A Survey of Capital Budgeting Techniques Applied by Sugar Companies in Western Kenya

Abstract

Capital budgeting is one of the most important factors in the process of corporate decision making. Capital budgeting models have been and continue to remain the predominant means for evaluating and selecting amongst investment opportunities. Firms that choose correctly reap improved financial performance while those that get the decision wrong either suffer losses as a result of making the ill-fated decision or incur a significantly high opportunity cost in the event that they chose not to invest. This was a census survey which intended to collect data from the nine sugar companies in Western Kenya, although data was collected from nine companies. In light of the above, this research paper seeks to provide empirical evidence about the capital budgeting techniques used by the sugar companies. The study utilized a self administered semi structured questionnaire to collect data from the eight chief financial officers of the sugar companies. The study finds that sugar companies regularly and always employ a simple payback period followed by discounted techniques such as NPV and IRR. A small percentage of the companies that use DCF techniques use WACC to determine the discount rate and the weights are determined by target/ market values and book values in the same proportion. However some gaps where noted in the application of finance theory. Some companies use accounting profits as opposed to cash flows, they use book values to determine weights as opposed to market values, they do not treat inflation correctly and finally scenario analysis is the dominant risk measure used as opposed to more sophisticated methods such as decision trees and simulation analysis. Real options approach which is a new technique has low popularity among the sugar companies. An interesting finding is that these companies have high debt to equity ratios indicating that they are, highly leveraged. An area worth further research is whether the use of a particular technique leads to high improved financial performance or vice versa.