The Impact of Project Selection and Evaluation on Capital Budget: A Case Study of Engen, International Business Division

Author: Malatji, Thabisho Ledwin
Supervisor: Professor Erik Schmikl
Date: September 2010

In any thriving organisation, the number of potential projects will far outweigh the capital funds available. Therefore, selection of those projects that have the greatest value to an organisation is extremely important, to ensure that the company sustains its operation and grows in the selected strategic direction. The process of ’project selection and evaluation’ is normally based on a set of criteria determined by the organisation, which may range from purely economic project drivers to subjective issues (for example, production, marketing, personnel and administration).

As a rule, projects cannot be moved to the next year, due to the urgency of legal compliance and supply/demand requirements. The main projects are related to legal compliance (for example, ISO14001, SANS – cleaner fuels, OHS Act regulations, Euro Emissions), which arise as local by-laws and regulations change. Some of the projects are ‘must do’, based on the company’s operational requirements.

Capital budget is a major resource in any organisation, and should therefore add value to the organisation. All organisations need to ensure that they do not consistently lose value in the long term, or they will not survive (Lynch, 2006:201). This, however, remains a great challenge for project selection teams to protect and optimise capital budget.
Although financial managers are concerned not only with how much cash they expect to receive, but also with when and how likely they are to receive it, evaluating the size, timing and risk of future cash flow is the essence of capital budgeting (Fire et al., 2004:5).

This research focused on the current project selection and evaluation process, and identifies the flaws therein. The objective of this research was to identify the primary factors that contribute to exceeding the budget on the capital expenditure plan, and establish the project selection and evaluation methodologies required to optimise capital investment strategy.

In this dissertation, the research was conducted in the social world, which was theoretical in nature, following a quantitative approach. The research design and methodology followed mixed methodologies.

The key objectives of the author with this dissertation were the following:
 That the practical contributions of this study, formulated within the ambit of this dissertation, would have a practical application in the solving of real-world problems.
 That the impact of the research would culminate in a paradigm shift, not only for the petroleum industry, but also have a broader application for similar organisations, going forward to become the accepted strategy for dynamic change initiatives pertaining to socioeconomic and technology environments.
 That the solution options should be of such a nature that they not only solve the research problem, but also the implementation thereof, from a practical operational perspective.

The literature study, discussed in chapter 2, emphasises the importance of senior leadership’s role in supporting the Project Portfolio Management system. The main areas covered in the literature review were Project Portfolio Management, leadership, project selection and evaluation, and project selection and evaluation analysis techniques. It was apparent that project life cycles should be monitored and factored into programme management, as the failure thereof could have an adverse impact on the funding process. It is imperative for the project selection process to be free from any bias and rigour. The project selection process should not only be profit driven, but also strategically aligned, in order to achieve the organisational prescriptive strategic goals. Engen IBD’s 2016 goal is huge and requires a strategic holistic approach, in order to create and support a competitive advantage, to ensure that all the anticipated benefits are envisaged.

The four processes of managing strategy are key success factors towards the process of cascading the strategy into operational processes for the employees to ‘gear into’. These processes provide a map to translate the vision into goals, targets, strategic initiatives and resource utilisation. The project selection process provides a systematic criterion to ensure a transparent evaluation process on the project proposals. It is imperative for any organisation’s senior management to appraise their project evaluation process, and maintain the communication loop in lieu of promoting good governance and guiding the proposal owners.

Senior management should note that they can make or break the project selection process, if they do not pay attention to the methods of ranking which are used to evaluate the projects and make ’go/kill’ decisions. It is up to top management to ensure that the decision-making processes for different scenarios are adopted and embarked upon by the project selection and evaluation team. Uncertainty will remain a great challenge to managers, since time pressure plays an important role in pressing most managers to make decisions. If a decision can be delayed somewhat, the right information may be obtained to reduce the uncertainty.

In concluding this dissertation, a preview of the objective of the dissertation is discussed briefly, in relation to the feedback from the respondents, the findings and the recommendations thereof. The objective of this research was to identify the key areas within the project selection and evaluation process, that should be acted upon to optimise the selection and evaluation process. The aim of action research is to enter into a situation, attempt to bring about change, and monitor the results. The action research applied in this dissertation is a type of applied research designed to find an effective way of bringing about conscious change in the project selection process, while providing an open field where management communicate better to optimise capital budgeting.

The research problem, which was investigated through investigative questions, was defined as ’the impact of project selection and evaluation on capital budgeting’. In lieu of addressing the problem, a research question was posed as: ’What are the mechanisms which can be deployed to lessen the adverse impact of project selection and evaluation process on the capital budget?’. A literature review was done, which covered key areas such as Project Portfolio Management, the project selection and evaluation process, and the evaluation analysis techniques. The literature study provided a basis for project management, from the corporate strategy perspective down to the operational level. Some of the most important factors are that the PPFM system should comprise aggregate data such as project type, correlation between projects, the status of each project, resource loading on each of the projects, and project ratios. Other important factors were that the project selection process should be driven by the strategic objectives, and not merely by financial benefits. The competencies of the project selection team were regarded as a key note towards the success of the selection process.

The literature study revealed that accounting tools provide a great deal in measuring the future value of investments and the various ways in which financial risks can be measured, prior to engaging in large investments. The research design and methodology included critical aspects pertaining to ‘data collection design and methodology’. The research was conducted in the social world, which was theoretical in nature, following a quantitative approach. The data analysis was based on the sample size, which was 43% of the IBD staff in Head Office. In terms of the influence within the department, the sample size could adequately reflect the true perception of the ‘as is’.

A Likert interval scale was used to measure the responses, and a midpoint was included in the scale (‘undecided’). The 5-point Likert interval scale provided the respondents with a fence to lean on, under the midpoint ‘undecided’. Had the midpoint been omitted, the respondents would have been forced to either choose ‘agree’ or ‘disagree’. It can be drawn from the overall feedback that IBD is going in the right direction when comparing the positive responses and the literature drawn in chapter 2. A questionnaire was designed and distributed to a sample size of 43% of the target population. This had a negative impact on the feedback, since some of the respondents leaned on the ‘undecided’ option because they were not forced to either ‘agree’ or ‘disagree’.

The data interpretation was done by using a Cronbach’s alpha analysis to measure how well a set of items (variables) measures a single unidimensional latent construct. Cronbach’s alpha tests the coefficient of reliability or consistency in the data, and when the data have a multidimensional structure; Cronbach’s alpha is usually low. A mean comparison was used to determine the questions, which were rated more from the respondents’ understanding and beliefs. The respondents provided feedback which had a strong correlation and consistency to the questions. Although the midpoint on the Likert interval scale provided the respondents with an ‘undecided’ option, the researcher is satisfied that the objective of this research has been met.

The investigative questions were all answered in relation to the literature study and the feedback from the questionnaire. The researcher is of the opinion that IBD is on the right track, in terms of harbouring their resources and investing them in the right projects. The recommendations that are outlined above will play an imperative role in ensuring that the current PPFM system is optimised and that its purpose is manifested for Engen IBD to accomplish its strategic goals.