Capital Budgeting Techniques Adopted By Companies Listed at the Nairobi Securities Exchange

Abstract

Capital budgeting decisions are very important for financial managers since they determine the choice of investment projects that will affect company value. The adoption of the appropriate capital budgeting tools provides managers with both the processes and techniques required to make decisions that will enhance the organization’s resource base while improving its ability to serve its members and evaluate effectiveness of its investments. The general objective of this study was to assess the capital budgeting techniques adopted by companies listed at the Nairobi Securities Exchange. The study had four specific research objectives including: determining the structure of capital budgeting process adopted by companies listed at the Nairobi Securities Exchange; determining the capital budgeting techniques adopted by companies listed at the Nairobi Securities Exchange; analyzing the factors affecting choice of a capital budgeting technique by companies listed at the Nairobi Securities Exchange; and determining the risks in capital budgeting techniques adopted by companies listed at the Nairobi Securities Exchange. This study applied a descriptive study design. The target population comprised all the companies listed at the Nairobi Securities Exchange as at December 31st, 2013. A sample size of 42 firms was selected from a total population of 62. Primary data was collected using a questionnaire. Data analysis was done using SPSS and Microsoft Excel to generate quantitative reports. The collected data was analyzed and presented in the form of tabulations, percentages, mean and standard deviation. The study found out that the companies had a clearly defined process governing capital budgeting. The study further found out that the organizations collected relevant and detailed information on each investment opportunity presented to them, analyzed investment opportunities thoroughly to establish their worthiness to the organization and their alignment to the strategic plan and set budgets for each investment project to be undertaken. The companies also evaluated the fitness of the investment opportunities against the corporate strategic plan. On the capital budgeting technique, the study found out that all the proposed capital budgeting techniques were utilized in the organization. The most utilized capital budgeting method was internal rate of return followed by net present value technique. Profitability index technique was third while Present- Value technique was fourth. Other techniques utilized included discounted Payback technique, Accounting/Average Rate-of-Return technique and Modified Internal Rate of Return (MIRR) technique. For those least utilized, the respondents identified failure to take into account time value of money as they key reason for not applying some techniques followed by lack of familiarity with the technique and cumbersome computations involved. On the factors affecting the choice of capital budgeting technique among the organizations listed at the NSE, certainty of the cash flow affected the choice of capital budgeting technique, The size of the firm, the state of the economy, prevailing corporate taxes in the economy, limitation of the strategic plan of the organization, amount of capital available for investment, environmental impact of the project and profitability levels of the project. Government regulations on the sector, affected the capital budgeting technique to little extent. On the risks in capital budgeting techniques, high inflation affecting interest rates ranked the greatest risk, other risks such as cash flow not flowing in as anticipated. Collapse of the investee company, management investing the invested funds in risky projects, and fluctuating cost of capital used in computations, re encountered only to a little extent with an average were encountered by the firms. The study recommends that capital budgeting be a key process in an organization’s development plan which needs to be handled with strict care because of the impact it has on the future of the organization. It recommends that capital budgeting appraisers collect as much information as possible concerning the investment project, macro-economic changes that are likely to affect the operating environment so as to come up with appropriate inflation adjusted cost of capital used in appraising projects. The study further recommends that capital budgeting process incorporate risk management officers who would advice the team on ways of minimizing such risks.