Abstract
M.Comm.
Owners and shareholders of an organisation want to invest in every project that is worth more than it costs. Ultimately, organisations make capital investments or accept capital projects to create and exploit profit opportunities. There is however a plethora of issues that needs to be considered when decisions regarding the acceptance or rejection of a capital intensive project are taken. To assist the organisation in making these important decisions, there are various methods of capital budgeting.
These methods are the traditional methods and the alternative methods of capital budgeting. The traditional methods are: the net present value method, the internal rate of return method, the modified internal rate of return method, the return on investment method, the payback method and the accounting rate of return method. These traditional methods have numerous shortcomings, of which the inability to account for risk, uncertainty, volatility and managerial flexibility is the most pertinent. In order to address these limitations, the alternative methods of capital budgeting have been developed, which are: sensitivity and scenario analysis, simulations, decision trees and real option valuation methods.
Flexibility is particularly important in the mining industry, where strategic decisions are made under multiple technical and market uncertainties, such as fluctuations in commodity prices. The mining industry is synonymous with uncertainty, which stems from both internal (endogenous) and external (exogenous) factors and capital intensive projects.
Previous studies have not explored which capital budgeting methods are utilised, they rather compared project values utilising the traditional and the alternative (real option valuations) methods. In South Africa (SA) no study has been conducted on the utilisation of real options as an alternative capital budgeting method in the mining industry.
The focus of this study was therefore to determine what the practices and perceptions are regarding the traditional and alternative capital budgeting methods within the mining industry in SA, with the focus on real option valuation methods.