THE RELATIONSHIP BETWEEN CAPITAL BUDGETING 
TECHNIQUES AND FINANCIAL PERFORMANCE OF 
COMPANIES LISTED AT THE NAIROBI STOCK EXCHANGE.
BY
MUNYAO A LB ANUS
A Research Project Submitted in Partial Fulfillment of the Requirements for the 
Degree o f Master ^ B u sin e ss  Administration University of Nairobi
2010
DECLARATION
I declare that this research project is my original work and has not been presented for a 
degree or any other academic award in any institution of learning.
Signature
Munyao Albanus
n / 5 - l / ' 2 O / 0D ate..... .................................
D61/70317/2007
This project has been submitted for examination with my approval as the University 
supervisor.
Signature ... Dale ... t Q . ' / f 4
Dr. Aduda J.O,
Lecturer,
Department of Finance and Accounting,
School o f Business,
University of Nairobi.
m
DEDICATION
To my Dear Wife Judith Ngina
My Daughters 
Jenna Muthio 
and
Bella Mukulu
May this project inspire you to excel.
iii
ACKNOWLEDGEMENT
To God be the glory and honor, for His mercies and divine provisions during my entire 
period of study.
My gratitude goes to all my lecturers and all my friends and colleagues, who encouraged, 
inspired, challenged and in all helped me to bear the burden. Special appreciation goes to 
the following:
To my supervisor Dr.Aduda, thank you very much for your guidance, patience, time and 
concern in guiding me and shaping my Project to its present state.
To my colleagues and friends, Rolnad Chogii, Jacqueline Ngeta, Beatrice Chelangat and 
David Mbithi for synergy, laughter and encouragement to complete this research.
Finally to my dear Wife, Judith and daughters, Jenna and Bella for your unrelenting 
support and care. Thank you for bearing with the late night studies and absence when you 
badly needed me.
IV
TABLE OF CONTENTS
Page
Cover page................................................................................................................... i
Declaration.....................................................................................................................ii
Dedication...................................................................................................................... iii
Acknowledgement....................................................................................................... iv
Table o f Contents......................................................................................................  v
List of tables..........................................................................................................  ix
List of figures................................................................................................................x
Abstract.......................................................................................................................  xi
CHAPTER ONE.................................................................................................................  1
1.0 INTRODUCTION........................................................................................................ 1
1.1 Background to the study...................................................................................... 1
1.1.2 Capital budgeting techniques.............................................................................. 2
1.1.3 Financial performance.......................................................................................... 3
1.1.4 Nairobi Stock Exchange..................................................................................  5
1.2 Statement of the Problem........................................................................................5
1.3 Research Objectives................................................................................................ 6
1.4 Significance of the Study......................................................................................  7
v
CHAPTERTWO...................................................................................................................... 8
LITERATURE REM EW
2.0 Introduction........................................................................................................... 8
2.1 Theoretical Framework......................................................................................... 8
2.1.1 The Contingency theory....................................................................................... 8
2.1.2 The Garbage Can theory.....................................................................................9
2.1.3 The Incrementalism theory................................................................................  10
2.1.4 The Real options theory..................................................................................... 10
2.2 The Evolution of Capital budgeting Practices.................................................  11
2.3 The Capital budgeting Process........................................................................... 12
2.4 Decision Criteria.................................................................................................  15
2.5 Risk Analysis....................................................................................................... 18
2.6 Performance Measures....................................................................................  19
2.7 Empirical studies on capital budgeting techniques and
financial performance............................................................................................  22
2.8 Summary and conclusions o f empirical studies...........................................  27
VI
CHAPTER THREE 29
RESEARCH DESIGN AND METHODOLOGY
3.0 Introduction........................................................................................................  29
3.1 Research Design...................................................................................................... 29
3.2 Population of the study........................................................................................... 29
3.3 Data collection......................................................................................................... 30
3.4 Test validity and reliability.....................................................................................30
3.5 Data Analysis.......................................................................................................... 30
CHAPTER FOUR..................................................................................................................32
DATA ANALYSIS, FINDING S AND DISCUSSION
4.1 introduction............................................................................................................. 32
4.2: General information...............................................................................................32
4.2.1: Response rate.............................................................................................  32
4.2.2: Distribution of respondents by designation...............................................  32
4.2.3: Distribution of respondents by length of Service with organization
(years)...................................................................................................................  33
4.2.4: Distribution of respondents by legal status..................................  34
4.3 Capital Budgeting Techniques............................................................................. 34
4.3.1 Use of Capital Budgeting Techniques................................................................ 35
4.3.2 Existence of a major switch in techniques used over the last 5 years............. 36
4.3.3 Techniques used when deciding investment projects to pursue..................... 36
4.3.4 Staff assigned full-time to capital investment analysis.................................... 37
4.3.5 Existence of written capital investment guidelines........................................  38
4.3.6 Technique companies use to assess a project’s risk.............................................38
vii
4.3.7 Approaches used in determining the minimum acceptable rate of return 39
4.4 Correlation and Regression analysis........................................................  40
4.4.1 Correlation analysis...............................................................................  40
4.4.2 Strength of the model..................................................................................  40
4.4.3 Regression Analysis......................................................................................  42
4.5 Summary of findings and interpretation.......................................................  43
CHAPTER FIVE........................................................................................................  45
5.0 SUMM ARY CONCLUSION AND RECOM M ENDATIONS...............
5.1: Summary....................................................................................................... 45
5.2 Conclusions.....................................................................................................  46
5.3 Policy Recommendations..................................................................................  46
5.4 Limitations of the Study..................................................................................  48
5.5 Suggestions for further study.......................................................................... 49
REFERENCES............................................................................................................50
Appendix I: Letter of authorization to collect data.................................................
Appendix II: Questionnaire....................................................................................
Appendix III: List of companies listed in Nairobi stock Exchange.........................
viii
LIST OF TABLES
Table 4.2.3: Length of Service with organization (years)....................................... 33
Table 4.3.1 Frequency of use of Evaluation Techniques............................................ 35
Table 4.3.2 Techniques used when deciding investment projects to pursue.......  37
Table 4.3.3 Technique companies use to assess a project’s risk................................. 39
Table 4.3.4 Approaches used in determining the minimum acceptable rate of return39
Table 4.4.1: Pearson Correlation coefficients............................................................. 40
Table 4.4.2: Model Summary....................................................................................... 41
Table 4.3.3: ANOVA................................................................................................... 41
Table 4.3.4: Coefficients of regression equation 43
LIST OF FIGURES
Figure 1: Gender Composition 
Figure 2: Legal status
Figure 3: Existence of a major switch in techniques used over the last 5 years 
Figure 4: Full time staff to handle capital investment analysis 
Figure 5:_Existence of written capital investment guidelines
x
ABSTRACT
The study was set out to determine the Capital Budgeting techniques used in investment 
appraisal decisions amongst Companies listed at the Nairobi Stock Exchange, and to find 
out the relationship between capital budgeting techniques and the financial performance 
of 47 companies listed in the Nairobi Stock Exchange. The study employed a census 
survey. Primary data was collected through questionnaires which were dropped and 
picked from the respondents. Of the target population of the study, 39 questionnaires 
were returned and this represented 82.9% response rate.
The study found out that all the four capital budgeting techniques; payback method, 
accounting rate of return internal rate of return and net present value were being used by 
the companies listed in the Nairobi stock exchange. On the relationship between capital 
budgeting techniques and corporate performance, the earnings before interest and tax and 
total assets, the data was collected from the capital Markets authority and NSE records. 
The data was analyzed using the statistical package for social sciences (SPSS) version 17.
The study used multiple regression analysis to find the association between capital 
budgeting techniques and the financial performance of companies listed at the Nairobi 
Stock Exchange. Forecasting model was developed and tested for accuracy in obtaining 
predictions. The finding of the study indicated that model was significant. This is 
demonstrated in the part of the analysis where R' for the association between capital 
budgeting techniques and the financial performance of companies listed at the Nairobi 
Stock Exchange w'as 76%. In other words the results revealed a consistent, significant 
positive association between capital budgeting techniques and corporate performance 
measured by ROA.
It is recommended that a similar study be carried out in other companies not listed in the 
Nairobi stock exchange to test the same relationship and also in a specific industry to 
obtain homogenous results.
XI
CHAPTER ONE: INTRODUCTION
1.0 INTRODUCTION
1.1 Background to the Study.
The survival of a company depends very much on its ability to generate returns 
from its investments. Capital expenditures required in investment normally 
involve large sums of money and the benefits of the expenditures may extend 
over the future. According to Mooi and Mustapha (2001), utilizing a systematic 
capital budgeting process would enhance capital expenditure decisions.
The terms capital budgeting and investment decisions will be used in the literature 
to refer one and the same thing. Capital budgeting is the process of evaluating and 
selecting long term investments consistent with the firm owners’ goal of wealth 
maximization. Examples o f capital budgeting include expenditure on land, 
buildings, equipment and permanent additions associated with plant expansion. 
Investment decisions involve the firm making cash outlay with the aim of 
receiving, in return, future cash flows. Decisions about buying a new machine, 
building a factory, extending a warehouse, improving a delivery service, 
instituting a staff training scheme or launching a new product line are examples of 
the investment decisions that may be made by a firm. The process would be based 
mainly on managers’ judgment or based on quantitative analysis using scientific 
and analytical tools.
One of the most significant decisions made by management is that of capital 
budgeting. Today’s companies often make decisions costing millions of shillings 
for capital improvements. These decisions have the capacity to literally bankrupt a 
company if they are made without a proper understanding of capital budgeting 
procedures. Investment decisions are worthwhile if they create value for its 
owners. Many managers may argue that if the project returns more than what was 
invested, the project is profitable, but this is simplistic because the argument 
ignores some very important elements such as the time value of money. More 
specifically, the problem of the management should be how to tell if it will create
1
value-in advance. To address this concern, companies use some form of capital 
budgeting techniques to determine if a project will add the minimum needed value 
to justify the capital outlay and the risk involved.
1.1.2 Capital budgeting techniques
The most common capital budgeting techniques used are net present value, 
internal rate of return, payback period, accrual accounting rate of return and the 
profitability index. The first four techniques are the most popular.
Net Present Value (NPV) is a technique that determines the present value of the 
inflows and outflows and then simply takes a difference between the two. If that 
difference is positive, it is considered to be returning the required rate of return 
and is acceptable project. If the amount is negative, it is not providing a sufficient 
return and would be rejected. In the event two or more mutually exclusive 
projects all have positive net present value, then the project with the highest NPV 
is selected. The generally accepted advantages o f NPV are that it considers the 
time value of money and it is relatively easy to calculate. On the other hand, it is 
often difficult for laymen to understand the results obtained and most importantly 
it assumes that interim payments received during the life of the project can be 
invested at the discount rate used in the calculation. This is often not a true 
statement and can be used to manipulate the results of the analysis.
Internal rate of return (IRR) is simply a variation of NPV in that it attempts to find 
the discount rate that provides a NPV of zero. As stated above, the net present 
value is calculated by using a predetermined discount rate. If the NPV is positive 
it is assumed that the actual return is higher. If the NPV is negative, it is presumed 
the actual return is lower. By continuously manipulating the discount rate it is 
possible to hone in on the rate where the NPV is zero. That rate is considered to 
be the internal rate o f return. Clearly, one of the disadvantages of IRR is that it is 
more difficult to calculate since it involves an iterative process. Furthermore, 
because of the often-misunderstood assumption about interim payments being 
reinvested at the IRR rate it is possible to have more than one IRR for one project.
2
both the primary and secondary market. It is currently divided into three 
segments: the main investment segment, the alternative investments segment, and 
the fixed income securities segment. There are 47 listed companies as at 30th June 
2010.
The NSE has both the primary secondary market. It has acted as an important 
avenue through which the government has carried out the divestiture programme 
and for firms seeking additional capital. It deals with both the fixed income 
securities such as Treasury and corporate bonds, debenture stocks, and preference 
shares and variable income securities such as ordinary shares. It is also among the 
most active stock exchanges in Africa.
1.2 Statement of the Problem:
According to financial theory, the objective of the firm is to maximize the wealth 
of its shareholders. The optimal investment decision is hence the one that 
maximizes the shareholders’ wealth. Sophisticated capital budgeting procedures 
can under the assumption o f economic rationality all be regarded as means, which 
a firm uses in order to fulfill its objective, i.e to maximize shareholders wealth. 
This fact indicates that firms can increase or even maximize their shareholders 
wealth by using sophisticated capital procedures. Hence from a perspective of the 
finance theory, the relationship between capital budgeting sophistication and 
financial performance is expected to be positive. Studies on the relationship 
between capital budgeting sophistication and financial performance of a firm have 
presented mixed results. Klammer,T.(1973), in his study of the relationship 
between sophisticated capital budgeting methods and financial performance in 
US, found out that, despite the growing adoption of sophisticated capital 
budgeting methods, there was no consistent significant association between 
financial performance and capital budgeting techniques. A similar research by 
Haka. Gordon and Pinches (1985), found out that there was no significant 
improvements in firms financial performance even though the firms had adopted 
sophisticated selection techniques. However they found that there were short-run
5
positive effects when firms adopt sophisticated capital budgeting selection 
procedures.
Moore J.& Reichert (1989) in their multivariate study of firm performance and 
the use of modem analytical tools and financial techniques study in 500 firms in 
US , the study showed that firms adopting sophisticated capital budgeting 
techniques had better than average firm financial performance. More specifically, 
firms using modern inventory management techniques and Internal Rate of Return 
(IRR) reported superior financial performance, unlike those firms using naive 
methods such as Pay Back method and Accounting Rate of Return (ARR).
Locally three studies on capital budgeting have been carried out. Olum’s (1976) 
study viewed capital investment Appraisal techniques from the point o f view of 
social responsibility, that is, the benefits of such projects to the society. Kadondi 
(2002) in her study looked at capital budgeting application by companies listed at 
the Nairobi Stock Exchange. Khakasa (2009) sought to provide empirical 
evidence on the current state of the use of formal appraisal investment techniques 
in IT investments among the Kenyan banking institutions. Following the 
conflicting results on the impact of capital budgeting techniques on financial 
performance, and lack of a local study on the same, this study seeks to survey the 
impact of capital budgeting techniques on the financial performance of companies 
listed at the Nairobi Stock Exchange.
1.3 Research Objectives
i) To determine the Capital Budgeting techniques used in investment appraisal 
decisions amongst Companies listed at the Nairobi Stock Exchange
ii) To establish the relationship between capital budgeting techniques and the 
financial performance of companies listed at the Nairobi Stock Exchange
nr
/
$ \
6
1.4 Significance of the Study
This study will be important to the following parties:
To Company
The results of this study will help managers to evaluate the current capital 
budgeting practices in their companies. By looking at the study, the managers will 
be able to see the capital budgeting techniques applied across the Kenyan 
companies and how these techniques can possibly improve the company’s wealth 
or value. With that, they can make some comparisons with their company’s 
practices. This is important because a company’s main objective is to maximize 
its shareholder’s wealth. To achieve this, the company will possibly need the most 
reliable tool that can assist in investment decision making.
Researchers
This study will provide useful information for researchers regarding the capital 
budgeting techniques and their impact on financial performance in companies 
listed at NSE. Other than that, the researchers can also use the study as their basis 
for further research.
The study will be important to academicians who may wish to carry out further 
research in capital budgeting as this will add more to the existing body of 
knowledge.
To Academicians
The study will also be significant to academicians. It will give detailed 
information to them on how far the techniques taught in class differ from that 
practiced in the real world. By having this information, academicians will be able 
to make some adjustments in trying to accommodate things taught in class with 
real life practices.
7
CHAPTER TWO: LITERATURE REVIEW
2.0 Introduction
This chapter will discuss the literature review used in this study. Section 2.1 
details the theoretical framework; Section 2.2 discusses the evolution of capital 
budgeting practices. Section 2.3 will discuss the capital budgeting process. 
Section 2.4 details the decision criteria methods, section 2.5 discusses Risk 
analysis, section 2.6 discusses the empirical studies and section 2.7 concludes and 
summarizes the empirical studies.
2.1 Theoretical Framework
2.1.1 The Contingency Theory
According to Pike (1986), resource-allocation efficiency is not merely a matter of 
adopting sophisticated, theoretically superior investment techniques and 
procedures. But consideration must also be given to the fit between the corporate 
context and the design and operation of the capital budgeting system. Pike (1986) 
focuses on three aspects of the corporate context, which are assumed to be 
associated with the design and operation of a firm’s capital budgeting system. The 
first aspect is a firm’s organizational characteristics. Decentralization and a more 
administratively oriented control strategy involving a higher degree of 
standardization are characteristics of large companies. Smaller, less complex 
organizations tend to adopt interpersonal, less sophisticated control systems. Haka 
et al (1985) however have an opposite opinion and argue that firms will 
experience more benefits from using sophisticated capital budgeting techniques, 
the more stable the environment. They base their argument on Schall & Sundem 
(1980) study, which shows that use of sophisticated capital budgeting techniques 
declines with an increase in environmental uncertainty.
8
The second aspect is environmental uncertainty. The more variable and 
unpredictable the context of operation is, the less appropriate are highly 
bureaucratic, mechanistic capital budgeting structures. Pike (1986) suggests that 
firms operating in highly uncertain environments are assumed to benefit from 
sophisticated investment methods, particularly in appraising risk.
The last aspect concerns behavior characteristics. Pike (1986) identifies three 
characteristics, i.e. management style, degree of professionalism and the history 
of the organization. An administratively-oriented capital budgeting control 
strategy is assumed to be consistent with an analytical style of management, a 
high degree of professionalism and a history o f undistinguished investment 
outcomes. The firm’s financial status may influence the design and effort put on 
capital budgeting. According to Axelsson,et al.,(2002), more effort will be 
devoted to budgeting in an adverse financial situation, since it will no longer be as 
simple to find an acceptable budget and there will a need for more frequent follow 
up. These arguments have been applied to capital budgeting by Haka et al. (1985). 
They argue that the implementation of sophisticated capital budgeting procedures 
is one o f many means of coping with acute resource scarcity. Another argument is 
that since the main value of adequate investment rules is in distinguishing 
profitable from unprofitable projects, highly profitable firms are expected to 
derive less benefit from such techniques than would less successful firms with a 
history of marginal projects Axelsson,et al.,(2002).
2.1.2 The Garbage Can Theory
The garbage can was first developed by Cohen et al. (1972) to describe decision­
making in colleges. The theory articulates that the educational institutions face 
decision situations involving unclear goals, unclear technology and fluid 
participation. The most important features of the garbage theory entails four 
independent streams of decision making: problems, solutions, participants and 
choice opportunities. The theory postulates that choices happen for no apparent 
reason. Outcomes are divorced from problems, people wander aimlessly in and 
out of decision arenas, some decisions are made, and some problems are solved
9
(Bendor et aL 2001). The fundamental premise o f the theory is that decisions in 
an organized anarchy cannot be understood using the intentions of organizational 
participants, and imposing a rational explanation on organizational behavior can 
only distort what is really going on. In Cohen et al.’s original approach, 
organizations that have to rely on policy managers for advice, will have budgetary 
policy outputs that resemble a random process where current output has no 
relationship to the previous output.
2.1.3 The Incrementalism Theory
The literature on budgetary decisions has been dominated by the theory of 
incrementalism and its various meanings (Berry. 1990). This theory suggests that 
policy makers use ‘rules of thumb’ in order to deal with the technical complexity 
of expenditure decisions. Wildavsky, the founder o f this theory, implies that the 
people who design the budget are concerned with relatively small increments to 
an existing base denoted as their fair share. It follows that budgeting is 
incremental to the extent that it results in marginal and regularity of changes in 
expenditure. Regularity embodies the idea of routine behavior in expenditure 
decisions. This view of incrementalism opines that small changes in expenditure 
base may be seen as preserving stability.
2.1.4 The Real Options Theory'.
The term ‘Real options’ was first coined by Myers (1984) in 1977, and the subject 
has generated much interest among some finance and academics and practitioners. 
Real options deal with choices about the real investments such as capital 
budgeting projects, as opposed to financial investments. Thus, a real option is a 
right but not an obligation to undertake some business decision. Among the more 
common real options in capital budgeting are the option to invest or not, the 
option to abandon or continue a project, and the option to delay or carry on with 
an investment (Chance and Peterson, 2002). Real options potentially offer a more 
efficient way for managers to allocate their firm’s capital and maximize 
shareholder value by leveraging uncertainty and limiting downside risk. The
10
theory further asserts that the presence of real options can make an investment 
worth more than its conventional discounted cash flow value.
Arnold. T. & Shockley,R (2003) attribute the wave of interest in real options to an 
increase in both supply and demand. The supply side reflects a growing body of 
literature pertaining to the real options approach. The demand side for real options 
reflects management’s need to position the firm to benefit from uncertainty and to 
communicate the firm’s strategic flexibility. Increasingly, managers in industries 
characterized by large capital investments and considerable uncertainty and 
flexibility, such as mining, oil and gas aerospace, pharmaceuticals, and 
biotechnology, are contemplating the use of real options. Real options hold a 
considerable promise because they recognize that managers can obtain valuable 
information after the acceptance of a project. Yet, real options are by no means a 
panacea or a silver bullet intended for all capital projects.
2.2 The Evolution of Capital Budgeting Practices
Budgeting for capital expenditure has evolved over the decades and its 
importance has increased (or decreased) over time. Overall, the discernible stages 
of changes in capital budgeting practices and systems can be identified (Shah, 
Anwar, 2007). The first stage is the Great Depression years during which efforts 
were mainly focused on designing ways to ensure economic recovery. At the 
time, public borrowing for financing capital outlays, except for emergencies, was 
not favored. Sweden introduced a capital budget that was to be funded by public 
borrowing and used to finance the creation of durable and self-financing assets 
that would contribute to an expansion of net worth equivalent to the amount of 
borrowing. This investment borrowing found extended application in other 
countries.
The second stage took place during the late 1930s when the colonial government 
in India introduced a capital budget to reduce the budget deficit by shifting some 
items o f expenditures from the current budget. It was believed that the 
introduction of this dual -budget system would provide a convenient way to 
reduce deficits while justifying a rationale for borrowing (Tarschys, 2002).
11 UNIVERSITY OF NAIROo.
LOWF® i
Tarschvs, (2002) states that, the third stage refers to the growing importance 
attached to capital budgets as a vehicle for development plans. This was partly by 
the soviet-style planning; many low-income countries formulated comprehensive 
five-year plans and considered capital budgets the main impetus for economic 
development. Where capital budgets did not exist, a variant known as the 
development budget was introduced.
The fourth stage reflects the importance of economic policy choices on the 
allocation of resources in government. The quantitative appraisal techniques were 
applied on a wider scale during the 1960s leading to more rigorous application of 
investment appraisal and financial planning (Shah, Anwar, 2007). In the 1960s 
and 1970s it was widely believed that government budget allocation, including 
investment expenditures, could be largely reduced to a scientific process by 
systems such as zero-based budgeting(ZBB). Spackman (2002) believed that this 
turned out to be true.
A fifth stage saw a revival of the debate about the need for a capital budget in 
government, particularly in the United States. Along with the growing application 
of quantitative techniques during the 1960s came the view that the introduction of 
capital budget could be advantageous. This view did not gain much support. A 
president’s commission in 1999 investigating budget concepts in USA concluded 
that capital budget could lead to greater outlays on bricks and mortar, and as a 
result, current outlays could suffer. The commission advocated the introduction of 
accrual accounting government accounts.
During the six stage, partly because of the experiences of Australia and New 
Zealand, there was renewed push by the professional bodies and, from the late 
1990s, the international financial institutions for the introduction o f accrual 
budgeting and accounting.
2.3 The Capital Budgeting Process
Capital budgeting is a multi-faceted activity. There are several sequential stages in 
the process.
12
2.3.1 Strategic Planning
A strategic plan is the grand design of the firm and dearly identifies the business 
the firm is in and where it intends to position itself in the future. Strategic 
planning translates the firm’s corporate goal into specific policies and directions, 
sets priorities, specifies the structural, strategic and tactical areas o f business 
development, and guides the planning process in the pursuit of solid objectives. A 
firm’s vision and mission is encapsulated in its strategic planning framework.
2.3.2 Identification o f Investment opportunities
The identification of investment opportunities and generation of investment 
project proposals is an important step in the capital budgeting process. Project 
proposals cannot be generated in isolation. They have to fit in with a firm’s 
corporate goals, its vision, mission and long-term strategic plan. If an excellent 
investment opportunity presents itself the corporate vision and strategy may be 
changed to accommodate it. Thus, there is a two-way traffic between strategic 
planning and investment opportunities. Some investments are mandatory- for 
instance, those investments required to satisfy particular regulatory, health and 
safety requirements- and they are essential for the firm to remain in business. 
Other investments are discretionary and are generated by growth opportunities, 
competition, and cost reduction opportunities and so on. These investments 
normally represent the strategic plan of the business firm and, in turn, these 
investments can set new directions for the firm’s strategic plan. Profitable 
investment proposal is not just born: someone has to suggest it. The firm should 
ensure that it has searched and identified potentially lucrative investment 
opportunities and proposals, because the reminder o f the capital process can only 
assure that the best of the proposed investments are evaluated, selected and 
implemented.
2.3.3 Preliminary screening o f  projects
Generally, in any organization, there will be many potential investment proposals 
generated. All the proposals cannot go through the rigorous project analysis 
process. Thus, the identified investment opportunities have to be subjected to a
13
preliminary screening process by management to isolate the marginal and 
unsound proposals, because it is not worth spending resources to thoroughly 
evaluate such proposals. The preliminary screening may involve some 
preliminary quantitative analysis and judgments based on intuitive feelings and 
experience of the managers.
2.3.4 Financial appraisal o f projects
Projects which pass through the preliminary screening phase become candidates 
for rigorous financial appraisal to ascertain if they would add value to the firm. 
This stage is also called quantitative analysis, economic and financial appraisal, 
project evaluation, or simply project analysis. This project analysis may predict 
the expected future cash flow of the project, analyze the risk associated with those 
cash flows, develop alternative cash flow forecasts, examine the sensitivity of the 
results to possible changes in the predicted cash flows, subject the cash flows to 
simulation and prepare alternative estimates of the project’s net present value. 
Financial appraisal will provide the estimated addition to the firm’s value in terms 
of the project’s net present values. If the projects identified within the current 
strategic framework o f the firm repeatedly produce negative NPVs in the analysis 
stage, these results send a message to the management to review its strategic plan. 
The result of the financial analysis heavily influences the project selection or 
investment decision. Therefore, project analysis is critically important for the 
firm.
2.3.5 Qualitative factors in project evaluation
When the project passes through the quantitative analysis test, it has to be further 
evaluated taking into consideration qualitative factors. Qualitative factors are 
those which will have an impact on the project, but which are virtually impossible 
to evaluate accurately in monetary terms. They are factors such as the societal 
impact of an increase or decrease in employee numbers, the environmental impact 
of the project, possible positive or negative governmental and political attitudes 
towards the project, the strategic consequences o f consumption of scarce raw 
materials, positive or negative relationships with labor unions about the project,
14
possible legal difficulties with respect to the use of patents, copyrights and trade 
or brand names and also the impact on firm’s image if the project is socially 
questionable.
2.3.6 The accept/ reject decision
NPV results from the quantitative analysis combined with qualitative factors form 
the basis of the decision support information. The analysts relay this information 
to the management with appropriate recommendations. The management 
considers this information and other relevant prior knowledge using their routine 
information sources, experience and judgment to make a major decision- to accept 
or reject the proposed investment project.
2.3.7 Project implementation and monitoring
Once investment projects have passed through the decision stage they then must 
be implemented by management. During this implementation phase various 
departments of the firm are likely to be involved. An integral part of project 
implementation is the constant monitoring of project progress with a view to 
identifying potential bottlenecks thus allowing early intervention. Deviations from 
the estimated cash flows need to be monitored on a regular basis with a view to 
taking corrective actions w'hen needed.
2.3.8 Post-implementation audit
Post-implementation audit does not relate to the current support process of the 
project; it deals with a post-mortem of the performance of already implemented 
projects. An evaluation of the performance of past decisions, however, can 
contribute greatly to the improvement of current investment decision-making by 
analyzing the past ‘rights’ and ‘wrongs’. The post-implementation audit can 
provide useful feedback to project appraisal or strategy formulation.
2.4 Decision Criteria
The decision criteria in capital budgeting are the calculated measures that one can 
use to compare the cash flow's of different projects or alternatives. Before a 
decision criterion is selected, it is important to have a clear understanding of the
15
decision criteria currently available. The following decision criteria will be 
examined in this study: Payback period, accounting rate of return, internal rate of 
return and Net present value.
2.4.1 Payback period (PB)
Linstrom, L (2005) defines the payback period as the expected length o f time for 
aggregate positive cash flows to equal the initial cost, or the time it is expected to 
take to recover the initial investment. In order to use the technique as a criterion, a 
cutoff period is specified and all those projects with payback periods shorter than 
the cutoff period are then acceptable whereas all those with payback periods 
longer than the cutoff period are not acceptable. The PB technique is popular with 
managers because it is simple and readily understood by the managers, it is 
thought lead to selection of the less risky projects in mutually exclusive decision 
situations, saves the management the trouble of having to forecast cash flows over 
the whole of a project’s life and it is a convenient method to use in capital 
rationing situations. However, this method does not consider all cash flows after 
the payback period, it also ignores the time value of money in that cash flows that 
occur at different points in are simply added and compared with the initial 
amount.
2.4.2 The Accounting Rate of Return (ARR)
Kadondi, E. (2002) defines the accounting rate of return as the average after-tax 
proft divided by the initial cash outlay. Using this method, managers would 
choose projects with the highest Accounting Rate of Return. This method has the 
advantage of using the familiar percentage concept and evaluates projects on the 
basis of profitability. However, this method is not reliable as it ignores the timing 
of the cash flows and since it is based on accounting income and not on the 
project’s cash flows. The method also, does not consider the time value o f money.
The net present value (NPV) and the Internal Rate of Return (IRR) are referred to 
as discounted cash flow approaches also referred to as sophisticated methods in 
this study.
16
2.4.3 The Net Present Value (NPV)
The net present value (NPV) criterion is widely accepted as the most reliable 
decision criterion to use for capital budgeting. It is defined as the present value of 
all the present and future projected positive cash flows.
The discount rate that should equate the rate of return on the next best investment 
alternative of similar risk,is also known as the opportunity cost of capital. The 
NPV decision rule is to give further consideration to those projects whose NPV’s 
are greater than zero. A positive NPV implies that the projected cash flows 
indicate a return in excess of the discount rate. Any project that provides returns 
in excess of the opportunity cost, certainly adds additional value of the company, 
thereby increasing shareholder wealth (Farragher, et al., 2001). NPV takes into 
account the timing of all the cash flow's, it’s a measure of the added value that a 
project is projected to make to the company value, by adding their NPV’s one can 
determine the added value of a selection of projects. However, the implicit 
assumption in respect of NPV is that all cash flows generated by a project could 
be reinvested at the rate, k for the remainder of the of the project life. It might be 
that the opportunity cost of capital in the short term differs from the cost for 
longer terms. In such a scenario it is difficult to determine one fixed discount rate 
for the NPV calculation.
2.4.4 The Internal Rate of Return (IRR)
The internal rate of return (IRR) is a measure of the return generated by a project. 
The IRR is defined as that rate of discount that causes the present value of the 
projected future project cash flows to exactly equal to the initial cost of the 
project. If managers use the IRR criterion and the projects are independent, they 
would accept any project that has an IRR greater than the opportunity cost of 
capital. Analysis by Kadondi, E. (2002) indicates deficiencies in the IRR criteria. 
First it does not obey the value-additivity principle, and consequently managers 
who use the IRR cannot consider projects independently of each other. Second, 
the IRR rule assumes that funds invested in projects have opportunity costs equal 
to IRR for the project. This implicit reinvestment rate assumption violates the
17
requirement that cash flows be discounted at the market-determined opportunity 
cost of capital. Finally, the 1RR rule can lead to multiple rates of return whenever 
the sign o f cash flows changes more than once. She offers the NPV criterion as 
solution to these shortcomings. The NPV rule directs the manager to discount 
project cash flows at the market-based cost of capital and to accept all projects 
with positive discounted values.
2.5 Risk Analysis
Given the impact of capital projects on a company’s long-term viability, it is 
important for companies to understand why projects could fail. The calculation of 
a decision criterion based on best-estimate predicted cash flows is therefore not 
sufficient, as it does not indicate the level and nature of the project risks 
(Linstrom, L, 2005). Hence the need for a better understanding of what can go 
wrong and what the impact would be on the project outcome. A number of risk 
analysis techniques are developed for this purpose. These include; sensitivity 
analysis, scenario Analysis, decision tree Analysis and Simulation.
2.5.1 Sensitivity Analysis
This focuses on determining by how much the NPV of a project will change in 
response to a given change in input variables, holding other factors constant for 
instance, change in price, change in cost of capital, change in tax, etc.
2.5.2 Scenario Analysis
This considers both the sensitivity of NPV to changes in key variables as well as 
the range of likely variable values. Under this approach, managers assess various 
possibilities which are grouped.
2.5.3 Decision Tree Analysis
This is suitable for use in multi-stage or sequential decision where more than one 
variable may be uncertain and also the value of some variable may be dependent 
on value o f other variables. Decision trees are designed to illustrate the full range 
of alternatives that can occur. Its logical analysis of a problem and enables a 
complete strategy to be drawn up to cover all eventualities.
18
2.7 Empirical studies on Capital Budgeting Techniques and Financial 
performance
Thomas Klammer (1973) sought to investigate the association of capital 
budgeting techniques and performance in American firms. Attention was directed 
at the relationship of performance and capital budgeting procedures because the 
future o f the firm is dependent largely on the investment decisions made today. A 
total of 369 manufacturing firms were sampled, o f which 184 firms’ responded 
48.9%.The study focused on the operating rate of return as a measure of the firms’ 
performance. Capital budgeting techniques tested were payback method and the 
discounting techniques. For testing the association of firm performance and 
capital budgeting techniques, the study adopted a hypothesis that, firms having 
better performance will have adopted more sophisticated capital budgeting 
techniques. A simple regression analysis was carried out to test the hypothesis. 
The results of the study indicated that, despite a growing adoption of sophisticated 
capital budgeting methods, the regression results did not show a consistent 
significant association between performance and capital budgeting techniques. 
This indicated that the mere adoption of various analytical tools is not sufficient 
to bring about superior performance and that other factor such as marketing, 
product development, executive recruitment and training, labor relations, etc., 
may have a greater impact on profitability.
Another study by Haka et al. (1985), aimed to determine the effect on a firm’s 
market performance of switching from naive to sophisticated capital budgeting 
selection procedures. They theoretically stated that, a firm should perform better 
if it employs sophisticated techniques than if it uses naive techniques. The study 
had a population sample of 50 firms, out of which 30 firms responded. To obtain 
a set of firms that switched from naive to sophisticated techniques the study used 
personal interviews for two main reasons; first to determine the firm had indeed 
adopted sophisticate capital budgeting techniques for evaluating a large part of 
their capital budget and that such techniques were properly employed. Second, it 
was important to ascertain as precisely as possible, when the adoption took place.
22
The results of the study provided a more definitive conclusion than Klammer's 
(1973) study. They found out that 48 months before the firms switched to 
sophisticated capital budgeting techniques, with three different 48-month periods 
after the switch, indicated no significant improvements in the relative market 
performance of the firms’ adopting sophisticated selection techniques. However, 
while they found no long-run effects on relative market returns for adopting firms, 
their results suggested that there was a short-run positive effect when firms adopt 
sophisticated capital budgeting selection procedures.
Consistent with Klammer’s (1973) study, other factors were found to vitiate the 
improvement of firm performance after a switch from naive to sophisticated 
capital budgeting selection techniques. These factors were found to be; economic 
stress (the acute resource scarcity), which they asserted that in times of economic 
stress, firms do some ‘belt tightening’ by instituting cost reduction procedures and 
the adoption of new criteria for capital budgeting could be one of these belt 
tightening procedure. The company’s reward structure was also another factor, 
where they found out that companies that reward their employees on the basis of 
long-term incentive plans may experience more benefits from sophisticated 
selection techniques than companies that reward using a short-term reward plan. 
Study concluded that the adoption of sophisticated capital budgeting selection 
techniques, in and of itself, does not result in superior market performance.
Mooi and Mustapha (2001) undertook a study to find out whether the degree of 
sophistication of capital budgeting practice affects the firm performance, in terms 
of profitability. The study used a sample of 42 firms listed at Kuala Lumpur Stock 
Exchange in Malaysia. The study used Return on Assets (ROA) and Earnings per 
Share (EPS) to measure performance of the firms, and used regression analysis to 
determine the association between capital budgeting sophistication and firm 
performance. The capital budgeting techniques which were surveyed were NPV, 
IRR, ARR and Payback. From the analysis, 19% of the responding firms used 
superior capital budgeting methods whose score was 0% to 60%, 42.9% of the 
firms had a score of 61% to 80% of usage of superior capital budgeting methods,
23
and 38.1% had a score of 81% to 100% of the usage of capital budgeting 
methods. The t- tests results of the stud) showed that the degree o f capital 
budgeting sophistication did not significantly affect firm performance, measured 
by ROA and EPS. Theoretically, the use of superior capital budgeting process 
should increase the effectiveness of the firms’ investments decision making. Thus 
their study failed to confirm with the theory.
Gilbert (2005) carried out a study to determine the application o f capital 
budgeting methods and their association with firm performance among South 
African manufacturing firms. A sample of 318 firms was surveyed, but only 118 
firms representing 37% responded. The survey tested the application and impact 
of payback method, accounting rate of return, net present value and the internal 
rate of return. The return on assets was also used as a measure of firm 
performance. The results of the study indicated that, 15% of the firms employed 
the payback method, 8% used purely the discounting methods while the rest 
employed a mixture of both non-discounting and discounting methods. It was also 
concluded that though many o f the managers were aware of the benefits of using 
the discounting methods, their responses involved the use of shortcuts, and 
approximations. The study conclude that, while discounted cash flow methods 
can, and do, play an important role in capital investment decision-making, the 
costs and sometimes impossibility of completing them, properly means that their 
use is always going to be limited. Thus the conclusion of the study was that 
capital budgeting techniques had no significant impact on the financial 
performance of the manufacturing firms.
A study by Olawale et al. (2010) was conducted to investigate if companies make 
use of sophisticated investment appraisal techniques when making investment 
decisions, and the impact of sophisticated appraisal techniques on the profitability 
of the manufacturing firms in the Nelson Mandela Bay Metropolitan area, South 
Africa. The study had a sample of 124 firms responding, 85 firms making 39% 
were found to be using sophisticated investment appraisal techniques when 
making investment decisions. Therefore the first objective that the manufacturing
24
firms make use of sophisticated investment appraisal techniques when making 
investment decisions was confirmed. The profitability of the firms was measured 
by return on assets (ROA), the return on assets was determined based on the 
calculation of the earnings after interest and taxes (EAIT) and total assets. The 
study used regression analysis to test the relationship of each independent variable 
on profitability. The traditional methods comprising the payback method and 
accounting rate of return were also regressed against profitability to determine 
their significance and relationships to profitability. The results of the study 
showed that the pay back method used by the respondents is not significant to 
profitability and does not have a positive relationship with profitability of the 
respondent firms. Accounting rate of return was also found insignificant to 
profitability and negatively related to profitability. However, the results indicated 
that use sophisticated investment appraisal techniques had a positive impact on 
profitability thus confirming the second objective o f the study.
Moore J.& Reichert (1989), in their multivariate study of firm performance and 
the use of modern analytical tools and financial techniques study in 500 firms in 
US , the study showed that firms adopting sophisticated capital budgeting 
techniques had better than average firm financial performance. More specifically, 
firms using modern inventory management techniques and Internal Rate of Return 
(IRR) reported superior financial performance, unlike those firms using naive 
methods such as Pay Back method and Accounting Rate of Return (ARR).
Yao et al., (2006), conducted a study to compare the use of capital budgeting 
techniques and their impact on performance in Netherlands and China. They 
compared 250 Dutch and 300 Chinese firms. Out of all the firms, 87 firms 
responded, 42 from Dutch and 45 from Chinese companies, resulting in a 
response rate of 17% for the Dutch and 15% for the Chinese sample. The results 
indicated that 49% CFOs in Chinese firms use the NPV method as opposed to 9 
% who use the traditional investment decision methods. In Dutch, the study found 
that 89% of the firms use NPV investment decision method while traditional 
investment decision methods took the rest of the respondents. Their study used
25
return on assets to measure performance which was used in a regression model as 
a dependent variable and measured against the various investment decision 
techniques. The results indicated that in both countries, sophisticated capital 
budgeting techniques mostly NPV and 1RR had a positive relationship with return 
on assets (ROA) while the traditional methods showed an insignificant 
relationship.
In Kenya, Olum’s (1976) study sought to view capital budgeting from the stand 
point of shareholders’ wealth maximization and examined the extent to which 
capital budgeting techniques were being practically applied by corporations in 
Kenya. He argues that the current Capital Investment appraisal techniques are 
applied from only two points o f view; namely that of a private entrepreneur and 
that of the whole society, considering commercial profitability and public 
profitability respectively. Kadondi (2002) undertook a study to determine the 
capital budgeting techniques used by companies listed at NSE and also to 
determine how the firms' and CEO characteristics influence the use of a particular 
technique. The study had a sample of 43 companies, out o f which 28(65%) 
companies responded to the study questionnaire. The study found out that 85% 
carry out capital budgeting in stages though many of the respondents ignored the 
first stages of capital budgeting. Of these, the study found that 31% used the 
payback method, 27% applied NPV while 23% were using the IRR technique.
Khakasa (2009), attempts to provide empirical evidence on the state of practice in 
Kenyan banking institutions in evaluating IT investments ex ante. The results of 
the survey showed that the most popular investment appraisal techniques used in 
such evaluation in Kenyan banks were cost-benefit analysis, risk analysis, 
competition, payback period and return on investment, while the least popular are 
the internal Rate of Return, computer based techniques and the Net Present Value. 
Of the 41 banks sampled, a total of 25 responses were obtained. This was a 
response rate of 60.97%. 100% of the responding institutions indicated that they 
used at least one of the economic techniques to appraise potential IT projects. 
Most institutions used more than one financial technique to appraise their
26
investments. The most popular economic technique is the Cost Benefit Analysis 
(CBA) method (92%), while Internal Rate of Return (IRR) ranked the lowest 
(0%). Besides CBA, payback period and Return on Investment were both used by 
60% of the responding institutions. Only 8% of the banking institutions used at 
least one of the discounting techniques. Net Present Value was found to be used 
by 8% of the banks, while IRR is used by none of the responding banks. Overall, 
the study concluded that banks had limited use of discounting techniques and this 
raised questions as to the extent of the use of cash flows to appraise potential 
projects.
2.8 Summary and Conclusions
The objectives of this study are to determine the capital budgeting techniques 
employed by listed companies and the effect of those techniques on the financial 
performance. The results of most studies have reported the use of both the naive 
capital budgeting and discounted cash flow techniques. The naive methods 
include; the payback method and the accounting rate of return. The discounted 
cash flow methods otherwise referred to as sophisticated capital budgeting include 
the net present value and the internal rate of return. Many companies seem to 
prefer the payback method and net present value to accounting rate of return and 
internal rate of return respectively.
In the literature, it has been argued that the use of capital budgeting practices may 
be related to improved financial performance. A number of arguments to support 
this have been cited. Some of the studies indicated that sophisticated capital 
budgeting techniques mostly NPV and IRR had a positive relationship with return 
on assets (ROA) while the traditional methods showed an insignificant 
relationship. However similar studies reported a negative relationship of the 
capital budgeting techniques and financial performance. The studies have 
indicated that, despite a growing adoption of sophisticated capital budgeting 
methods, there is no consistent significant association between performance and 
capital budgeting techniques. This indicates that the mere adoption o f various 
analytical tools is not sufficient to bring about superior performance and that other
27
factor such as marketing, product development, executive recruitment and 
training, labor relations, etc., may have a greater impact on profitability.
Local studies on the other hand have mainly dealt with the application of the 
capital budgeting techniques in listed companies and also in the banking sector. 
Their findings indicate that discounted cash flow methods are not extensively 
being used to appraise investment decisions. The study in the banking sector 
particularly found the overwhelming application o f the naive capital budgeting 
techniques. Thus given these conflicting findings in the literature and lack of 
substantive local study on the effect of capital budgeting techniques on financial 
performance, this study seeks to establish the effect of the capital budgeting 
techniques on financial performance of companies listed at NSE.
28
CHAPTER THREE
RESEARCH DESIGN AND METHODOLOGY
3.0 Introduction
This chapter covered the design of the study, the target population of the study, 
data collection method, data quality, measurement of variables used in analyzing 
the data, statistical technique used for data analysis.
3.1 Research Design
The study employed a survey design to determine the capital budgeting 
techniques and their impact on financial performance in companies quoted at the 
NSE. The survey design was chosen because it best suited as it was exploratory 
and gave the researcher an opportunity collect the relevant data to meet the 
objectives of the study. Again the survey design extensively used in the similar 
studies reviewed in the literature. For instance the study by Klammer (1973), 
Moore J. & Reichert (1989) and Khakasa (2009) just to mention a few employed 
this type of research design.
3.2 Population of the Study
The target population consisted of all the 47 companies listed at The Nairobi 
Stock Exchange as at 30lh June 2010. The choice of quoted companies was 
preferred because they represented the main sectors of the Kenyan economy, and 
are therefore considered as adequate representation of companies in Kenya. In 
addition, since they are publicly quoted and publish their annual reports, 
information about the measurement of the financial performance were readily 
available, unlike those of unlisted companies.
The study employed a census survey, because the NSE as of the time of the study 
had only 47 listed companies, therefore the whole population of the companies 
was included in this study. Thus, no sampling procedure was conducted. It was 
also noted that in comparison to similar studies conducted elsewhere, the size of 
the population in this study is small. The study covered a period of four years 
from 2004-2007. The justification for the choice of this period was that the period
29
was considered both current and long enough for any capital budgeting decision 
to be taken, implemented and results established. As the study used ROA to 
measure financial performance of the companies, as a comparative measure its 
best to compare it against a company's previous ROA. Previous studies have also 
employed a similar period of time for instance the study by Axelsson, et al. (2002) 
and Farragher,et.al (2001).
3.3 Data collection
The study employed both Primary and secondary data. The primary data was 
related more to the qualitative than the quantitative data. The data was collected 
through questionnaires which were administered by the researcher. The secondary 
data w'as collected from the published accounts of the companies. The published 
accounts were obtained from NSE library and Capital Markets Authority (CMA).
3.4 Test Validity and Reliability
Reliability of the measures was assessed with use of Cronbach’s alpha. 
Cronbach’s alpha which allows for measurement of reliability of the different 
categories. It consists of estimates of how much variation in scores o f different 
variables is attributable to chance or random errors (Selltiz, et al. 1976). As a 
general rule, a coefficient greater than or equal to 0.5 was considered acceptable 
and a good indication of construct reliability (Nunnally, 1978).
3.5 Data Analysis
Data obtained were analyzed in general for selected companies listed at the NSE. 
Regression analysis was used to test the impact of capital budgeting techniques on 
the financial performance. This study employs a model used by Olawale, F. et al. 
(2010) and Klammer (1973). The regression equation used was;
ROA = _a + /?] NPV + p i ARR + PB + p4 IRR + |35 Cont + el 
Where
ROA= Return on assets (profitability)
NPV= the effect in sh.of the present value technique.
ARR= the effect in sh. of the accounting rate of return technique.
PB = the effect in sh. of the payback technique.
IRR = the effect in sh. of the internal rate of return.
30
Corn. = is a vector of control variables, 
a = a constant
p \ ,p l ,p 5 ,$ 4  and 05 are regression coefficients 
e 1 = represents the error term.
The statistical package for social sciences will (SPSS) version 17 was used to 
analyze the data into frequency distribution. The primary data from the 
questionnaire were analyzed using descriptive statistics, particularly frequencies 
and percentages. Information then was generalized and summarized using tables 
and histograms where appropriate.
31
CHAPTER FOUR
4.0 DATA ANALYSIS, FINDINGS AND DISCUSSION 
4.1: Introduction
The research objectives were to determine the Capital Budgeting techniques used 
in investment appraisal decisions amongst Companies listed at the Nairobi Stock 
Exchange and to find out the relationship between capital budgeting techniques 
and the financial performance of companies listed at the Nairobi Stock Exchange. 
This chapter presents the analysis and findings with regard to the objective and 
discussion of the same. The data was collected from the population of 47 
companies listed at Nairobi stock exchange. The findings are presented in pie 
charts, histograms frequency distributions and narrations.
4.2: General information
The general information considered in this study were Designation, years have 
you worked for your current organization and legal status of the company.
4.2.1: Response rate
A total of 47 questionnaires were issued out. The completed questionnaires were 
edited for completeness and consistency. Of the 47 questionnaires used in the 
sample, 39 were returned. The remaining 8 were not returned. The returned 
questionnaires’ represented a response rate of 82.9%, which the study considered 
adequate for analysis.
4.2.2: Distribution of respondents by designation
As can be observed, in Figure I, the respondents were made up of 6 1.5% were 
investment managers, 30.8% were finance managers and 7.7% were risk 
managers.
32
Figure 1: Gender Composition
4.2.3: Distribution of respondents by length of Service with 
organization (years)
The results presented in table 4.1 shows that majority of the respondents (35.9%) 
had worked in there respective organization for over six years, 33.3% had been in 
their organization for 4 to 5 years and the remaining 30.8% had worked for 2 to 3 
years in their current organizations.
Table 4.2.3: Length of Serv ice w ith organization (years)
Number of service years Frequency Percent Cumulative Percent
2-3 years
.
12 30.8 30.8
4-5 years 13 33.3 64.1
over 6 years 14 35.9 100.0
Total
____________________________
39 100.0
Source: researcher’s raw data.
33
4.2.4: Distribution of respondents by legal status
As can be observed, in Figure 2, 69.2% of the respondents were from private 
companies while 30.8% were from public companies.
Figure 2: Legal status
Public company 
30 .8%
4.3 Capital Budgeting Techniques
This section covered information posed to respondents on the following issues; 
Use of Capital Budgeting Techniques, a major switch in techniques used over the 
last 5 years, techniques company favor when deciding investment projects to 
pursue, average proportion of total capital expenditures company made in the last 
five years, written capital investment guidelines, technique company use to assess
34
a project's risk and approaches used to determine the minimum acceptable rate of
return.
4.3.1 Use o f Capital Budgeting Techniques
The respondents were to rate how frequently their company’s used the following 
evaluation techniques when deciding investment projects to pursue. As shown in 
table 4.3.1, payback period was the most frequently used evaluation technique 
(mean of 3.4872), followed by Internal rate of return (mean of 3.3077), Net 
present value (mean of 3.0513) and Accounting rate of return (mean of 3.000) 
respectively. Payback period was frequently used due to its easy of calculation 
and interpretation as compared to other evaluation techniques.
Table 4.3.1 Frequency of use o f Evaluation Techniques
Mean Std. Deviation
Net present value 3.0513 .91619
Internal rate of return 3.3077 .92206
Accounting rate of return 3.0000 .97333
Payback period 3.4872 .85446
UNIVERSITY OF NAlROSt
LOWER Ka ***►■f-p | a
35
As can be observed, in Figure 3, 53.8% of the respondents were of the opinion 
that their firms had made a major switch in techniques used over the last 5 years 
while 46.2% of respondents firms had not made a major switch in techniques used 
over the last 5 years
Figure 3: Existence o f a major sw itch in techniques used over the last 5 years
4 .3 .2  E x i s t e n c e  o f  a  m a j o r  s w i t c h  in  t e c h n i q u e s  u s e d  o v e r  t h e  l a s t  5  y e a r s
4.3.3 Techniques used when deciding investment projects to pursue
The respondents were to indicate the type techniques their respective company’s 
favour when deciding investment projects to pursue. The findings in table 4.3.2 
indicate that 83.6% of the respondents firms favored net present value techniques 
when deciding investment projects to pursue, followed by Internal rate of return at 
41.0%, Accounting rate of return and Payback period at 3.3% respectively.
36
T a b l e  4 . 3 . 2  T e c h n i q u e s  u s e d  w h e n  d e c i d i n g  i n v e s t m e n t  p r o j e c t s  t o  p u r s u e
Frequency Percent Cumulative Percent
Net present value 17 43.6 43.6
Internal rate of return 16 41.0 84.6
Accounting rate of return 3 7.7 92.3
Payback period IT " 7.7 100.0
Total 39 100.0
Source: researcher’s raw Data.
4.3.4 S taff assigned full-time to capital investment analysis
As shown in figure 4, most o f the respondents (92.3%) were of the opinion that 
their respective firms had full time staff assigned to capital investment analysis, 
while only 7.7 % of the respondents were of the opinion that their firms do not 
have full time staff assigned to deal with capital investment analysis.
Figure 4: Full time staff to handle capital investment analysis
NO
7 .7 %
37
4 .3 .5  E x i s t e n c e  o f  w r i t t e n  c a p i t a l  i n v e s t m e n t  g u i d e l i n e s
The findings in figure 5 show that 79.5% of the respondents firms had written 
capital investment guidelines while 20.5% did not have the same.
Figure 5: Existence o f written capital investment guidelines
4.3.6 Technique companies use to assess a project’s risk
The respondents were to rate technique company’s used to assess a project’s risk. 
As shown in table 4.3.3, Sensitivity analysis was the most frequently used project 
risk assessment technique (mean of 3.7852), followed by Scenario analysis
38
(mean o f 3.1026), Simulation analysis (mean o f  2.9744) and Decision tree
analysis (mean o f 2.5897) respectively.
Table 4.3.3 Technique companies use to assess a project’s risk
Mean Std. Deviation
Scenarios analysis 3.1026 .91176
Sensitivity analysis 3.7852 .50637
Decision tree analysis 2.5897 .93803
Stimulation analysis 2.9744 1.08790
4.3.7 Approaches used in determining the minimum acceptable rate o f return
The findings in results in table 4.3.4 show that majority (61.5%)of the 
respondents prefer Cost of equity capital over other approaches in determining 
minimum rate of returns for investments, followed by weighted average cost of 
capital at 30.8% rating and cost of debts at 7.7% respectively.
Table 4.3.4 Approaches used in determining the minimum acceptable rate of 
return
Frequency Percent Cumulative Percent
Weighted average cost of capital 12 30.8 30.8
Cost o f debt 3 7.7 38.5
Cost o f equity capital 24 61.5 100.0
Total 39 100.0
Source: researcher’s raw data.
39
4 .4  C o r r e l a t i o n  a n d  R e g r e s s i o n  a n a l y s i s
4.4.1: Correlation analysis
Two predictor variable are said to be correlated if their coefficient of correlations 
is greater than 0.5. In such a situation one of the variables must be dropped or 
removed from the model. As shown in table 4.4.1, none of the predictor variables 
had coefficient of correlation between themselves more than 0.5 hence all of them 
were included in the model.
Table 4.4.1: Pearson Correlation coefficients
ROA NPV ARR IRR PB CONT
ROA 1.000
NPV .025 1.000
ARR .135 .159 1.000
IRR .058 -.030 .147 1.000
PB • .350 .371 .172 .098 1.000
CONT .262 -.400 -.116 .098 -.299 1.000
Source: researcher’s raw data.
4.4.2 Strength of the model
Analysis in table 4.4.2 shows that the coefficient of determination (the percentage 
variation in the dependent variable being explained by the changes in the 
independent variables) R2 equals 0.760, that is, CONT, IRR, ARR, PB, NPV 
explain 76 percent of ROA leaving only 24 percent unexplained. The P- value of 
0.001 (Less than 0.05) implies that the model of ROA is significant at the 5 
percent significance.
40
T a b l e  4 . 4 . 2 :  M o d e l  S u m m a r y
R
Adjusted 
R R 
Square Square
Std. Error 
o f the 
Estimate Change Statistics
R
Square F Sig. F
Change Change dfl df2 Change
.872 .760 .754
1 1
.05163 .760 4.893 5 
‘ 1 ____ 1_____
33 .001
_____ ________________________________
Predictors: (Constant), CONT. IRR, ARR, PB, NPV
Table 4.4.3: ANOVA
Model
Sum of 
Squares df Mean Square F Sig.
1 Regression .025 5 .005 4.893 .001
Residual .088 33 .003
Total .113 38
Predictors: (Constant), CONT, IRR, ARR, PB, NPV :Dependent Variable: ROA
The probability value (p-value) of a statistical hypothesis test is the probability of 
getting a value of the test statistic as extreme as or more extreme than that 
observed by chance alone, if the null hypothesis HO is true. The p-value is 
compared with the actual significance level of the test and, if it is smaller, the 
result is significant. The smaller it is, the more convincing is the rejection of the 
null hypothesis. ANOVA findings in table 4.4.3 shows that there is correlation 
between the predictors variables (CONT, IRR, ARR, PB, NPV ) and response 
variable (ROA) since P- value o f 0.001 is less than 0.05.
41
4.4.3 Regression Analysis
The established multiple linear regression equation becomes:
Y = 0.001 + 0.038X, + 0.027X2 + 0.042X3 + 0.025X4 + 0.019X5 
Where
Constant = 0.001, shows that if CONT, IRR, ARR, PB, NPV were all rated as 
zero. ROA rating would be 0.001
X|= 0.038, shows that one unit change in NPV results in 0.038 units increase in
ROA
X2= 0.027, shows that one unit change in ARR results in 0.027 units increase in
ROA
X3= 0.042, shows that one unit change in IRR results in 0.042 units increase in 
ROA
X4= 0.025, shows that one unit change in PB results in 0.025 units increase in
ROA
Xs= 0.019, show's that one unit change in CONT results in 0.019 units increase in
ROA.
Ranking of the individual independent variables, it shows that, IRR is highly 
related w'ith ROA, followed by NPV, ARR, PB and controlled variables 
respectively.
42
T a b l e  4 . 4 . 4 :  C o e f f i c i e n t s  o f  r e g r e s s i o n  e q u a t i o n
Unstandardized
Coefficients
Standardized
Coefficients t Sig.
B Std. Error Beta
(Constant) 0.001 0.073 0.0136986 0.994
NPV 0.038 0.014 0.191 2.7142857 0.003
ARR 0.027 0.012 0.149 2.2500 0.004
IRR 0.042 0.011 0.063 3.8181818 0.001
PB 0.025 0.01 1 0.365 2.2727273 .000
CONT 0.019 0.009 0.253 2.1111111 0.04
Dependent Vanable: ROA
4.5 Sum m ary of findings and interpretation
From the study it was found that of the respondents, 61.5% were investment 
managers, 30.8% were finance managers and 7.7% were risk managers. This 
means that most companies listed at the Nairobi Stock exchange have investment 
managers who solely handle investments.
The findings also indicate that 69.2% of the respondents were from private 
companies while 30.8% were from public companies, an indication that twice as 
much of the listed companies are private companies. At the same time 79.5% of 
the respondents firms had written capital investment guidelines.
It was noted that company’s used the following capital budgeting evaluation 
techniques when deciding investment projects to pursue payback period (mean of 
3.4872), Internal rate of return (mean of 3.3077) and Net present value (mean of 
3.0513) in order of preference.
43
The study indentified the following indicators as the most significance technique 
company’s used to assess a project’s risk Sensitivity analysis (mean o f 3.7852), 
Scenarios analysis (mean of 3 .1026) and Stimulation analysis (mean of 2.9744).
The respondents were to indicate the type techniques their respective company’s 
favour when deciding investment projects to pursue. The findings in table 4.3.2 
indicate that Feedback on techniques used when deciding investment projects to 
pursue indicated that most firms favored net present value followed by internal 
rate of return techniques when deciding investment projects to pursue. At the 
same time 79.5% of the respondents firms had written capital investment 
guidelines.
It was apparent that majority (61.5%)of the respondents preferred Cost of equity 
capital over other approaches in determining minimum rate of returns for 
investments, followed by weighted average cost of capital at 30.8% rating and 
cost of debts at 7.7% respectively.
The study used regression analysis to find the association between capital 
budgeting techniques and the financial performance of companies listed at the 
Nairobi Stock Exchange. Forecasting model was developed and tested for 
accuracy in obtaining predictions. The finding of the study indicated that model 
was significant. This is demonstrated in the part of the analysis where R2 for the 
association between capital budgeting techniques and the financial performance 
of companies listed at the Nairobi Stock Exchange was 76%. All the independent 
variables were also linearly related with the dependent variable thus a model of 
five predictor variables (CONT, IRR, ARR, PB, NPV) could be used to forecast 
ROA of companies listed at NSE.
Ranking of the individual independent variables, showed that. IRR is highly 
related with ROA, followed by NPV, ARR, PB and controlled variables 
respectively.
44
CHAPTER FIVE
5.0 SUMM ARY, CONCLUSIONS, AND RECOM M ENDATIONS  
5.1: Summary
The objectives of this study were to determine the Capital Budgeting techniques 
used in investment appraisal decisions amongst Companies listed at the Nairobi 
Stock Exchange and to find out the relationship between capital budgeting 
techniques and the financial performance of companies listed at the Nairobi Stock 
Exchange. The study was set out to determine the Capital Budgeting techniques 
used in investment appraisal decisions amongst Companies listed at the Nairobi 
Stock Exchange, and to find out the relationship between capital budgeting 
techniques and the financial performance of 47 companies listed in the Nairobi 
Stock Exchange.
The choice of quoted companies was preferred because they represented the main 
sectors of the Kenyan economy, and are therefore considered as adequate 
representation of companies in Kenya. In addition, since they are publicly quoted 
and publish their annual reports, information about the measurement of the 
financial performance were readily available, unlike those of unlisted companies. 
The study employed a census survey. Primary data was collected through 
questionnaires which were dropped and picked from the respondents. Of the 
target population of the study, 39 questionnaires were returned and this 
represented 82.9% response rate.
The study found out that all the four capital budgeting techniques; payback 
method, accounting rate of return internal rate of return and net present value 
were being used by the companies listed in the Nairobi stock exchange. On the 
relationship between capital budgeting techniques and corporate performance, the 
earnings before interest and tax and total assets, the data was collected from the 
capital Markets authority and NSE records. The data was analyzed using the 
statistical package for social sciences (SPSS) version 17.
45
The study used multiple regression analysis to find the association between 
capital budgeting techniques and the financial performance of companies listed at 
the Nairobi Stock Exchange. Forecasting model was developed and tested for 
accuracy in obtaining predictions. The finding of the study indicated that model 
was significant. This is demonstrated in the part of the analysis where R2 for the 
association between capital budgeting techniques and the financial performance 
of companies listed at the Nairobi Stock Exchange was 76%. In other words the 
results revealed a consistent, significant positive association between capital 
budgeting techniques and corporate performance measured by ROA.
5.2 Conclusion
The main purpose of this study were: firstly, to determine the Capital budgeting 
techniques used in investment appraisal decisions amongst the listed companies at 
the Nairobi Stock Exchange, and secondly to establish the relationship between 
capital budgeting techniques and the financial performance of companies listed at 
the Nairobi stock exchange. In order to achieve the first objective, a thorough 
literature review was done. Based on the literature it was found that companies 
used various capital budgeting techniques to appraise investment decisions.The 
results of the study show that majority of respondents employ the four capital 
budgeting techniques in the capital budgeting process these are; net present value, 
internal rate of return, accounting rate of return and the pay back method .
A basic principle of finance theory is that the return required on an investment 
should reflect the riskiness of the investment and the returns available elsewhere 
from investments of similar risk. This leads to the use ways of analyzing risk. 
According to the study, majority of the respondents carried out risk analysis. The 
study shows that sensitivity analysis is highly favored when carrying out risk 
analysis. The implication for corporate managers is that accept-reject decisions 
may be biased in favour of high-risk investments and against low-risk 
investments, with the possibility that poor high-risk investments will be accepted 
and good low risk investments will be rejected.
46
The results of the regression analysis show that the capital budgeting techniques 
significantly affect firm performance, measured by ROA. Ranking of the 
individual independent variables, showed that, 1RR is highly related with ROA, 
followed byNPV, ARR. PB and controlled variables respectively .Theoretically, 
the use of sophisticated capital budgeting techniques should increase the 
effectiveness of the firms’ investments decision making. Thus, the results of this 
study concurred with the theory and the previous studies.
5.3: Policy Recommendations
The following recommendations are given to policy makers.
This research finds that managers feel that capital budgeting is at times 
implemented without adequate education to implementers and ill fitting financial 
and operating structures. It thus recommends that proper understanding of the 
demand placed by implementation of these projects on the resources of a firm 
should be well assessed before implementation It is important for the management 
of the companies to get involved in training and skill development especially in 
areas of capital budgeting and investments. Training consultants could be used to 
train the employees who will be advising the management on the best investment 
alternatives.
In addition, low levels of financial literacy can impact the degree to which 
companies use investment appraisal techniques. The government through the 
ministry of finance should broaden its efforts to ensure that a high level of 
financial literacy is universal to company managers. Government agencies such as 
NSE and capital markets authority should therefore organize training for newdy 
listed companies. Further studies could investigate if industry differences and the 
age of the firm could have a major impact on the use of investment appraisal 
techniques.
From the research findings, the respondents strongly advocated that policies 
should not always from up-down. The need for employee participation in making 
investment decisions that affect their duties was strongly advocated for.
47
This research therefore recommends increased consultation and dialogue between 
the implementing employees and management. The management staff to device 
methods o f increasing employee participation.
5.4 Limitations of the Study
In the course of the study, the following limitations were encountered;
The target population was not easily accessed. This was hampered by company 
policies and bureaucracy regarding their information outflow. The formal 
procedure is that a document received should go through all the steps until the 
relevant officer ascertains that the information being sought can or cannot be 
given out. In some cases the researcher had to go through this to access to data. 
This was found to be too long. This seriously impeded the researcher’s effort to 
conduct the census.
Respondents from mostly the private companies were reluctant to give 
information about their operations; this they thought was too much beyond what 
is required by law and were hence reluctant to give information. In some situation 
the company legal officer had to be called upon to assess the implication of the 
data being sought.
Another potential limitation was the reliability of the data obtained. Inaccuracies 
could have resulted from the survey respondents misunderstanding the survey 
questions or terminologies used in capital budgeting. Indeed the researcher had to 
in many cases explain the meaning of some of the terminologies to the 
respondents who then could attempt to accord the right response.
48
$.5 Suggestions for Further Research
Since the study focused on the companies listed in Nairobi stock exchange, it is 
recommended that a similar study be carried out in other companies not listed in 
the Nairobi stock exchange to test the same relationship between capital 
budgeting techniques and their financial performance.
Further studies are needed to test the relationship between the capital budgeting 
techniques and firm performance by use of a different firm financial 
performance measurement other than ROA for instance earnings per share (EPS). 
Future research could also focus on a specific industry to obtain homogeneous 
results.
The capital budgeting practices of listed companies are not likely to be 
representative of all Kenyan companies. This is so because the study only focused 
on the listed companies ignoring the unlisted companies. Thus it is recommended 
that another study be done in companies not listed at the NSE to test the same 
objective.
49
REFERENCES
Arnold, T. & Shockley.R(2003). Real Options, Corporate Finance, and the 
Foundations o f
Value Maximization, Journal o f Applied Corporate Finance 15 (No. 2), 82-88.
Axelsson, H,Jakovicka, J & Kheddache, M .(2002). Capital Budgeting 
Sophistication and Performsnce- A Puzzling Relationship; Unpublished Doctoral 
Thesis, Graduate Business School, Goteborg University.
Bendor, J., T. M. Moe & K. W. Shotts (2001/ Recycling the Garbage Can: An 
Assessment o f
the Research Program, American Political Science Review, Vol. 95, pp. 169-90.
Berry, W.D,( 1990). The Confusing Case o f  Budgetary Incrementalism : Too Many 
Meanings for a Single Concept,Journal of Politics, Vol.52,pp. 167-96. Copeland, 
Thomas E. (1979). Financial Theory and Corporate Policy, Reading: 
Addison-Wesley Publishing Company, Inc., 1st Edition.
Copeland, Thomas E. (1979). Financial Theory and Corporate Policy, 
Reading:
Addison-Wesley Publishing Company, Inc., 1st Edition.
Chance, D. M. & Peterson,P.P (2002). Real Options and Investment Valuation, 
Charlottesville, VA, Research Foundation of AIMR.
Cohen, M., J. March & J. Olsen. (1972). A Garbage Can M odel o f  
Organizational Choice,
Administrative Science Quarterly, Vol. 17, pp. 1-25.
Copeland, Thomas E. (1979). Financial Theory and Corporate Policy, 
Reading:
50
Addison-Weslev Publishing Company. Inc., 1st Edition.
Mallik, A.K. & Rakshit, D. (2005). EVA-Based Segm ental Reporting: A Case 
Study, Research Bulletin, pp. 12-27.
Farragher, Edward J., Robert T. Kleiman & Anandi P. Sahu (2001 ).The  
A sso c ia tio n  B etw een  the U se o f  Sophistica ted  C a p ita l B udgeting  P ractices
a n d
C orpora te  P erform ance, The Engineering Economist, Vol. 46, No. 4, pp.
300-
311.
Gilbert, E. (2005). Capital Budgeting: A case study analysis o f  the role o fform al 
evaluation techniques in the decision making process', Graduate School of 
Business, University of Cape Town, Vol. 19, No. I, pp 19-36
Haka, Gordon & Pinches (1985). The Accounting Review, Vol. 60, No.4, pp.651 -
669.
Johnson, H. (1999). Making Capital Budgeting Decisions, Financial Times 
Prentice Hall.
Kadondi, E.A (2002). A Survey o f  Capital Budgeting Techniques used by 
Companies listed at the NSE, Unpublished MBA project, University of Nairobi.
Khakasa,E. (2009). Evaluating Information Technology Investments - A Survey o f  
Kenyan Commercial Banks, Unpublished MBA project, Strathmore University, 
Kenya.
Kim, S. H., {\919.M aking the Long Term Investment Decision, Management 
Accounting, 60 (No. 9, March), 41-49.
Klammer, T. (1973). The Association o f  Capital Budgeting Techniques with Firm 
Performance-, The Accounting Review, Vol.48, No.2, pp 353-364.
51
Linstrom. L. (2005/ A portfolio Approach to Capital Project Management; 
Unpublished M.Eng dissertation, University of Pretoria.
Mooi, S. & Mustapha, M. (2001). Firm Performance and Degree o f  
Sophistication o f  Capital Budgeting Practice: Some Malaysian Evidence; 
Proceedings of the Asia Pacific Management Conference, pp.279-290
Moore J. & Reichert,A (1989) . A Multivariate Study o f  Firm Performance and 
the Use o f  Modern Analytical Tools and Financial Techniques', Interfaces, Vol.
19. No. 3.
Mvers.M.,Gordon, L.& Hamer. M. (1991/ Postauditing Capital Assets and  Firm 
Performance: An Empirical Investigation. Managerial and Decision Economics, 
Vol. 12, No.4, pp. 317-327.
Myers, S. (1984). Finance Theory and Financial Strategy, Interfaces 14 (No. 1), 
126-137.
Nunally, C.J (1978). Psychometric Theory, New York, McGraw-Hill.
Olawale, F.& 01umuyiwa,0.,George, H. (2010) .An investigation into the Impact 
o f  Investm ent Appraisal techniques on the Profitability o f  M anufacturing Firms in 
the N elson Mandela Bay Metropolitan Area, South Africa, African Journal of 
Business Management,Vol.4(7), pp. 1274-1280.
01um,C.D (1976). Capital Investment Appraisal Techniques and Publicity 
Finances Investment project in the Private Sector, Unpublished MBA project, 
University of Nairobi.
Pike R.H (1986) .Sophisticated Capital Budgeting Systems and Their Association  
•with Corporate Performance; Managerial and Decision Economics, Vol. 5, No.2, 
pp 91-97.
Schall, L & Sundem, G. (1980). Capital Budgeting Methods and  Risk: A  Further 
Analysis, Financial Management, Spring, pp. 7-11.
52
SeIltiz,C..Wrightsman.L.S & Cook,W(1976). Research Methods in Social 
Relations
Shah. Anwar, (ed.), (2007). Budgeting and Budgetary’ Institutions, (Washington: 
World Bank)
Spackman, M. (2002/ M ulti-Year Perspective in Budgeting a n d  Public 
Investment
Planning, Draft background paper for discussion at Session III. 1 of the OECD 
Global
Forum on Sustainable Development (Paris: OECD).
Tarschys.D. (2002). Time H orizons in Budgeting, OECD Journal on Budgeting,
Vol. 2, No. 2.
Yao,L. Smid,P & Hermes, N. (2006). Capital Budgeting Practices: A 
Comparative Study o f  the Netherlands and China\ Unpublished Master Business, 
University of Groningen
53
[0V£RSnY OF NAIROBI 
SCHOOL OF BUSINESS
k£BA PROGRAM -  LOWtR KABETE CAMPUS
Telephone: 020-20J9162 P.O.Box 30197
Telegrams: "Varsiiy". Nairobi Nairobi. Kenya
Telex: 22093 Varsity_______________________________________________
DATE.. 1 0 _H t e P j '  201 .0
TO WHOM IT MAY CONCERN
The bearer of this letter...... ..............................................................................
Registration No:...... D G . i / y o S i l f ^ o o j ...............................
is a Master of Business Administration (MBA) student of the University of 
Nairobi.
He/siwr is required to submit as part of his/fuef coursework assessment a 
research project report on a management problem. We would like the 
students to do their projects on real problems affecting firms in Kenya. We 
would, therefore, appreciate if you assist him/her by allowing him/her to 
collect data in your organization for the research.
The results of the report will be used solely for academic purposes and a 
copy of the same will be availed to the interviewed organizations on request.
• DIVERSITY OF NAIROBI
SCIiOOL OF 8 U S IN --J
MSA OFFICE 
DR. W.N. IRAK! p. O. Box 30187
CO-ORDINATOR, MBA P R C flS ttW 1
ScHOol o f '%  H4IROBI
«  Y c T E S s
Na ir o b i01 97
QUESTIONNAIRE.
PART A: General Information
1. Respondent’s N am e........................................ (Optional):
2. Name of organization......................................
3. What is your designation?
•  Investment manager ( )
•  Risk manager ( )
•  Finance manager ( )
Any other (specify)......................................................
4. For how many years have you worked for your current organization?
i) Below 1 year ( )
ii) 2-3 years ( )
iii) 4-5 years ( )
iv) Over 6 ( )
5. Legal status of your company
State-owned ( )
Private company ( )
Public company ( )
Any other (specify)--------------------------------
54
FART B: Use o f Capital Budgeting Techniques
6. Please indicate how frequently your company employs the following 
evaluation techniques when deciding which investment projects to pursue.
Never
Always
Almost never Almost always
1
4
2 3
Net present value (NPV) 
( )
( ) ( ) ( )
Internal rate of Return (IRR)
( )
( ) ( ) ( )
Accounting Rate of Return (ARR)
( )
( ) ( ) ( )
Payback period (PB) 
( )
( ) ( ) ( )
Others specify
7. Has there been a major switch in techniques used over the last 5 years?
( ) Yes ( ) No
If yes, please specify:----------------------------------------------------------------------------
8. Which of the following technique(s) does your company favor when deciding 
which investment projects to pursue?
• Net present Value (NPV)
( )
• Internal Rate of Return (IRR)
( )
55
• Accounting Rate o f Return (ARR)
( )
• Payback period (PB)
( )
Any other, specify
9. Please estimate the average proportion of total capital expenditures your 
company made in the last five years that should be classified within these 
three investment categories:
• Replacement projects:  %
• Expansion projects- existing operations  %
• Expansion projects- new operations -----------%
Total 100%
10. Is there at least one member of your staff assigned full-time to capital 
investment analysis?
( ) Yes ( )N o
11. Does your company possess a capital investment manual (written capital 
investment guidelines)?
( ) Yes ( )No
12. Which technique does your company use to assess a project’s risk? (please 
tick one per line)
56
Never
Always
Almost never Almost always
1
4
2 3
Scenario analysis ( )
( )
( ) ( )
Sensitivity analysis ( )
( )
( ) ( )
Decision tree analysis ( )
( )
( ) ( )
Simulation analysis ( ) ( ) ( )
( )
13. Which o f the following approaches is used in your company to determine the 
minimum acceptable rate of return (discount rate) to evaluate proposed
capital investments? (Please tick one only).
• Weighted average cost of capital (WACC) ( )
• Cost of debt ( )
• Cost of equity capital ( )
• An arbitrarily chosen figure is used ( )
Any other rate (please specify)----------------------------------------
End of Questionnaire. 
Thank you.
57
LIST OF COM PANIES LISTED AT NSE (AS AT 30™ JUNE 2010)
Agriculture
1. Rea Vipingo Ltd.
2. Sasini Tea & Coffee Ltd.
3. Kakuzi Ltd.
Commercial and Services
1. Access Kenya Group
2. Marshalls E.A. Ltd.
3. Car & General Ltd.
4. Hutchings Biemer Ltd.
5. Kenya Airways Ltd.
6. CMC Holdings Ltd.
7. Uchumi Supermarkets Ltd.
8. Nation Media Group Ltd.
9. TPS (Serena) Ltd.
10. ScanGroup Ltd.
! 1. Standard Group Ltd.
12. Safaricom Ltd.
Finance and Investment
1. Barclays Bank of Kenya Ltd.
2. CFC Stanbic Bank Ltd.
3. Housing Finance Ltd.
4. Centum Investment Ltd.
5. Kenya Commercial Bank Ltd.
6. National Bank of Kenya Ltd.
7. Pan Africa Insurance Holdings Co. Ltd
8. Diamond Trust Bank o f Kenya Ltd.
9. Jubilee Insurance Co. Ltd
10. Standard Chartered Bank Ltd.
11. NIC Bank Ltd.
12. Equity Bank Ltd.
13. Olympia Capital Holdings Ltd
14. The Co-operative Bank of Kenya Ltd.
15. Kenya Re-Insurance Ltd.
10
I n d u s t r i a l  a n d  A l l i e d
I. Athi River Mining Ltd.
. BOC Kenya Ltd.
. British American Tobacco Kenya Ltd.
4. Carbacid Investments L td..
5. E.A. Cables Ltd.
6. E.A. Breweries Ltd.
7. Sameer Africa Ltd.
8. Kenya Oil Ltd.
9. Mumias Sugar Company Ltd.
10. Unga Group Ltd.
II. Bamburi Cement Ltd.
12. Crown berger (K) Ltd.
13. E.A Portland Cement Co. Ltd.
14. Kenya Power & Lighting Co. Ltd.
15. Total Kenya Ltd.
16. Eveready East Africa Ltd.
17. Kengen Ltd.