Capital Budgeting
Capital Budgeting
Capital Budgeting
INTRODUCTION
INTRODUCTION TO BUDGETING
BUDGETING: Budgeting is nothing but technique of expressing largely in financial terms of
management plans for operating & financing the enterprise during periods of time. It
is relating active and stresses what should happen, it has an easements of Wishful
Thinking injected into it knowingly as it used a motivation device. It is prepared by
the office of the controller which coordinates the control function. It is prepared for a
period of one year.
An estimation of the revenue & expenses over a specified future period of
time. A budget can be made for a person, a family or a group of people, a business,
government, country or multinational organization or just about anything else that
makes & spends. Money budgets are a microeconomic concept that show the tradeoff
made when one good is exchanged for another. A surplus budget means profits are
anticipated, a balanced budget means revenue are expected to equal expenses; and a
deficit budget means expenses will exceed revenue. Budgets are usually compiled and
re-evaluated on a periodic basis. Adjustments are made to budgets based on the goals
of the budgeting organization. In some cases, budget makers are happy to operate at a
deficit, while in other cases, operating at a deficit is seen as financially irresponsible.
DEFINITION OF BUDGETING: Budgeting is the formulation of plans for future activity that seek to substitute
carefully constructed objectives for hit and miss performance and provide yard sticks
by which deviations from planned achievements can be measured.
Whether or not funds should be invested in long term projects such as settings of
SCOPE OF STUDY:
Main financial function in modern times is allocation of capital in efficient
resources.
3
Which is the most crucial step in the firm? These decisions involve
heavy
involvement of funds so these long term decisions have a great implication on the
growth and profitability of the firm.
Scope of the study is limited in collecting the financial data of Bevcon wayors
for five years and the budgeted figures for each year.
DATA SOURCES:
a) Primary Data:
The data will be collected though holding discussions with the employees of the
company and discussing the questionnaires with existing customers of the
company.
b) Secondary Data:
The present study is based on Secondary data. The various source of secondary data
include
Internet
Magazines
5
RESEARCH DESIGN:
The research is primarily both explanatory as well as descriptive in nature. A wellstructured questionnaire was prepared and personal interviews were conducted to
collect the customers requirements, through this questionnaire.
SAMPLING METHODOLOGY:
a) Sampling Technique:
Capital budgeting
b) Sampling size:
Sample size refers to number of elements to be included in the study.
Sample size is 50 investors of Bevcon Wayors
DATA COLLECTION
Primary data:
Primary data is the data which is collected by
(1)
LIMITATIONS:
All the techniques of capital budgeting presume that various investment
proposals under consideration that are mutually exclusive which may not
(2)
(3)
may not be exact. Obviously, the result based upon wrong data cannot be good.
There are certain factors like morale of employees, goodwill of the firm, etc.,
which cannot be correctly qualified but which otherwise substantially influence
(4)
(5)
CHAPTER II
7
REVIEW
OF
LITERATURE
CAPITAL BUDGETING:
A capital expenditure is an outlay of cash for a project that is expected to
produce a cash inflow over a period of time exceeding one year. Examples of projects
include investments in property, plant, and equipment, research and development
projects, large advertising campaigns, or any other project that requires a capital
expenditure and generates a future cash flow.
Because capital expenditures can be very large and have a significant impact
on the financial performance of the firm, great importance is placed on project
selection. This process is called capital budgeting.
KINDS OF CB DECISIONS:
Capital Budgeting refers to the total process of generating, evaluating,
selecting and following up on capital expenditure alternatives basically; the firm may
be confronted with three types of capital budgeting decisions
(i)
(i)
such a way that the acceptance of one which exclude the acceptance of other projects.
The alternatives are mutually exclusive and only one may be chosen.
(ii)
than it can finance. It may be defined as a situation where a constraint in placed on the
total size of capital investment during a particular period. In such a event the firm has
to select combination of investment proposals which provides the highest net present
value subject to the budget constraint for the period. Selecting or rejecting the projects
for this purpose will require the taking of the following steps:
1)
2)
(IRR).
Selecting of rejects depends upon the profitability subject to the budget
limitations keeping in view the objectives of maximizing the value of firms.
The future benefits will occur to the firm over a series of years.
Importance of Investment Decisions:Investment decisions require special attention because of the following reasons.
Growth
The effects of investment decisions extend in to the future and have to be
endured for a long period than the consequences of the current operating expenditure.
A firms decision to invest in long-term assets has a decisive influence on the rate and
direction of its growth. A wrong decision can prove disastrous for the continued
survival of the firm; unwanted or unprofitable expansion of assets will result in heavy
operating costs of the firm. On the other hand, inadequate investment in assets would
make it difficult for the firm to complete successfully and maintain its market share.
Risk
A long-term commitment of funds may also change the risk complexity of the
firm. If the adoption of an investment increases average gain but causes frequent
fluctuations in its earnings, the firm will become more risky. Thus, investment
decisions shape the basic character of a firm.
10
Funding
Investment decisions generally involve large amount of funds, which make it
imperative for the firm to plan its investment programmes very carefully and make an
advance arrangements for procuring finances internally or externally.
Irreversibility
Most investment decisions are irreversible. It is difficult to find a market for
such capital items once they have been acquired. The firm will incur heavy losses if
such assets are scrapped.
Complexity
Investment decisions are among the firms most difficult decisions. They are
an assessment of future events, which are difficult to predict. It is really a complex
problem to Economic, political, social and technological forces cause the uncertainty
in cash flow estimation.
TYPES OF INVESTEMENT DECISIONS
There are many ways to classify investments. One classification is as follows:
Expansion of existing business
Expansion of new business
Replacement and modernization.
Expansion and Diversification
A company may add capacity to its existing product lines to expand existing
operations. For example, the Gujarat State Fertilizer Company (GSFC) may increase
its plant capacity to manufacture more urea. It is an example of related diversification.
A firm may expand its activities in a new business. Expansions of a new business
require investment in new products and a new kind of production activity within the
firm. If a packaging manufacturing company invests in a new plant and machinery to
produce ball bearings, which the firm business or unrelated diversification.
Sometimes a company acquires existing firms to expand its business. In either case,
the firm makes investment in the expectation of additional revenue. Investments in
existing or new products may also be called as revenue-expansion investments.
T And Modernization
The main objective of modernization and replacement is to improve operating
efficiency and reduces costs. Cost savings will reflect in the increased profits, but the
firms revenue may remain unchanged. Assets become outdated and obsolete with
11
technological changes. The firm must decide to replace those assets with new assets
that operate more economically.
Yet another useful way to classify investments is as follows:
Independent investments
Contingent investments.
Independent Investments
Independent investments serve different purposes and do not compete with each
other. For example, a heavy engineering company may be considering expansion of
its plant capacity to manufacture additional excavators and addition of new
production facilities to manufacture new product-light commercial vehicles.
Depending on their profitability and availability of funds, the company can undertake
both investments.
Contingent Investments
Contingent investments are dependent projects; the choice of one investment
necessitates undertaking one or more other investments. For example, if a company
decides to build a factory in a remote, backward area, if may have to invest in houses,
roads, hospitals, schools etc. for employees to attract the work force. Thus, building of
factory also requires investments in facilities for employees. The total expenditure
will be treated as one single investment.
12
The first two steps, discussed in the subsequent chapters, are assumed as given.
Thus, our discussion in this chapter is confined to the third step. Specifically, we
focus on the merits and demerits of various decision rules.
Evaluation criteria
A number of investment criteria (or capital budgeting techniques) are in use in
practice. They may be grouped in the following two categories.
1. Discounted cash flow criteria
Net present value(NPV)
Internal rate return(IRR)
Profitability index(PI)
2. Non discounted cash flow criteria
Payback period(PB)
Discounted payback period
Accounting rate of return(ARR)
value of the company they would choose all projects with positive net present values,
even if that value is just $1. On the other hand, if they have limited resources, they
will rank the projects and pick those with the highest NPV's.
The discount rate used most frequently is the company's cost of capital.
Net present value (NPV) or net present worth (NPW)[ is defined as the total
present value (PV) of a time series of cash flows. It is a standard method for using the
time value of money to appraise long-term projects. Used for capital budgeting, and
widely throughout economics, it measures the excess or shortfall of cash flows, in
present value terms, once financing charges are met.
The rate used to discount future cash flows to their present values is a key
variable of this process. A firm's weighted average cost of capital (after tax) is often
used, but many people believe that it is appropriate to use higher discount rates to
adjust for risk for riskier projects or other factors. A variable discount rate with higher
rates applied to cash flows occurring further along the time span might be used to
reflect the yield curve premium for long-term debt.
14
bonds, even putting the money in a bank account). Thus, the IRR should be compared to any
alternate costs of capital including an appropriate risk premium.
In general, if the IRR is greater than the project's cost of capital, or hurdle rate, the project
will add value for the company.
In the context of savings and loans the IRR is also called effective interest rate.
In cases where one project has a higher initial investment than a second mutually exclusive
project, the first project may have a lower IRR (expected return), but a higher NPV (increase
in shareholders' wealth) and should thus be accepted over the second project (assuming no
capital constraints).
IRR assumes reinvestment of positive cash flows during the project at the same
calculated IRR. When positive cash flows cannot be reinvested back into the project, IRR
overstates returns. IRR is best used for projects with singular positive cash flows at the end of
the project period.
Profitability index
Yet another time adjusted method of evaluating the investment proposals is the
benefit-cost (B/C) ratio or profitability index. Profitability index is the ratio of the present
value of cash inflows at the required rate of return, to the initial cash out flow of the
investment.
Evaluation of PI method
Like the NPV and IRR rules, PI is a conceptually sound method of arising
investment projects. It is a variation of the NPV method and requires the same
computations as the NPV method.
Payback period
The payback period is one of the most popular and widely recognized traditional
methods of evaluating investment proposals. Payback is the number of years required to
15
cover the original cash outlay invested in a project. If the project generates constant
annual cash inflows, the payback period can be computed by dividing cash outlay by the
annual cash inflow.
Evolution of payback:
Many firms use the payback period as an investment evaluation criterion and a
method of ranking projects. They compare the projects payback with pre-determined
standard pay back. The would be accepted if its payback period is less than the maximum
or standard payback period set by management as a ranking method. It gives highest
ranking to the project, which has the shortest payback period and lowest ranking to the
project with highest payback period. Thus if the firm has to choose between two mutually
exclusive projects, the project with shorter payback period will be selected.
Simplicity
The significant merit of payback is that it is simple to understand and easy to
calculate. The business executives consider the simplicity of method as a virtue. This is
evident from their heavy reliance on it for appraising investment proposals in practice.
Cost effective
Payback method costs less than most of the sophisticated techniques that require a
lot of the analysts time and the use of computers.
Short-term
Effects a company can have more favorable short-run effects on earnings per share
Liquidity
The emphasis in payback is on the early recovery of the investment. Thus, it gives
an insight into the liquidity of the project. The funds so released can be put to other uses.
In spite of its simplicity and the so, called virtues, the payback may not be a desirable
investment criterion since it suffers from a number of serious limitations.
Risk shield
16
The risk of the project can be tackled by having a shorter standard payback period. As
it may be in a ensured guaranty against its loss. A company has to invest in many projects
where the cash inflows and life expectancies are highly uncertain. Under such
circumstances, pay back may become important, not so much as a measure of profitability
but, as a means of establishing an upper bound on the acceptable degree of risk.
ACCOUNTING DATA
The ARR can be readily calculated from the accounting data, unlike in the NPV and
IRR methods, no adjustments are required to arrive at cash flows of the project.
ACCOUNTING PROFITABILITY
The ARR rule incorporates the entire stream of income in calculating the projects
profitability.
The ARR is a method commonly understood by accountants and frequently used as
a performance measure. As decision criterion, however it has serious short comings.
17
Accounting profits are based on arbitrary assumptions and choices and also include noncash items. It is, therefore in appropriate to relay on them for measuring the acceptability
of the investment projects.
ARBITRARY CUT-OFF
The firm employing the ARR rule uses an arbitrary cut-off yardstick. Generally,
the yardstick is the firms current return on its assets (book -value). Because of this, the
growth companies earning very high rates on their existing assets may project profitable
projects and the less profitable companies may accepts bad projects.
PROJECT CLASSIFICATION
Project classification entails time and effort the costs incurred in this exercise
must be justified by the benefits from it. Certain projects, given their complexity and
magnitude, may warrant a detailed analysis; others may call for a relatively simple
analysis. Hence firms normally classify projects into different categories. Each category is
then analyzed somewhat differently.
While the system of classification may vary from one firm to another, the following
categories are found in cost classification.
Mandatory investments
These are expenditures required to comply with statutory requirements.
Examples of such investments are pollution control equipment, medical dispensary, fire
fitting equipment, crche in factory premises and so on. These are often non-revenue
producing investments. In analyzing such investments the focus is mainly on finding the
most cost-effective way of fulfilling a given statutory need.
Replacement projects
Firms routinely invest in equipments means meant to obsolete and inefficient
equipment, even though they may be a serviceable condition. The objective of such
investments is to reduce costs (of labor, raw material and power), increase yield and
18
Expansion projects
These investments are meant to increase capacity and/or widen the distribution
network. Such investments call for an expansion projects normally warrant more careful
analysis than replacement projects. Decisions relating to such projects are taken by the
top management.
Diversification projects
These investments are aimed at producing new products or services or
entering into entirely new geographical areas. Often diversification projects entail
substantial risks, involve large outlays, and require considerable managerial effort and
attention. Given their strategic importance, such projects call for a very through
evaluation, both quantitative and qualitative. Further they require a significant
involvement of the board of directors.
Miscellaneous projects
This is a catch-all category that includes items like interior decoration,
recreational facilities, executive aircrafts, landscaped gardens, and so on. There is no
standard approach for evaluating these projects and decisions regarding them are
based on personal preferences of top management.
19
CHAPTER III
INDUSTRY PROFILE
COMPANY PROFILE
20
Industry Profile
Industry Profile: The Financial Services Industry
The financial services industry covers a broad range of business organizations
including banks, credit card companies, insurance companies, stock brokerages and
investment fund corporations.
Banking
Banking is composed of three different subfields including commercial banks, savings
banks, and credit unions. Commercial banks represent the largest portion of the
industry. Not only do these banks save and invest money but also are involved in
international trading and lending. Savings banks primarily serve their clients in
lending and saving of money. Both commercial and savings banks are regulated and
overseen by one of the 12 Federal Reserve districts and the FOMC. Banks are
required under regulation to hold a percentage of deposits as required reserves equal
to the federal funds rate. Excess reserves beyond the required reserve rate are used by
banks in investment opportunities, loans, mortgages, or exchanged among banks that
are in need of reserves. The difference between commercial banks and savings banks
is seen in the types of clients and consumers they do transactions with and the amount
of services they provide. People that in one way or another had a "bond", such as
members of a labor union, originally created credit unions,
The Foreign Exchange Market (ForEx)
Bloomberg and its competitors all follow the foreign exchange market closely for
their clients. The foreign exchange market (forex) is simply the market in where
currencies from all over the world are traded. The forex market is the largest financial
market in the world. The forex market see's over $2 trillion in daily trades. This
market, with the help of companies such as Bloomberg, is expected to grow rapidly as
businesses become more aware and informed. The forex market involves the buying
of one currency from all over the world, while at the same time selling another. As
global currencies are valued against one another buyers look for currencies on the rise
and try to sell those that are weak. As one might assume, the most often traded
21
currencies are the U.S. Dollar, the Euro, the British Pound, the Swiss Franc, and the
Japanese Yen.
Investment Services
The investment service industry involves the investment of money into securities.
These securities include stocks, bonds, or mutual funds. Securities are bought and
sold daily on the market by investment service agencies for clients all over the world.
Insurance
The insurance business involves insurance carriers, brokerages and agencies.
Insurance companies charge premiums to cover the risks of their clients. The premium
that the insurance company charges is based directly on the likelihood that a client
will suffer a financial loss. The insurance companies use formulas and algorithms to
determine the risk of their clients. Insurance companies use underwriters to measure
risk and price the policy accordingly. The premiums that customers pay are invested
in order to build a strong portfolio to cover client losses. Life insurance, property and
casualty insurance, reinsurance,
Bloomberg
Founder, and current mayor of New York City, Michael Bloomberg, established
Bloomberg L.P. in 1981. Bloomberg L.P. provides corporations and business
professionals with global financial information. The goal of the company is to provide
as much financial information possible. Clients of Bloomberg receive financial news
and data through multiple mediums including Bloomberg television and Bloomberg
radio. The company's primary clients are large banks, investment firms, law practices,
government agencies, corporations and news stations.
Bloomberg L.P. includes Bloomberg Professional and Bloomberg Terminal.
Bloomberg Professional is the company's core business and provides clients with "the
world's fastest growing real time financial information network."(Quotes) Bloomberg
Terminal is the core product of the company. Terminal is a computer system designed
to allow clients to follow real time financial action. It is within Bloomberg Terminal
that users can analyze many different types of financial markets including, but not
limited to, the foreign exchange market, commodities, and equities.
22
Company profile:
Bevcon Wayors Pvt Ltd, Hyderabad is a major player / manufacturer
of Material Handling Equipments in the India. Bevcon is also one of the fastest
growing.
Established in 1991, Bevcon had a steady growth and now have established
as one of the leading Material Handling, Crushing and Screening Systems Company
in India.
Equipments Manufactured
Bevcon Wayors is into the Business of Bulk Material Handling, Crushing, and
Screening Equipment for all sectors of industries. Bevcon Wayors Designs,
Manufactures, Supplies and undertakes Erection & commissioning at customers site.
All Equipments and products undergo rigorous quality control checks and are
manufactured to the highest Engineering Standards.
MCs expertise is outstanding in following project areas: masonry / Concrete
dams spill ways, tunneling, formation of earth dams and bunds, canals, bridges, roads
and buildings. Befittingly, the company has the privilege of working for or on behalf
of such infrastructure majors as the Tehri Hydro power Development Corporation,
steel Authority of India Limited, NTPC, NHPC, Reliance, and Engineering projects
India Limited.
MCs expertise, virtually in all areas of civil and engineering construction, is best
reflected in the successful execution of following projects.
Rs.350 Cores Koteshwar Dam for the Tehri Hydro Electric power project in
Uttaranchal,
Rs.250 - Crores project for transportation of iron ore form Kalta iron ore mines to
SAIL in orissa state engaging an unprecedented workforce of 4000 people.
Rs.150-crores project for construction of B.G. single Line Tunnel No.5 (Bakkal
Tunnel) form Km 43.040 to 48.940 on the Katra-Laole section of the Udahampur
srinagar- Baramulla Rail Link.
24
work
25
DEPARTMENTS OF BW
BW MANAGEMENT
Bevcon Wayors
Regulatory Board
BEVCON WAYORS
Cherlapalli
Complete
Aided
institute
Research &
Development
Sector
Industrial Sector
Services support
Sector
Board of directors:
Mr. C. M. Ramesh, Chairman & Managing Director
Operating efficiently out of a network of corporate and project offices across the
country, Ramesh presents the picture of a cutting edge entrepreneur endowed with
exemplary vision, leadership, resource mobilization, and management skills.
Current diversification plans of Mr.Ramesh include tapping the excellent hydropower
generation opportunities that the highly progressive State of Sikkim is unfolding.
Mr. C.M. Rajesh Director
Mr. C.M. Rajesh, Director of Bevcon Wayors Limited A graduate in the Arts
from Andhra Loyola College, Vijayawada, Andhra Pradesh is the current successful
Director of the profit-making Bevcon Power Projects Limited in Khammam district of
Andhra Pradesh. He brings a sharp sense of focus, dynamism, dedication and
26
success in such mega projects could steer Bevcon Wayors to the companys stated
goal of industry leadership.
Value of
Value of
Value of
work
work
work to be
awarded
executed
executed
250.00
46.76
203.24
335.00
99.34
235.66
152.29
34.34
117.95
77.04
48.55
228
particulars,
design
and
drawings
28
58.32
13.31
acres
khariff
I.D.(package
No33)
IE
S
President
Executive Director
29
45.01
Partners:
Clients:
Milestones:
30
CHAPTER - IV
DATA ANALYSIS
AND
INTERPRETATIONS
2010-11 TO 2014-15
sno
Particulars
(RS IN MN)
2010-11
2011-12
2012-13
2013-14
2014-15
Cash inflow
1.
381.98
656.30
600.10
617.68
637.82
2.
Other income
2.42
2.31
1.21
0.42
10.06
TOTAL
384.4
658.61
601.31
618.10
647.88
(9.24)
38.69
35.25
38.37
OTHER INCOME
406.89
649.37
640.00
653.35
686.25
340.95
492.27
538.59
545.36
435.13
65.94
157.10
101.41
107.89
251.12
(Less) depreciation
11.28
12.81
16.87
18.17
18.50
3.
4.
5.
31
Taxable income
54.66
144.29
84.54
89.82
232.62
Less tax
3.50
11.00
8.50
10.50
10.95
4.11
0.29
0.00
0.00
0.00
47.05
133.00
76.04
79.32
221.67
(Add) depreciation
11.28
12.81
16.87
18.17
18.50
58.33
145.81
92.91
97.49
240.17
Note: (cash outflows and cash flows after tax is taken as initial investment for capital
budgeting calculations)
BEVCON WAYORS PVT LTD has entail investment of 470.00millions
And the annual cash flows from 2010-15 then the payback period may be calculated
as follows.
Payback period:
Calculation of cash flow after taxes (cfat)
(RS IN MN)
Serial no
Years
Cash flows
2010-11
58.33
58.33
2011-12
145.81
204.14
2012-13
92.91
297.06
2013-14
97.49
394.55
2014-15
240.17
634.72
From the table it shows that pay back periods lies the 4th and 5th year with 394.55 and
634.72 i.e. initial investments of 470 millions
The amount has been recovered in the fourth year and the remaining
amount in FIFTH YEAR (470.00 - 394.55= 75.45)
recovered in 2 years. This means the payback period lies between 4TH
YEAR and 5th year the payback period is computed below:
32
75.45
240.17
* 100
* 100
The term average annual net earnings are the average of the earnings after
depreciation and tax. Over the whole of the economic life of the project order and
these giving on ARR above the required rate may be accepted.
33
Original investment
-----------------------2
(b)
(RS IN MILLIONS)
YEARS
Mar 2010-11
Mar 2011-12
Mar 2012-13
Mar 2013-14
Mar 2014-15
Total
47.05
133.00
76.04
79.32
221.67
557.08
TOTAL AMOUNT
NO OF YEARS
= 557.08
5
= 111.41
111.41
470.00
= 0.23* 100
= 23%
34
Average rate of return method allows the management of Bevcon wayors to fix a
minimum rate of return. So any project below the minimum rate is rejected finally the
ARR WHICH IS 30% efficient and accepted
TIME ADJUSTED (OR) DISCOUNTED CASH FLOW METHOD:
The time adjusted or discounted cash flow methods into accounts the
profitability time value of money. These methods are also called the modern methods
of capital budgeting.
1. NET PRESENT VALUE METHOD: (NPV)
Net present value method or NPV is one of the discounted cash flows
methods. The method is considered to be one of the best of evaluating the
capital investment proposals. Under this method cash inflows and outflows
associated with each project are first calculated.
Role of discounting factor:
The cash inflows and out flows are converted to the present values using
discounting factor which is the actuary discount factor of Bevcon wayors is
9%
The rate of return is considered as cut off rate or required rate or
rate generally determined on the basis of cost of capital to allow for the risk
element involved in the project.
STEPS FOR CALCULATION OF NPV:
1) Calculation of each cash flows after taxes of three years, which is arrived
at by deducting depreciation, interest and tax from earnings
Before tax and interest (EBIT). This residue is profit after tax to arrive at
Cash flow after tax.
2) This cash flow after tax are multiplied with the values obtained from the
Table (the present value annuity table against the 8% actuary discount
Rate i.e. in the case of project.
3) NPV is derived by deducting the sum of present values from the initial
Investment.
35
4) Initial investments are the sum of cash flows of three years shown in
Capital expenditure table i.e.
NPV AT 9%
STATEMENT SHOWING CALCULATION OF NPV (RS IN MN)
.
Serial no
YEARS
CFATS
PVIF AT 9%
PV` S
2010-11
58.33
0.917
53.48
2011-12
145.80
0.841
122.61
2012-13
92.92
0.772
71.73
2013-14
97.49
0.708
69.02
2014-15
240.17
0.649
155.87
Total
472.71
470.00
Npv
2.71
Accept reject criterion: The accept reject decision of NPV is very simple. If
the NPV is positive the project should be accepted and if NPV is negative the
project should be accepted and if NPV is negative the project should be
rejected NPV > 0
(ACCEPT)NPV < 0
(REJECT)
Hence in the case of Bevcon wayors the project is npv is positive so the project can be
accepted.
Internal rate of return is that rate of return at which the sum of discounted cash
inflows equals to the sum of discounted cash outflows.
In this method the discount rate is not known but the cash inflows or outflows are
known.
Step 1:
Calculate cash flow after tax.
Step 2: Calculate fake payback period.
Step 3: Look for the factor in the present value annuity table in the years column until
you arrive at the figure closest to fake payback period.
Step 4: Note the corresponding percentage.
Step 5: Calculate npv at that percentage.
Step 6: If npv is positive take a rate higher and calculate npv.
Step 7: Continue step 5 until you arrive at two rates one giving positive and other
negative npv.
Step 8:
Actual irr can be calculated as
Lower rate + present value at lower rate- cash outflows
* diff rate
Present value at lower rate-present value higher rate
FORMULATION OF STEPS:
STEP 1: Calculation of cash flows after taxes
YEARS
2010-11
58.33
2011-12
145.81
2012-13
92.92
2013-14
97.49
2014-15
240.17
TOTAL
634.72
Average CFATS =
Total amount
---------------------No of years
37
634.72
= ------------------5
= 126.94
470.00
126.94
3.7025
(Rs mill)
YEARS
CFATS
PVIF @ 28%
PVS
2010-11
58.33
0.781
45.55
2011-12
145.81
0.610
2012-13
92.92
0.476
44.22
2013-14
97.49
0..372
36.26
2014-15
240.17
0.291
69.88
Total
284.85
Intial investment
470.00
NPV
-185.15
88.94
CFATS
PVIF @ 28%
PVS
2010-11
58.33
0.757
44.15
2011-12
145.80
0573
83.54
2012-13
92.92
0.434
40.32
2013-14
97.49
0.329
32.07
38
2014-15
240.17
0.249
59.80
TOTAL
259.88
Less initial
470.00
investment
NPV
-210.12
NPV IS NEGATIVE
ANNUITY LIES BETWEEN 28% AND 32%
Net present value of lower rate
IRR = Lower rate + ------------------------------------- x Difference in rates
Difference in present value Cash inflows.
=
28+
28+
284.85- 470.00
284.85- 210.12
185.15/ 74.73
( 32-28)
X4
IRR = 38%
Profitability index
CFATS
58.33
145.80
92.92
97.49
240.17
Total
PVIF @ 9%
0.917
0841
0.772
0.708
0.649
PVS
53.48
122.61
71.73
69.02
155.87
472.71
472.71
= -----------------470.00
Profitability index = 1year
= 1.00
ACCEPT-REJECT CRITERION:
There is a slight difference between present value index method and
profitability index method. Under profitability index method the present value of cash
inflows and cash outflows are taken as accept-reject decision.
I.e. the accept reject criterion is:
If Profitability Index
> 1 (ACCEPT).
Profitability Index
< 1 (REJECT).
40
Questionnaire Analysis
1. When deciding on an investment opportunity, risk consideration is always
vital?
A
B
C
Particulars
Yes
No
Not sure
Total
No. of respondents
45
3
2
50
Interpretation:
41
A
B
C
Particulars
Yes
No
Not sure
Total
No. of respondents
13
34
3
50
Interpretation:
The other reasons for choosing option A is we can also know profit/loss
occurred by the company in the particular financial year.
42
Particulars
Yes
No
Not sure
Total
A
B
C
No. of respondents
12
18
21
50
Interpretation:
The capital budgeting data given in the statement should be rearranged or re-organized because as it is one of the procedure for
preparing the financial statement.
The question here is confused so that many of them chose to option C.
43
4. Is implementation and control to achieve the target is always the way the
think tanks has thought of in the first place?
Particulars
Yes
No
Not sure
Total
A
B
C
No. of respondents
15
14
21
50
Interpretation:
44
5. For your firm an average rate of returns and simple payback method
effectively deal with the opportunity cost concept associated with investment
decision.
Particulars
Yes
No
Not sure
Total
A
B
C
No. of respondents
18
12
20
50
Interpretation:
The above payback method says that the capital budgeting is a formal
process to know the risk and profitability of the company.
45
The graph clearly indicates that the employees have clear information
an average rate of returns and simple payback method effectively deal
with the opportunity cost concept associated with investment decision.
6. For time bounded projects and from execution point of view NPV technique
for estimating capital budgeting is more significant in nature.
Particulars
Yes
No
Not sure
Total
A
B
C
No. of respondents
14
15
21
50
Interpretation:
A
B
C
Particulars
Yes
No
Not sure
Total
Interpretation:
47
No. of respondents
32
11
7
50
The employees are satisfied with the information they received from the
concept of NPV focuses on opportunity cost and helping to take risk in
accountant thereby covers uncertainty f cash flows in better way.
The above data shows that most of them have chosen the option A
which is the absolute answer for the question.
A
B
C
Particulars
Yes
No
Not sure
Total
Interpretation:
48
No. of respondents
29
10
11
50
From the data we can observe that 29 of them have answered YES
which is majority for this question.
The information from the above the employees are satisfied with their
firm use Net Present Value (NPV) technique.
9. While using NPV technique do you conduct sensitivity and simulation test
in order to develop an understanding about both reward and challenges
entailing from the uncertainties of variables to the investment?
A
B
C
Particulars
Yes
No
Not sure
Total
49
No. of respondents
12
18
20
50
Interpretation:
The employees are able to find the using NPV technique do you
conduct sensitivity and simulation test in order to develop an
understanding about both reward and challenges entailing from the
uncertainties of variables to the investment
The obtained analysis here shows mean of the three options.
10. Has rewards been beneficial and shown to have increase in value due to
helpful and encouraging movement in the concerned variables?
A
B
C
Particulars
Yes
No
Not sure
Total
50
No. of respondents
12
23
15
50
Interpretation:
The information suggests that the employees get the rewards been
beneficial and shown to have increase in value due to helpful and
encouraging movement in the concerned variables.
The above analysis shows that the most of them have chosen the option
B which the absolute response for it.
11 .Has challenges evolved from balancing the possibility for such benefits and
gains against the odds of losses arising out of adverse or opposite movement in
the variables concerned?
A
B
C
Particulars
Agree
Disagree
Not satisfied
Total
51
No. of respondents
20
14
16
50
Interpretation:
The employees are clear about the challenges evolved from
balancing the possibility for such benefits and gains against the odds of losses
arising out of adverse or opposite movement in the variables concerned.
A
B
C
Particulars
Agree
Disagree
Not satisfied
Total
52
No. of respondents
16
23
11
50
Interpretation:
The above graph clearly suggest that employees-2 and emplooyes-3 are
not satisfied with the need for the Fluctuations of any kind or quantity
have always had destabilizing effects on investment strategies and
performance on your firm.
13. Is your firm familiar with Simulation analysis (appraises and evaluates the
future cash flow and returns on investments when more than one uncertain
element is involved).
A
B
C
Particulars
Agree
Disagree
Not satisfied
Total
53
No. of respondents
23
16
11
50
Interpretation:
The analysis here shows the correct response that the respondents are
agreed with the question.
14. In the capital budgeting simulation major goals are always to increase
market value of the investment by keeping pace with innovations and
technology?
A
B
C
Particulars
Agree
Disagree
Not satisfied
Total
54
No. of respondents
14
20
16
50
Interpretation:
15.Do you think that simulation analysis is more realistic than any other anal
ysis because it allows and introduces uncertainty for many variables to be
considered?
A
B
C
Particulars
Agree
Disagree
Not satisfied
Total
55
No. of respondents
16
17
17
50
Interpretation:
16. Do you think that rationality and adequate discount rate helps in handling
the risk?
A
B
C
Particulars
Agree
Disagree
Not satisfied
Total
56
No. of respondents
36
12
2
50
Interpretation:
The information suggests that the employees get rationality and adequate discount rate
helps in handling the risk.
A
B
C
Particulars
Agree
Disagree
Not satisfied
Total
57
No. of respondents
9
33
8
50
Interpretation:
The information above depicts that the employees-1 are not recognized for
their help of profitability index to determine which of the project will
provide highest value per rupees of investment.
18. Do you think that investment decisions should be made only on the outcome
of profitability?
A
B
C
Particulars
Agree
Disagree
Not satisfied
Total
58
No. of respondents
13
11
26
50
Interpretation:
The employees are clear about the challenges investment decisions should be made
only on the outcome of profitability
The question here is not agreeable because it does not show different level
of assets of the company.
19. By sound forecasting techniques your firm may predict the ways to
negotiate the risk involved in capital budgeting?
A
B
C
Particulars
Agree
Disagree
Not satisfied
Total
Interpretation:
59
No. of respondents
15
23
12
50
The graph clearly says that sound forecasting techniques your firm may
predict the ways to negotiate the risk involved in capital budgeting.
20. Do you think that to avoid mistakes, it is important that a decisionmaker identify the risks and devise ways to mitigate those risks?
A
B
C
Particulars
Agree
Disagree
Not satisfied
Total
Interpretation:
60
No. of respondents
29
11
10
50
CHAPTER V
FINDINGS
&
SUGGESTIONS
61
FINDINGS
1.
It is observed that company is able to increase the profits from year to year
continuously.
2. Even the gross profits from the year 2010-2015 were consistently in increasing
mode.
3. It is observed that net worth of the company is considerably in good mode.
4. By source and application of funds it is known that the company is increasing
its operations.
5. The sound forecasting techniques your firm may predict the ways to negotiate
the risk involved in capital budgeting
6. The employees deciding on an investment opportunity, risk consideration is
always vital.
7. The capital budgeting data given in the statement should be re-arranged or reorganized because as it is one of the procedure for preparing the financial
statement.
8. The employees in all he division of the company interact with each is
implementation and control to achieve the target is always the way the think
tanks has thought of in first place.
9. The information from the above the employees are satisfied with their time
bounded projects and from execution point of view NPV technique for
estimating capital budgeting is more significant in nature.
10. The employees are able to find the using NPV technique do you conduct
sensitivity and simulation test in order to develop an understanding about both
reward and challenges entailing from the uncertainties of variables to the
investment.
SUGGESTIONS
62
1. Various developments are taking place in the chemical industry so to pace with
the technological developments the company has to develop the full fledged
research department.
2. Company need to control operating expenses which may affect the
profitability of the firm.
3. Management need to tap the opportunities in the industry which enhance the
growth of the company.
4. In respect of service activities the system of recording of receipts and issues
and delivery of items were considerable and need to be much effective.
5. In some cases, several zero NPV discount rates may exist, so there is no
unique IRR
6. Despite a strong academic preference for NPV, surveys indicate that
executives prefer IRR over NPV although they should be used in concert
7. Capital budgeting investments and projects must be funded through excess
cash provided through the raising of debt capital, equity capital, or the use of
retained earnings
8. As large sum of money is involved which influences the profitability of the
firm making capital budgeting an important task.
9. Long term investment once made can not be reversed without significance loss
of invested capital.
10. The investment becomes sunk, and mistakes, rather than being readily
rectified, must often be borne until the firm can be withdrawn through
depreciation charges or liquidation. It influences the whole conduct of the
business for the years to come.
11. Investment decision are the base on which the profit will be earned and
probably measured through the return on the capital. A proper mix of capital
investment is quite important to ensure adequate rate of return on investment,
calling for the need of capital budgeting.
63
ABBREVIATIONS
PI
Profitability index.
CB
Capital budgeting
CFS
Cash flows.
CCFS
EAT
EBIT
CFAT
PVS
PVIF
PBP
ARR
NPV
IRR
B/C
Bibliography
Reference Text Books
Prasanna Chandra, 2006, Financial Management Theory and Practice,
6th Edition, Tata McGraw Hill.
I.M. Pandey : Financial Management, Vikas Publishers.
Brigham, E.F. and Ehrhardt.M.C., 2006, Financial Management Theory and
Practice, 10th Edition, Thomson South-Western.
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