. The present research study will attempt to fill this gap by exploring if a capital expenditure in fixed assets from IGT will lead to an increase in the net income of the Illinois Lottery.
2 Problem Indication

As mentioned previously, the purpose of this research is to investigate whether a capital expenditure from IGT can lead to an increase in the net income of the Illinois Lottery. Expanding IGT’s asset portfolio with secure and advanced software and hardware will allow consumers to play lottery games online. Prior research (Elsdijk, unpublished) showed that sales declined significantly (23.8%) of players in the age group 18 to 30 years. Focusing on the e-commerce sales channel could lead to regaining consumers in the age group 18 to 30 years. The urgency of this research is significant because Northstar (and IGT indirectly) are responsible for meeting the net income target of the Illinois Lottery. Higher net income and revenues of the Illinois lottery will also result in higher management fees for Northstar and IGT. In addition to higher income, it is hypothesized that sophisticated capital budgeting practices will give IGT an understanding of the risks and returns involved to measure the effectiveness of their investments. (Is this your problem statement?) The knowledge gained from this research could be beneficial for the stakeholders. A novel perspective on the stakeholders’ process for capital expenditures could allow improvement and a more preventative framework for strategic decision making (or is this your problem statement?). Additionally, a profitable investment in Illinois could lead to investments in other states. In order to explore whether an investment is profitable for all stakeholders involved, the following problem statement and associated research questions will be examined.

How can IGT determine whether a capital expenditure in hard- and software for enhancement of e-commerce, will contribute to an increase in the net income of the Illinois Lottery? Include the main topic in (capital budgeting) in this question. Also, is capital budgeting contributing to a more effective process for strategic decision making? Or are capital budgeting practices contributing to net income? The current question doesn’t connect with your paper..

• What is capital budgeting and what is the relation to management accounting? (Theory)
• What is the role of the management accountant in capital budgeting practices? (Theory)
• How should companies account for capital expenditures according International Financial Reporting Standards? (Theory)
• What are the stages in the capital budgeting process? (Theory)
• Which capital budgeting evaluation techniques are considered most effective? (Theory)
• Which inputs are most vital in capital budgeting? (Theory)
• How can risk and uncertainty be incorporated in the capital budgeting process? (Theory)
• What are common judgement traps in decision making? (Theory) Why this question?
• Why did Northstar not deliver the expected financial results to the Illinois Lottery and what has been done to resolve this matter? (Results from qualitative research) I think this should go in your introduction to validate your problem statement.
• How does IGT currently apply capital budgeting in practice? (Results from qualitative research)
• How does IGT cope with uncertainty in the capital budgeting process? (Results from qualitative research) Isn’t this the same question as the one question before?
• What is the prognosis of future cash flows of the investment project considering risk and uncertainty? (Results from qualitative research and quantitative data analyses)

Feedback: Lot of research questions: Is the scope of research capital budgeting or strategic decission making or both? Or are you looking at how to consider uncertainty in decision making. Choose your focus and build a conceptual model.
3 Initial Theoretical Framework

The corporate finance theory, and specifically the literature on capital budgeting, will contribute to the understanding of this study. Capital budgeting is a management accounting tool which supports strategic decision making practices. Allocating funds among competing investment projects is one of the most critical decisions that top management has to deal with, as it is the means of implementing a firm’s strategy (McGrath et al., 2004;). Management accounting practices must meet three criteria (Drury, 2004; Vlotman, 2001): 1) Allocation of cost and revenues from goods and services (cost accounting); 2) provision of reliable information for prudential management decisions (accounting for decision making); and 3) provision of information for planning, control, and performance measurement (accounting for planning and control; responsibility accounting). Capital budgeting meets all three of these criteria. Moreover, capital budgeting is the process of planning, analyzing, selecting, and managing capital investments (Baker & Powell, 2005).

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A number of seminal theories and developments in the literature will guide the theoretical framework. The tensions between theory and practice in management accounting, as well as insight into recent findings in contemporary management accounting research will be discussed (Baldvinsdottir, Mitchell, & Nørreklitc, 2010). Consistent with Baldvinsdottir and colleagues (2010), it will be argued that there is a need to retain a focus on the technical core of practice.

Furthermore, decision making is an essential component in the current study. Specifically, psychological approaches to judgments and decision making will give a broader perspective beyond corporate finance theory (Kahneman, 2011).

Returning to finance theory, Modigliani and Miller’s (1958) theory lays the foundation for project valuation, particularly in regards to the combination of equity and debt used for funding a project and the calculation of cash flows. Although this theory was fixated on firm valuation, different from the current study, it is a starting point in the finance literature for, inter alia, capital budgeting and project valuation.

More recent literature (Graham & Harvey, 2001) will provide a better understanding of which capital budgeting methods are being used in practice today. In that study, 392 CEOs of large companies were interviewed regarding the cost of capital, capital budgeting and capital structure. The results give insight into which methods are most commonly used in practice, consistent with the focus on applied practices in the current study. Myers (1977) coined the term, real options, which incorporates uncertainty of future cash flows, irreversibility of capital investments, and the timing of the project initiation, all relevant to the proposed analyses in the current study. A clear understanding in techniques for incorporating risk in IGT’s capital budgeting practices will be provided, such as steps for accounting for risk and uncertainty in the capital budgeting process (Baker & English, 2011). Lastly, trade journals in the gaming industry will be consulted to discuss relevant developments in the gaming market.
4 Research methods

The main research question in this study will be examined utilizing qualitative methods. Specifically, reliable, valid qualitative data will be collected and used to create values for the key variables in this study. This data will serve as input for the calculations of the capital budgeting analyses (see Analyses section for a description). Qualitative research methods in this paper will follow the framework developed by Madill and Gough (2008).

First, in order to find out whether a capital expenditure is profitable, data will be collected via qualitative methods. More specifically, five structured interviews with key informants (employees) within the company will be conducted:

 Chief Executive Officer Northstar;
 Vice President of Finance and Administration at IGT;
 Vice President of Operations at IGT;
 Senior Director of Marketing at Northstar;
 Senior Manager Market Research at Northstar.

In addition to the interviews, original sources will be consulted, such as:

 Archival documents;
 Annual report,
 Corporate governance code,
 Risk management policy.
 Trade Journals;
 Public Gaming International Magazine,
 La Fleur’s Magazine.
 Internet material.