capital budgeting processes and “small projects”: a...

Capital Budgeting Processes and “Small Projects”: An Investigative Study within Exxaro Resources

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I

Capital Budgeting Processes and “Small Projects”:

A study within Exxaro Resources

A Research Report Presented to

The Graduate School of Business

University of Cape Town

In partial fulfilment

of the requirements for the

Masters of Business Administration Degree

By Mapikwa S. Mobwano

December 2008

Supervisor: Professor Colin Firer


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II

Dedication

Albert Athende e Mapikwa Mobwano

1946-2008

For encouraging learning and emphasizing that education is the road to success.


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III

ACKNOWLEDGEMENTS

This report is not confidential. It may be used freely by the Graduate School of Business.

I wish to thank Mr. Frikkie Els, Capital Strategy Manager at Exxaro Corporate Finance and

Treasury department, for providing valuable background on the development of the Exxaro

Capital Management System. I am grateful to Leon Groenewald and Mellis Walker, Financial

Managers, Exxaro Coal and Exxaro Sand and Base Metal for their support and facilitation to

access project databases. I would also like to thank Dirk Van Staden, Exxaro Chief Financial

Officer, for allowing me to conduct the study in the company.

I also wish to thank my supervisor, Professor Colin Firer, for guidance during this process.


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IV

DECLARATION

1. I know that plagiarism is wrong. Plagiarism is to use another’s work and pretend that it is

one’s own.

2. I have used a recognised convention for citation and referencing. Each significant

contribution and quotation from the works of other people has been attributed, cited and

referenced.

3. I certify that this submission is all my own work.

4. I have not allowed and will not allow anyone to copy this essay with the intention of

passing it off as his or her own work.

Modular:

Mapikwa Sam Mobwano

Signature: ______________________ Student Number: mbwmap001

Date: ________12th of December, 2008__________________


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ABSTRACT

Capital Budgeting Processes and “Small Projects”:

A study within Exxaro Resources

“Small projects” are not given the necessary attention in relation to capital budgeting, yet

possibly represent the bulk of capital expenditure of a company.

This research seeks to establish the adherence of “small projects” to the capital budgeting

process in Exxaro. The research first establishes the value of “small projects” relative to the

company total capital expenditure and, the knowledge of the corporate capital budgeting

processes at business units. The stages of capital budgeting process followed by “small projects”

are then assessed as well as the adherence to the post investment review and measure of value.

The research found that “small projects” did not represent the bulk of capital expenditure in

Exxaro in 2006 and that there was a good understanding of Exxaro’s capital management system

at business units. The research also found that there was not enough evidence to conclude that

the corporate capital budgeting processes were not followed when dealing with the majority of

“small projects”. This conclusion is weakened by the strong biases and inconsistencies

established in the study.

KEY WORDS: Small projects, Capital Budgeting process, Capital

Expenditure, Post Investment Review, Measure of value


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VI

GLOSSARY OF TERMS

BEE : Black Economic Empowerment

BOARD: Board of Directors

BU : Business unit

EVA : Economic Value Add

EXCO : Executive Committee

EGM : Executive General Manager

FEL : Front End Loading

IRR : Internal rate of return

NPV : Net present value

PIR : Post Investment Review

PBP : Pay Back Period

SBU : Strategic Business Unit (Commodity business)

SHEQ: Safety Health Environment and Quality

VBM : Value-Based Management


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VII

TABLE OF CONTENTS

ACKNOWLEDGEMENTS ....................................................................................................... III

DECLARATION......................................................................................................................... IV

ABSTRACT .................................................................................................................................. V

GLOSSARY OF TERMS ........................................................................................................... VI

TABLE OF CONTENTS ......................................................................................................... VII

1. INTRODUCTION................................................................................................................. 1

2. AREA OF STUDY ................................................................................................................ 4

2.1. Project Classification and Value ..................................................................................... 4

2.2. “Small projects” and Capital Budgeting Process ............................................................ 5

2.3. Value Drivers of “Small projects” .................................................................................. 6

2.4. “Small projects” and Post Investment Review ............................................................... 7

3. LITERATURE REVIEW .................................................................................................... 9

3.1. Introduction ..................................................................................................................... 9

3.2. Capital Investment Classification ................................................................................... 9

3.3. Capital Budgeting Techniques ...................................................................................... 10

3.3.1. The Traditional method: The Non DCF Methods................................................. 11

3.3.2. The Discounted Cash Flow Method ..................................................................... 12

3.3.3. Other methods of Investment appraisal ................................................................ 13

3.4. Capital Budgeting Process ............................................................................................ 13

3.4.1. Identification of investment opportunities ............................................................ 14

3.4.2. Development and Preliminary Screening ............................................................. 16

3.4.3. Capital Project Evaluation and Selection .............................................................. 16

3.4.4. Authorization ........................................................................................................ 17

3.4.5. Implementation, Monitoring and control .............................................................. 17

3.4.6. Post Investment Audit ........................................................................................... 18

3.5. Capital Budgeting Sophistication ................................................................................. 19


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3.6. Non Financial techniques and Influence activities in Capital budgeting process ......... 21

3.6.1. Non Financial Techniques: Value Based Management ........................................ 21

3.6.2. Influence activities ................................................................................................ 22

3.7. Capital Budgeting Excellence and Best practice .......................................................... 22

4. EXXARO’S CAPITAL BUDGETING PROCESS .......................................................... 24

4.1. Background ................................................................................................................... 24

4.2. Exxaro Capital management process ............................................................................ 26

4.2.1. Project Development Model ................................................................................. 26

4.2.2. Post Investment Review (PIR) .............................................................................. 29

4.3. Conclusion .................................................................................................................... 30

5. RESEARCH HYPOTHESES ............................................................................................ 31

5.1. Proportion of “small projects” capital expenditure ....................................................... 32

5.2. Knowledge of corporate capital management system .................................................. 32

5.3. Capital Budgeting process followed by “small projects” in Exxaro ............................. 32

5.4. Post Investment review and “small projects” ............................................................... 33

5.5. Measure of Value for “Small Projects” ........................................................................ 34

6. RESEARCH METHODOLOGY ...................................................................................... 35

6.1. Preliminary Interviews and Discussion ........................................................................ 35

6.2. Research Questionnaire ................................................................................................ 36

6.3. Sample size and Target Population ............................................................................... 36

6.4. Data Collection ............................................................................................................. 37

6.5. Analysis of Results and Hypothesis Testing ................................................................. 38

7. RESEARCH FINDINGS .................................................................................................... 41

7.1. proportion of “Small projects” Capital Expenditure ..................................................... 41

7.2. knowledge of corporate capital management system ................................................... 42

7.3. Capital Budgeting process followed by small project in Exxaro .................................. 44

7.3.1. “Small projects” at Potential study phase ............................................................. 45

7.3.2. “Small projects” at Pre-feasibility phase .............................................................. 47

7.3.3. “Small projects” at Feasibility phase .................................................................... 50

7.3.4. “Small projects” at Implementation phase ............................................................ 52


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7.4. Post Investment review and “Small projects” ............................................................... 53

7.5. Measure of Value for Small Projects ............................................................................ 57

8. DISCUSSION ...................................................................................................................... 59

8.1. Interpretation of the data ............................................................................................... 59

8.2. Limitations and Biases of the research ......................................................................... 61

8.2.1. Sample and results biases...................................................................................... 61

8.2.2. Low response rate ................................................................................................. 62

8.2.3. Inconsistency of Answers ..................................................................................... 62

8.3. Area of further research ................................................................................................ 63

9. CONCLUSION ................................................................................................................... 64

10. BIBLIOGRAPHY ........................................................................................................... 66

11. APPENDIX ...................................................................................................................... 70

A. Preliminary Interviews and Discussions .............................................................................. 70

A.1 Interviewees Details ....................................................................................................... 70

A.2 Request for Permission .................................................................................................. 71

A.3 e-mail discussion ............................................................................................................ 72

B. Exxaro Capital management models .................................................................................... 73

B.1 Governance during each phase ....................................................................................... 73

B.2 Project Development Model /Road Map ........................................................................ 74

B.3 Project Development Model /Road Map Guidelines: Objectives, Deliverable and focus

items ...................................................................................................................................... 75

C. Exxaro Post Investment Review Guidelines ........................................................................ 76

D. Research Questionnaire ........................................................................................................ 78

E. Detailed Results .................................................................................................................... 88


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LIST OF FIGURES

Figure 3-1: Capital Budgeting Process (Adapted from Dayananda et al 2002; Brink and

Marokane, 2004) ........................................................................................................................... 15

Figure 3-2: The Capital Planning Decision Process .................................................................... 19

Figure 4-1: Project development desired outcome ................................................................... 24

Figure 4-2Distribution of project size ................................................................................... 25

Figure 4-3: Project Development Model (Road Map) ........................................................... 26

Figure 6-1: Respondents profile per Business units ..................................................................... 38

Figure 7-1: Results of the knowledge and alignment of the corporate Capital Management ....... 43

Figure 7-2: Results of the Use of Corporate Financial Parameter ................................................ 44

Figure 7-3: Results of “small projects” at Potential Study Phase ................................................. 45

Figure 7-4: Results of the consistency trends on Potential studies responses .............................. 46

Figure 7-5: Results of “small projects” at Pre-feasibility phase ................................................... 48

Figure 7-6: Results of consistency trends on pre- feasibility ........................................................ 49

Figure 7-7: Results of “small projects” at Feasibility stage .......................................................... 50

Figure 7-8: Results of “small projects” at Implementation phase ................................................ 53

Figure 7-9: Histogram of “small projects” at Post Investment Review ........................................ 54

Figure 7-10: Result of process followed during Post investment review ..................................... 55

Figure 7-11: Analysis of key performance areas .......................................................................... 56

Figure 7-12: Results of variance analysis of financial parameters ............................................... 56

Figure 7-13: Results on the measure of value for “small projects” .............................................. 57


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XI

LIST OF TABLES

Table 2-1: Exxaro Approval Framework Summary ....................................................................... 4

Table 2-2: Post Investment Review Register of approved Capital Projects ................................... 7

Table 4-1: Decision Gate Management ........................................................................................ 27

Table 7-1: Results of Proportion of total Small Capital Expenditure ........................................... 41

Table 7-2: Result on the necessity of a detailed feasibility for “small projects” .......................... 51


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1. INTRODUCTION

Companies do not generally have unlimited capital to invest in all projects proposed in the

company. A project is considered as any proposal that will result in the use of a firm’s scarce

resources (Damodaran 2001). Projects classified as “big” or “small”, depending on their capital

requirements, have to compete for the same scarce resources. Whether it is a multibillion

acquisition or small purchase, projects should be able to generate additional revenue or reduce

costs. Therefore, to qualify for a share of the scarce resources, projects must go through a

selection process, meet certain criteria, and demonstrate value-creation. Block (2005:59)

highlights the finding by Stanley and Block (1984), that maximizing return on equity,

maximizing growth in earnings per share and maximizing shareholder value were considered as

primary goals of managers. It can therefore be argued that managers should ensure that all

projects (big and small) that make use of the company’s scarce resources, create or increase

shareholders value by meeting criteria set as part of corporate strategy.

Exxaro Resources, formerly Kumba resources, acknowledged in its 2002 annual report that

effective investment of its capital is of crucial importance in optimizing shareholders value.

Exxaro Resources (Pty) Ltd is a diversified mining company born out of what was known as the

biggest BEE transaction in the history of the South African mining industry. The newly formed

company combined the unbundled coal assets of Kumba Resources from its iron ore assets and

the coal assets of Eyesizwe coal, a BEE company born out a previous BEE deal. The company is

divided into commodity businesses of coal, base metal and heavy minerals. The commodity

businesses are also known as strategic business units (SBU’s). A strategic business unit is made

up of several business units (BU’s) or operations.

The new company, 51% owned by black investors, was required from inception to generate

dividends to allow for the servicing of the financing of the transaction. The structure of the BEE

transaction limits the company to a certain extent from raising funds in the market by issuing

additional share offers.


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Capital budgeting and capital expenditure, an area that was always under scrutiny, received

renewed attention due to limited available capital.

Exxaro is at the stage where it needs to grow to generate value for its shareholders and service its

debts. The company should not necessarily limit its capital expansion especially on the big

projects, but needs to ensure that its capital is used wisely and specifically on projects that will

create value.

Exxaro Resources introduced a capital management system (capital budgeting process) in 2003

to govern capital expenditure. The aim of the process was to develop projects in a structured

way, improve the quality of the projects through their life cycles and, ensure that capital is spent

only on projects that have met criteria set in the capital management system. A project that has

passed all the hurdles in the process, and has been approved, will have a high probability of

creating value. However, the capital management system seemed to have worked mainly for the

assessment of “big projects” and it appears that “small projects” are not subjected to the same

scrutiny and do not adhere to the capital budgeting process. Very often, managers do not realize

that “small projects” that are not given proper attention are potentially the biggest value

destroyers. These projects not only waste capital that could have been used in other value-

creating projects, but also increase the financial strain on the company. These concerns were

also shared by SBU financial managers as well as the chief financial officer during preliminary

interviews and the researcher’s request for permission to conduct the study. In the current

context of capital rationalization, and focus on value-creation, it was also their view that a better

understanding of the approval processes and capital expenditure of “small projects” was required

in the company to ensure a better capital expenditure discipline.

The purpose of this research, conducted in Exxaro, is therefore to:

Determine the importance of “small projects” in terms of proportion of total capital

expenditure allocated to “small projects” in the company;

Investigate the approval process followed by “small projects” within Exxaro and, assess

whether the guidelines set in the capital management system are adhered to.

Evaluate if Post investment reviews are generally conducted on “small projects”.


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The main objectives of post investment reviews are to determine the value-creation of a project

and to capture the “lessons learned” for future reference. This study, however, will not seek to

determine the value-creation or destruction of “small projects”, as this will require detailed study

into the performance of each project.

Permission to conduct the study was requested and granted by the chief financial officer on

condition that sensitive project details are not discussed in the report. (Appendix A.2).

The other constraint anticipated was the reluctance of project managers or project engineers to

disclose information or answer the questionnaire in an objective manner. This could bring a

certain level of bias into the results of the survey. The fact that only 22% project managers

surveyed responded to the questionnaire might be an indication of such reluctance.

The research begins by providing detailed description of the problem that is being researched in

the “area of study”. This is followed by the review of the literature on capital budgeting

processes then by the capital budgeting processes as applied in Exxaro. The method of data

collection and analyses used as well as the hypothesis test used are described under research

methodology. The findings and related analysis are detailed under the research finding section.

The research is concluded with recommendations and the identification of areas for further

research.


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2. AREA OF STUDY

2.1. PROJECT CLASSIFICATION AND VALUE

The classification of projects by companies into “small” or “big” is probably relative to company

size, turnover and, most likely, the capital expenditure. For the purpose of this study it will be

important to clearly define what can be classified as a “big” or “small” project in the Exxaro

context. Exxaro’s approval framework as summarized in Table 2-1 will be used as the guideline

to categorize the size of projects according to the capital expenditure.

From Table 2-1, it can be concluded that projects that require the approval of the executive

director and above, can be classified as “big projects”. Where the approval of the executive

general manager is required i.e. projects of less than R20 million, such projects will be

considered as “medium” sized. Projects with capital expenditure of less than R5 million will be

considered as “small projects” and will be the focus of this research. For practical reasons,

projects with capital expenditure of less than R100 000 will be excluded as subjecting such small

expenditure to full capital budgeting, in the mining industry context, would be time consuming.

Table 2-1: Exxaro Approval Framework Summary Partnerships and

Joint Ventures

R mil

Approval of Capital Projects

Authority to

initiate projects1

R mil

Included in the

budget

R mil

Not included

in budget

R mil

Board > 50 >50 >50 >30

Exco <50 >30 <50 >30 <50 >20 <30

Executive Director >20 <30 >20 <30 >10 <20

Executive General Managers <20 <20 <10

Source: Exxaro

Between the 2006 and 2007 financial year, more than 320 projects of less than R5 million were

expensed in Exxaro. This clearly indicates that “small projects” are very important in terms


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magnitude. It will also be important to determine the total value of the “small capital projects” in

Exxaro, using the categorization presented above. The purpose of this exercise will be to

determine the proportion of “small projects” relative to the total capital expenditure of Exxaro.

The total capital expenditure of “small projects” in Exxaro will emphasize the importance of this

group of projects and, observe whether Copeland’s (2000:156) assertion that “small projects”

represent up to 80% of capital expenditure of a company, is also applicable to Exxaro.

2.2. SMALL PROJECTS AND CAPITAL BUDGETING PROCESS

There is very little literature on capital budgeting of “small projects”. This could be because

“small projects” are often considered as negligible or perhaps because the sizes of the capital

investments do not require as much resources as “big projects”. In times of capital rationing, the

focus is normally directed to shelving big capital expenditure. According to Copeland

(2000:156), “eliminating or postponing big capital spending which represents only 20% of the

capital of most big companies, will not create sustainable value for the companies. However,

rigorous and disciplined evaluation of “small items that often get rubber stamped” will ensure

sustainable value-creation in companies. This certainly implies that “small projects” whilst

collectively amounting to substantial value, are not subjected to proper capital budgeting

processes. The lack of research and literature in the area of “small projects” and capital

budgeting process indicates that this is still a grey area and emphasises the relevance of this

study. This research will therefore try to establish the behaviour of “small projects” relative to

capital budgeting by determining whether, in the case of Exxaro, “small capital projects” escape

the scrutiny of the capital budgeting process, and if this is proved to be true, understand the

reasons therefore.


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2.3. VALUE DRIVERS OF “SMALL PROJECTS”

The drivers of value are essential parts of any process which is genuinely focused on value-

creation (Copeland and Ostrowski, 1993:55). Projects are accepted or rejected based on the

perceived or promised value-creation. Although most projects will be accepted based on their

ability to demonstrate positive cash flow returns over a period of time, other projects may need

to be evaluated based on the risk that they are intended to mitigate and could therefore

demonstrate a negative cash flow. It is therefore important to include relevant non financial data

and forecasts that support the projects (Adams, Bourne and Neely, 2004:30).

Angus (2006:17-18) presents South African Breweries (SAB)’ categorization of capital

investment into: Safety Health Environment and Quality (SHEQ), Policy Replacement, Capacity

Maintenance, Expansion, and Financial. Capital investment opportunities are required to be

classified in one of the categories prior to the evaluation of the attractiveness of the project.

Exxaro uses a similar method where all projects (“big” and “small”) are classified into:

Expansion or New, Sustaining or Replacement and SHEQ. As in the case of SAB, this

categorization is performed prior to the evaluation of the projects. Projects under SHEQ will

clearly have value drivers that are non- financial. Angus (2006:22) notes that SHEQ and

replacement projects in SAB were not evaluated using financial analysis techniques and that, the

main driver for policy replacement investment was the “asset refreshment policy”.

Similarly, a project with a capital expenditure of less than R1 million might not have the same

drivers of value as a project of R20 million. Angus (2006:26) concludes that there is a

proportional increase of formal financial analysis techniques employed by managers as the risk

of capital investment increases.

In introducing the concept of “value-based management”, Copeland and Ostrowski (1993:55)

suggest that detailed NPV method should be used in determining value of “large projects” and

that the method does not work for “small projects” because “the scale is wrong.” They argue that

value drivers, such as specific easily tracked metrics, are the most appropriate way of

determining value for “small projects”.

It is therefore important to determine the measure of value used when dealing with “small

projects” in Exxaro. The research will therefore seek to determine if the value for “small


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projects” in Exxaro is evaluated in terms of NPV, IRR, PBP and EVA or “the value-based

management” approach which evaluates specific value drivers is used.

2.4. SMALL PROJECTS AND POST INVESTMENT REVIEW

The post implementation review is critical in determining the value-creation of projects. Exxaro

has put in place a detailed guideline on conducting a post investment review with the aim of

understanding the successful and unsuccessful aspects of previous investments in order to

improve the quality of new investments. The process is supposed to be applicable to all capital

projects including “small projects”. The preliminary interviews and research seem to indicate

that post investment reviews were, however, not widely conducted on “small projects”. There

was thus no data base or information sharing on lessons learned. There is evidence that suggests

that projects approved mainly at board level are scheduled for post investment reviews. Table 1

highlights the schedule dates of post investment reviews at Exxaro for 2008.

Table 2-2: Post Investment Review Register of approved Capital Projects SBU BU Description Date

Approved

Date

Commissioned

Date Post

Investment

Review

Coal Leeuwpan Road deviation 17-Feb-03 End 2004 Q2-2008

Coal Leeuwpan Jig Plant 07-Jun-04 Aug-05 Q3-2008

Coal Grootegeluk GG6 Plant 07-Jun-04 Jun-06 Q4-2008

Mineral

Sands

Ticor Indian Rim

Mar-2008

Source: Exxaro

Copeland (2000:156) argues that the small items are often “gold plates” or duplicates of other

capital requests. This is probably because “small projects” are not evaluated in the context of


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“the big picture” or the audit review is not applied rigorously enough to identify the duplication

or the “gold plating”. Scherrer (2003:52) suggests that timely capital expenditure can save and

help a business grow but unnecessary assets can become a liability for the company.

It appears that small capital projects, which potentially represent the bulk of the capital spend of

a company, are not subjected to the same process as “big projects”. The question that arises from

this assumption is: How is the value-creation of “small projects” assessed after implementation if

they are not subjected to a post investment audit?

This study will also aim to establish if “small projects” in particular are subjected to post

investment reviews. If “small projects” potentially represent the bulk of the capital spend, up to

80% according to Copeland (2000:156), are not subjected to post investment reviews, the risk

foreseen in this area is that the achievement of the proposed value cannot be ascertained and this

could possibly lead to value destruction for the company.


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3. LITERATURE REVIEW

3.1. INTRODUCTION

Capital budgeting and capital rationing, where budgets are constrained, are problems that

managers have to face on a regular basis, especially when dealing with strategic budget

allocation (Kachani & Langella 2005:196). Capital budgeting can be defined as a process of

evaluating and selecting long term projects that are consistent with the firm’s goal of maximizing

wealth (Gitman 2003:356 in Fouche 2006:8).

There is very limited literature dealing specifically with capital budgeting and “small projects”.

This literature review will start by briefly reviewing the general capital investment classification

and the capital budgeting techniques used in project appraisals. A detailed review is then

conducted on the capital budgeting processes. The concept of capital budgeting sophistication is

discussed and the capital budgeting excellence principles or “best practice” concludes this

section.

3.2. CAPITAL INVESTMENT CLASSIFICATION

Project classification is important and could have a direct impact on the application of the capital

budgeting. Maccarrone (1996:46) identifies four parameters of classification, namely; the

objective, the dimension, the interdependence and the urgency of the project. Peterson and

Fabozzi (2002:7) classify project according to the life of the project, the risk and the dependence

on other projects. Dayananda, et al (2002:8), classify the capital investment as independent

projects, mutually exclusive projects and contingent projects. This classification is based on how

these projects influence the investment decision process.

Maccarrone (1996:46) sub- categorizes investment by objective into:

Compulsory investment, guided by regulatory framework;

Investment in existing business which includes: replacement investments, expansion, new

products and investments aimed at improving the firm competitiveness;


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Investment in new business areas;

Acquisition; and

Research and development investments.

Peterson and Fabozzi (2002:9) use the same subdivision but relate them to the classification

under risk. Maccarrone (1996:46) on the other hand relates risk to the classification under

dimension classification. The risk in this case refers to the absolute variance of the outcomes.

It appears that investment projects are seldom explicitly classified according to the size of the

capital investment. However classification based on the size is often confused with what is

considered as the risk level of the project. Projects involving small amounts of capital are

considered less risky than projects which involve high capital exposure. (Brink and Marokane,

2006:27).

The classification based on the size of investment has direct impact on the capital budgeting

process followed by these projects. Brink and Marokane (2006:28) found that five out of seven

companies surveyed only used formal capital budgeting for projects that must be approved by the

board, despite the fact that projects at business units run into millions.

Although the basic elements of the investment appraisal process are the same for high and low capital investments, all seven companies indicate that their rigour of the appraisal process is proportional to the size of the capital exposure. For high capital exposure, more effort and resources are dedicated to validating assumptions and undertaking sensitivities. (Brink and Marokane, 2006:28).

This is an indication of how the investment size influences the application of capital budgeting

process.

3.3. CAPITAL BUDGETING TECHNIQUES

Capital budgeting literature has mainly focused on capital budgeting techniques (Dobbins and

Pike, 1980). Although this is considered as an over -researched area (Adams et al, 2004:23), it is

important to highlight the techniques used because they form an integral part of a capital

budgeting process.


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According to Pogue (2004:565), the two main methods that are still most widely used are:

The traditional method of accounting that does not make any adjustment for the time

value of money ( rate of return and payback); and

The discounted cash flow (DCF) techniques of net present value (NPV) and internal rate

of return (IRR) which progressively reduce the value of cash flows received in the future.

3.3.1. The Traditional method: The Non DCF Methods

3.3.1.1 Pay Back Period(PBP)

This method is probably the simplest method of evaluation used in capital budgeting. The

payback period computes the numbers of years required to recover the initial investment. The

method places emphasis on the liquidity and risk position of the project (Akalu 2001:375). The

major pitfall of this method is that it does not take into account the time value of money. Akalu

(2001:376) referring to Longmore (1989), present the discounted payback period, as variation of

the payback period. This method was introduced to address the shortfall of the payback period,

by discounting the cash flow of the project.

3.3.1.2 Rate of return

The accounting or average rate of return utilises accounting profit to determine the expected

return of the project, thereby measuring the benefit of the project. As with the pay back period

method, the rate of return also ignores the time value of money, as well as the timing and pattern

of the profit of the project (Akalu 2001:376).

The variation of this method according to Akalu (2001:376) includes the return on investment

(ROI) and return on capital employed (ROCE).


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3.3.2. The Discounted Cash Flow Method

3.3.2.1 The Net Present Value (NPV)

The net present value basically nets the present value of the investment from the present value of

the revenue of the investment (Akalu, 2001: 377).

“A well established rational economic process used for budgeting capital investments applies

cost benefit analysis using the net present value (NPV) model. This process consists of

estimating and comparing the risk adjusted discounted present value of expected benefits with

expected costs. It should be noted that the use of the risk adjusted discounted cash flow

techniques does not guarantee higher firm performance (Gordon and Loeb, 2006:122, referring

to Haka, Gordon and Pinches, 1985). However Gordon and Loeb (2006:122) go on to argue that

the use of NPV should at least assist organizations in efficient allocation of resources. Despite its

drawback, Gilbert (2003:11) summarizes finance theorists by suggesting that the application of a

positive NPV criterion is the optimal approach to evaluating capital investment. This is valid

provided that the discount rate has been adjusted for risk.

3.3.2.2 The Internal Rate of Return (IRR)

Akalu (2001:377) suggests that the internal rate of return can be considered as the rate that

equates the cost and benefits of a project in terms of present value, and the cut-off rate that

should be used to evaluate the benefit of a project. Akalu (2001:377) also argues that the IRR is

easy to interpret because it shows the percentage benefit of the project, and is more convenient to

use than other DCF methods because the discount rate does not have to be computed.

In summary, although DCF methods are considered as growing in popularity, they are still not

used universally (Hodgkinson and Skinner, 2004:8). Gilbert (2003:17) presents evidence that

suggests a shift in behaviour from the traditional corporate finance theory. From the surveyed

manufacturing companies in South Africa, he concluded that a significant proportion of firms do

not use DCF methods to evaluate projects and when used, they are used in conjunction “with

other theoretically inferior techniques”.


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13

3.3.3. Other methods of investment appraisal

Other alternatives to the DCF based methods have been proposed to address the problems

associated with DCF methods. They are to a certain extent extensions of the DCF method (Akalu

2001:378). The alternative methods used include:

Option pricing;

Adjusted present value; and

Equity cash flow.

3.4. CAPITAL BUDGETING PROCESS

Capital budgeting processes should not primarily be concerned with the selection of an

appropriate evaluation technique, although many authors have concentrated on the comparisons

of evaluation techniques, determining hurdle rates of return and incorporating risk into the

equations (Dobbins and Pike, 1980:13). They further argue that the evaluation techniques should

be incorporated within the whole capital investment process from the conception of an

investment opportunity to its completion.

Maccaronne (1996:43) in referring to the work by Marsh, Barwise, Thomas and Wensley (1988),

Mukherjee and Henderson (1987) as well as Pinches (1982), identifies six phases of capital

budgeting which include:

Identification of investment opportunities

Development and evaluation

Selection

Authorization

Implementation and control

Post investment audit


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14

Fouche (2006:9) presents five distinct but interrelated steps of capital budgeting as proposed by

Gitman (2003) being: proposal generation, review and analysis, decision making,

implementation and follow up. The model however excludes the post investment review.

Dayananda, et al (2002:5), present a model with twelve steps as illustrated in Figure 3-1 below.

The colour coding of the same model by Brink and Marokane (2004:20) synthesize the process

into six phases. The researcher has grouped them further to correlate with Maccarrone’s

(1996:44) model and Dayananda, et al (2002:5).

3.4.1. Identification of investment opportunities

This is one of the most important phases in capital budgeting (Dayananda et al 2002:6). This

phase is critical in determining the overall quality and effectiveness of the capital budgeting

process, but can not easily be formalized (Maccarrone, 1996:46). This phase ensures that project

proposals fit with the company mission and vision as well as the long term strategic plan

(Dayananda et al 2002:6).


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15

Figure 3-1: Capital Budgeting Process (Adapted from Dayananda et al 2002; Brink and Marokane, 2004)

Corporate goal

Strategic planning

Investment opportunities

Preliminary screening

Financial appraisal, quantitative analysis, project evaluation or project analysis

Qualitative factors: judgments and gut feeling

Post implementation audit

Continue expand or abandon project

Facilitation, monitoring, control and review

Implementation

Reject Accept

Accept/reject decisions on the projects

Strategic planning and

identification of investment

opportunities

Preliminary

Authorization/ acceptance or

rejection of decision

Implementation, monitoring and review

Post implementation

audit

Capital project evaluation


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16

3.4.2. Development and Preliminary Screening

This phase involves some preliminary analysis, quantitative or otherwise, in order to narrow the

number of projects that will need more accurate analysis (Dayananda et al 2002:6-7). This phase

also initiates development of the proposal by collecting relevant and detailed information for

each alternative, thus evaluating their profitability and global attractiveness (Maccarrone,

1996:43). The attractiveness of the alternative will be based on how each affects the future cash

flow, and hence the value of the firm.

3.4.3. Capital Project Evaluation and Selection

The selection at this stage is based on detailed financial appraisal of the project and strategic

factors (Maccarrone, 1996:43). These factors are referred to as qualitative factors by Dayananda

et al (2002:7). The detailed financial appraisal at this stage is also referred to as project

quantitative analyses, since it involves the prediction of the cash flow, the risk associated with

the cash flow, and development sensitivity analysis (Dayananda et al 2002:7). As the investment

decision clearly depends on the results of the quantitative analyses, it is critical to focus on this

complex analytical phase of the capital budgeting process (Dayananda et al 2002:7).

Qualitative factors such as the positive or negative impact in terms of environment, society,

company reputation and possible legal difficulties, are factors that are not easy to measure but

which could have a serious impact on a project that has been proven viable by quantitative

analysis. It is therefore important to take these factors into account at this phase of capital

budgeting (Dayananda et al 2002:8). Depending on the results of both quantitative as well as

qualitative analyses, some projects might go ahead at this stage, or be cancelled or postponed to

another planning period, despite having met the strategic intent of the company (Maccarrone,

1996:43).


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17

3.4.4. Authorization

Projects that have shown strong fundamentals in the previous phase must still be approved by

either line management or the appropriate investment committees before implementation

(Maccarrone, 1996:43). Dayananda et al (2002:8) argue that management still has the

responsibility of making the final decision of accepting or rejecting a proposed investment

despite the fact that the project might have positive quantitative (NPV) and qualitative attributes.

Although these attributes form the basis of decision support information, managers or the

investment committee must still use their experience, expertise, prior knowledge, “gut feel” and

judgment to make a decision.

Peterson and Fabozzi (2002:7) distinguish between authorization which relates to the gathering

of further information and approval which relates to allowing the capital expenditure. They

recognize that some firms would authorize and approve a project at the same time, while others

will first authorize then later approve.

3.4.5. Implementation, Monitoring and control

The logical step after the formal authorization of a project will be its implementation. During the

implementation phase, it will be critical to have follow-up procedures that will ensure adherence

to budgeted costs and deadlines (Maccarrone, 1996:43).

Dayananda et al (2002:8) emphasize that constant monitoring is an integral part of the project

implementation and, should aim at identifying potential bottlenecks to allow proactive

intervention. The tracking of cash flow on a regular basis is very important and corrective action

should be taken on any deviation when needed.


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18

3.4.6. Post Investment Audit

“The post-audit (PA) of investments is the control process aimed at making an overall revision of all those activities concerning the management of an investment proposal, from its definition, to its implementation, up to the end of its life” (Azzone and Maccarrone, 2001:73).

The post investment audit concludes the capital budgeting process but does not form part of the

decision process. “It deals with the post mortem of already implemented projects” (Dayananda

et al 2002:8).

In this phase, the actual targets versus the budgeted targets of each project are compared in order

to assess forecast accuracy and identify error patterns. Feedback from this process should then

positively influence the whole decision process (Maccarrone, 1996:43). This view is supported

by Dayananda et al (2002:8) who suggest that analysis of past rights and wrongs can improve

current decision making. Although Dayananda et al (2002:8) suggest that the post audit be

conducted only at the end of the project, Azzone and Maccarrone (2001:73) propose three

categories of post investment audit that relate to the timing. An early post investment audit is

suggested at start up, an intermediate post investment audit during the operational phase and a

final post investment audit at the end of the investment life cycle.

Peterson and Fabozzi (2002:7) suggest that detailed post investment audits are normally

performed mainly on “large projects”. This suggests that “small projects” are normally

overlooked and the question posed is whether the errors on “small projects” will be captured and

positively influence current decision making?

The review of the capital budgeting process indicates that the process is a fairly complex one.

Different authors seem to have different divisions of the phases of this process. It is critical to

have a simpler model that would be applicable to all types of projects. Adams et al (2004:29)

concludes that most organizations surveyed were not satisfied with their capital planning process

despite the fact that some of the dissatisfaction relates to issues that are difficult to change. There

was however, a clear willingness to improve the process.


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19

Adams et al (2004:24) present a simpler “ideal model” of the capital planning process. The

model as illustrated in Figure 3.2 below also indicates the possible short-cuts that some projects,

particularly “small capital expenditure”, do go through.

Figure 3-2: The Capital Planning Decision Process (Adams et al 2004)

3.5. CAPITAL BUDGETING SOPHISTICATION

Farragher, Kleiman and Sahu (2001:301-302) present the concept of Capital Budgeting

Sophistication as introduced by Klammer (1973) which was expanded on by Kim and Farragher

(1982) and later analyzed by Pike (1984). In these studies large corporations based in the United

Kingdom were analysed.

Farragher et al (2001:301) highlight that while the Klammer (1973) definition of sophistication

was limited to a discounted cash flow analysis and an industry adjusted rate of return, Kim and


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Farragher (1982) include a metric that encompass the entire range of activities associated with

allocating resources to investments. These include:

Preparation of a long term capital budget;

Employment of a full time capital investment staff;

Undertaking a systematic search for investment opportunities;

The use of a formal screening committee;

Formal incorporation of risk analysis;

Monitoring the implementation of accepted proposals; and

Conducting a post audit of operating investments.

According to Farragher et al (2001:301), the Kim and Farragher (1982) study finds a positive

relationship between capital budgeting sophistication and the above mentioned activities. On the

other hand, Farragher et al (2001:302) report that the metric used in the study of large

corporations in the United Kingdom by Pike (1984), which includes twelve procedural activities

(planning, administration, and control) and sixteen quantitative techniques (evaluation measures,

risk analysis process and management science techniques), show that better performing

companies are less likely to use a sophisticated capital budgeting process than are poorer

performing companies.

Farragher et al (2001:307) also agrees with Pike (1984) and rejects the hypothesis that

“companies with high performance employ more sophisticated capital budgeting process than do

companies with lower performance.”

Clearly, the level of sophistication is not about the use of different techniques, but about the

integration of different steps in ensuring proper selection and the value-creation of the project. It

can therefore be argued that the latter is really the basis of an effective capital budgeting process.


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21

3.6. NON FINANCIAL TECHNIQUES AND INFLUENCE ACTIVITIES IN CAPITAL

BUDGETING PROCESS

3.6.1. Non Financial Techniques: Value-Based Management

It is important to understand whether there are factors and other non financial techniques that

influence the appraisal of projects and decision making.

Angus (2006:8), referring to Gilbert (2005) and Erasmus (2005), highlights the fact that many

capital investments are done with little consideration of formal appraisal techniques. Angus

(2006:8) presents the findings of Du Toit and Erasmus (2005) which indicate that more than 15%

of companies who responded to the survey did not use discounted cash flow techniques at all to

appraise capital investment.

While Copeland and Ostrowski (1993:55) agree that DCF methods should be used for the

analysis of “large projects”, they suggest a different and less complicated method for evaluating

“small projects”. Copeland and Ostrowski (1993:55) introduce the concept of “value-based

management” (VBM) that focuses on value drivers.

“Value drivers are the specific, easily tracked metrics that link micro-level

decisions to capital efficiency” (Copeland and Ostrowski 1993:55).

They further argue that focusing on value drivers can unlock many hidden sources of

improvement in capital efficiency.

Copeland and Ostrowski (1993:55) suggest fives fundamental steps behind VBM, namely:

Diagnosis and assessment of the potential for capital efficiency improvement, as well as

the validity of the current performance metrics;

Development of new processes that focuses on grass roots activities. This should include

careful identification of value drivers that are easily monitored;

Change of mindset, by ensuring participation of grass roots in the identification of value

drivers and suggestion of new ideas;

Implementation of new guidelines and incentives; and

Follow through to capture lessons learned and continuously improve on the value drivers.


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22

3.6.2. Influence activities

Gallagher (2007:6) quoting Hammond et al (2006) puts forward the notion that sometimes the

problem does not lie with the decision process (capital budgeting process) but rather in the mind

of the decision maker. It can be argued that capital budgeting processes are often influenced by

factors that are non objective and as such make the process less than perfect. These factors are

presented by Laux (2006), as “influence activities” and by Gallagher (2007), as “biases”.

The non objectives factors presented above will not be the focus of this research. However, they

are factors that are present in decision making processes and it is important to understand their

impact in capital budgeting processes and the bias that they can bring into the process, as well as

their impact on the results of the survey. Certainly, these non objectives factors will have a much

greater impact on “small projects”, than on “big projects”, especially if it can be proven that

“small projects” are not subjected to rigorous capital budgeting processes.

3.7. CAPITAL BUDGETING EXCELLENCE AND BEST PRACTICE

The recommendation by Adams et al (2004:29-30) based on the survey conducted, present eight

points which can be considered as fundamental principles toward achieving best practice in

capital budgeting. The principles are that:

Capital decisions must be guided and closely integrated with strategy execution.

Capital proposals must be subjected to rigorous assessment before final investment

decisions are taken.

Project proposals must demonstrate positive cash flow returns over a given period of time

(ideally over the life of the project) and cost of capital and time value of money must be

included consistently in the financial modelling calculation.

Some projects might be evaluated on the basis of the risks that they could attract if not

implemented. The negative cash flow in this case could be less important than the

company reputation.


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23

Capital budgeting processes need to address multiple stakeholders’ point of view.

Proposal should then be supported by relevant non financial data.

For larger investments, the alternative options for capital spending, timing and project

implementation stages need proper evaluation.

All capital plans should have measurable outcomes, to track progress and value

realization over time, both during and after implementation.

Continuous process improvement and learning from past mistakes is not optional. It is a

necessity. This knowledge is to be documented and, where appropriate, included as part

of staff training.


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24

4. EXXARO’S CAPITAL BUDGETING PROCESS

4.1. BACKGROUND

Exxaro Resources introduced a capital budgeting process in order to improve the value-creation

of projects. The company realized that the maximization of value in the business depended

heavily on the quality of the decision made, to ensure that only the right opportunities progress to

the next stage by dealing with all challenges before the business case is finalized. This will

ensure the quality of execution by challenging the project in terms of “value improving

practices” and benchmarking to match best performance. The desired outcome as intended is

illustrated in Figure 4.1 below.

Figure 4-1: Project development desired outcome (Source: Exxaro internal presentation)

The company focused on the concept of Benefit Management to ensure high decision quality and

high execution quality. To ensure its effectiveness, the benefit management system developed

was based on three pillars, namely:

Governance structure;

Business case based decision making; and

Modified capital management process.

“Best in class”Performance

AveragePerformance

AveragePerformance

Failure

Poor Best

Best

Execution Quality

Dec

isio

n Q

ual

ity “Best in class”

Performance

AveragePerformance

AveragePerformance

Failure

Poor Best

Best

Execution Quality

Dec

isio

n Q

ual

ity


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25

These principles are the foundation of Exxaro’s capital management process.

Governance in this case refers to the layer of control that is exercised on behalf of project

sponsors. The aim of the governance structure was to establish a culture of mutual co-operation

between line management and the project team, to clearly define the responsibilities (of project

sponsors, steering committees, and project managers) and to facilitate appropriate management

of all stake holders.

Business case based decision making is intended to ensure that there is a link between project

deliverables and corporate strategy. This phase was also intended to assess whether the

company’s strategic priorities were reflected in the total portfolio of the project, and conducts

regular reviews throughout the project life.

The modification to the capital management process is the third leg of the benefit management

philosophy and had to incorporate benefit planning into the project planning process, develop

appropriate metrics to assess the projected benefits and integrate risk management principles.

Exxaro developed the assumption that a few “large projects” commanded most of the resources

in terms of project focus and the large number of “small projects” did not enjoy as much focus.

The Capital Management process was developed to ensure that all projects in the spectrum as

illustrated in Figure 4.2 were subjected to the same process.

Figure 4-2 Distribution of project size source: Exxaro 2003, internal presentation

Small number of

“big” capital investment

Large number of“small” capital

investment

Sm

all

100%

Lar

ge

Resources allocation

Inv

estm

ent

size

0%


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26

4.2. EXXARO CAPITAL MANAGEMENT PROCESS

4.2.1. Project Development Model

Exxaro has developed a capital management process model that is embedded in the project life

cycle. The project development model or “road map” (Figure 4-3) as it is known, was developed

to bring excellence in decision-making and execution. The model applies the traditional steps of

capital budgeting process (screening, evaluation, selection, authorization, and implementation) at

each stage of project life cycle. This is to ensure that there is sufficient “front end loading”,

which is the practice of taking sufficient time in the earlier phases of the project to properly

assess an opportunity, identify value levers, risks, uncertainties, and achieve quality deliverable

before committing capital expenditure (Els 2003a).

Detailed model and guidelines are attached in appendix A2 and A3.

Figure 4-3: Project development model (road map) (source: Exxaro 2003, internal presentation)

The amalgamation of capital budgeting processes with the project life cycle ensures that there is

a “staged approval” approach in the capital management system. The staged approvals, managed

by “decision gates” at each phase, depend on the independent functional reviews (technical,

Decision Makers

Project Team

Decision Gates

Documentation

Deliverable /Recommendation

Phase POTENTIAL(Assess)

PRE-FEASIBILITY(Select)

IMPLEMENT OPERATE

Timeline

FEASIBILITY(Develop)

EXIT, RECYCLE EXIT, RECYCLENew Opportunities

(to Assess)

PerformanceAssessment

Doc

EvaluationReport

Doc

Pre-feasibilityStudy

Doc

EXIT, RECYCLE

FeasibilityStudy

Doc

FunctionalAsset(s)

OpportunityValue

EnhancingProject

Commit resources

to pre-feasibilitystudy

Commit resources

to feasibilitystudy

Commitresourcesto Optimi-

sation

Assethandover

Doc

PeerReview

Peer Review

PeerReview

PeerReview

Close out Review

Decision Makers

Project Team

Decision Gates

Documentation


Phase POTENTIAL(Assess)

PRE-FEASIBILITY(Select)

IMPLEMENT OPERATE

Timeline

FEASIBILITY(Develop)

EXIT, RECYCLE EXIT, RECYCLENew Opportunities

(to Assess)


Doc

EvaluationReport

Doc


Doc

EXIT, RECYCLE

FeasibilityStudy

Doc

FunctionalAsset(s)

OpportunityValue

EnhancingProject

Commit resources


Commit resources

to feasibilitystudy

Commitresourcesto Optimi-

sation

Assethandover

Doc

PeerReview

Peer Review

PeerReview

PeerReview

Close out Review


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27

marketing, financial, and optimization). The purpose of the project review is to ensure that

critical decisions and project parameters are addressed before committing funds to the project.

The decision gate management process is detailed in table 4-1 below

Table 4-1: Decision Gate Management Phase 1: Potential

study

Phase 2: Pre-

feasibility

Phase 3:

Feasibility

Phase 4: Implement

Objectives Test for strategic

alignment

Ensure strategic

alignment and

challenge

assumptions

Resource

allocation, review

of critical risks and

recommendation

for approval

Final approval

Gate keeper

Strategic

coordinating forum

(SCF)

Steering Committee

(Steercom)

Investment Review

Committees (IRC)

Executive

Committee/ Board

(EXCO/Board)

Functional

review

Peer Review Peer Review Peer Review Close out Review

Documentation Evaluation Report Pre-feasibility study Feasibility study Functional asset

document

The model illustrated in Figure 4-3 indicates that demonstrating the feasibility of a project

generally occurs in phases which follow a logical progression (Fouche 2006:13). Each phase has

key deliverables and items that it needs to be focussed on.

Phase1: Potential Study

The objective of the potential study phase is to clearly frame the goal of the project by

determining the potential value of the opportunity and ensure alignment with business strategy.

The key deliverables for this phase includes a detailed valuation report and planning for the

subsequent phases. The main items that need to be focussed on are:

Test for strategic fit

Preliminary assessment (e.g. technical, market, etc)


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28

Determine regulatory approval required

Plan for phase 2

Report on cost and other performance for current phase

The project at this stage is presented to the “strategic coordinating forum” (SCF) for approval to

the next phase.

Phase 2: Pre- feasibility

The main objective of this phase is to produce and select the best alternative for the project. The

key deliverable for this phase is a pre-feasibility study with a 70-85% accuracy level. The study

should include a preliminary design as well as a refined business case.

The items of focus should include:

Preliminary development of alternatives

Calculated expected value

Identification of preferred alternatives

Regulatory approval

Planning for Phase 3 (including funding approval and resource requirements)

Reporting on cost and other performance for current phase

The Steering Committee approves and recommends the project for a full feasibility study

Phase 3: Feasibility

The major deliverable for this phase of the study is a bankable feasibility study which should

include the final design, final project specification, and final business case. The feasibility study

should focus on:

Fully defining the scope of the project;

Refining estimates and assumptions;

Calculating final expected value;

Regulatory approval; and

Develop detailed implementation plan for phase 4.

The investment review committee is the responsible decision-making body at this phase of the

project. The decision of this committee will recommend final approval to the General Manager,


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29

Executive Director, Exco or Board of Directors depending on the magnitude of the capital

requirement. The approval framework is described in table 2-1 above.

Phase 5: Implementation

The objective of this phase is to produce an operating asset consistent with the final scope of the

project as described in the bankable feasibility study, by implementing the execution plan. The

outcome of this phase is to ensure that the asset is ready for hand-over to the operation.

The main focus is therefore:

Implement execution plan

Finalise operations plan

Business plan for phase 5 project review

Regulatory compliance

Phase 6: Operation

The operation phase deals with the start-up, operation and evaluation of assets to ensure

performance specifications. The focus of this phase is to monitor and evaluate performance for

the post investment review.

4.2.2. Post Investment Review (PIR)

The purpose of the post investment review (PIR) is to improve the quality of investment

decisions by analysing and understanding the successful and unsuccessful aspects of previous

investments. The objective therefore is to determine to what extent the assumptions used in the

original motivation actually materialized in practice and to analyse why these variances

occurred.

Exxaro’s intention is to share information from the post investment review as widely as possible

to create improvement in the capital investment. The company recommends two types of PIR

namely, the independent PIR conducted by a team appointed by the investment review

committee and a self managed PIR conducted by each business unit. Both PIR’s must be based


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30

on the same principles. The company should conduct a PIR between 12 to 18 months after

commissioning. Short life projects should have a review done 3 months after commissioning and

long life and complex investment projects can be reviewed up to 2 years after commissioning.

A detailed guideline on how to conduct post investment review is attached in Appendix C.

4.3. CONCLUSION

“The project development model” defines the “Exxaro way” of developing and realizing value

from opportunities. It provides a structured approach and promotes systematic thinking. The

“road map” represents a high-level project success plan and enables improved decision-making

and execution of a specific opportunity.

The Exxaro capital budgeting process is consistent with most theories as presented in the

literature review, especially in terms of “best practices” and capital budgeting sophistication as

proposed by Adams et al (2004:29).

The company capital budgeting process as described above is certainly detailed and quite

rigorous. The process was designed to cater for all capital investment projects.

The research questionnaire was developed based on the company approved processes to test

whether “small project” were subjected to this process.


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31

5. RESEARCH HYPOTHESES

The limited literature on “small projects” has indicated that this category is very important and

can represent the bulk of capital expenditure of a company (Copeland, 2000:156). The literature

has also indicated that this group of projects is not given proper attention and does not always

follow the capital budgeting process (Copeland, 2000:156; Brink and Marokane, 2004:28).

The general review on capital budgeting processes clearly indicates how they have become

sophisticated processes. The Exxaro process is an example of a sophisticated process. The

importance of Post investment review has been highlighted by Azzone and Maccarrone

(2001:86) and by the Exxaro guidelines on PIR.

These areas of literature review have raised questions about the importance of “small projects” in

terms of value and the processes followed by these projects in Exxaro. This research will attempt

to answer the following questions relating to capital expenditure of “small projects”:

Do “small projects” represent the bulk of capital expenditure in Exxaro?

Are “small projects” in Exxaro subjected to the same rigorous capital budgeting process

as “big projects”?

What is the level of knowledge at BU level of Exxaro corporate guidelines on capital

budgeting? Is there alignment between the BU’s and the corporate process?

Is the measure of value used for “small projects” appropriate and comparable to the

measure of value of “big projects”?

Are the proposed values of “small projects” evaluated after the implementation phase?

The hypotheses that seek to address these research questions, will be based on the literature

review and Exxaro guidelines on capital budgeting. This will essentially be an “audit” on the

applicability of Exxaro’s own processes.


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32

5.1. PROPORTION OF “SMALL PROJECTS” CAPITAL EXPENDITURE

Hypothesis 1: “Small projects” represent 80% of capital expenditure in Exxaro.

Hypothesis 1 relates to the assertion by Copeland (2000:156) that small capital expenditures

represent 80% of capital expenditure. The results of this test will seek to confirm or reject this

hypothesis.

5.2. KNOWLEDGE OF CORPORATE CAPITAL MANAGEMENT SYSTEM

Hypothesis 2: Exxaro corporate capital management system has not been rolled out

throughout the company.

Before testing whether “small projects” are subjected to detailed capital budgeting processes, it

was deemed necessary to test the knowledge of the corporate guidelines on capital budgeting at

business units. Although business units can draw up their own processes, they must strictly

follow Exxaro corporate guidelines. The rolling out of the corporate guidelines will ensure that

there is knowledge and alignment at business units. This hypothesis is based on the assumption

that “small projects” at BU’s are not subjected to capital budgeting process perhaps due to lack

of appreciation of the corporate guidelines.

5.3. CAPITAL BUDGETING PROCESS FOLLOWED BY “SMALL PROJECTS” IN

EXXARO

Hypothesis 3: The majority of “small projects” are not subjected to all the stages of capital

budgeting processes.

This hypothesis relates to the views of Copeland (2000:156), Brink and Marokane (2004:28) as

well as to the concerns raised by SBU financial managers during the preliminary interviews and

discussions. The Exxaro capital budgeting process as detailed in the review is used as the basis

for testing this hypothesis.


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33

Due to the depth of detail required in each phase of the capital budgeting process, sub hypotheses

are developed to test the adherence to the requirements of all steps. The following sub-

hypotheses are suggested:

Hypothesis 3a: The majority of “small projects” are not subjected to full potential

studies;

Hypothesis 3b: The majority of “small projects” are not subjected to detailed pre-

feasibility studies;

Hypothesis 3c: The majority of “small projects” are not subjected to detailed feasibility

studies; and

Hypothesis 3d: The majority of “small projects” are not subjected to a formal

implementation studies.

It is the assumption of the researcher that “small projects” do not follow all the prescribed

processes.

5.4. POST INVESTMENT REVIEW AND “SMALL PROJECTS”

Hypothesis 4: The majority of “small projects” are not subjected to post investment reviews

This hypothesis emanates from the suggestion by Peterson and Fabozzi (2002:7) that detailed

post investments reviews are performed mainly on “large projects”. The implication of this view

is that “small projects” are not subjected to the same process. The experience of the researcher in

the company also led to the assumption that PIR’s are not conducted on “small projects”.


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34

5.5. MEASURE OF VALUE FOR “SMALL PROJECTS”

Hypothesis 5: The value of the majority of “small projects” is not measured in terms of NPV,

IRR, EVA and PBP.

This hypothesis emanates from the Copeland and Ostrowski (1993:55) suggestion that value

drivers, which are specific metrics that can be easily measured, are the best way of determining

the value of “small projects”.

Angus (2006:26) concludes that the use of formal financial analysis tools increases with the risk

of the project. Brink and Marokane (2004:28) link risk to the size of the project and Adams, et al

(2004:30) insist on the inclusion of non financial data to support a project. These conclusions

lead to the assumption that, for “small projects”, non financial measures will be used to

determine value.


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35

6. RESEARCH METHODOLOGY

This research will focus on assessing the approval process that “small projects” in Exxaro follow

by determining if the approved “capital management system” of the company is adhered to. The

methodology used to complete this study is detailed in the following sections.

6.1. PRELIMINARY INTERVIEWS AND DISCUSSION

In finalizing the research topic for this study, unstructured interviews were conducted with the

Financial Manager of the Coal SBU. The result of this interview assisted in narrowing the area of

the study. The Financial Manager as a member of various investment review committees,

confirmed with certainty that projects which were approved by the Executive General Managers,

Executive Committee and, the board of the company, strictly followed the company capital

budgeting process. However, the Financial Manager of the coal SBU seemed to have a view that

“small projects” approved at business units, probably did not go through the same process. In

trying to understand the capital budgeting process at Exxaro the researcher was referred to the

Capital Strategy Manager, from the company corporate finance and treasury department, with

whom he conducted his second unstructured interview. The interview provided the background

to the development of the capital management in the company as detailed in chapter 4 of this

report. The Capital Strategy Manager further confirmed the strict processes followed by the “big

projects” in the company. Further discussions were held with the Financial Manager of heavy

mineral and base metal. He agreed with the assertion that not enough attention was given to

“small projects”. (See appendix A).


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36

6.2. RESEARCH QUESTIONNAIRE

The research questionnaire was developed based on Exxaro guidelines on capital budgeting

processes. The full questionnaire is attached in Appendix B. The questionnaire is divided into 7

main areas. The introductory section is designed to assess the knowledge of the capital budgeting

process within Exxaro. The questions from section 2 to 6 inclusive relate to the different phases

of capital budgeting with section 6 focusing on post investment review and, section 7 concluding

with general questions.

The questions in each phase deal with three critical areas, namely; stage approval, detailed

guidelines and peer review. These are fundamental principles of Exxaro capital management that

must be adhered to before a project could proceed to the next phase.

The questionnaire was designed to query the process followed by each selected project. The

recipients of the questionnaire were asked not to answer the questions in a general manner, or

according to the process that was supposed to be followed. However, due the sensitive nature of

capital budgeting, the researcher anticipated a certain degree of bias from the respondents in

answering the questionnaires. This could be the case if the survey was seen as a form of audit on

project managers. A set of questions were therefore inserted to “countercheck” the consistency of

the answers provided (Leedy and Ormrod, 2005). A question such as: “Do you usually conduct

pre-feasibility studies on “small projects”?” was inserted to check the consistency of the answer

obtained where it was indicated that the specific project was subjected to a pre-feasibility study.

6.3. SAMPLE SIZE AND TARGET POPULATION

The population size of ‘small projects” or small capital expenditure in 2006 was 320 projects.

This population included capital expenditure of less than R 200,000. It was deemed appropriate

to limit the sample size to 100, because of the homogeneous nature of the population (Leedy and


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37

Ormrod, 2005:207). This means that the process followed by 100 “small projects” will be very

similar to the rest of the “small projects”. The secondary reason for limiting the selection to 100

projects was to reduce the likelihood of sending more than two questionnaires to the same

project manager. However, there were still cases where the random selection of projects resulted

in some project managers being recipients of more than two questionnaires.

The research questionnaires were sent mainly to project managers and chief engineers who

worked on the randomly selected projects. The questionnaire was not sent to all engineers in

order to minimize the bias of answering the questions in a general manner. By answering the

questions based on the work done on the selected projects, the researcher hoped to get good

insight into the process followed by “small projects”.

6.4. DATA COLLECTION

The first phase of data collection involved the collation of the capital expenditure database from

each commodity business. The data bases were provided by commodity business financial

managers in excel format and included capital expenditure of all business units within the

specific SBU or commodity business. The capital expenditures were categorized into SHEQ,

sustaining capital and expansion and ad-hoc capital expenditure (i.e. capital expenditure not

foreseen during the planning phase of capital that should be included in the budget). The first

task was to randomly select projects with capital expenditure of less than R5 million. The

database did not have a record of the approval process that took place at the business units. 100

questionnaires were sent electronically to the responsible people whose name appeared on the

list. The responses were sent back to the researcher by e-mail. The slow pace of responses

prompted follow ups by e-mail, telephone calls and visits. The resistance experienced was the

first indication of how the questionnaire was received. It was generally seen as an audit on

project managers instead of an academic research.


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6.5. ANALYSIS OF RESULTS AND HYPOTHESIS TESTING

A total of 100 questionnaires were originally sent out, and five e-mails were returned as

“undelivered” as the recipients had left the company since 2006 and their e-mail addresses had

been cancelled. Therefore 95 questionnaires were considered sent, but only 21 responses were

received back, representing a response rate of 22%.

The response distribution is illustrated in Figure 6-1 below.

Respondents Profile

0

5

10

15

20

25

30

35

Zincor

Glen D

ougla

s

Ferro

allo

y

KZN Sand

s

Groot

egelu

kNBC

NCC

Leuw

pan

Nu

mb

er o

f q

ues

tio

nn

aire

s

0%

10%

20%

30%

40%

50%

60%

% o

f re

spo

nd

ents

sample Responses Respondents (%)

Figure 6-1: Respondents profile per Business units

A response rate of 22% can be considered a low return and places a limitation on the study, as

the results could not strongly be inferred to hold true for the company. The highest response

came from Grootegeluk with 10 responses, followed by KZN Sands with 5 and Zincor with 3.

These are the biggest business units in Exxaro and it can be expected that there will be a strong

bias toward the big 3.

Responses were collated in an Excel spread sheet. A score of 1 was given for question where

there was an answer. (Tick or cross). Where there was no answer a score of 1 was given to a “no

response”. The total of “yes”, “no”, “not sure” and “no responses” were calculated per question


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39

and per business unit. All the scores, per question, were added together to determine the

proportions. The scores are not presented per business unit because the aim of the research was

not to determine whether one business unit followed the process better than the other, but rather

to get a sense of the process followed in the whole of Exxaro.

The results of the questionnaires under a specific “Hypothesis” start by presenting the proportion

of 21 projects that obtained approval at a specific stage. This is followed by presenting the

proportion the respondents who followed the specified steps and the proportion of projects

submitted for peer review. The proportion of projects that followed the detailed process is then

computed in order to be used in the hypothesis testing.

The z-test is considered as the appropriate statistical test when the parameter of interest is the

population proportion (Utts and Heckard, 2007:511). The results of the questionnaire are

presented as one sample from Exxaro; the test selected for this research is the “One sample z-

test”.

The aim of this research is to validate the hypotheses proposed in chapter 5, namely that the

majority (more than 50%) of “small projects” do not follow the detailed steps of the capital

budgeting process. The researcher will seek to reject the null hypothesis (H0) in favour of the

hypothesis (Ha) (Utts and Heckard, 2007:503). The null hypotheses and the alternative

hypotheses will be written as follow:

H0: p≥ 50% (indicating that the majority of “small projects” follow the process/steps).

This is a one-sided test and the null hypothesis (Utts and Heckard, 2007:498).

Ha: p<50% (indicating that the majority of “small projects” do not follow the

process/steps).

In order to conduct the z-test, Utts and Heckard (2007:512) suggest that the following two

conditions must be met:

The sample should be a random sample from the population, and

The quantities np0 and n(1- p0) must be greater than 10.


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40

Both conditions were tested and met with this research. The projects were randomly selected, as

mentioned earlier, and the sample size (n=21) was sufficient to meet the second condition. Utts

and Heckard (2007:512) argue that, testing a null hypothesis that H0: p≥ 50% (p=50%), a sample

size of at least n=20 would be needed to meet the second condition.

The p-value is computed using the statistical function for z-test in excel. Since the answer

provided by the excel function is a two tailed p-value, we divide the value by 2 to obtain the one-

tailed p-value. This value is then compared to the level of significance of 0.05 or 5%, which is

the level of significance conventionally used by most researchers (Utts and Heckard, 2007:503).

The conclusion of the test is then presented depending on the rejection or non rejection of the

null hypothesis.

The second section of results under a specific “hypothesis”, presents the results of the

countercheck questions as well as some comments from respondents. These results are presented

in terms of proportion and no statistical test was conducted on these sets of questions.

The research findings are presented in chapter 7 and the contrast between the conclusions of the

hypotheses testing and the results of the countercheck questions are discussed in chapter 8.


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41

7. RESEARCH FINDINGS

The findings of this research are presented in five important areas:

The proportion of “small projects” capital expenditure;

Knowledge of Exxaro’s capital management system, the availability and alignment of

BU’s capital budgeting process to Exxaro’s capital management system;

The capital budgeting process followed by “small projects” up to the implementation

phase;

The post investment review; and

The appropriate measure of value for “small capital projects”.

These essential areas address the research questions and hypotheses derived from the research

questions are tested.

The presentation of findings starts with the results of the survey, followed by observations to test

the consistency of the survey results. The conclusions of the hypotheses and sub hypotheses are

then presented based on the results of the z-test.

7.1. PROPORTION OF “SMALL PROJECTS” CAPITAL EXPENDITURE

Hypothesis 1: “Small projects” represent 80% of capital expenditure in Exxaro.

Table 7-1: Results of Proportion of total Small Capital Expenditure

Small Capex(<R5m) 2006

Total Exxaro Capex 2006

Sustaining and environmental R 130,242,434 R 640,000,000

Expansion Coal R 23,162,002 R 235,000,000 Mineral sands R 4,969,416 R 29,000,000 Base metals R 6,497,241 R 8,000,000

Industrial minerals R 6,901,671 R 11,000,000

Total R 171,772,763 R 923,000,000


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42

The value of the 320 small capital expenditure (less than R 5 million) collected from all BUs

amounted to R171 million, against a total capital expenditure of R 923 million as presented in

the Exxaro 2007 Annual Report. The small Capex therefore represented only 19% of the total

capital expenditure in 2006. A hypothesis testing is not required in this case, because the total

population of “small projects” has been taken into account.

Based on the classification of “small projects” in Exxaro, this group of projects represents the

bulk in terms of the numbers. However this group of projects did not represent 80% of the total

capital expenditure in Exxaro in 2006. The hypothesis is therefore rejected.

7.2. KNOWLEDGE OF CORPORATE CAPITAL MANAGEMENT SYSTEM

Hypothesis 2: Corporate capital management system has not been rolled out effectively

throughout the company.

(H0: Corporate capital management system has been rolled out effectively in the

company)

The researcher considered the testing of the knowledge of the corporate capital management as

an important step before testing the process followed by project managers and chief engineers

when dealing with “small” capital expenditures. The knowledge of the corporate capital

management at business units’ level will be a demonstration of an effective roll out. The

researcher assumed that the capital budgeting process was not adhered to because the corporate

capital management system had not been rolled out effectively.

The results of the survey indicate that, out of 21 respondents, 95% indicated that they had a good

knowledge of Exxaro’s corporate guidelines on the capital management system. 100% of the

respondents confirmed that the business units had formal capital approval processes and 71%

indicated that the business units’ approval processes were aligned to the corporate guidelines. An

average of 80% of the respondents broadly indicated that the project that they worked on went


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43

through all the phases of capital budgeting, while 71% confirmed that the results of the financial

valuations of the project that they worked on were reviewed and signed off by a financial analyst

at the BU.

Knowledge and Roll out Capital Management system

0%

10%

20%

30%

40%

50%

60%

70%

80%

90%

100%

Knowledge of ExxaroCorporate Capital

Management processand Project

developmentframework

Formal approvalprocess at yourBusiness Unit

Differencebetween BUand Corporate CapitalManagement process

All the steps of capitalmanagement process

and projectdevelopment phases

followed with theproject

Results of the financialvaluations reviewedand signed off by a

financial analyst at thebusiness unit

Yes No Not sure n=21

Figure 7-1: Results of the knowledge and alignment of the corporate capital management system

The computed one-tailed p-value for this data was 0.486 (or 49%). This is not small considering

a significance level of 0.05 (or 5%). There is therefore not enough evidence to reject the null

hypothesis (H0) and conclude that corporate capital management was not rolled out effectively in

the company.

However, to test the consistency of the result above, a question was asked to determine if

specific recommended financial parameters were used at different stages of the approval process.

The results as illustrated in Figure 7-2 indicates a worrying trend with an increase of “no

responses” of 8, 7 and 5 at the potential study phase, pre-feasibility phase and feasibility phase

respectively.


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44

use of Corporate financial guidelines

0

5

10

15

20

25

Potential study: Hurdle rate(19.79%) IRR ( >27%)

Pre feasibility: Hurdlerate(17.79%) IRR (>26%)

Feasibility: Hurdlerate(15.79%) IRR(>25%)

project phase

No

of

pro

ject

s

Yes no not sure No response

Figure 7-2: Results of the use of corporate financial parameter

5 respondents out of 21 consistently indicated that they did not use the corporate financial

guidelines.

This inconsistency is the first indication of the bias in the results of this survey. The possible

impact of the bias is discussed under the section on limitations of the research.

7.3. CAPITAL BUDGETING PROCESS FOLLOWED BY SMALL PROJECT IN

EXXARO

Hypothesis 3: The majority “small projects” are normally not subjected to all the

stages of capital budgeting processes

The full capital budgeting process is divided into phases. Each phase has specific guidelines that

must be adhered to before the project is reviewed and approved for the next stage. Therefore, to

test this hypothesis, sub-hypotheses had to deal with each phase separately.


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45

7.3.1. “Small projects” at potential study phase

Hypothesis 3a: The majority of “small projects” are not subjected to detailed potential

studies.

(H0: The majority of “small projects” are subjected to detailed potential studies).

The results of the survey as presented in Figure 7-3 indicate that 62% of the respondents confirm

that “small projects” were completed and approved at this stage. Although not all the projects

were formally completed and approved for the next phase, 86% of the respondents still clearly

framed the goal of the project at this stage. 67% tested the project for strategic fit, 81% produced

a valuation report at this phase, and 67% planned for the subsequent phase in terms of capital and

value assurance. A total of 71% of the respondents confirmed that the project was subjected to

review before approval.

Potential study phase

0% 10% 20% 30% 40% 50% 60% 70% 80% 90% 100%

Peer review (Technical, marketing financial etc...) before approval

Step4:Planning for subsequent phases (including capital,resources and value assurance requirements)

step 3Valuation report( including known cases, and identificationof a range of options)

Step2:Test for strategic fit ( alignment with business strategy)

Step1:Clearly framed goal (indicating potential value of theproject/ business case)

Potential study completed and approved

Yes No Not sure No response

Figure 7-3: Results of “small projects” at potential study phase


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46

The data suggests that on average, 71% of the “small projects” are subjected to a full potential

study.

The computed one-tailed value p-value for this data set was 0.499 (or 49.9%). This is not small

considering the significance level of 5%. Statistically, there is not enough evidence to reject the

null hypothesis and conclude that “small projects” are not subjected detailed potential studies.

When checking the consistency of the responses as presented in Figure 7-3, project managers

were asked questions designed to determine whether they usually conduct detailed potential

studies on “small projects” and whether detailed potential studies were necessary for “small

projects”?

Potential study trends

0%

20%

40%

60%

80%

100%

Usually conduct a detailed potential studyon small projects

Detailed potential study is necessary forsmall projects

Yes No Not sure No response n=21

Figure 7-4: Results of the consistency trends on potential studies responses

The results as illustrated in Figure 7-4 reveal that 48% of respondents usually conduct a detailed

potential study on small projects. An equal proportion of respondents indicated that they do not

usually conduct a detailed potential studies. 62% of the respondents thought that a detailed

potential study was not necessary for “small projects”. These results are not consistent with the

responses presented in Figure 7-3.

The inconsistency is further demonstrated by comments from some of the respondents:

“As per our policy followed a value of 250 000 is set as a cut off line. Other wise it will become an exercise that will cost more to evaluate than what the project is worth.” (Respondent 2008)


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47

“The level of detail information required for small projects is normally easily accessible and accurate to a feasibility level, referring to cost of project. Also resources does not allow for time spend on “small projects.” (Respondent 2008)

“…maintenance, replacement and, rebuilt of equipment if equipment strategy has been approved, a potential study is not needed” “Potential study should be incorporated with the pre-feasibility without necessarily doing separate studies” (Respondents2008).

These comments indicate that although some parts of the potential study were addressed in other

aspects of the project development, not all steps of the potential study are followed.

7.3.2. “Small projects” at pre-feasibility phase

Hypothesis 3b: The majority of “small projects” are not subjected to detailed pre-

feasibility studies.

(H0: The majority of “small projects” are subjected to detailed pre-feasibility studies).

The results from the 21 respondents indicate that 57% of the projects were approved at this stage.

Considering the focus items of the pre-feasibility phase, 71% of the 21 respondents developed

alternatives and determined the expected value of the project with 70 to 80% accuracy. At this

stage, 62% identified the preferred alternative, refined the business case and planned for the next

phase. The worrying factor is that only 48% of the projects went through an independent peer

review. This result is mainly influenced by 29% of the respondents who chose not to respond to

this question. On average 63% of “small projects” that respondents worked on, adhered to all the

steps prescribed for projects at this level of capital budgeting.


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Pre-feasibility phase

0% 10% 20% 30% 40% 50% 60% 70% 80% 90% 100%

Enough time spent at this stage of the project

Peer/ independent review before approval

Step5: Updated Planning for subsequent phases (including moreaccurate capital, resources and value assurance requirements)

Step4: Refined Business case

Step3: Identification of preferred alternative

Step2: Determination of expected value with 70-85% accuracy ofestimates

Step1: Generation and preliminary development of alternatives

Pre feasibility study approved for this project?


Figure 7-5: Results of “small projects” at pre-feasibility phase Computing the one-tailed p-value for the z-test at a significance level of 5% provided a value of

0.4985 (or 49.8%). The null hypothesis that small project are subjected to detailed pre-feasibility

cannot be reject. There is not enough evidence to reject the null hypothesis (H0) and conclude

that “small projects” are not subjected to detailed pre-feasibility studies.

As with the countercheck questions for potential study, respondents were asked to indicate if

they usually conducted a detailed pre-feasibility study on “small projects” and whether they

considered this phase as necessary. The results presented in Figure 7-6 reveal that 52% of the

respondents do not usually conduct detailed pre-feasibility studies on “small projects”. While

43% thought it was necessary to conduct detailed pre-feasibility studies, 48% did not concur and

10% of the 21 respondents were “not sure”. These results demonstrate a high degree of

inconsistency in the responses on steps followed.


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49

Pre-feasibility trends

0%

20%

40%

60%

80%

100%

Usually conduct a detailed pre feasibilitystudy on small projects

Detailed pre feasibility study is necessaryfor small projects


Figure 7-6: Results of consistency trends on pre-feasibility

The following are two samples of comments by respondents:

“Depending on the nature of the project and impact on business unit it might be required; once again I feel enough information is available in a replacement project to only perform a feasibility study” (Respondent 2008).

“The cost of full potential studies and pre-feasibility makes them not worth for small project (up to 20% of the small project definition); furthermore the difference between estimation at 20% accuracy and 10% accuracy (between pre-feasibility and feasibility) is insignificant for “small projects”.” (Respondent 2008)

Most of the respondents expressed similar views. These comments further emphasize

inconsistencies in the manner the questionnaires were answered and confirm the findings

presented in Figure 7-6; namely, that detailed pre-feasibility studies are usually not conducted on

“small projects”.


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50

7.3.3. “Small projects” at feasibility phase

Hypothesis 3c: The majority of “small projects” are not subjected to detailed feasibility

studies.

(H0: The majority of “small projects” are subjected to detailed feasibility studies).

The aim of this hypothesis was not to demonstrate that “small projects” do not go through

feasibility studies but rather to verify that all the detailed steps were followed. The funds release

process at Exxaro dictates that proof of approval at feasibility phase must be submitted before

expensing the capital. Since all the selected projects were expensed, it will be safe to conclude

that all selected projects were approved at this stage. The objective of this hypothesis is to assess

whether “small projects” rigorously followed the steps by addressing all the focus items of the

feasibility phase as prescribed in the corporate guidelines.

Feasibilty phase

0% 10% 20% 30% 40% 50% 60% 70% 80% 90% 100%

Peer/ independent review before final capital approval

Step6: Execution plan with schedule

Step5: finalized Planning for subsequent phases (including finalcapital, resources and value assurance requirements)

Step4: Final business case

Step3 Determination of final expected value with 90% accuracy inestimates

Step2: Final project specification and engineering

Step1: Fully defined scope

Feasibility study approved


Figure 7-7: Results of “small projects” at feasibility stage


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51

Although the feasibility phase is a stage where all projects must be approved, two respondents

either answered that they did not get approval or that they were not sure if the project was

approved. This is confusing considering the fact that no funds are released without proof of

approval at feasibility stage. However these two answers could not be discarded because they did

not consistently answer “no” to all questions.

Although the results presented in Figure 7-7 indicate that 90% of the respondents confirmed

approval of the project at feasibility stage, only 52% indicated that the project went through a

peer review and had fully defined scope. 81% of the respondents had final project specification

and engineering. 95% of the respondents determined the final expected value with 90%

accuracy. The results also indicate that 62% of the respondents finalized planning for the

subsequent phase, and 67% of the respondents indicated the finalization of the execution plan

with a schedule of the project.

The computed one-tailed p-value for this z-test was 0.49925 (or 50%). At a statistical

significance level of 5%, this p-value is not small and therefore the null hypothesis cannot be

rejected. There is not enough evidence to conclude that “small projects” do not go through

detailed feasibility phase.

The fact that only 76% of the respondents finalized the business and 52% fully defined the scope

of the project, while 90% of the projects were approved and all selected projects were expensed,

is a clear sign of some inconsistencies in the way the questionnaires were answered.

To further check for consistency the researcher asked whether a detailed feasibility study was

necessary for “small projects”. 13 out of 21 or 62% respondents indicated that it was necessary.

Table 7-2: Result on the necessity of a detailed feasibility for “small projects” Yes No Not sure No response

Detailed feasibility study is necessary for “small projects” 13 6 1 1


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52

At feasibility stage it would have been expected to have consistency with all the steps. Although

this was not case, there seemed to be consistency between respondents of the majority of projects

that went through the detailed feasibility phase and the majority of respondents who thought that

detailed feasibility studies are necessary for “small projects”.

7.3.4. “Small projects” at implementation phase

Hypothesis 3d: The majority of “small projects” are not subjected to formal

implementation studies.

(H0: The majority of “small projects” are subjected to formal implementation studies).

The aim of this hypothesis was to confirm whether “small projects” were taken through the

implementation phase in a formal manner and the execution plans were implemented as

proposed in the feasibility phase. The results illustrated in Figure 7-8 indicates that 81% of the

respondents confirmed that the “asset hand over” was conducted formally and was approved.

71% of the respondents confirmed the implementation of the execution plan as proposed in the

feasibility. On the other hand, only 38% of the respondents indicated that a close out review was

conducted after the asset hand over.

The computed p-value for this z-test was 0.498791 (or 49.87%). At a significance level of 0.05

(or 5%) the p-value is large and therefore the null hypothesis cannot be rejected. Statistically,

there is not enough evidence to reject the null hypothesis and conclude that the majority of

“small projects” are not subjected to a formal implementation phase.


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53

Implementation phase

0% 10% 20% 30% 40% 50% 60% 70% 80% 90% 100%

Execution plan implementedas proposed in the feasibility

study

Close out review conductedafter the asset handover

Asset hand over formallyconducted and approved


Figure 7-8: Results of “small projects” at implementation phase

The results of the sub hypotheses 3a, 3b, 3c, and 3d, indicate that there is insufficient statistical

evidence to suggest that the majority of “small projects” in Exxaro are not subjected to all the

stages of capital budgeting process. Hypothesis 3 can therefore be rejected.

7.4. POST INVESTMENT REVIEW AND “SMALL PROJECTS”

Hypothesis 4: The majority of “small projects” are not subjected to detailed post

investment reviews.

(H0: The majority of “small projects” are subjected to detailed post investment reviews).

The results of the responses are presented in Figure 7-9. As anticipated, the majority of the

respondents did not take “small projects” through post investment reviews. Only 38% of the

respondents indicated that a post investment review was conducted on the project that they


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54

worked on. 48% indicated that the project was not subjected to a post investment review and

10% indicated that they were not sure.

Small projects and Post investment review

0

2

4

6

8

10

12


Nu

mb

er o

f re

spo

nse

s

0%

10%

20%

30%

40%

50%

(%)

6.1 Was a post investment review conducted on this project? (%)

Figure 7-9: Histogram of “small projects” at post investment review

The computed one-tailed p-value for the z-test was 0.4465 (or 44.65%). We can therefore not

reject the null hypothesis. Although there was a trend towards less projects (38%) being

submitted for Post investment reviews, there is not sufficient statistical evidence to conclude that

the majority of “small projects” in Exxaro are not submitted to a detailed Post investment

reviews

As a result of the conclusion reported above, and in the light of those respondents who had

answered “yes”, the researcher decided to investigate further to get insight into the manner in

which the post investment reviews were conducted. Further analyses of the PIR process, the key

performance areas and variance analysis of financial parameters were conducted on the 38% of

respondents who indicated that post investment reviews were done on “small projects” that they

worked on.


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55

Figure 7-10 indicates that the post investment review identified the factors that positively

influenced the decision to invest in the project in 63% of the cases. The same proportion also

confirmed that PIR revealed a full adherence to the prescribed investment review process.

However, only 25% of this group of respondents confirmed that lessons learned from the phases

of the project development were summarized during the post investment review.

Completed Post investment review

0% 10% 20% 30% 40% 50% 60% 70% 80% 90% 100%

Post investment reviewrevealed a full adherence to

prescribed investment reviewprocesses

Post Investment Reviewdetermined w hich factorspositively influenced the

decision to invest in the project

lessons learned from eachphase of the project

development captured orsummarized during the psot

investment review


Figure 7-10: Result of process followed during PIR

The key performance analysis during PIR should be conducted in the areas of finance,

marketing, and technical performance. Taking into account the number of projects that went

through a performance review, 75% focused mainly on finance and technical performance. Only

13% indicated a focus on marketing performance. (See Figure 7-11). This is understandable

because a small project will less likely impact the BU’s bottom line and the product produced by

the company.


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56

Key Performance Areas

0% 10% 20% 30% 40% 50% 60% 70% 80% 90% 100%

Analysis of Technicalperformance

Analyis of marketperformace

Analysis Financialperfomance


Figure 7-11: Analysis of key performance areas

A further analysis of 75% of the post investment reviews that focused on the analysis of the

financial performance, revealed that 83% of the post investment analyzed the variance in terms

of start up capital, revenue and, timing. 67% considered the variance of NPV and IRR.

Only 33% considered the variance of the operating costs. (Figure7-12)

Variance analysis of Financial parameters

0% 10% 20% 30% 40% 50% 60% 70% 80% 90% 100%

Variance analysis of Timing (start up/ commissioning)

Variance analysis of NPV andIRR of the project

Variance analysis of OperatingCost

Variance analysis of Revenue (volume, price, exchange rate)

Variance analysis of Start upcapital


Figure 7-12: Results of variance analysis of financial parameters


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57

7.5. MEASURE OF VALUE FOR “SMALL PROJECTS”

Hypothesis 5: The value of the majority of “small projects” is not measured in terms of

NPV, IRR, EVA and PBP.

(H0: The value of the majority of “small projects” is measured in terms of NPV, IRR,

EVA and PBP).

The assumption in testing this hypothesis is that the primary measures of value for “big projects”

are factors such as NPV, IRR and, PBP. The expectation was that because the NPV or IRR of

“small projects” in most cases have little impact on the business bottom line, the focus of value

should be on value drivers as suggested by Copeland and Ostrowski (1993:55).

Measure of Value for small projects

0

2

4

6

8

10

12

14

16


Nu

mb

er o

f re

spo

nse

s

0%

10%

20%

30%

40%

50%

60%

70%

80%

% o

f re

spo

nse

s

NPV, IRR, Pay Back, are necessarily appropriate measures of value for small projects

(%)

Figure 7-13: Results on the measure of value for “small projects”

The results as presented in Figure 7-13 suggest that out of the 21 responses received, 71%

thought that NPV, IRR and, payback period were still the best way of measuring the possible

value to be created by “small projects”.


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58

The computed one-tailed p-value for this z-test was 0.4993 (or 49.93%). The null hypothesis

cannot be rejected as there is not sufficient statistical evidence to conclude that the value of the

majority of “small projects” is not measured in terms of NPV, IRR, EVA and payback period.

This conclusion is consistent with the comments made by respondents.

“These are basic financial tools to check feasibility and compare projects” (Respondent 2008). “Those measures are not always appropriate because they can not always be measured. They are nevertheless necessary because they at least give an idea on the influence of the project on the bottom line (positive or negative).”(Respondent 2008)

The above comments suggest that respondents were generally aware that value drivers were the

best way of measuring the value of “small projects” but they still preferred to focus on NPV,

IRR, and PBP.


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59

8. DISCUSSION

8.1. INTERPRETATION OF THE DATA

The suggestion by Copeland (2000:156) that small capital represents up to 80% of capital

expenditure highlights the importance of this group of projects. The first finding of this study

revealed that “small projects” did not represent the bulk of capital expenditure of Exxaro in

2006. This finding should not be construed as reducing the importance of “small projects” in

Exxaro. The finding should be considered in relation to the maturity and size of the company.

Exxaro is a relatively new BEE company that it is still in the growth stage. Mining investments

are usually capital intensive and a company that is busy expanding will have the bulk of its

capital expenditure leaning toward “big projects”. Mature companies on the other hand will most

probably focus on the improvement of their processes and therefore will have the bulk of their

capital expenditure leaning toward “small projects”. The size of the company can also influence

the classification of “big” and “small projects”. The cut-off point of what can be considered as a

“small project” for big companies will be much higher than what is considered as “small project”

for small or medium sized companies. In the global context, Exxaro can be considered as a

medium sized company and therefore its cut-off will be much lower.

The background on the development of Exxaro’s capital management system indicated the

company’s intention to ensure effective management of its capital. This was to be done by

ensuring the spread of the capital management system knowledge company-wide. The second

finding of this research strongly and clearly supports this objective. This finding was crucial as it

effectively negated the possible assumption that the process was not followed because of lack of

knowledge of the company process on capital budgeting.


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60

The findings associated with hypothesis 3, did not support the researcher’s prediction that the

steps of the company’s capital budgeting process were not followed. Although the conclusion of

the hypothesis testing seemed to suggest that the majority of “small projects” do go through all

the steps of capital budgeting, the results of the consistency check (i.e. countercheck) questions,

as well as the comments provided by respondents, to a large extent weakened these conclusions.

This is due to the contradictions between the two set of answers given. However the conclusions

cannot be nullified even though the contradictions are very strong. This is because statistical tests

were not conducted on the countercheck questions.

The results of the various steps certainly indicate that some “focus items” are covered at different

phases; they are not always addresses at the stage prescribed in the corporate capital management

system. This has probably influenced the respondents in thinking that they followed all the

prescribed steps.

Although there was insufficient statistical evidence to conclude that the majority of “small

projects” were not subjected to post investment reviews, the trend indicated that “small projects”

were not subjected to this important step. The results also indicated that the post investment

review of those projects that went through this process, focused on evaluating aspects that do not

directly show the positive impact of the “small project”. Key areas such as the capturing of the

lessons learned and the focus on operating costs were neglected in the process. The number of

projects that went through this process is so negligible that no inference can be made about the

practice in the company. However the trends still indicate that a need exists for improving the

post investment review for “small projects”.

The finding on the appropriate measure of value for “small projects” was also contradictory.

While most respondents admitted using NPV, IRR, EVA and PBP, to value “small projects”,

they also commented that that these DCF measures were not appropriate for “small projects” as

they could not always be measured, especially if the project is only a small part of a bigger


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61

process. It can be concluded that the focus on using DCF measures is one born out of habit, and

does not necessarily aim at demonstrating the real value of “small projects”.

8.2. LIMITATIONS AND BIASES OF THE RESEARCH

The intention of this research was to understand the process followed by “small projects” and

thereby contribute to the limited literature on capital budgeting, by first considering the Exxaro

case. However, the research encountered serious constraints that placed serious limitations on the

interpretation of data and consequently on the applicability of the findings in Exxaro. The biases

were anticipated due to the sample distribution between business units, and the possible

perception and interpretation of the survey. It was further influenced by the low response return

rate.

8.2.1. Sample and results biases

The sample and consequently the results were always going to be biased toward the big

operations. The sample distribution is illustrated in Figure 6-1. The “big 3” operations

(Grootegeluk, Zincor, and KZN Sands) handle the bulk of the capital expenditure. The results

were going to be affected on how the “big 3” generally handled “small projects”. Leeuwpan,

being a medium sized operation was allocated slightly more questionnaires than Zincor, to try

and balance the results. Unfortunately out of 15 “small projects” selected from Leeuwpan, only

one respondent completed the questionnaire. The smaller business units that did not respond to

the questionnaire also shifted the biases toward the “big” operations. The low return from KZN

Sands also meant that the results were going to be biased towards Grootegeluk responses. This

was evident from the fact that while most of KZN Sands insisted that they conducted post

investment reviews on all “small projects”, the response from Grootegeluk indicated that, in

general, post investment reviews were not conducted. Consequently, the overall result for this

question was low at 38%.


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62

8.2.2. Low response rate

Although the researcher expected a high response rate because of the support provided by

financial managers, the return rate was quite low at 22%. Leedy & Ormrod (2005) argue that low

return rate is one of the major drawbacks of using questionnaires. The researcher tried to counter

the risk of low return by making telephone call follow-ups, resending e-mail and conducting sites

visits. The result was ultimately still relatively low. This was mainly due, as anticipated by the

researcher, to the fact that the questionnaires were probably received as an audit on project

managers. The company’s tightening on capital requests certainly fuelled this perception.

The impact of this low return rate is that the p-values were large, thus indicating insufficient

statistical evidence. This is especially illustrated by the fact whilst only 38% of respondents

admitted to subjecting “small projects” to post investment review, the z-test indicated insufficient

statistical evidence to reject the null hypothesis.

8.2.3. Inconsistency of Answers

The inconsistent manner in the way questions were answered could be directly linked to the

perception of being audited. The research anticipated this sort of bias and inserted countercheck

questions for consistency. The results of countercheck questions are presented under hypothesis

2 and, sub hypotheses 3a, 3b, 3c and, illustrated by Figures: 7-2, 7-4, 7-6 and Table 7-2.

As an example, it is less likely for a respondent to reply “yes” to all steps of pre-feasibility when

referring to the particular project and respond “no” when asked if they usually conduct pre-

feasibility on all “small projects”. Comments provided by respondents were also meant to check

the thinking of respondents in certain areas. In general, the comments which were provided

further emphasized the inconsistencies in the data.

The strong inconsistencies at the potential study and pre-feasibility phases are an indication that

the principle of front end loading, which is the practice of taking sufficient time in earlier phase

of the project to properly assess an opportunity, identify value levers, risks, uncertainty, and


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63

achieve quality deliverable before committing capital expenditure, (Els 2003a), was not being

adhered to in the company.

8.3. AREA OF FURTHER RESEARCH

The treatment of small capital expenditure in the context of capital budgeting is an area that

needs further research. The scope of this study was limited to Exxaro and its business units. This

study used Exxaro as a starting point. However understanding the treatment of “small projects”

in a much wider context could certainly advance learning and improvement of the process in this

area of capital budgeting.

The researcher acknowledges that the biases shown by respondents have seriously limited the

applicability of this study. Therefore a much refined study in the form of case studies, evaluating

specific projects in terms the process followed and post investment review, will significantly

advance learning in this area.

This study did not test the significance of the results of the countercheck questions. Further

studies in this area should consider conducting paired tests, to determine the significance of the

difference between the results of the main questions and the countercheck questions. This would

assist the researcher in making deductions that are more conclusive.

This study focussed on showing that “small projects” do not follow the capital budgeting

processes. It is important to understand that the processes were designed primarily to deal with

“big projects”. Copeland and Ostrowski (1993:55) imply that the scale used to evaluate “big

projects” is wrong for “small projects”. They also insist on a “consistent but less cumbersome”

way of evaluating “small projects” and introduced the concept of “value-based management” to

address this anomaly.

A key area of further research will be to test the applicability of VBM as a form of capital

budgeting process for “small projects”. The ultimate goal is to research and a design a capital

budgeting process that will effectively and consistently evaluate “small projects”.


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64

9. CONCLUSION

“Small projects” are an important part of any company capital expenditure yet capital budgeting

of “small projects” is an area that is often neglected. The literature reviews and preliminary

interviews have certainly proven the case for this study. Although the literature review

highlighted the process followed by “big projects”, it also offered the principles of capital

budgeting process that “small projects” should adhere to.

The assertion by Copeland (2000:156) that “small projects” can represent up to 80% of capital

expenditure was not observed in the case of Exxaro. The hypothesis was not supported in this

case possibly because the definition of “small project” was probably not clear in the assertion by

Copeland (2000:156). It may be possible that “small” in the Copeland (2000:156) context, could

include “medium” in the Exxaro context.

Exxaro capital budgeting processes and the principles behind them are described in details in

chapter 4. The assessment of the knowledge of the company’s capital budgeting processes at

business units was an important hypothesis to test. Although the findings did not support the

hypothesis, they discounted the possible justification that lack of adherence could be due to lack

of knowledge of the process.

This study has attempted to demonstrate that “small projects” do not follow Exxaro’s capital

budgeting processes by investigating the process followed by this group of projects.

Brink and Marokane (2004:28) have presented some evidence of “small projects” not following

the normal process because they are not considered as risky investments and Copeland

(2000:156) argues that they merely get “rubber stamped”. The findings of this research could not

conclude that “small projects” in Exxaro did not follow the capital budgeting process. However

the findings indicated that some key principles such as front end loading, and independent

reviews were not adhered to.

Although the trends of the results also indicated that “small projects” did not go through the post

investment reviews, there was not enough evidence to accept hypothesis 4. In the few cases

where a post investment reviews were conducted, the analyses focussed on elements that are not


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65

easily measurable for “small projects”. An effective post investment review is needed to ensure

the capturing of lessons learned and to improve the capital budgeting process of “small projects”.

The findings of this research also rejected the final hypothesis that the value of the majority of

“small projects” is not measured in terms of NPV, IRR, EVA and PBP. It was found that these

measures of value were mainly used out of habit. Most respondents commented that these

measures were not appropriate for “small projects”.

Overall, all the hypotheses of this research were not supported by the findings of the study. The

low return rate, strong biases and inconsistencies in answering the questions have influenced the

outcome of this research. Although the findings did not support the researcher’s initial

predictions, the study should at least provide new focus into “small projects”. Further research on

understanding and improving the capital budgeting process of “small projects” can improve on

the work of this research.


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66

10. BIBLIOGRAPHY

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Angus, W.A. 2006 “The Role of Formal Financial Analysis in Making Capital Investment

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Azzone, G. & Maccarrone, P. 2001. “The Design of the post-audit process in large organizations:

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Block, S. 2005. “Are there Differences in Capital Budgeting Procedures between Industries? An

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Decisions: A study of the South African Oil Refining & Marketing Industry” Unpublished MBA

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Copeland T.E. & Ostrowski, K.J. 1993. “The Hidden Value of Capital efficiency.” Mckinsey

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Damodaran, A. (2nded). 2001. Corporate Finance Theory and Practice. New York: Wiley &

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Dayananda, D. Irons, R. Harrison, R. Herbohn, J. & Rowland, P. 2002. Capital Budgeting:

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no. 2, 13-24.

Els, F. 2003. “Capital projects: The Benefits Management Challenge” Unpublished Internal

company presentation, Kumba resources.

Els, F. 2003. “Project development model”. Unpublished Internal company presentation, Kumba

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Els, F. 2007. “Capital management process: high level summary” Unpublished Internal company

presentation, Exxaro resources.

Exxaro, 2008. “Exxaro Annual Report 2007”.

Farragher, E.J., Kleiman, R.T. and Sahu, A.P. 2001. “The Association between the Use of

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Gallagher, G. 2007. “Biases and Capital budgeting decision.” Unpublished MBA Research

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11. APPENDIX

A. PRELIMINARY INTERVIEWS AND DISCUSSIONS

A.1 Interviewees Details

Name Leon Groenewald

Position Financial manager Exxaro coal

Date

One-on-one interview

Name Frikkie Els

Position Manager Capital Strategy,Exxaro coal

Date

Name Elaine Fouche

Position Optimization Engineer , Exxaro Technology

Date

One on one interview

Name Mellis Walker

Position Financial manager, Exxaro Sand & Base Metal

Date

e-mail discussion


______________________________________________________________________________

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71

A.2 Request for Permission


______________________________________________________________________________

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72

A.3 e-mail discussion


______________________________________________________________________________

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73

B. EXXARO CAPITAL MANAGEMENT MODELS

B.1 Governance during each phase

Phase# #

Plan Do Review

Execute

Business Case Framing / Optimisation

• Business success • Project execution objectives

Project Definition / kick off• Project Charter, scope of work,

project plan• Working procedures &

communication protocols• Work Breakdown Structures (WBS)• Project team structure

• Completeness• Risk areas• Potential future

problems• Guidance• Recommendation

Gate Readiness (Independent

review)

Sponsor, Steercom, PM / team) facilitated by

Optimisation / TechnologyProject team

Optimisation/Technology

Framing / Kick-off

IRC:Technology / Marketing /

Finance

Process Optimisation

Develop project within mandate according to charter to provide

expected deliverables

Ad hoc: technology selection /project status review)

Phase# #

Plan Do Review

Execute

Business Case Framing / Optimisation

• Business success • Project execution objectives

Project Definition / kick off• Project Charter, scope of work,

project plan• Working procedures &

communication protocols• Work Breakdown Structures (WBS)• Project team structure

• Completeness• Risk areas• Potential future

problems• Guidance• Recommendation

Gate Readiness (Independent

review)

Sponsor, Steercom, PM / team) facilitated by

Optimisation / TechnologyProject team

Optimisation/Technology

Framing / Kick-off

IRC:Technology / Marketing /

Finance

Process Optimisation

Develop project within mandate according to charter to provide

expected deliverables

Ad hoc: technology selection /project status review)


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B.2 Project Development Model /Road Map

Phase

Decision Makers

Project Team

Decision Gates (DG)

Decision Maker(s)

PHASE 1POTENTIAL

PHASE 2PRE-FEASIBILITY

PHASE 3FEASIBILITY PHASE 4

IMPLEMENTPHASE 5OPERATE

Project Team

Decision Maker(s)

Project Team

Decision Maker(s)

Project Team

Decision Maker(s)

Project Team

Decision Maker(s)

Asset Team

EXIT, RECYCLE EXIT, RECYCLE EXIT, RECYCLE New Opportunities(to Phase 1)

Opportunity

Focus Items

ValueEnhancing

Project

FocusItems

Documentation



Timeline

FocusItems

FocusItems

FocusItems

Value Identification Value Realisation

FocusItemsO

ptim

isa

tion

Op

timis

atio

n

Val

ue E

ng

inee

erin

g

DG 1Commit resources



to feasibilitystudy

DG 3 bCommit to

implementation

Doc

EvaluationReport

Doc Doc


Va

lue

En

gin

eeri

ng

DG 4Asset handover

Doc

3 a F/ Study 3 b Value Eng

EXIT, RECYCLE

FocusItems

FeasibilityStudy

Doc

BankableFeasibility

Study

FunctionalAsset(s)

DG 2 aCommit resources

to ValueEngineering

Phase

Decision Makers

Project Team

Decision Gates (DG)

Decision Maker(s)

PHASE 1POTENTIAL

PHASE 2PRE-FEASIBILITY

PHASE 3FEASIBILITY PHASE 4

IMPLEMENTPHASE 5OPERATE

Project Team

Decision Maker(s)

Project Team

Decision Maker(s)

Project Team

Decision Maker(s)

Project Team

Decision Maker(s)

Asset Team

EXIT, RECYCLE EXIT, RECYCLE EXIT, RECYCLE New Opportunities(to Phase 1)

Opportunity

Focus Items

ValueEnhancing

Project

FocusItems

Documentation



TimelineTimeline

FocusItems

FocusItems

FocusItems

Value Identification Value Realisation

FocusItemsO

ptim

isa

tion

Op

timis

atio

n

Val

ue E

ng

inee

erin

g




to feasibilitystudy

DG 3 bCommit to

implementation

Doc

EvaluationReport

Doc Doc


Va

lue

En

gin

eeri

ng

DG 4Asset handover

Doc

3 a F/ Study 3 b Value Eng

EXIT, RECYCLE

FocusItems

FeasibilityStudy

Doc

BankableFeasibility

Study

FunctionalAsset(s)

DG 2 aCommit resources

to ValueEngineering


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B.3 Project Development Model /Road Map Guidelines: Objectives, Deliverable and focus item

Focus Items • Clearly frame goal • Test for strategic fit • Preliminary assessment

(eg technical, market, etc) • Determine regulatory

approval required • Plan for Phase 2 • Report on cost and other

performance for current phase

• Other focus items…….

• Generate alternatives • Preliminary development

of alternatives • Calculate expected value • Identify preferred

alternatives • Regulatory approval • Plan for Phase 3 (incl

funding approval and resource requirements)

• Report on cost and other performance for current phase


• Fully define scope • Refine estimates and

assumptions • Calculate final expected

value • Regulatory approval • Develop detailed

implementation plan for phase 4


• Implement execution plan • Finalise operations plan • Business plan for phase 5

Project review • Regulatory approval • Other focus items……

• Operate asset • Monitor and evaluate

performance • Identify new opportunities • Regulatory approval • Other focus items……

PHASE 1

POTENTIAL PHASE 2

PRE-FEASIBILITY PHASE 3

FEASIBILITY PHASE 4

IMPLEMENT PHASE 5

OPERATE Phase

Clearly frame the goal Determine potential value of the opportunity and alignment with business strategy

Objective Generate alternatives Generate and select the preferred project alternative

Fully define scope Finalise scope, cost and schedule and arrange project funding

Implement execution plan Produce an operating asset consistent with scope, cost and schedule

Monitor performance Start-up, operate and evaluate asset to ensure performance specifications and maximum returns to shareholders

• A valuation report including formulation of a reference case, documenting known data and identifying a range of options aligned with business strategy ranked by cost and uncertainty

• Plan for next and subsequent phases including funding, resource requirements and value assurance requirements

• A development plan - definition of a preferred option with 70 – 85% accuracy in estimates

• Preliminary basis of design

• Refined business case • Updated plan for next

and subsequent phases including funding, resource requirements and value assurance requirements

• Final basis of design • Project specification –

completed engineering definition, 85 – 90% accuracy in estimates, implementation plan and schedule

• Final business case • Finalised plan for next

and subsequent phases including funding, resource requirements and value assurance requirements

• Asset completed and ready for handover

• Post investment review • Extract maximum value

from operating the asset

Key


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C. EXXARO POST INVESTMENT REVIEW GUIDE LINES

(Source Exxaro)

The PIR should cover all aspects of the authorisation and will compare actual achievements and performance and future results now expected with those that were projected in the original capital submission (“performance v/s promise”). All key business drivers (technical, marketing and financial) should receive attention.

The PIR report should address the following issues (where appropriate): • An introduction explaining the background to the project and the review methodology • A discussion of significant issues that influenced both the successful and unsuccessful

aspects of the project. In the original capital motivation the key drivers that will be monitored and tracked for purposes of the PIR, should be listed (as addendum).

• A discussion of the direct causes of the issues identified with recommendations for future investments

• Adherence to the prescribed investment review process • A discussion, if warranted, of the root or system causes which positively or

negatively influenced the investment decision-making process. • A discussion of “performance v/s promise” in terms of technical, marketing and

financial parameters • A financial analysis comparing the value delivered by the project and that forecast in

the approved submission (in terms of financial results and other measures of success)

The financial analysis should include a variance analysis between the original capital authorisation and the review. The variance analysis should be appropriately segmented, eg:

- Start-up Capital - Revenue (volumes, prices and exchange rates) - Operating Costs - NPV and IRR of the project as specified in the capital authorisation. - Timing and “Other” as appropriate for each project - Include information regarding the major differences. - Other appropriate information

• Lessons learned and best practices are deliverables from each phase of the project

development model and should also be captured during the PIR

Specific learning points should be highlighted, eg


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• What was meant to have happened • What actually did happen • What worked well • What did not work well • What would we do differently next time? • etc

These learning points should be captured in a database for review and use at initiation meetings of new projects


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D. RESEARCH QUESTIONNAIRE

University Of Cape Town, Graduate School of Business MBA Research Questionnaire

By Mapi Mobwano Thank you for taking time to complete this questionnaire. Filling this questionnaire will not take more than 10 minutes of your time. The aim of this questionnaire is to understand and possibly improve the capital budgeting as well as the approval process followed by “Small Projects” in Exxaro. In the context of this study Small Project is defined as any project requiring a capital of less than R 5 million and not requiring the approval of the commodity Executive General Manager (EGM). Small project are therefore projects that can be approved by the Business Unit Manager. The questionnaire should be answered in relation to the specific project that you worked on as indicated on the e-mail. The project was selected randomly from the projects undertaken by each business units during 2006 and 2007. This is an anonymous survey and, the names of the project managers, nor the specific project will not be reflected in the final report. This is research is mainly for academic purposes. However the results will be shared in the company in order to improve the capital budgeting processes relating to small projects 1. Introduction 1.1 Are you familiar with the Exxaro Corporate Capital Management process and Project development framework?

Yes No Not sure 1.2 Is there a formal approval process at your Business Unit?

Yes No Not sure 1.3 If yes please describe briefly: ________________________________________________________________________________________________________________________________________________________________________________________________________________________________________________________________________________________________


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1.4 Does the Business unit capital approval process differ from the Corporate Capital Management process?

Yes No Not sure If yes please describe how: ________________________________________________________________________________________________________________________________________________________________________________________________________________________ 1.5 Were all the steps of capital management process and project development phases (as listed in the table below) followed with this particular project?

(Please tick where appropriate) Yes No Not Sure Potential study Pre feasibility Feasibility Implementation Operation

1.6 Were the results of the financial valuations reviewed and signed off by a financial analyst at the business unit?

Yes No Not sure 1.7 Were the following corporate guidelines (in terms financial parameters) used at the different stages of project development?

(Please tick where appropriate)

Hurdle rate ( nominal)

IRR ()

Potential study 19.79% >27% Pre feasibility 17.79% >26% Feasibility 15.79% >25% Implementation Operation


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2. Potential study 2.1 Was a potential study completed and approved for this project?

Yes No Not sure 2.2. Were the following aspects covered in the potential study?

(Tick where appropriate) Yes No Not

sure Clearly framed goal (indicating potential value of the project/ business case)

Test for strategic fit ( alignment with business strategy) Valuation report( including known cases, and identification of a range of options)

Planning for subsequent phases (including capital, resources and value assurance requirements)

2.3 Was the potential study subjected to a peer review (Technical, marketing financial etc...) before approval?

Yes No Not sure 2.4 If a full potential study was not conducted, please indicate the reasons: ________________________________________________________________________________________________________________________________________________ 2.5 Do you usually conduct a detailed potential study on small projects?

Yes No Not sure ________________________________________________________________________ 2.6 Do you think a detailed potential study is necessary for small projects?

Yes No Not sure If no please describe why:


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________________________________________________________________________________________________________________________________________________ 2.7 What will be the best way of evaluating small project at potential study stage? (Please comment) ________________________________________________________________________________________________________________________________________________ 3. Pre Feasibility 3.1 Was the pre feasibility study approved for this project?

Yes No Not sure 3.2 Were the following aspects covered in the Pre feasibility study?

(Tick where appropriate) Generation and preliminary development of alternatives Determination of expected value with 70-85% accuracy of estimates Identification of preferred alternative Refined Business case Updated Planning for subsequent phases (including more accurate capital, resources and value assurance requirements)

3.3 Was the pre feasibility study subjected to a peer/ independent review before approval? 3.4. Was enough time spent at this stage of the project?

Yes No Not sure 3.5 Do you usually conduct a detailed pre feasibility study on small projects?

Yes No Not sure ________________________________________________________________________ 3.6. Do you think a detailed pre feasibility study is necessary for small projects?

Yes No Not sure If no please describe why:


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________________________________________________________________________________________________________________________________________________ 3.7 What will be the best way of evaluating small project at pre feasibility stage? (Please comment) ________________________________________________________________________________________________________________________________________________ 4. Feasibility 4.1 Was the feasibility study approved for this project?

Yes No Not sure 4.2. Were the following aspects covered in the potential study?

(Please tick where appropriate) Fully defined scope Yes No Not sure Final project specification and engineering Determination of final expected value with 90% accuracy in estimates

Final business case finalized Planning for subsequent phases (including final capital, resources and value assurance requirements)

Execution plan with schedule 4.3 Was the feasibility study subjected to a peer/ independent review before final capital approval? 4.4. Do you think a detailed feasibility study is necessary for small projects?

Yes No Not sure If no please describe why: ________________________________________________________________________________________________________________________________________________


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4.5 What will be the best way of evaluating small project at feasibility stage? (Please comment) ________________________________________________________________________________________________________________________________________________ 5. Implementation 5.1 Was the asset hand over formally conducted and approved?

Yes No not sure 5.2 Was close out review conducted after the asset handover?

Yes No Not sure 5.3 Was the execution plan implemented as proposed in the feasibility study?

Yes No Not sure

5.4 What is the best way of handling the implementation phase of small projects? ________________________________________________________________________________________________________________________________________________________________________________________________________________________

6. Post Investment Review 6.1 Was a Post investment review conducted on this project?

Yes No Not sure (If no move to question 6.9, if yes proceed with the next question) 6.2 Did the Post investment review reveal a full adherence to prescribed investment review processes?

Yes No Not sure


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6.3 Did Post investment review determine which factors positively influenced the decision to invest in this project?

Yes No Not sure If yes please list at least two of these factors ________________________________________________________________________________________________________________________________________________ 6.4 Was an analysis of “actual performance Vs promised” conducted in these areas? (Please tick where appropriate)

Parameter () Technical marketing Financial

6.5 Did the financial analysis cover a variance analysis of the following parameter? (Please tick where appropriate)

() Start up capital Revenue ( volume, price, exchange rate) Operating Cost NPV and IRR of the project Timing ( start up/ commissioning)

6.6 Were lessons learned from each phase of the project development captured or summarized during the Post investment review? Yes No Not sure


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6.7 Was the forecasted “overall project value” (in term of financials and other measures of success) delivered during implementation?

Yes No Not sure 6.8 How did the actual value compare with the forecasted value as approved in the submission of the feasibility study?

() Greater Equal Smaller

Can you offer an explanation for the difference? ________________________________________________________________________________________________________________________________________________ 6.9 If the Post investment review was not conducted, how was the project value been assessed after implementation? (Please describe) ________________________________________________________________________________________________________________________________________________ 6.10. Do you think a detailed feasibility study is necessary for small projects?

Yes No Not sure 6.11 What will you suggest as the best way of conducting Post investment review for small projects? ________________________________________________________________________________________________________________________________________________


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7. General 7.1 To your knowledge, is there a data base where lessons learned from Post investment reviews can be captured for reviews and use at initiation of new projects? Yes No Not sure 7.2 Do you think that financial measures such as NPV, IRR, Pay Back, necessarily appropriate measures of value for small projects?

Yes No Not sure If yes please comment: ________________________________________________________________________________________________________________________________________________ If No, please indicate what other measures (key performance indicators) should be used to assess small projects: ________________________________________________________________________________________________________________________________________________________________________________________________________________________________________________________________________________________________ 7.3 Should small Projects (less than R 5 million) strictly follow the following process? 7.4 When should small projects ignore some of the steps of capital budgeting as listed above? ________________________________________________________________________________________________________________________________________________

Yes No Not Sure Potential study Pre feasibility Feasibility Implementation Operation


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7.5 Please comment on what you consider as best capital budgeting process for small projects. ( projects of less than R 5 million)

________________________________________________________________________________________________________________________________________________________________________________________________________________________________________________________________________________________________


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E. DETAILED RESULTS


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Results

yes No Not sure Total

1.1 Are you familiar with the Exxaro Corporate Capital Management process and Project developme 20 1 0 21

1.2 Is there a formal approval process at your Business Unit? 21 0 0 21

1.4 Does the Business unit capital approval process differ from the Corporate Capital Management pr 3 15 3 21

1.5 Were all the steps of capital management process and project development phases (as listed in the table below) followed with this particular project?

Yes No Not SurePotential study 14 7 0 21

Pre feasibility 13 8 0 21

Feasibility 18 3 0 21

Implementation 19 1 1 21

Operation 20 0 1 21

1.6 Were the results of the financial valuations reviewed and signed off by a financial analyst at the bu 15 5 1 21

1.7 Were the following corporate guidelines (in terms financial parameters) used at the different stages of project development?(Please tick where appropriate)

Hurdle rate ( nominal)

IRR yesno not sure

Potential study 19.79% >27% 7 5 1 13

Pre feasibility 17.79% >26% 8 5 1 14

Feasibility 15.79% >25% 10 5 1 16

Implementation 0

Operation 0

2. Potential study

2.1 Was a potential study completed and approved for this project? 13 4 2 19

2.2. Were the following aspects covered in the potential study?Yes No Not sure 0

Clearly framed goal (indicating potential value of the project/ business case) 18 2 1 21

Test for strategic fit ( alignment with business strategy) 14 4 3 21

Valuation report( including known cases, and identification of a range of options) 17 4 0 21

Planning for subsequent phases (including capital, resources and value assurance requirements) 14 5 2 21

2.3 Was the potential study subjected to a peer review (Technical, marketing financial etc...) before ap 15 5 1 21

2.4 If a full potential study was not conducted, please indicate the reasons:

2.5 Do you usually conduct a detailed potential study on small projects? 10 10 0 20

2.6 Do you think a detailed potential study is necessary for small projects? 7 13 0 20

If no please describe why:

2.7 What will be the best way of evaluating small project at potential study stage? (Please comment)

3. Pre Feasibility

3.1 Was the pre feasibility study approved for this project? 12 9 0 21

3.2 Were the following aspects covered in the Pre feasibility study?Generation and preliminary development of alternatives 15 5 0 20

Determination of expected value with 70-85% accuracy of estimates 15 5 0 20

Identification of preferred alternative 13 5 0 18

Refined Business case 13 5 0 18

Updated Planning for subsequent phases (including more accurate capital, resources and value assurance requirements)

13 5 018

3.3 Was the pre feasibility study subjected to a peer/ independent review before approval? 10 5 0 15

3.4. Was enough time spent at this stage of the project? 14 6 1 21

3.5 Do you usually conduct a detailed pre feasibility study on small projects? 10 11 0 21

3.6. Do you think a detailed pre feasibility study is necessary for small projects? 9 10 2 21

If no please describe why:

3.7 What will be the best way of evaluating small project at pre feasibility stage? (Please comment)


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4. Feasibility

4.1 Was the feasibility study approved for this project? 19 1 1 21

4.2. Were the following aspects covered in the potential study? Yes No Not sureFully defined scope 11 6 0 0

Final project specification and engineering 17 3 0 20

Determination of final expected value with 90% accuracy in estimates 20 0 0 20

Final business case 16 2 2 20

finalized Planning for subsequent phases (including final capital, resources and value assurance 13 4 1 18

Execution plan with schedule 14 4 1 19

4.3 Was the feasibility study subjected to a peer/ independent review before final capital approval? 11 2 0 13

4.4. Do you think a detailed feasibility study is necessary for small projects? 13 6 1 20

If no please describe why:4.5 What will be the best way of evaluating small project at feasibility stage? (Please comment)

5. Implementation

5.1 Was the asset hand over formally conducted and approved? 17 1 2 20

5.2 Was close out review conducted after the asset handover? 8 10 2 20

5.3 Was the execution plan implemented as proposed in the feasibility study? 15 5 0 20

5.4 What is the best way of handling the implementation phase of small projects?

6. Post investment review

6.1 Was a post investment review conducted on this project? 8 10 2 20

(If no move to question 6.9, if yes proceed with the next question)6.2 Did the post investment review reveal a full adherence to prescribed investment review processes 6 3 1 10

6.3 Did Post Investment Review determine which factors positively influenced the decision to invest 6 2 2 10

If yes please list at least two of these factors

6.4 Was an analysis of “actual performance Vs promised” conducted in these areas? 2 1 1 4

(Please tick where appropriate)

Parameter ()Technical 8 1 1 10

marketing 1 3 1 5

Financial 8 1 1 10

6.5 Did the financial analysis cover a variance analysis of the following parameter?(Please tick where appropriate)

()Start up capital 8 0 1 9

Revenue ( volume, price, exchange rate) 9 1 0 10

Operating Cost 5 2 1 8

NPV and IRR of the project 5 3 1 9

Timing ( start up/ commissioning) 8 1 0 9

6.6 Were lessons learned from each phase of the project development captured or summarized during the Post investment Review? 2 2 0 4

6.7 Was the forecasted “overall project value” (in term of financials and other measures of success) delivered during implementation? 2 2 0 4

6.8 How did the actual value compare with the forecasted value as approved in the submission of the feasibility study? ()

Greater 2 5 0 7

Equal 6 1 0 7

Smaller 0 6 0 6

Can you offer an explanation for the difference?

6.9 If the Post Investment review was not conducted, how was the project value been assessed after implementation? (Please describe)

6.10. Do you think a detailed Post investment review is necessary for small projects? 9 8 1 18

6.11 What will you suggest as the best way of conducting post investment review for small projects?


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7. General

7.1 To your knowledge, is there a data base where lessons learned from post investment reviews can be captured for reviews and use at initiation of new projects? 5 12 3 20

7.2 Do you think that financial measures such as NPV, IRR, Pay Back, necessarily appropriate measures of value for small projects? 15 2 2 19

If yes please comment:

If No, please indicate what other measures (key performance indicators) should be used to assess small projects:

7.3 Should small Projects (less than R 5 milllion) strictly follow the following process?Yes No Not Sure

Potential study 11 7 2 20

Pre feasibility 10 7 2 19

Feasibility 18 0 2 20

Implementation 18 0 2 20

Operation 18 1 1 20

7.4 When should small projects ignore some of the steps of capital budgeting as listed above? 0

7.5 Please comment on what you consider as best capital budgeting process for small projects. ( projects of less than R 5 million) 0

Results per Business unit


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Zincor Glen D KZN sands Grootegeluk NBC LeuwpanTotal yes No Not sure yes No Not sure yes No Not sure yes No Not s yes No Not sureyes No Not sure

21 3 1 4 1 10 1 1

21 3 1 5 10 1 1

21 3 1 1 2 2 1 8 1 1 1

1

21 3 1 3 2 6 4 1 1

21 3 1 3 2 5 5 1 1

21 3 1 4 1 8 2 1 1

21 2 1 1 4 1 10 1 1

21 2 1 1 5 10 1 1

21 3 1 2 3 8 1 1 1 1

13 2 1 1 1 1 3 3 1

14 3 1 1 4 3 1 1

16 3 1 1 1 5 3 1 1

0 1 1 1

0 1 1

19 2 1 3 1 1 7 2 1 1

1

0

21 3 1 5 7 2 1 1 1

21 3 1 2 1 2 8 2 1 1

21 3 1 5 8 2 1 1

21 3 1 4 1 6 3 1 1 1

21 3 1 5 6 3 1 1 1

20 2 1 1 3 2 4 5 1 1

20 1 2 1 1 4 4 5 1 1

21 3 1 3 2 5 5 1 1

1

20 3 1 4 6 4 1 1

20 3 1 4 6 4 1 1

18 3 1 3 5 4 1 1

18 3 1 3 5 4 1 1

18 3 1 4 5 4 1

15 3 1 3 2 4 1 1

21 3 1 3 2 6 4 1 1

21 3 1 1 4 5 5 1 1

21 3 1 2 3 3 5 2 1 1


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21 3 1 4 1 9 1 1 1

0 3 1 1 7 3 1 1

20 3 1 3 1 10 1 1

20 3 1 4 10 1 1

20 3 1 1 1 2 9 1 1 1

18 3 1 2 1 7 2 1 1

19 3 1 3 1 7 2 1 1

13 3 1 1 5 2 1

20 3 3 2 5 4 1 1 1

20 3 1 5 6 1 2 1 1

20 2 1 1 3 2 2 5 2 1 1

20 3 1 4 1 6 3 1 1

20 1 1 1 1 5 1 8 1 1

1

10 1 1 1 1 4 1 1

10 1 1 1 1 3 1 1 1

4 1 1 1 1

1

10 1 1 1 1 5 1

5 1 1 1 1 1

10 1 1 1 1 5 1

9 2 1 1 4 1

10 2 1 1 5 1

8 2 1 1 3 1

9 2 1 1 4 1

9 2 1 1 4 1

1 4 1

4 1 2 1

1 5

4 1 2 1

7 1 1 4 1

7 1 1 1 4

6 2 4

18 1 1 1 3 1 3 5 1 1 1


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20 2 1 1 3 2 8 1 1 1

19 3 1 5 5 2 2 1

1

20 2 1 1 4 1 4 4 1 1 1

19 3 1 3 1 2 5 2 1 1

20 3 1 5 7 2 1 1

20 3 1 5 7 2 1 1

20 3 1 5 7 1 1 1 1

0

0

capital budgeting processes and “small projects”: a...

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