Pa y, H. M.A.; Fi e , C.
A icle
Capi al budge ing unde unce ain y: An empi ical s udy
Sou h A ican Jou nal o Business Managemen
P o ided in Coope a ion wi h:
Uni e si y o S ellenbosch Business School (USB), Bell ille, Sou h A ica
Sugges ed Ci a ion: Pa y, H. M.A.; Fi e , C. (1990) : Capi al budge ing unde unce ain y: An empi ical
s udy, Sou h A ican Jou nal o Business Managemen , ISSN 2078-5976, A ican Online Scien i ic
In o ma ion Sys ems (AOSIS), Cape Town, Vol. 21, Iss. 3, pp. 52-58,
h ps://doi.o g/10.4102/sajbm. 21i3.917
This Ve sion is a ailable a :
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52
S.-A .Tydsk .Bcd y sL
1990,21(3)
Capi al budge ing unde unce ain y:
an
empi ical s udy
H.M.A. Pa y and C. Fi e *
G adua e
School
o
Business Adminis a ion, Uni e si y
o
he Wi wa e s and,
P.O.
Box
98, Wi s 2050, Republic
o
Sou h A ica
Recei ed
21
Feb ua y 1990; accep ed 19 Ma ch 1990
The p ac ices
o
and a i udes owa ds isk analysis in Sou h A ican indus ial companies is s udied. Majo
indings a e ha ew companies use he sophis ica ed me hods
o
isk analysis ecommended in he inancial
li e a u e; he e
is
a wide use
o
quan i a i e echniques by he mo e capi al in ensi e companies; he e
is
gene al
dissa is ac ion wi h he applica ion
o
hese echniques in indusuy; companies pe cei e a need o mo e
use
o
quan i a i e isk-analysis echniques
o
aid decision-making.
I
is hoped ha a g ea1e unde s anding
o
he cu en p ac ices
o
isk-analysis echniques and he a i udes
o
decision-make s will assis in he selec ion
o
app op ia e capi al budge ing me hodologies o imp o e in esunen decisions made unde unce ain y.
Die p ak yk an, en die houding eenoo isiko-analise in Suid-A ikaanse nywe heidsmaa skappye wo d bes u-
dee . Die belang iks e be indinge is da min maa skappye geb uik maak an die e ynde me odes an isiko-
analise
soos in inansille li e a uu besp eek; da daa
'n
g o e oepassing is an kwan i a iewe egnieke deu
die mee kapi aalin ensiewe onde nemings; da daa algemene on e edenheid
oo
die oepassing an die
egnielce hee s; maa skappye bese die behoe e
om
in
'n
g o e ma e geb uik e maak an die kwan a iewe
isikome odes i beslui neming. Daa wo d e ou da g o e beg ip an die lopende p ak yk an isiko-
analise en die houding an beslui neme s sal byd ae o be e keuses an geskik e kapi aalbeg o ingsme odes
om beleggingsbeslui e e neem in onseke e oms andighede .
.,.o
whom all co espondence should be add essed.
In oduc ion
1be en i onmen
in
which company execu i es make
business decisions
has
become inc easingly u bulen and
unce ain du ing he 1980s. This
has
been pa icula ly
ue
in
Sou h A ica which has
seen
a g ow h in he
impo ance
o
poli ical and social issues in co po a e
decision-making.
1be
long- enn su i al
o
companies
depends on hei abili y o exploi new business
oppo uni ies, sus ain p o i able ope a ions and di es
o
unp o i able asse s. 1bese ac i i ies in ol e imponan
capi al budge ing decisions which shape he u u e
o
he
company.
1be heo y
o
inance
has
made a ailable se e al
quan i a i e echniques which ha e conside able
po en ial in assis ing decision-make s in dealing wi h he
unce ain y su ounding such decisions. Howe e
esean:he s
ha e obse ed ha many companies a e
ailing o
use
capi al budge ing echniques ha ha e
become
uni e sally accep ed by academics (Biennan,
1986, and Gilman and Fo es e , 1977). No all
p ospec i e p ojec s a e equally isky, and an imponan
a ea
in
he
heay desc ibes how o inco po a e isk in o
he
capi al in esbnen app aisal p ocess.
Ongoing
esea ch in
he
US
and UK has had, as i s
goal,
he
e alua ion
o
he
ex en o which inns a e
adop ing isk-adjusbnen echniques
in
hei analyses.
Howe e ,
ecy
li le
is
known
abou how Sou h A ican
companies cope wi h he isks
o
in es ing capi al and o
wha ex en hey a e awa e
o
and use he quan i a i e
lechniques a ailable o
hem.
Thus
he
objec i es
o
he
esea ch epo ed he e a e
o es ablish and compa e he awa eness and
use
o
isk-
analysis echniques in capi al budge ing ac oss Sou h
A ican indus ial companies
o
di e ing capi al
inaensi y, o in es iga e
he
a i udes
o
decision-make s
owa ds
hese
isk-analysis echniques and o assess hei
pe cei ed needs o me hodologies o cope
wi h
unce ain y.
Risk assessmen and adjus men echniques
While in ui ion
is
o
en used o e alua e he isk o a
capi al budge ing p oposal, he e a e se e al
onnal
echniques which
can
help in assessing isk.
These
include sensi i i y analysis, decision ees,
simula ion
and scena io analysis. A good unde s anding o
hese
me hods
is
e y impo an i sound capi al
budge ing
decisions a e o be made by op execu i es.
Sensi i i y analysis is used o de e mine which o
he
inpu a iables a e c i ical o he success
o
he
p ojec .
All
such a iables a e lexed by a gi en amoun ,
and
he
ela i e impac
o
he lexing on he p ojec 's
Ne
P esen Value (NPV)
o
In e nal Ra e
o
Re u n (IRR}
calcula ed. The echnique su e s om he p oblem
ha
changes in a iables a e conside ed in isola ion,
bu
i
does p o ide use ul insigh s in o p ojec iskiness.
Scena io analysis, in addi ion o measu ing
he
sensi i i y
o
changes
in
key a iables, also
looks
a
he
ange
o
likely alues
o
hese a iables. Usually
wo s
and bes case alues a e used o p oduce es ima es o
he
wo s and bes possible ou comes.
Assigning
p obabili ies o hese ou comes, as well
as
o
he
expec ed ou come, allows o he calcula ion
o
an
expec ed NPV and i s associa ed s anda d de ia ion.
The
ac ha only a
ew
disc e e ou comes
a e
p oduced limi s he alue
o
scena io analysis. The
well-
known echnique
o
Mon e Ca lo simula ion
(He z,
1964)
is
a mo e igo ous me hod
o
assessing a p ojec 's
s and-alone isk. I ies oge he sensi i i ies and
inpu
a iable p obabili y dis ibu ions, and equi es he
use
o
a compu e and ai ly sophis ica ed so wa e. The
ou pu
is an NPV p obabili y dis ibu ion, he s anda d
de·
ia ion
o
which
is
a measu e
o
p ojec isk.
S.A J.Bus.MgmL1990,21(3)
Decision- ee analysis is gene ally
used
in
conjunc ion
wi h
p ojec s ha equi e capi al ou lays o e
se e al
yea s
(B igham, 1988: 331) and p o ides es ima es o
expec ed
NPV and he concomi an s anda d de ia ion.
The
ou me hods ou lined abo e a e designed o
p o ide
an assessmen o he ela i e iskiness o a
p ojec .
Once managemen
has
a easonable ' eel•
o
he
le el .
o
isk
in o~ ed
in
an
in es men
p oposal,
i
mus
be
mco po a ed m o he capi al budge ing
decision
c i e ia. The e a e wo undamen al
ways
in
which
he
adjus men can be made. Fi s ly,
he
hu dle
a e
o
p ojec
accep ance can
be
changed
by
a sui able
p emium,
o discoun ,
o
allow o isk
ha
is
di e en
om
he 'no m~l' le el accep ed
by
he
company.
Secondly,
he es ima ed cash
lows
can
be
adjus ed o
allow
o
changing le els
o
isk o e
he
li e o
he
p ojec .
The
hu dle a e
o
be
adjus ed
o
accoun
o
isk
will
depend
on
which capi al budge ing me hod
is
used.
The
wo
popula me hods o isk adjus men a e
maximum
payback
pe iod and he isk-adjus ed discoun
a e.
I
a p ojec has been assessed
o
ha e
isk
ha
is
highe
han no mally accep able o
he
company,
he
maximum
payback pe iod
may
be
sho ened.
Howe e ,
he
payback me hod
on
i s
own canno e ec i ely
deal
wi h
isk,
as
i only ac s
as
a cons ain
on
he
iming
o
cash
in lows and does no conside
he
a iabili y o
hose
in lows. All esul s beyond
he
payback pe iod
a e
igno ed,
hough dlese may be he
mos
di icul
o
o ecas
and may hus ca y
he
mos
isk.
The
adjus men
o
he maximum payback pe iod,
al hough
simple
and eadily unde s andable, should
be
ega ded
as
a c ude me hod which a emp s
o
a oid
a
loss
si ua ion. The me hod should only
be
used
as
a
supplemen a y capi al budge ing ool oge he
wi h
mo e
sophis ica ed echniques.
The echnique known
as
he isk-adjus ed discoun
a e
in ol es changing he hu dle a e i he in e nal a e
o e u n
is
used o he discoun a e i
he
ne
p esen
alue
o p o i abili y index
is
used.
De e mining
how
much
o adjus he discoun a e
o
di e en
le els
o
isk
is
a di icul ask.
I
he an icipa ed isk o a p ojec
is
equal
o
he isk class
o
he
i m,
he
cos o capi al
(which
includes a isk ac o )
is
he
app op ia e discoun
a e.
I
he p oposed p ojec
has
been assessed
o
be
mo e
o less isky han he isk class
o
he
i m,
he
a e
o discoun should be adjus ed
up
o
down
om
he
cos
o
capi al because he discoun a e should e lec
he
iskiness
o
he cash
lows
being discoun ed.
I
may
be con enien o
use
a isk classi ica ion
sys em
o
p ojec s, each class o in es men
ha ing
a discoun
a e
app op ia e o
i s
isk. P ojec s
in ol ing
con ac ual o legal obliga ions
may
be
low
isk
and
equi e a discoun a e below
he
cos o capi al.
Ongoing p ojec s in ol ing exis ing business ope a ions
may
equi e he i m's cos o capi al
as
he discoun
a e.
In es men s in o
new
p oduc s
and
ma ke s
may
equi e a isk p emium
o
i e o
en
pe cen
abo e
he
mn's p esen cos
o
capi al o accoun
o
he
unce ain y
o
cus ome and compe i o eac ion,
lea ning cu e e ec s, ad e ising expenses, p ice le els,
53
e c. Resea ch and de elopmen p ojec s a e usually
qui e isky and a e likely
o
equi e a subs an ial
isk
p emium.
The
isk-adjus ed discoun a e me hod
has
a numbe
o limi a ions.
In
using a cons an isk-adjus ed discoun
a e
in
he calcula ion o ne p esen alue, i
is
assumed
ha
he
isk
o achie ing u u e expec ed cash
lows
emains
he
same
o e
he
li e
o
he
p ojec This
may
no
be
ealis ic, pa icula ly i he p ojec in ol es
he
in oduc ion o a
new
p oduc . In his case i
may
be
expec ed ha
he
majo isk occu s du ing
he
ea ly
yea s
while
he
p oduc is de eloped, ma ke ed
and
p omo ed.
The
isk-adjus ed discoun a e should
he e o e dec ease o e
ime
a he
han
emaining
cons an .
The
isk o a p ojec
may
only apply
o
he
ini ial
capi al cos o he plan du ing
he
enginee ing,
~ns uc ion
and
commissioning s ages. Raising
he
discoun a e
o
u u e e enues
which
may
be
ela i ely
ce ain
is
a
poo
way
o
adjus o he isk ela ed o
he
cos o
he
plan .
Ano he
weakness
o he isk-adjus ed discoun a e
is
ha
i
does
no
ell
decision-make s
which
isks
hey
a e
aking.
Theo e ically, a isk- ee a e should
be
used o
discoun
o
he
ime
alue o
money,
and
adjus men s
o
any
isks
should
be
made sepa a ely.
The e
a e
wo
p incipal me hods
which
accoun
o
isk
by
adjus ing
he
p ojec 's cash
lows,
namely p ojec
li e adjus men
and
he
ce ain y equi alen app oach.
P ojec li e adjus men in ol es
he
unca ion o cash
lows
by
educing
he
p ojec li e
and
hence he appa en
e u n
in
o de
o
accoun
o
isk. The echnique
is
c i icised
by
Van
Ho ne (1976) because he e
is
al eady
an
unce ain y elemen
in
p ojec li e
and
no
conside a ion
is
gi en o
he
o he a iables
which
a ec
he
p obabili y dis ibu ion o
he
p o i abili y measu e
(i.e.
he essence o isk). The me hod
is
subjec i e,
c ude
and
g ossly in e io
o
o he mo e sophis ica ed
echniques.
A alid al e na i e
o
adjus ing
he
discoun a e
is
o
i s educe each expec ed cash
low
o
i s
ce ain y-
equi alen
and
hen
discoun
o
ime
using
he
isk- ~
a e.
An
app op ia e isk- ee a e
would
be
he
e u n
expec ed
on
T easu y Bills. This in ol es de e mining
..
wha
ce ain e u n
he
decision-make
would
be
willing
o
ake
in
place o each yea 's unce ain e u n. Fo
example,
assume
ha
he expec ed e u n
in
yea
' '
is
R5000.
The
decision-make
may
indica e ha he
is
indi e en be ween ecei ing
an
unce ain R5000
and
a
ce ain
R3000.
The
R3000
is
he
ce ain y-equi alen
and
ep esen s a iskless e u n. The ce ain y-coe icien ,
which
inc eases
as
isk dec eases
and
has
a
alue
be ween
ze o and one,
is
equal
o
0,60 (R3000/R5000).
Ce ain y-coe icien s a e de e mined
o
each yea 's
cash
low
and
he ne p esen alue calcula ed using he
o mula:
NPV
=
=O
(l+i)
1
Ci
= Expec ed ne cash
low
in
pe iod
S4
J = Ce ain y-coe icien o pe iod
i = Risk- ee a e (a e ax)
n = P ojec li e
The NPV decision ule emains unchanged, i.e. a
p ojec should be accep ed
i
he NPV is posi i e.
The ce ain y-equi alen app oach is heo e ically
sound and a oids many
o
he objec ions ela ed o
adjus ing he discoun a e. The deg ee
o
isk
adjus men
can
be decided by managemen o each ime
pe iod and he me hod also disagg ega es he
discoun ing o ime and he adjus ing o isk. Despi e
i s ad an ages he use
o
he ce ain y-equi alen me hod
aises implemen a ion p oblems in ha decision-make s
may ind i easie o subjec i ely aise he discoun a e
o a isky p ojec a he
han
o
speci y ce ain y-
equi alen s o each yea .
P io
esea ch
O e he pas wo decades nume ous s udies ha e been
conduc ed a ound he wo ld o s udy capi al budge ing
p ac ice (eg. Pe y, 1975; Pe y, Sco and Bi d, 1975;
Gi man and Fo es e , 1977; Schall, Sundem and
Geijsbeek, 1978; Kim and Fa aghe , 1981; Bu le ,
1982; S anley and Block, 1983; Bie man, 1986;
Linneman and Klein, 1985; Pike and Sha p, 1989).
The esul s indica e ha companies use mo e han one
echnique wi h in e nal a e
o
e u n and payback being
he mos popula . The e is a s ong p e e ence o he
use
o
IRR as he p ima y echnique: he s udy by
S anley and Block (1983) indica ing a 65% usage. They
epo a end o e ime away om he less sophis ica ed
e u n
on
in es men me hod and owa ds inc eased use
o
IRR as he p ima y me hod. A s udy by Pike and
Sha p (1989) in he Uni ed Kingdom ound ha 75%
o
i ms
use
IRR, his pe cen age ha ing g own om 44%
in 1975.
The mos popula seconda y
o
supplemen a y
echnique was shown by many su eys o be payback
pe iod, wi h usage anging om 38% o 44%. The use
o
ne p esen alue as a seconda y me hod was epo ed as
26% by Gi man and Fo es e (1977) and 30% by
S anley and Block (1983).
Pe y (1975) ocused on he use
o
capi al budge ing
ools
acco ding
o
he size
o
i m and ype
o
indus y.
Al hough he ound no de ini e pa e n o be disce nible
in e ms
o
he use
o
he echniques in di e en
indus ies he did conclude
ha
' he
capi al in ensi e indus ies seem
o
p e e he
ime-weigh ed measu es -discoun ed a e
o
e u n
and
ne p esen alue -and
he
less capi al
in ensi e i ms p e e payback'.
He
also obse ed ha highly capi al in ensi e
companies ha
a e
mo e capi al in ensi e end o use a
g ea e numbe
o
di e en capi al budge ing
echniques.
Kim and Fa aghe (1981) ound ha i ms in
' echnologically-o ien ed' indus ies end o be mo e
ad anced in he use
o
sophis ica ed capi al budge ing
p ac ices.
Wo k by Pe y, e al. (1975)
and
Schall, e
al.
(1978),
S.-A .Tydsk .Bed y sl.1990,21(3)
indica ed ha he weigh ed a e age cos
o
capi al
is
used as a discoun a e by 30% and 46%
o
inns
espec i ely. A wide a ie y
o
me hods is used wi h
he
mos popula me hod in he ea lie s udy being a
managemen de e mined a ge a e
o
e u n. A
signi ican numbe
o
i ms (17% and 26%) p e e o
use
he
cos
o
a speci ic sou ce
o
unds as a discoun a e.
Se e al esea che s (Pe y, 1975; Gi man
and
Fo es e , 1977; Schall, e
al.
1978 and Bu le ,
1982)
ound ha mos companies gi e explici conside a ion
o
isk and unce ain y when making capi al budge ing
decisions. Thei s udies indica ed ha 70% o 80% o
i ms make some o m
o
isk adjus men . Schall,
e
al.
(1978) epo ed ha al hough only 36%
o
he
esponding i ms used a quan i a i e isk-assessmen
echnique, 78% had speci ic me hods
o
adjus ing
o
isk.
The ques ion
o
how i ms adjus ed o isk was
also
in es iga ed by Pe y (1975), Pe y, e
al.
(1975), Gi man
and Fo es e (1977) and Bu le (1982). The
isk
adjus ed discoun a e was gene ally ound o
be
he
mos popula echnique bu Pe y, e
al.
(1975)
ound
ha a su p isingly la ge
77%
o
i ms used an adjus men
o
he payback pe iod as a me hod
o
accoun ing o
isk.
This me hod was epo ed by Bu le (1982) o
be
he
second mos popula echnique wi h 42% usage
by
esponden s. These wo esul s a e in con as o
he
ai ly low usage
o
adjus ed payback ound by bo h Pe y
(1975) and Gi man
and
Fo es e (1977).
A la ge ac ion
o
Sou h A ican i ms (36%)
uses
subjec i e judgemen when adjus ing o isk (Bu le
1982). This is signi ican ly highe han ha ound by
he
Ame ican esea che s and sugges s a lowe
sophis ica ion in capi al budge ing unde unce ain y
o
Sou h A ican companies. This conclusion
is
suppo ed
by he di e ence in use
o
he ce ain y-equi alen s
app oach by Ame ican and Sou h A ican i ms; 26%
in
he Uni ed S a es e sus 18% in Sou h A ica.
Pe y, e
al.
(1975) sough addi ional in o ma ion
om
esponden s in an a emp o disco e he ex en
o
which di e si ica ion is used
o
educe isk. Al oge he
57%
o
he esponden s answe ed
no
o he ques ion:
'Is
di e si ica ion
o
co po a e in es men s (in
o de o educe isk) an impo an capi al-
budge ing objec i e
o
you i ms?'
Thus he e seems
o
be
a di e ence
o
op1mon
be ween co po a e decision-make s and academics wi h
ega d o
he
impo ance
o
po olio di e si ica ion as a
p ac ical isk- educ ion echnique.
In a ecen su ey by Bie man (1986), in o ma ion
was
ob ained om senio inancial o ice s
o
some
o
he
la ges Ame ican companies, ela ing o di icul ies
encoun e ed in implemen ing capi al budge ing
echniques. Mos
o
he
commen s e lec ed di icul ies
expe ienced in coping wi h unce ain y and he majo
conclusion d awn was ha a
gap
exis ed be ween
he
needs
o
decision-make s
and
he me hods cu en ly
being used o e alua ing capi al in es men s. This gap
seemed o be pa icula ly signi ican in he a ea
o
isk
analysis.
S.A J.Bus.Mgm l990,21(3)
The
esea ch
ques ion
I
inancial heo y is o be co ec ly applied
in
capi al
budge ing, he issue
o
he inco po a ion o isk analysis
in o capi al budge ing is one
o
undamen al impo ance.
This s udy add esses he ques ion
o
how
Sou h
A ican companies cope wi h he isks
o
in es ing
capi al and o wha ex en hey a e awa e
o
and use
he
quan i a i e echniques a ailable
o
hem. I also
in es iga es whe he he e
is
a ' di e ence
in
capi al
budge ing p ac ice adop ed by companies
o
di e en
capi al in ensi y. A su ey
o
he p ac ices and a i udes
o decision-make s ac oss companies
o
di e en capi al
in ensi y will, i is hoped, help o iden i y app op ia e
me hodologies o dealing wi h unce ain y. The
ollowing hypo heses we e es ed:
Hypo hesis
1
'The me hods mos commonly used o analyse he isks
o capi al in es men p ojec s a e ela i ely subjec i e
and
unsophis ica ed compa ed wi h modem a ailable
me hods.'
Hypo hesis
2
'The e
is
a g ea e use
o
quan i a i e isk-analysis
echniques in mo e capi al in ensi e companies.·
Hypo hesis
3
'The e is a g ea e conce n abou isks speci ic
o
he
in es men p ojec being conside ed (unsys ema ic isk)
in
he mo e capi al in ensi e companies.'
Hypo hesis
4
'Decision-make s a e dissa is ied wi h he a ailable
me hods o isk analysis. Mo e speci ically, he
pe cep ions a e ha :
(i)
The me hods a e oo complex and academic and
he e o e imp ac ical.
(ii) The me hods a e oo cos ly and ime-consuming.
(iii) Decision-make s a e no su icien ly skilled in he
use
o
he me hods o ully bene i
om
hem.'
Hypo hesis
5
'The e is a need by decision-make s o
he
use
o
mo e
quan i a i e and sophis ica ed app oaches o e alua ing
capi al in es men p ojec s unde unce ain y.'
Me hodology
A ques ionnai e was sen
o
he inancial di ec o
o
each
o he 270 indus ial companies lis ed
on
he
Johannesbu g S ock Exchange. In o de
o
keep he
ques ionnai e leng h and complexi y o a easonable
le el, he esea ch issues we e kep ela i ely simple.
The ques ionnai e was di ided in o ou sec ions. The
i s sec ion, en i led 'company backg ound',
was
included o ob ain in o ma ion on
he
cha ac e is ics o
he
esponding i ms in e ms
o
he business sec o ,
asse size, capi al budge size, g ow h a e and
p o i abili y.
Sec ion wo was designed as a b ie inqui y in o
he
55
capi al budge ing p ac ices used by
he
esponden s,
while
he
hi d sec ion comp ised he main body
o
he
ques ionnai e and had he objec i e
o
es ablishing how
companies deal wi h isk and unce ain y when making
capi al budge ing decisions.
The inal sec ion con ained se en ques ions in ended
o elici in o ma ion om esponden s conce ning hei
a i udes owa ds isk analysis. Fou
o
he ques ions
a emp ed
o
de e mine he ex en
o
esponden s' needs
wi h ega d
o
coping wi h unce ain y, and
h ee
ques ions
p obed
he le el
o
sa is ac ion
o
esponden s
conce ning he a ailable isk-analysis echniques.
Company inancial s a emen s we e used o calcula e
capi al in ensi y, which
was
de ined
as
o al asse s
di ided
by
ne sales. A e age alues o he pas
h ee
yea s we e used
o
classi y companies in o ou
ca ego ies
o
app oxima ely equal size. These had capi al
in ensi y a ios
o
0--0,50; 0,51-0,70; 0,71-0,85; >
0,85.
Resul s
Al oge he
71
eplies we e ecei ed
by
he cu o da e
o
8 Decembe 1986.
O
hese 65 we e usable, equi alen
o
a esponse a e o 24%. In all ou capi al in ensi y
g oupings esponse a es we e o e 20%.
A wide c oss-sec ion
o
companies we e included
in
he
sample
o
esponden s. They had a e age o al asse s
o
R90 million and capi al budge s anging om R0,25
million
o
mo e han R500 million. The e was a s ong
co ela ion be ween asse size and · he magni ude
o
he
capi al budge .
Table 1 se s ou
he
capi al budge ing me hods in use
and hei ela ion
o
capi al in ensi y.
The a e age numbe
o
echniques used
by
each
company
was
2,9 indica ing ha decision-make s
use
a
mul i- echnique app oach
o
capi al budge ing. This
app oach
o
no elying on a single echnique could be an
a emp
by
companies
o
cope be e wi h unce ain y.
The mos popula p ima y echnique o e all
was
in e nal a e
o
e u n (43%) ollowed by e u n on
in es men (32%). Howe e , a p onounced di e ence
be ween i ms o high and low capi al in ensi y in he use
o
a p ima y capi al budge ing echnique
was
ound.
62%
o high capi al in ensi y i ms p e e he IRR
Table
1
Capi al
budge ing
me hods
in
use
Capi al
in ensi y
Mclhod
Low
High
To al
In e nal
me « mum
64'1,
76'1,
69'1,
Ne
p esen
alue
SO'I,
52'1, 51'1,
P o i abili y
index
11'1,
14'1, 12'1,
P esen
alue payback
31'1,
41'1,
35'1,
Accoun ing paybad
56'1, 59'1. 57'1,
Rc um m in es mm
75'1,
52'1,
65'1,
A enge
numbe
o
me hods
2,9
2,9
29

56
me hod
compa ed
wi h
only
24%
o
low
capi al in ensi y
inns. The mos popula p ima y
me hod
o
low
capi al
in ensi y inns
is
ew n
on
in es men (47%). These
esul s
a e
a s ong indica ion o lowe sophis ica ion
in
capi al budge ing
by
companies o lowe capi al
in ensi y.
The mos popula seconda y echnique
used
by
all
esponden s
was
accoun ing payback (36%). This
me hod
was
p e e ed
as
a supplemen a y echnique
by
35%
o
low
capi al in ensi y inns and
38%
o
high
capi al in ensi y inns. This esponse
is
no
su p ising
as
he
payback
me hod
can
be
conside ed
o
be a c ude
o m
o isk analysis and i s popula i y as a
supplemen a y decision-making aid
has
p e ailed o
yea s.
Ne p esen
alue
was
epo ed
as
being a p ima y
echnique
by
only
10%
o he esponden s and
as
a
seconda y
echnique
by
22%
o esponden s. This
me hod
is
he e o e also conside ed
by
indus ial
p ac i ione s
o
be
o bene i mainly as a supplemen a y
echnique.
This
inding
is
in
con as
o
he
gene ally
accep ed
iew
ha he
NPV
echnique
is
supe io o
he
o he capi al budge ing
me hods
(Cla k, Hindelang and
P i cha d.
1984:
57-76).
Al oge he
84%
o
he o al esponden s indica ed
ha
hey
use
some
o m
o discoun a e
when
doing a
capi al budge ing analysis. The mos popula basis o
discoun ing
is
he
use o he weigh ed a e age cos o
capi al
(31%).
Ame ican esea che s, Pe y, e al. (1975)
and
Schall, e
al.
(1978) es ablished ha
he
weigh ed
a e age cos o capi al
was
used
by
30%
and
46%
o hei
esponden s espec i ely.
The
nex mos commonly
used
discoun a e
is
he
in la ion a e,
which
is
used
by
30%
o
esponden s
al hough he e
is
li le heo e ical jus i ica ion
o
i s
use.
Possible
easons
o i s popula i y could
be
ha he
in la ion a e
is
concep ually simple
o
unde s and and
o ecas s
o u u e a es a e usually eadily a ailable.
The mos signi ican di e ence be ween
high
and
low
capi al in ensi y i ms
is
in
hei
use
o
he a e - ax cos
o deb ,
which
was
used
as
a discoun a e
by
32%
o
low
capi al in ensi y
i ms
bu
by
only
8%
o
high
capi al
in ensi y
i ms.
This could e lec a lack o sophis ica ion
by
low
capi al in ensi y i ms. The a e - ax cos o deb
is
usually he leas expensi e sou ce
o
unds
o a
company and i used
as
a discoun a e, could lead
o
some p ojec s being accep ed
in
e o .
O he discoun a es
used
we e a a e
based
on pas
expe ience
(13%
o
esponden s)
and
a a e speci ied
by
a holding company
(6%).
I
hus
appea s ha a subs an ial p opo ion o
esponding companies a e using discoun a es
which
a e
heo e ically inco ec . This p obably esul s
in
sub-
~I
decisi~-making
when
conside ing capi al
m es men p ojec s using ime-weigh ed e alua ion
echniques.
Rlsk-analysls
p ac ices
Responden s we e asked
o
indica e
wha
hei inns
unde s ood
by
he enn isk
in
he
con ex o capi al
S
.-A .Tydsk .Bed y sl.1990,21(3)
budge ing. P obabili y o no achie ing a a ge
e u n
was
selec ed
by
41
%
o
he esponden s,
whe eas
13%
de med isk
as
he p obabili y o making a
loss.
Bo h
hese de mi ions can
be
ca ego ised as being
associa ed
wi h nega i e a ia ion o semi- a iance
s a is ic
(Copeland and Wes on,
1983:
149). The
majo i y
o
esponden s (54%) a e he e o e conce ned
wi h
his
downside isk and
22%
de ined isk
as
he
a ia ion
in
possible ew ns. Li le di e ence
was
no ed
be ween
high and
low
capi al in ensi y companies.
The s udy
by
Pe y, e
al.
(1975) indica ed ha
40%
o
esponden s de ined isk
as
nega i e a iance
and
30%
as
o al a iance. I he e o e appea s ha
in
1986
Sou h
A ican indus ial companies we e mo e conce ned
wi h
he downside isks o capi al in es men s
han
he
Ame ican esponden s
in
he
1975
s udy.
86%
o companies
in
he high capi al in ensi y
s a um
use quan i a i e me hods when assessing
isk
compa ed
wi h only
39%
in
he low capi al in ensi y s a um.
P e ious su eys
in
Ame ica
by
Pe y
and
Bowlin
(1976) and Schall, e
al.
(1978) indica ed
ha
he
ac ions o esponden s using quan i a i e
isk-
assessmen echniques we e
30%
and
36%
espec i ely.
Howe e i would
be
inco ec
o
deduce
ha
Sou h
A ican companies make g ea e
use
o
quan i a i e
echniques, since
he
Ame ican s udies
we e
ca ied
ou
en
yea s p e iously, and ecen longi udinal
s udies
ha e shown a end owa ds he
use
o mo e
quan i a i e
echniques
in
he Uni ed S a es o Ame ica
(Cla k
e
al.
1984:
57-60).
Table 2 shows he esponses
o
ques ions
ela ing
o
he esponden s amilia i y wi h quan i a i e
echniques
o
he assessmen o isk.
I
is
e iden ha he mos widely
used
echnique
o
assessing unce ain y
is
sensi i i y analysis
wi h
61
%
o
companies epo ing some deg ee o
use;
23%
using
he
me hod some imes and
38%
using
i
o en.
Only
5%
indica ed ha
hey
a e no amilia
wi h
his
echnique.
The second mos popula echnique
is
scena io
analysis, used
by
35%
o companies, al hough
only
15%
use
his echnique o en. A signi ican
ac ion
o
companies (a leas
31
% )
is
no amilia
wi h
scena io
analysis. The
use
o scena io analysis
is
mo e
p e alen
in
Ame ica since
50%
o
i ms
in es iga ed
by
Linneman
and Klein (1985) epo ed using
i
Decision ees and Mon e Ca lo simula ion
a e
no
a
all popula as isk-assessmen echniques
wi h
only
11
%
and
7%
o esponden s espec i ely epo ing
some
Table
2
Quan i a i e
echniques
o
assessmen
o
isk
Familia Used
Teclmique
o
No
No bu
no
some· Used
assess isk esponse amilia used imes o ien
Sensi i i y
analysis
17%
5%
17%
23%
38%
Decision ees
18%
19%
52%
9%
2%
Monie Ca lo
simula ion
18%
44%
31%
5%
2%
Scena io analysis
17%
31%
17%
20%
15%
_
---
S.A J.Bus.MgmL1990,21(3)
deg ee
o
use
and
only
2%
epo ing ha hey used hese
me hods
o en. A la ge ac ion
o
inns (44%)
epo ed
ha hey a e
no
e en amilia wi h Mon e Ca lo
simula ion
and
19%
a e
no
amilia wi h decision ees.
Pe y
and
Bowlin (1976) ound in hei su ey ha 30%
and 37%
o
esponden s use decision ees and
simula ion espe.c i ely. This is u he e idence ha
Sou h A ican companies a e less sophis ica ed in capi al
budge ing han hei Ame ican coun e pa s.
I can be concluded om he esul s
o
he esea ch
ha e y ew i ms use he mo e sophis ica ed me hods
a ailable o isk assessmen , namely, decision ees and
Mon e Ca lo simula ion. Sensi i i y analysis
is
used
easonably widely
bu
i
is
a ela i ely unsophis ica ed
app oach. The su ey did no indica e any signi ican
di e ences in
he
deg ee
o
amilia i y
o
use
o
he ou
isk-assessmen echniques ac oss companies
o
di e en
capi al in ensi y.
Responden s we e asked whe he , ha ing iden i ied a
p ojec
o
isk di e en om he company a e age, hey
make a quan i a i e, subjec i e
o
no adjus men o hei
capi al budge ing me hodology. Only 3% made no
adjus men , 34% used a subjec i e app oach and 63%
employed
a
leas
one
quan i a i e echnique. 79%
o
high capi al in ensi y companies use quan i a i e
echniques compa ed o only
50%
o
low capi al
in ensi y i ms. Ame ican s udies epo ed ha 70%
o
80%
o
i ms make some o m
o
quan i a i e isk
adjus men
The esponden s we e also asked o indica e whe he
hey
we e amilia wi h
o
use six gi en isk-adjus men
me hods. The esul s a e epo ed in Table
3.
The echnique ha
is
used o en by mos esponden s
(32%) is an adjus ed hu dle a e o he in e nal a e
o
e u n. In con as a isk-adjus ed discoun a e is used
o en by only 14%
o
esponden s. This would be
expec ed gi en he highe use
o
IRR compa ed o NPV
(see Table I). 23%
o
esponden s equen ly adjus he
hu dle a e o he accoun ing a e
o
e u n. Adjus ing
he maximum payback pe iod is used o en by only 9%
o
i ms bu used some imes by 32%
o
i ms.
This
esul
con i ms he p e ious conclusion ha payback pe iod
is
conside ed o be mo e
o
a supplemen a y echnique
in
capi al budge ing.
Adjus men
o
p ojec li e was used by 25%
o
esponden s
and
he use
o
ce ain y-equi alen s was
epo ed by 21 %
o
i ms.
31
%
o
esponden s we e no
amilia wi h ce ain y-equi alen s al hough mos we e
amilia wi h he o he i e isk-adjus men me hods.
I can be concluded ha he e is a p e e ence by nea ly
hal
o
he esponding i ms o he use
o
ela i ely
unsophis ica ed echniques
o
isk adjus men . namely,
adjus men
o
hu dle a es o IRR and ROI.
App oxima ely
one
hi d
o
i ms use he isk adjus ed
discoun a e
o
some
ex en
Howe e , only one i h
o
i ms make some use
o
ce ain y-equi alen s, which
is
he echnique ega ded as being supe io and he mos
sophis ica ed as an aid o isk adjus men (Cla k,
e
al.
1984: 176-193). The ce ain y-equi alen s me hod was
epo ed by Bu le (1982)
o
be used by only 18% o
57
Table
3 Quan i a i e echniques o adjus men o isk
Technique Familia
Used
IO
adjus
No
No
bu
no
some·
Used
o
isk
esponse
amilia
used
imes o en
Risk
adjul ed
dilCOUll
a e
22%
6%
37%
22'l>
14'l>
In e nal
a e
o(
e u n
hu dle
a e
17%
S%
25%
22%
32%
Re u n
on
in es men
hu dle
a e
18%
3%
31%
25% 23%
Maximwn
payback
pe iod
20%
S%
34%
32%
9%
P ojec
li e
16%
6%
43%
20%
S%
Ccnain y-equi alai s
23%
31%
25%
12%
9%
esponding companies, and his inding lends suppo
o
he abo e conclusion.
No signi ican di e ences we e ound conce ning he
amilia i y and use
o
speci ic quan i a i e echniques o
high
o
low capi al in ensi y i ms. Howe e , i ms
o
highe capi al in ensi y clea ly place mo e eliance on he
use
o
quan i a i e isk-adjus men me hods han on
subjec i e adjus men .
In o de
o
p o ide some addi ional insigh s in o how
companies cope wi h unce ain y, esponden s we e
asked
o
indica e o wha ex en di e si ica ion was
conside ed as pa
o
hei capi al budge ing objec i es.
Al oge he 46%
o
he esponden s did no ega d
po olio di e si ica ion as an impo an isk- educ ion
echnique, and his e lec s a di e ence
o
opinion
be ween co po a e decision-make s and academics. A
simila obse a ion was made by Pe y, e
al.
(1975) who
ound ha 57%
o
esponden s we e unce ain abou he
desi abili y
o
ha ing a di e si ica ion objec i e in o de
o educe isk.
A i udes
o
isk
analysis
Responden s we e asked o indica e hei deg ee
o
ag eemen o disag eemen
o
each
o
se en s a emen s
conce ning di e en aspec s
o
isk analysis. The e was
gene al ag eemen ha decision-make s a e no
su icien ly skilled in he use
o
sophis ica ed isk-
analysis echniques o bene i om hem.
Howe e , esponden s nei he ag eed no disag eed,
bu exp essed neu ali y when p esen ed wi h he
s a emen s ha sophis ica ed isk-analysis echniques a e
oo cos ly and ime consuming
o
be jus i ied, and ha
hey a e oo complex and academic o be
o
eal p ac ical
use. Whils i was di icul o d aw any gene al
conclusions om hese esponses, hey may well
be
indica i e
o
a gene al lack
o
unde s anding
o
ad anced
isk-analysis echniques.
High capi al in ensi y companies el ha decision
make s a e gi en enough in o ma ion on he unce ain y
o
capi al in es men p oposals, whe eas he
esponden s om companies wi h low capi al in ensi y
disag eed.
58
All
mns el ha he e was a need o mo e
quan i a i e
app oaches
o coping wi h unce ain y,
al hough he eeling was s onge amongs he capi al
in ensi e i ms. Howe e , all esponden s indica ed ha
en ep eneu ial skills and judgemen emained an
impo an pa
o
he
p ocess, despi e he
need
o a
quan i a i e app oach.
Fmally mns, especially hose in capi al in ensi e
indus ies, disag eed wi h he p oposi ion ha , because
e en he mos sophis ica ed
o
echniques canno p edic
he u u e, hey should no
be
used.
Conclusions
Hypo hesis 1 is con i med. App oxima ely
one
hi d
o
he esponden s
do
no use any quan i a i e echnique o
assess
isk
o
adjus o
iL
O
he emainde , almos all
use
he ela i ely unsophis ica ed sensi i i y analysis.
Few
i ms
use a sophis ica ed me hod o
isk
adjus menL
The g ea e
use
o
quan i a i e isk-analysis ools by
mo e capi al in ensi e i ms con i ms hypo hesis 2.
Al oge he 80%
o
high capi al in ensi y i ms ega d
unsys ema ic isk as e y impo an , and mos aim o
achie e a
deg ee
o
di e si ica ion in o de
lo
educe
isk. Hypo hesis 3 is hus also con i med.
Pa s (i) and (ii)
o
hypo hesis 4 could no
be
con i med, bu i ms did indica e ha a lack
o
skills
p ecluded hem om ully bene i ing om echniques
o isk analysis, hus con i ming
pa
(iii).
In
con i ming hypo hesis 5, companies did indica e a
need o mo e quan i a i e echniques
lo
be
used by
decision-make s. These iews we e mo e s ongly held
by hose mns wi h high capi al in ensi ies, bu
esponden s empe ed his iew wi h he
need
o
complimen a y en ep eneu ial skills and judgemenL
A majo inding
o
his esea ch is ha e y ew
companies appea o use sophis ica ed capi al budge ing
echniques. Al hough mos
o
he high capi al in ensi e
companies use he in e nal a e
o
e u n as a p ima y
me hod,
he
low capi al in ensi e companies clea ly
p e e
o
use
he
accoun ing a e
o
e u n. The mos
popula
seconda y capi al budge ing me hod is he
payback pe iod which is conside ed o
be
ela i ely
c ude and unsophis ica ed. The equen use
o
sophis ica ed
isk-analysis echniques
is
also limi ed
lo
a
small mino i y
o
companies. Howe e , he esea ch
esul s indica e a
wide
use
o
quan i a i e isk-analysis
echniques by he mo e capi al in ensi e companies.
The e
also appea s o be gene al dissa is ac ion wi h he
applica ion o
hese
echniques in indus y. Mos
S.-A .Tydsk .Bcd,y sl.1990,21(3)
companies ne e heless pe cei e a need o g ea e
use
o
quan i a i e isk-analysis echniques
o
aid decision-
making.
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