University of Zimbabwe
Faculty of Commerce
Department of Accounting
Project Topic
An analysis of the effectiveness of capital budgeting process in the mobile telecommunication industry in Zimbabwe: Based on the massive investment by Econet Wireless Zimbabwe
Done by:
Tozivepi Desire M
R164112R
Program: HACC 2017
TABLE OF CONTENTS
Page
1 Introduction 3-4
1.1 Background 4
1.1.1 Overview of Capital Budgeting 4-5
1.1.2 Mobile Telecoms in Zimbabwe 5
1.2 Problem Statement 5
1.3 Research Objectives 6
1.4 Research Questions 6
1.5 Research Hypothesis 6
1.6 Scope of the Study 6
1.7 Significance of the Study 6
2. Literature Review 7
2.1 Definition and Purpose 7
2.2 Stages in the Capital Budgeting Process 7-8
2.2.1 Responsibility in Capital Budgeting 8
3. Research Methodology 9
3.1 Research Design 9
3.1.1 Research Philosophy 9-10
3.1.2 Research Methodology 10
3.2 Population and Sampling 10
3.2.1 Population and Target Population 10
3.2.2 Sampling 10
3.2.2.1 Sample Size 10
3.2.2.2 Sampling Method 10-11
3.3 Sources of Data 11
3.4 Data Collection 11-12
4 Research Plan 13
5 References 14
CHAPTER 1
INTRODUCTION
Capital budgeting is the most important function done by financial managers and it is not only a popular corporate finance topic but one that has been widely researched by academics particularly in international researches. A capital budgeting project is a decision to make a cash outlay to receive future cash inflows, therefore shareholder value is created if the present value of cash inflows exceeds that of the outlay.
The importance of the capital budgeting process for the firm lies in the fact that relatively large amounts of money are committed for a long time thus once the decision is made to embark on a particular project the process cannot be reversed unless a value destruction decision is taken to salvage what has been invested.(J Hall 2001) .
A number of stages, calculations, evaluation methods and refinements to the capital budgeting process can be used and it is these aspects of the capital budgeting process that are investigated in this study and the uncertainty involved in the process.
1.1 Background to the Study
“Honorable members will be aware that in the hyperinflationary environment characterizing the economy at present, our people are now using multiple currencies for day to day business transactions, alongside the Zimbabwe Dollar. These currencies include the South African rand, United States dollar, Botswana pula, Euro, pound Sterling, among others. In line with the prevailing practices by the general public, Government is, therefore, allowing the use of multiple foreign currencies for business transactions, alongside the Zimbabwe dollar.” (Acting Minister of Finance, Cde Patrick Chinamasa on Budget Presentation to Parliament on 29 January 2009.)
The introduction of the multi-currency system by the then Acting Minister, Hon Patrick Chinamasa saw a new lease of life in local business operations, containment in inflation and a drastic reduction in currency risk greatly associated with the moribund local currency. The new dispensation of the Government of National Unity saw the resurrection of planning and budgeting which had become almost obsolete in the hyperinflationary economy as the political climate calmed and more stable currencies were in use in the transaction process system of the nation.
The era has seen organizations making out capital expenditures either to replace outdated equipment usually inherited before the nation’s independence or equipment for expansion to meet the greater demand for local products. Mining houses, organizations in the communication industry and the beverage sector have been involved in multi-million (US) dollar capital outlays to enhance capacity and realize economic gains in the more stable environment in comparison with yesteryears.
Capital budgeting or investment appraisal is the planning process used to determine whether firms’ long term investments such as new machinery, new plants, new products and research and development projects are worth pursuing. It is a budget for major capital, or investment expenditures of an organization and requires higher accuracy in the decision-making process and involves higher level management.
Therefore, whether in good times or in anticipation of market contractions, the expenditure of cash in exchange for future generated uncertain benefits requires a distinctive decision making structure. Central to this decision making framework is capital budgeting. The capital budgeting process is the decision makers’ primary tool for evaluating the benefits of projects under consideration and for selecting long term investments from among alternative available projects. The methods and analysis used in the acceptance or rejection of a project are important because the commitment to a given capital project involves a significantly large, future oriented sum of money and is frequently irreversible; i.e. the decision, once made, locks the firm into a production technology for an extended period of time. These decisions will directly impact the firm’s expected future earnings and future cash flows as well as their timing and risk levels.
1.1.1 Overview of Capital Budgeting
Capital budgeting is the most important function performed by financial managers since results of investment appraisal decisions span for years and a firm loses its flexibility. Therefore a firm’s capital budgeting decisions define its strategic direction as moves into new markets; products are preceded by capital expenditures. Therefore tomorrow’s business success depends on investment decisions made today, prospects or aspects of the investment decision which are used to help management make investment decisions are often inadequate and misleading(J.H. Hall 2001). Business organizations are continually faced with the problem of deciding whether the commitment of resources i.e. time and money, is worthwhile in terms of the expected benefits. If the expected benefits are likely to accrue over a relatively long term, the solution is more complex and chances of making an incorrect decision increase (Bierman & Smidt 1993).
1.1.2 Mobile Telecoms in Zimbabwe
Mobile Telecommunications have an important role to play Zimbabwe development. The extent of contribution these business units can make towards the growth and development of Zimbabwe is dependent on the level of success attained by their operations. The fact is that, underlying the success of a business enterprise is the establishment and application of controls by the owners or management in addition to the systematic record keeping of business transactions, which at the end of the period, keeps the owner well informed about the performance of the business.
Furthermore, analysis of capital budgeting is needed so that financial statements will be fairly and consistently describe as a financial performance. Without information and standards, users of financial statements would need to learn the accounting rules of each business, and comparisons between the firms would be difficult.
In Zimbabwe Mobile Telecommunications have dominated on the Zimbabwe Stock Exchange with respect to Econet Wireless Zimbabwe. The head offices are usually located in the Central Business Districts.
1.2 Statement of the Problem
The selection of capital investments is one of the most important strategic decisions financial managers of a firm can make therefore capital budgeting is one of the most decisive influences on firm value, competitiveness and ultimately, survival.
The motivation to undertake this study stems from the better outlook in the nation though hinged on the success of the inclusive government which has resulted in capital expenditures being undertaken therefore necessitating a critical analysis of the appraisal methods in the wireless communications industry, particularly the three service providers Econet Wireless Zimbabwe, Net-one and Telecel Zimbabwe.
An industry requiring large capital outlay with a vast untapped market in Zimbabwe, and high potential for exponential growth, the telecoms industry is on its boom. The use of multiple currencies spawned massive investments in the sector as mobile operators embark on programmes to grow their subscriber base. The industry having endured a decade long of underinvestment as the economic crisis took a toll on the sector, the massive expansion programmes have resulted in the increase in the mobile penetration rate to 21% as of August 2009 from 14% in February 2009. Mobile penetration rate describes the number of active mobile phone numbers, (usually as a percentage) within a specific population.
“The equipment facility is valued at US93.9m. We have not been able to identify a bank or an equipment supplier willing to take the financial and political risk for such a large facility to a Zimbabwean company.” (Econet CEO, Mr. Mboweni in response to a question by financial Gazette reporter, Munyaradzi Mugowo.)
The aim is to analyze the applicability of investment appraisal techniques in an environment of high political risk, and bring out limitations in such tools. Thus the statement, ‘An analysis of capital budgeting process: mobile telecoms sector’
1.3 Research Objectives
? To bring out the limitations faced by a financial manager when using investment appraisal techniques for making capital expenditure decisions in environments of political uncertainty.
? To establish the importance of capital budgeting.
? To test the effectiveness of investment appraisal techniques.
? To determine strategies used by financial managers in the capital budgeting process.
1.4 Research Questions
? What are the limitations faced by a financial manager in using appraisal techniques?
? What strategies are used by financial managers in the capital budgeting process in an environment of uncertainty?
? What is the effectiveness of investment appraisal techniques in decision making?
? How significant is the analysis of capital budgeting in the mobile industry?
1.5 Research Hypothesis
? Ho: A firm in an environment of high uncertainty and risk when assessing complex projects uses sophisticated capital budgeting techniques and risk based analysis.
? H1: A firm in an environment of high uncertainty and risk when assessing complex projects does not use sophisticated capital budgeting techniques and risk based analysis.
1.6 Scope of the Study
Econet Wireless Zimbabwe, having made the largest investment into its network of US$115m as reported in the interim results for the half year ended 31 August 2009, including Telecel and Net-one who also have planned expansion projects.
Conceptually the study hovers around the implicit role proper analysis of capital budgeting and the techniques play far as mobile sectors business were in concern in Zimbabwe. The research was limited to Econet Wireless in Zimbabwe due to my schedule. The effectiveness of the various capital budgeting techniques were also put into consideration
1.7 Significance of the Study
This research’s aim is to explore the use of investment appraisal techniques reflecting their limitations.
The research will assist financial managers in project appraisal in environments of great uncertainty, as ‘we cannot direct the wind, but we can adjust our sails.’ Therefore the research seeks to have a capital budgeting process in a high risk environment and to reflect the use of risk based analysis by financial managers when assessing projects.
CHAPTER 2
LITERATURE REVIEW
2.0 Introduction
Therefore having introduced the subject in consideration, this chapter seeks to further and critically analyze and review literature relevant to the research objectives to give a sound theoretical framework of the study, by relating it, exposing shortcomings and the knowledge gap, to be covered by the project. Literature of the various capital budgeting techniques, their strengths and weaknesses, input information in the process and uncertainty in investment appraisal will be explored.
2.1 Definition and Purpose
Investment (project) appraisal refers to evaluations of decisions made by organizations on allocating resources to investments of a significant size.
Du Toit, Neuland ; Oost (1997) define capital budgeting as the identification, evaluation and selection of the long-term or fixed assets that will increase shareholder value. Capital Budgeting is usually an exercise in estimating the net value of future cash flows and other benefits as compared to the initial investment required (Ray Aggarwal 1993).
The objective of profit making entities is to adopt projects which will eventually yield better returns for shareholders as owners of an organization. According to N Bhana, the market attempts to distinguish between good and poor investment decisions as well as investments made by focused and diversified companies, therefore the market reacts more favourably to investments that create future growth opportunities than to investments that can be categorized as extending existing investment opportunities.
Typical capital spending and investment decisions include:
-Make or buy decisions, and outsourcing certain organizational functions
-Acquisition and disposal of subsidiary organizations
-Entry into new markets
-The purchase (or sale) of plant and equipment
-Developing new products or services (or discontinuing them)
2.2 Stages in the Capital Budgeting Process
In the journal, “An Emphirical Investigation of the Capital Budgeting Process,” the capital budgeting process is divided into four stages, namely:
? identification and development of investment proposals;
? financial evaluation of projects;
? implementation of projects;
? Project review.
Cost Accounting A Managerial Emphasis by Charles T Horngren ; George Foster, categorizes the stages in the capital budgeting process as;
? Analysis of financial/quantitative aspects of the project
? Analysis of the qualitative/non financial aspects of the project
? Financing the project
? Implementing the project and monitoring its performance
2.2.1 RESPONSIBILITY OF CAPITAL BUDGETING
In accordance to Raj Aggarwal, management of the capital budgeting process is generally a significant and important responsibility of top management. According to the chief executive officer of Emmerson Electric, ‘the job of management is to identify and successfully implement business investment opportunities’ (Knight 1992). The most important feature of effective capital budgeting administration is the awareness on the part of all managers that long run expenditures should be generators of long run profits. Therefore approval of overall capital budgets is usually the responsibility of the board of directors (Charles T Horngren). Investment decision making is invariably a top management exercise because of the long term nature and of the consequences of such decisions (T Lucey 2008). In a study of the role of board of directors in the capital budgeting process by Grinstein and Tolkowsky (2004) , four main roles were identified done by board of directors through their committees;
• Review and approve large capital requests that the CEO brings
• Review and approve annual capital budgets
• Review and approve merger and acquisition transactions
CHAPTER 3
RESEARCH METHODOLOGY
3.0 Introduction
This section gives a brief overview of the research methodology that the study intends to employ. Appropriate theoretical and empirical lessons to be drawn from the review of literature will assist shape the methodology.
Therefore this chapter will highlight the research methods used by the researcher in gathering information for the research. The researcher issued out three questionnaires to financial managers in the wireless communications industry to get their views on the topic.
3.1 Research design
The researcher used both primary and secondary data.
? Primary Data
Primary data is collected from the affected individuals and the sources include:
• Experiments
• Observations
• Questionnaires
• Focus Groups
• Interviews
? Secondary Data
The secondary sources of data that the researcher will use are:
• Company annual reports, fliers and booklets
• Newspapers and magazines
• The internet
• Textbooks
• Journals
• Government and trade body publications
The secondary data was reviewed in the literature review chapter of the project. The advantage of using secondary data is that it is cheap to gather and it provides a wide range of information on the research topic. It however needs to be complemented with primary data.
3.1.1 Research Philosophy
Data was both qualitatively and quantitatively analyzed in order to produce an informative project. Graphs and charts were used for analyzing the findings so as to identify important variables, their significations and allowing for literature review and interpreting them theoretically.
3.1.2 Research Method
Research methods which were used to obtain information included a case study which was descriptive and illustrative in nature. Scapens (1990) adds the following types:
? Experimental-case studies where the research examines the difficulties in implementing new procedures and techniques in an organization and evaluating the benefits.
? Exploratory- case studies where existing theory is used to understand and explain its happening.
Furthermore a survey was also considered and included exploratory as well as explanatory surveys. The advantages of using both the techniques are that further analysis can be made as well as comparisons.
3.2 Population and Sampling
The population that the researcher selected was the management accountants’ or financial managers in wireless telecommunications corporations. These are the individuals that are in charge of capital budgeting in an organization and so they will be able to provide constructive answers to the questions contained in the questionnaire.
3.2.1 Population and Target Population
The target population shall be the Zimbabwean mobile communications industry, the research being confined to Econet Wireless Zimbabwe, Telecel Zimbabwe and Net-one.
3.2.2 Sampling
Sampling was aimed at reducing the total population to a manageable size whilst at the same time maintaining representation, validity and credibility of the total population. A purposive sample of three firms was used in this research and simple random sampling was used to select the sample.
3.2.2.1 Sample Size
The research has not selected a sample as the sector consist of only three entities hence the whole population will be considered respondents’ views will be taken to be the conclusions of the population.
The researcher handed out three questionnaires. The questionnaires were distributed to wireless communications in Zimbabwe.
3.2.2.2 Sampling Method
Probability and Non-Probability sampling methods, they can further be explained as Probability sampling states that in every element in population has a known non-zero probability of selection for example simple random sample is the best known probability sample, in which each member of the population has an equal probability of being selected.
In a Non-Probability sampling the probability of any particular member of the population being chosen is unknown.
3.3 Sources of Data
The sources of data to be used in the research will mainly be primary sources. The following sources will be used:
? Finance Manager
? Management Accountant
3.4 Data Collection
? Research instruments
The researcher intended to use both questionnaires and interviews to collect data. However due to the busy schedules of the required individuals for interviews, the researcher was not able to conduct an interview.
A structured questionnaire was used. The questionnaire used guided questions with yes and no responses for most of the questions. The questionnaire can be viewed in the Appendix section of the research project.
All questionnaires were send via mail to all respondents by the researcher. No training or briefing of any assistants was conducted due to the prohibitive costs. The researcher issued out each questionnaire with a cover letter meant to explain the purpose of the research in more detail.
Telephone calls and e-mails were made to respondents to pave way for the timely completion and return of the questionnaire, to confirm receipt of the questionnaire and to follow up on the completed questionnaire.
? Reasons for using questionnaires
? The respondents can thoroughly think about a question because they are not under pressure to respond immediately
? If the questions are prepared and designed correctly, the questionnaire provides accurate and straightforward responses
? It is the cheapest method of gathering data relative to other data gathering methods such as interviews.
? It gives the respondents anonymity which means they are able to air their views without fear.
? Disadvantages of questionnaires
? The respondents might not fully understand the questions.
? You are not able to get more information from the respondents’ gestures and actions as you would in an interview because the respondents fill out the questionnaire when you are not there so you cannot evaluate their actions and gestures.
? The response rate might be low. There is a need to keep following up on the respondents to ensure that they fill in the questionnaire.
? The researcher cannot ask for further clarification on issues raised
? Reasons for using Interviews
The interviewer can explain a question to the interviewee to make sure that the interviewee has understood the question.
? Visual aids can be used by the interviewer to elaborate on a question
? Response rates are very high when compared to other techniques
? Interaction between the researcher and the respondent ensures more conclusive responses
? Disadvantages of interviews
? Time consuming both in conducting the interview and analysis of responses. There are also a lot of formalities involved.
? Relatively more costly in terms of money and time.
CHAPTER 4
RESEARCH PLAN
4.1 Time Budget
Table 1.1
Activity Time Frame
Chapter 1: Introduction 7 days
Chapter 2: Literature Review 10 days
Chapter 3: Research Methodology 15 days
Chapter 4: Plan 5 days
Chapter 5: References 3 days
Handover of Project 1 June
Total 40 days
The table above shows the forty days (40) required conducting the research in order to meet deadline, and the assumed handover date is 1 June which is highlighted above.
4.2 Resources Required
Table 1.2
Expected Expenditure Amount ($)
Transport and Food 20
Stationery 10
Cell phone Charges 5
Printing 5
Personal 5
Total 45
Table 1.2 shows the expenditure that might be required for the financing the proposed viable research.
CHAPTER 5
REFERENCES
? Bierman, H. & Smidt, S. 1993. The capital budgeting decision. 8th Edition. New York: Macmillan, 591p.
? Carlo Alberto Magni, (2007). “Theoretical flaws in the use of the CAPM for investment decisions” Revised Nov 2007
? Charles T Horngren, George Foster, Cost Accounting A Managerial Emphasis, 7th Edition, Prentice Hall International Editions,
? Du Toit, G. S., Neuland, E.W. & Oost, E. J. 1997. Capital investment Decisions. Pretoria: Unisa Press, 321p.
? Elias Munapo, (2007). “The Variable Sequencing Approach: A Solution to the Capital Budget Allocation Model,” Advances in Applied Mathematical Analysis, Volume 2 Number 1 (2007), pp. 15–30
? F. Vigario, Managerial Finance, 2nd Edition, (Interpak Books 2002), Chapter 5
? Geofrey T. Mills, (1996). “The impact of inflation on capital budgeting and working capital,” Journal of Financial & Strategic Decisions Vol 9 (No. 1 Spring) pp.1-9
? J.H. Hall, (2001). “An Emphirical Investigation of the Capital Budgeting Process” University of Pretoria 0001
? James C. Van Horne, John Martin Wachowicz, Fundamentals of Financial Management, Edition 11. (Prentice Hall 2001)
? Jensen, Michael C, William H. Meckling (1976). “Theory of the firm: Managerial behavior, Agency costs & Ownership structure,” Journal of Financial Economics 3(No 3, Oct) pp305-360
? Johnson H Thomas, Robert S Kaplan (1987). Relevance lost: The Rise and Fall of Management Accounting (Boston: Harvard Business School Press)
? Lawrence D. Schall, Gary L. Sundem, William R. Geijsbeek, Jr, (1978). “Survey and Analysis of Capital Budgeting Methods,” The Journal of Finance, Vol. 33, No. 1 (Mar.,), pp. 281-287
? Terry Lucey, Management Accounting 5th Edition, BookPower 2008 Chapter 17, pg 412
