A survey of capital budgeting techniques used by companies listed at the Nairobi stock exchange

Abstract

The heart of Financial Management lies in making decisions that will maximize the value of the firm. Probably the most important financial decisions involve those whose results will be felt over an extended period. Capital investment decisions are some of the very vital decisions taken by management of organizations. They are not easily reversible and place organizations on new paths leading to long-run survival or ultimate failure. To make sound capital budgeting decisions, theory advocates for the use of a systematic approach which involves, a continuous and creative search for investment opportunities, forecasting the supply and cost of funds for investment purposes, estimating each project's cash flows and other benefits, ranking and choosing among competing projects, post-auditing already committed investments and strategic capital budgeting. Use of discounted cash flow techniques, incremental cash flow approach, project specific cost of capital and risk analysis have been strongly advocated by academicians. Empirical evidence shows that management of corporations do not necessarily follow theoretically sound techniques but to some extent use techniques from the "dark- ages". It is however reassuring to note that organizations are gradually coming to use more refined techniques in their capital budgeting analysis. What remains of great concern to most managementis the problem of increasing complexity of activities and the environment in which they operate. This study set out to determine the capital budgeting techniques used by companies listed at the Nairobi Stock Exchange, to ascertain whether the techniques used conform to theory and to practices of organizations in the developedeconomies as evidenced by studies done in these economies. - VB - This study surveyed 43 companies listed at the Nairobi Stock Exchange about the capital budgeting techniques that they employ in their capital investment decisions. Most companies ignore the first stages of the capital budgeting process. Companies are concerned about incorporating risk in their capital budgeting process. Most companies employ non-discounted cash flow techniques to evaluate investment proposals. Companies use cost of specific source of funds and management determined target rates of return to determine project discount rate. Companies consider strategic aspects of capital budgeting and do engage in post auditing of completed projects. No relationship was established between firm, CEO and project characteristics and capital budgeting techniques.