Capital Budgeting
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CHAPTER –I INTRODUCTION 1
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Transcript of Capital Budgeting
CHAPTER –I
INTRODUCTION
1
INTRODUCTION
Meaning:
Capital Budgeting decisions pertaining to fixed /long term assets which by
definition refer to assets which are in operation, and yield a return, over a period of time,
usually exceeding one year. They, therefore involve a series of outlays of cash resources in
return for anticipated flow of future benefits.
Importance:
Capital budgeting also has a bearing on the competitive position of the enterprise
mainly because of the fact that they relate to fixed asset. The fixed asset represents a true
earning asset of the firm. They enable the firm to generate finished goods that can be
ultimately being sold for profits.
The Capital Expenditure decision has its effects over a long time span and
inevitable affects the company’s future cost structure.
The Capital investment decision once made are not easily reversible without much
financial loss to the firm because their may be no market for second-of –hand plant and
equipment and their conversion to other uses may most financially viable.
Capital investment involves cost and the majority of the firms have search capital
resources.
2
SCOPE OF THE STUDY :
The efficient allocation of capital is the most important financial function in
the modern times. It involves decision to commit the firm’s, since they stand the long-
term assets such decision are of considerable importance to the firm since they send to
determine its value and size by influencing its growth, probability and growth.
The scope of the study is limited to collecting the financial data of KESORAM
CEMENTS for four years and budgeted figures of each year.
NEED AND IMPORTANCE:
Capital Budgeting means planning for capital assets. Capital Budgeting decisions are
vital to an organization as to include the decision as to:
Whether or not funds should be invested in long term projects such as settings
of an industry, purchase of plant and machinery etc.,
Analyze the proposals for expansion or creating additions capacities.
To decide the replacement of permanent assets such as building and
equipments.
To make financial analysis of various proposals regarding capital investment so
as to choose the best out of many alternative proposals.
OBJECTIVES OF THE STUDY:
The study on “capital budgeting in Kesoram Limited – A case study” is based on
the following objectives.
1. To evaluate the capital budgeting practices relating to various projects of Kesoram
Limited Hyderabad
2. To Asses the long term requirements of funds and plan for application of internal
resources and debt servicing.
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3. To Assess the effectiveness of long term investment decisions of Kesoram
4. To offer conclusion derived from the study and give suitable suggestions for the
efficient utilization of capital expenditure decisions.
METHODOLOGY:
At each point of time a business firm has a number of proposals regarding various
projects in which, it can invest funds. But the funds available with the firm are always
limited and are not possible to invest trend in the entire proposal at a time. Hence it is very
essential to select from amongst the various competing proposals, those that gives the
highest benefits. The crux of capital budgeting is the allocation of available resources to
various proposals. There are many considerations, economic as well as non-economic,
which influence the capital budgeting decision in the profitability of the prospective
investment.
Yet the right involved in the proposals cannot be ignored, profitability and risk are directly
related, i.e. higher profitability the greater the risk and vice versa there are several methods
for evaluating and ranking the capital investment proposals.
.
LIMITAIONS OF THE STUDY:
1. The study is limited to Kesoram Limited only.
2. The study is limited to certain projects of Kesoram only.
3. Period of the study is restricted to five years only.
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CHAPTER – II
INDUSTRY PRIFILE
5
INDUSTRY PROFILE
In the most general sense of the word, a cement is a binder, a
substance which sets and hardens independently, and can bind other materials together.
The word "cement" traces to the Romans, who used the term "opus caementicium" to
describe masonry which resembled concrete and was made from crushed rock with burnt
lime as binder. The volcanic ash and pulverized brick additives which were added to the
burnt lime to obtain a hydraulic binder were later referred to as cementum, cimentum,
cäment and cement. Cements used in construction are characterized as hydraulic or non-
hydraulic.
The most important use of cement is the production of mortar and concrete—the bonding
of natural or artificial aggregates to form a strong building material which is durable in the
face of normal environmental effects.
Concrete should not be confused with cement because the term cement refers only to the
dry powder substance used to bind the aggregate materials of concrete. Upon the addition
of water and/or additives the cement mixture is referred to as concrete, especially if
aggregates have been added.
It is uncertain where it was first discovered that a combination of hydrated non-hydraulic
lime and a pozzolan produces a hydraulic mixture (see also: Pozzolanic reaction), but
concrete made from such mixtures was first used on a large scale by Roman
engineers.They used both natural pozzolans (trass or pumice) and artificial pozzolans
(ground brick or pottery) in these concretes. Many excellent examples of structures made
from these concretes are still standing, notably the huge monolithic dome of the Pantheon
in Rome and the massive Baths of Caracalla. The vast system of Roman aqueducts also
made extensive use of hydraulic cement. The use of structural concrete disappeared in
medieval Europe, although weak pozzolanic concretes continued to be used as a core fill in
stone walls and columns.
Modern cement
Modern hydraulic cements began to be developed from the start of the Industrial
Revolution (around 1800), driven by three main needs:
Hydraulic renders for finishing brick buildings in wet climates
Hydraulic mortars for masonry construction of harbor works etc, in contact with sea water.
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Development of strong concretes.
In Britain particularly, good quality building stone became ever more expensive during a
period of rapid growth, and it became a common practice to construct prestige buildings
from the new industrial bricks, and to finish them with a stucco to imitate stone. Hydraulic
limes were favored for this, but the need for a fast set time encouraged the development of
new cements. Most famous was Parker's "Roman cement." This was developed by James
Parker in the 1780s, and finally patented in 1796. It was, in fact, nothing like any material
used by the Romans, but was a "Natural cement" made by burning septaria - nodules that
are found in certain clay deposits, and that contain both clay minerals and calcium
carbonate. The burnt nodules were ground to a fine powder. This product, made into a
mortar with sand, set in 5–15 minutes. The success of "Roman Cement" led other
manufacturers to develop rival products by burning artificial mixtures of clay and chalk.
John Smeaton made an important contribution to the development of cements when he was
planning the construction of the third Eddystone Lighthouse (1755-9) in the English
Channel. He needed a hydraulic mortar that would set and develop some strength in the
twelve hour period between successive high tides. He performed an exhaustive market
research on the available hydraulic limes, visiting their production sites, and noted that the
"hydraulicity" of the lime was directly related to the clay content of the limestone from
which it was made. Smeaton was a civil engineer by profession, and took the idea no
further. Apparently unaware of Smeaton's work, the same principle was identified by
Louis Vicat in the first decade of the nineteenth century. Vicat went on to devise a method
of combining chalk and clay into an intimate mixture, and, burning this, produced an
"artificial cement" in 1817. James Frost,orking in Britain, produced what he called "British
cement" in a similar manner around the same time, but did not obtain a patent until 1822.
In 1824, Joseph Aspdin patented a similar material, which he called Portland cement,
because the render made from it was in color similar to the prestigious Portland stone.
All the above products could not compete with lime/pozzolan concretes because of fast-
setting (giving insufficient time for placement) and low early strengths (requiring a delay
of many weeks before formwork could be removed). Hydraulic limes, "natural" cements
and "artificial" cements all rely upon their belite content for strength development. Belite
develops strength slowly. Because they were burned at temperatures below 1250 °C, they
contained no alite, which is responsible for early strength in modern cements. The first
cement to consistently contain alite was made by Joseph Aspdin's son William in the early
1840s. This was what we call today "modern" Portland cement. Because of the air of
mystery with which William Aspdin surrounded his product, others (e.g. Vicat and I C
7
Johnson) have claimed precedence in this invention, but recent analysis of both his
concrete and raw cement have shown that William Aspdin's product made at Northfleet,
Kent was a true alite-based cement. However, Aspdin's methods were "rule-of-thumb":
Vicat is responsible for establishing the chemical basis of these cements, and Johnson
established the importance of sintering the mix in the kiln.
William Aspdin's innovation was counter-intuitive for manufacturers of "artificial
cements", because they required more lime in the mix (a problem for his father), because
they required a much higher kiln temperature (and therefore more fuel) and because the
resulting clinker was very hard and rapidly wore down the millstones which were the only
available grinding technology of the time. Manufacturing costs were therefore
considerably higher, but the product set reasonably slowly and developed strength quickly,
thus opening up a market for use in concrete. The use of concrete in construction grew
rapidly from 1850 onwards, and was soon the dominant use for cements. Thus Portland
cement began its predominant role. it is made from water and sand
Types of modern cement
Portland cement
Cement is made by heating limestone (calcium carbonate), with small quantities of other
materials (such as clay) to 1450°C in a kiln, in a process known as calcination, whereby a
molecule of carbon dioxide is liberated from the calcium carbonate to form calcium oxide,
or lime, which is then blended with the other materials that have been included in the mix .
The resulting hard substance, called 'clinker', is then ground with a small amount of
gypsum into a powder to make 'Ordinary Portland Cement', the most commonly used type
of cement (often referred to as OPC).
Portland cement is a basic ingredient of concrete, mortar and most non-speciality grout.
The most common use for Portland cement is in the production of concrete. Concrete is a
composite material consisting of aggregate (gravel and sand), cement, and water. As a
construction material, concrete can be cast in almost any shape desired, and once
hardened, can become a structural (load bearing) element. Portland cement may be gray or
white.
Portland cement blends
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These are often available as inter-ground mixtures from cement manufacturers, but similar
formulations are often also mixed from the ground components at the concrete mixing
plant.
Portland blastfurnace cement contains up to 70% ground granulated blast furnace slag,
with the rest Portland clinker and a little gypsum. All compositions produce high ultimate
strength, but as slag content is increased, early strength is reduced, while sulfate resistance
increases and heat evolution diminishes. Used as an economic alternative to Portland
sulfate-resisting and low-heat cements.
Portland flyash cement contains up to 30% fly ash. The fly ash is pozzolanic, so that
ultimate strength is maintained. Because fly ash addition allows a lower concrete water
content, early strength can also be maintained. Where good quality cheap fly ash is
available, this can be an economic alternative to ordinary Portland cement.
Portland pozzolan cement includes fly ash cement, since fly ash is a pozzolan, but also
includes cements made from other natural or artificial pozzolans. In countries where
volcanic ashes are available (e.g. Italy, Chile, Mexico, the Philippines) these cements are
often the most common form in use.
Portland silica fume cement. Addition of silica fume can yield exceptionally high
strengths, and cements containing 5-20% silica fume are occasionally produced. However,
silica fume is more usually added to Portland cement at the concrete mixer.
Masonry cements are used for preparing bricklaying mortars and stuccos, and must not be
used in concrete. They are usually complex proprietary formulations containing Portland
clinker and a number of other ingredients that may include limestone, hydrated lime, air
entrainers, retarders, waterproofers and coloring agents. They are formulated to yield
workable mortars that allow rapid and consistent masonry work. Subtle variations of
Masonry cement in the US are Plastic Cements and Stucco Cements. These are designed to
produce controlled bond with masonry blocks.
Expansive cements contain, in addition to Portland clinker, expansive clinkers (usually
sulfoaluminate clinkers), and are designed to offset the effects of drying shrinkage that is
normally encountered with hydraulic cements. This allows large floor slabs (up to 60 m
square) to be prepared without contraction joints.
White blended cements may be made using white clinker and white supplementary
materials such as high-purity metakaolin.
Colored cements are used for decorative purposes. In some standards, the addition of
pigments to produce "colored Portland cement" is allowed. In other standards (e.g.
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ASTM), pigments are not allowed constituents of Portland cement, and colored cements
are sold as "blended hydraulic cements".
Very finely ground cements are made from mixtures of cement with sand or with slag or
other pozzolan type minerals which are extremely finely ground together. Such cements
can have the same physical characteristics as normal cement but with 50% less cement
particularly due to their increased surface area for the chemical reaction. Even with
intensive grinding they can use up to 50% less energy to fabricate than ordinary Portland
cements.
Non-Portland hydraulic cements
Pozzolan-lime cements. Mixtures of ground pozzolan and lime are the cements used by
the Romans, and are to be found in Roman structures still standing (e.g. the Pantheon in
Rome). They develop strength slowly, but their ultimate strength can be very high. The
hydration products that produce strength are essentially the same as those produced by
Portland cement.
Slag-lime cements. Ground granulated blast furnace slag is not hydraulic on its own, but
is "activated" by addition of alkalis, most economically using lime. They are similar to
pozzolan lime cements in their properties. Only granulated slag (i.e. water-quenched,
glassy slag) is effective as a cement component.
Supersulfated cements. These contain about 80% ground granulated blast furnace slag,
15% gypsum or anhydrite and a little Portland clinker or lime as an activator. They
produce strength by formation of ettringite, with strength growth similar to a slow Portland
cement. They exhibit good resistance to aggressive agents, including sulfate.
Calcium aluminate cements are hydraulic cements made primarily from limestone and
bauxite. The active ingredients are monocalcium aluminate CaAl2O4 (CaO · Al2O3 or CA
in Cement chemist notation, CCN) and mayenite Ca12Al14O33 (12 CaO · 7 Al2O3 , or C12A7
in CCN). Strength forms by hydration to calcium aluminate hydrates. They are well-
adapted for use in refractory (high-temperature resistant) concretes, e.g. for furnace
linings.
Calcium sulfoaluminate cements are made from clinkers that include ye'elimite
(Ca4(AlO2)6SO4 or C4A3 in Cement chemist's notation) as a primary phase. They are used
in expansive cements, in ultra-high early strength cements, and in "low-energy" cements.
Hydration produces ettringite, and specialized physical properties (such as expansion or
rapid reaction) are obtained by adjustment of the availability of calcium and sulfate ions.
Their use as a low-energy alternative to Portland cement has been pioneered in China,
10
where several million tonnes per year are produced. Energy requirements are lower
because of the lower kiln temperatures required for reaction, and the lower amount of
limestone (which must be endothermically decarbonated) in the mix. In addition, the lower
limestone content and lower fuel consumption leads to a CO2 emission around half that
associated with Portland clinker. However, SO2 emissions are usually significantly higher.
"Natural" Cements correspond to certain cements of the pre-Portland era, produced by
burning argillaceous limestones at moderate temperatures. The level of clay components in
the limestone (around 30-35%) is such that large amounts of belite (the low-early strength,
high-late strength mineral in Portland cement) are formed without the formation of
excessive amounts of free lime. As with any natural material, such cements have highly
variable properties.
Geopolymer cements are made from mixtures of water-soluble alkali metal silicates and
aluminosilicate mineral powders such as fly ash and metakaolin.
11
COMPANY PROFILE
COMPANY PROFILE
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Kesoram Cement Industry is one of the leading manufactures of cement in India. It is a
day process cement Plant. The plant capacity is 8.26 lakh tones per annum It is located at
Basanthnagar in Karimnagar district of Andhra Pradesh. Basanthnagar is 8 km away from
the Ramagundram Railway station, linking Madras to New Delhi. The Chairman of the
Company is syt. B.K.Birla,
HISTORY :
The first unit at Basanthnagar with a capacity of 2.1 lakh tones per annum
incorporating humble suspension preheated system was commissioner during the year
1969. The second unit was setup in year 1971 with a capacity of 2.1 lakh tones per annum
went on stream in the year 1978. The coal for this company is being supplied from
Singereni Colleries and the power is obtained from APSEB. The power demand for the
factory is about 21 MW. Kesoram has got 2 DG sets of 4 MW each installed in the year
1987.
Kesoram Cement has setup a 15 KW captor power plant to facilitate for
uninterrupted power supply for manufacturing of cement at 24th august 1997 per hour 12
mw, actual power is 15 mw.
The Company was incorporated on 18th October, 1919 under the Indian Companies Act,
1913, in the name and style of Kesoram Cotton Mills Ltd. It had a Textile Mill at 42,
Garden Reach Road, Calcutta 700 024. The name of the Company was changed to
Kesoram Industries & Cotton Mills Ltd. on 30th
August, 1961 and the same was further changed to Kesoram Industries Limited on 9th
July, 1986. The said Textile Mill at Garden Reach Road was eventually demerged into a
separate company.
The First Plant for manufacturing of rayon yarn was established at Tribeni, District
Hooghly, West Bengal and the same was commissioned in December, 1959 and the
second plant was commissioned in the year 1962 enabling it to manufacture 4,635 metric
tons per annum (mtpa) of rayon yarn. This Unit has 6,500 metric tons per annum (mtpa)
capacity as on 31.3.2009.
The plant for manufacturing of transparent paper was also set up at the same location at
Tribeni, District Hooghly, West Bengal, in June, 1961. It has the annual capacity to
manufacture 3,600 metric tons per annum (mtpa) of transparent Paper.
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The Company diversified into manufacturing of cast iron spun pipes and pipe fittings at
Bansberia, District Hooghly, West Bengal, with a production capacity of 45,000 metric
tons per annum (mtpa) of cast iron spun pipes and pipe fittings in December, 1964.
The Company subsequently diversified into the manufacturing of Cement and in 1969
established its first cement plant under the name 'Kesoram Cement' at Basantnagar, Dist.
Karimnagar (Andhra Pradesh) and to take advantage of favourable market conditions, in
1986 another cement plant, known as 'Vasavadatta Cement', was commissioned by it at
Sedam, Dist.
Gulbarga (Karnataka). The cement manufacturing capacities at both the plants were
augmented from time to time according to the market conditions and as on 31.3.2009
Kesoram Cement and Vasavadatta Cement have annual cement manufacturing capacities
of 1.5 million metric tons and 4.1 million metric tons respectively.
The Company in March 1992, commissioned a plant at Balasore known as Birla Tyres in
Orissa, for manufacturing of 10 lac MT p.a. automotive tyres and tubes in the first phase in
collaboration with Pirelli Ltd., U.K., a subsidiary company of the world famous Pirelli
Group of Italy - a pioneer in production and development of automotive tyres in the world.
The capacity at the said plant was further augmented during the year by 19 MT per day
aggregating to 271 MT per day production facility. The Greenfield Project of 257 MT per
day capacity in the State of Uttarakhand with a capex of about Rs.760 crores commenced
the commercial production in phases during the financial year 2008-09.The Company as
on 31.3.2009 had the manufacturing capacities of 3.71 million tyres, 2.95 million tubes
and 1.53 million flaps per annum in the Plants including at Uttarakhand Plant.
It has small manufacturing capacities of various Chemicals at Kharda in the State of West
Bengal also. It has the annual manufacturing capacities of 12,410 mtpa of Caustic Soda
Lye, 5,045 mtpa of Liquid Chlorine, 6,205 mtpa of Sodium Hypochlorite, 8,200 mtpa of
Hydrochloric Acid, 3,200 mtpa of Ferric Alum, 18,700 mtpa of Sulphuric Acid and
1,620,000 m3pa of purified Hydrogen Gas.
The Company is a well-diversified entity in the fields of Cement, Tyre, Rayon Yarn,
Transparent Paper, Spun Pipes and Heavy Chemicals with two core business segments i.e.
Cement and Tyres.
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In Spun Pipes & Foundries, a unit of the Company, work suspended from 2nd May, 2008
still commences till further notice.
The Company as of now is listed on three major Stock Exchanges in India i.e. Bombay
Stock Exchange Ltd., Mumbai, Calcutta Stock Exchange Association Ltd., Kolkata and
National Stock Exchange of India Ltd., Mumbai and at the Societe de la Bourse de
Luxembourg, Luxembourg.
A further expansion upto 1.65 million tons of cement per annum in Vasavadatta Cement at
Sedam in Karnataka as unit IV at the same site is in progress, with a 17.5 MW Captive
Power Plant, involving a capital expenditure of about Rs. 783.50 crores (including the cost
of Captive Power Plant).
The commercial production of cement in the aforesaid unit IV has commenced in June
2009.
The work for the further expansion in the Tyres Section at Uttarakhand for radial tyres
with 100 MT per day capacity and bias tyres with 125 MT per day capacity involving an
estimated aggregate capital outlay of about Rs. 840 crores is under progress. The Board
has further approved a Motor Cycle Tyre Project of 70 MT per day capacity at the same
site involving a capital outlay of Rs.190 crore. The civil construction of both the Projects
is in full swing. The commercial production in both the Projects is likely to start by
December 2009/ January 2010.
Birla Supreme in popular brand of Kesoram cement from its prestigious plant of
Basantnagar in AP which has outstanding track record. In performance and productivity
serving the nation for the last two and half decades. It has proved its distinction by bagging
several national awards. It also has the distinction of achieving optimum capacity
utilization.
Kesoram offers a choice of top quality portioned cement for light, heavy
constructions and allied applications. Quality is built every fact of the operations.
The plant lay out is rational to begin with. The limestone is rich in calcium
carbonate a key factor that influence the quality of final product. The day process
technology uses in the latest computerized monitoring overseas the manufacturing process.
Samples are sent regularly to the bureau of Indian standards. National council of
construction and building material for certification of derived quality norms.
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The company has vigorously undertaking different promotional measures for
promoting their product through different media, which includes the use of news papers
magazine, hoarding etc.
Kesoram cement industry distinguished itself among all the cement factories in
Indian by bagging the National Productivity Award consecutively for two years i.e. for the
year 1985-1987. The federation of Andhra Pradesh Chamber & Commerce and Industries
(FAPCCI) also conferred on Kesoram Cement. An award for the best industrial promotion
expansion efforts in the state for the year 1984. Kesoram also bagged FAPCCI awarded
for “Best Family Planning Effort in the state” for the year 1987-1988.
One among the industrial giants in the country today, serving the nation on the
industrial front. Kesoram industry ltd., has a checked and eventful history dating back to
the twenties when the Industrial House of Birlas acquired it. With only a textile mill under
its banner 1924, it grew from strength to strength and spread its activities to newer fields
like Rayon, Transparent paper, pipes, Refractors, tyres and other products.
Looking to the wide gap between the demand and supply of a vital commodity
cement, which play in important role in National building activity the Government of India
had de-licensed the cement industry in the year 1966 with a review to attract private
entrepreneur to augment the cement production. Kesoram rose to the occasions and
divided to set up a few cement plants in the country.
Kesoram cement undertaking marketing activities extensively in the state of
Andhra Pradesh, Karnataka, Tamilnadu, Kerala, Maharashtra and Gujarat. In A.P. sales
Depts., are located in different areas like Karimnagar, Warangal, Nizamabad, Vijayawada
and Nellore. In other states it has opened around 10 depots.
The market share of Kesoram Cement in AP is 7.05%. The market share of the
company in various states is shown as under.
STATES MARKET SHARE
Karnataka 4.09%
Tamilnadu 0.94%
Kerala 0.29%
Maharashtra 2.81%
Process and Quality Control :
It has been the endeavor of Kesoram to incorporate the World’s latest technology
in the plant and today the plant has the most sophisticated.
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X-ray analysis :
Fully computerized XRF and XRD X-RAY Analysers keep a constant round the
clock vigil on quality.
Supreme performance :
One of the largest Cement Plants in Andhra Pradesh, the plant in corporate the
latest technology in Cement - making.
It is professionally managed and well established Cement Manufacturing Company
enjoying the confidence of the consumers. Kesoram has outstanding track record in
performance and productivity with quite a few national and state awards to its credit.
BIRLA SUPREME, the 43 Grade Cement, is a widely accepted and popular brand
in the market, commanding a premium.
However to meet the specific demands of the consumer, Kesoram bought out the
53 grade BIRLA SUPREME – GOLD, which has special qualities like higher fineness,
quick-setting, high compressive strength and durability.
Supreme Strength :
Kesoram Cement has huge captive Limestone Deposits, which make it possible to
feed high- grade limestone consistently, Its natural Grey colour is anion- born ingredient
and gives good shade.
Both the products offered by Kesoram, i.e. BIRLA SUPREME-43 Grade and
BIRLA SUPREME-GOLD-53 Grade cement are outstanding with much higher
compressive strength and durability.
The following characteristics show their distinctive qualities.
17
Comprehensive
Strength
Opc 43
grls 8112
1989
Birla
Supreme 43
grade
Opc 43 gr
Is 1226987
Birla
Supreme
Gold 53 gr
3 days mpa Min. 23 31 + Min. 27 38+
7 days mpa Min. 23 42+ Min. 37 48+
28 days mpa Min. 43 50+ Min. 53 60+
D.C. SYSTEM :
Clinker making process is a key step in the overall cement making process. In the case of
BIRLA SUPREME/GOLD, the clinker-making process is totally computer. control. The
Distributed Control System (DCS) constantly monitors the process and ensures operating
efficiency. This eliminates variation and ensures consistency in the quality of Clinker.
PHYSICAL CHARACTERISTICS
Ope 43
Is 8 112-89
Birla
Supreme
43 grade
Ope 53 gr
Is 12269-87
Birla Supreme
Gold 53 gr
Setting time Min30 120-180 Min 30 130-170
a. Initial (mats) Max 600 180-240 Max 600 170-220
b. final (mats) Min 225 270-280 . Min 225 300-320
Fincncssm 2/Kg Max 10 1.0-2.0 Max 10 0.5-1.0
Soundness Max 0.8 0.04-0.08 Max 0.080. 0.04-0.2
a. le-chart (mm)
b. autoclave (%)
SUPREME EXPERTISE:
The Best Technical Team, exclusive to Kesoram, mans the Plant and monitors the
process, to blend the cement in just the required proportions, to make BIRLA
SUPREME/GOLD OF Rock Strength.
18 MILLION TONES OF SOLID FOUNDATION :
Staying at the top for over a Quarter Century, Quarter Century is no less an achievement.
Infact. Kesoram is synonymous with for over 28 years.
Over the years, Kesoram has dispatched 18 million tones of cement to the nook and
corners of the country and joined hands in strengthening the Nation. No one else in
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Andhra Pradesh has this distinction. The prestigious World Bank aided Ramagundam
Super Thermal Power Project of NTPC and Mannair Dam of Pochampad project in AP arc
a couple of projects for which Kesoram Cement was exclusively uses: to cite an example.
CHEMICAL CHARACTERISTICS :
Opc 43 gr
Is 81 132-989
Birla
Supreme
43 grade
Ope 53 gr
Is 12269-
87
Birla
Supreme
Gold 53 gr.
Loss on inflection % Max 5 <1.6 Max 4.0 <1.5
Insoluble residue % Max 2.0 <0.8 Max 2.0 < 0.6
Magnesium oxide % Max 6.0 < 1.3 Max 6.0 < 1.3
Lime saturation factor 0.66-1.02 0.8-0.9 0.8-1.02 0.88-0.9
Alumna: iron ratio MinO.66 1.5-1.7 MinO.66 1.5-1.7
Sulfuric anhydride % Max 2.5/3 1.6-2.0 Max 2. 5/3 1.6-2.0
Alkalis Chlorides Max 0.05 Max 0.01 Max 0.05 Max 0.4
Kesoram Cement - advantages :
Helps in designing sleeker and more elegant.
Structures, giving greater flexibility in design concept.
Due to its fine quality, super fine construction can be achieved.. Its gives maximum
strength at Minimum use of cement with water in the water cement ratio, especially the 53
grade Birlas supreme-gold.
Feathers in Kesoram's cap :
Kesoram has outstanding track record, achieving over 100% capacity utilization I
productivity and energy conservation. It has proved its distinction by bagging several
national and state awards, noteworthy being.
NATIONAL :
1. National productivity award for 1985-86
2. National productivity award for 1986-87
3. National award for mines safety for 1985-86
4. National award for mines safety for 1986-87
5. National award for energy conservation 1989-90
19
STATE
1. A.P. State productivity award for 1988
2. State award for best industrial management 1988-89.
3. Best industrial productivity award of FAPCCI (federation of A.P. chamber of
commerce and industry), 1991
4. Best management award of the state Govt. 1993
5. FAPCCI award for the workers welfare, 1995-96.
I.S.O. 9002
All quality systems of Kesoram have been certified under I.S.O. 9002/1.S. 4002, which
proves the worldwide acceptance of the products.
All quality systems in production and marketing of the product have been certified by
B.I.S. under ISO 9002/1S 14002.
The first unit was installed at basanthnagar with a capacity of 2.5 –lakhs TPA (tones per
annum) incorporating humble supervision, preheated system, during the year 1969.
The second unit followed suit with added a capacity of 2 lakhs TPA in 1971.
The plant was further expanded to 9 lakhs by adding 2.5 lakhs tones in august 1978, 1.13
lakhs tones in January 1981 and 0.87 lakhs tones in September 1981.
Power:
Singarein collieries make the supply of coal for this industry and the
power was obtained from AP TRANSCO. The power demand for the factory is about
21MW. Kesoram has got 2-diesel generator seats of 4 MW each installed in the year 1987.
Kesoram cement now has a 15MWcaptive power plant to facilities for
uninterrupted power supply for manufacturing of cement.
Performance:
The performance of kersoram cement industry has been
outstanding achieving over cent percent capacity utilization all through despite many odds
like power cuts and which most 40% was wasted due to wagon shortage etc.
The company being a continuous process industry works round the clock and
has excellent records of performance achieving over 1005 capacity utilization.
Kesoram has always combined technical progress with industrial
performance. The company had glorious track record for the last 27 years in the industry.
Technology:
Kesoram cement uses most modern technology and the computerized
control in the plant. A team of dedicated and well- experienced experts manages the plant.
20
The quality is maintained much above the bureau of Indian standards.
The raw materials used for manufacturing cement are:
Lime stone
Bauxite
Hematite
Gypsum
Environmental and Social Obligations:
For environmental promotion and to keep –up the ecologicalbalancae,this section
has planted over two lakhs trees .on social obligation front ,this section has undertaken
various social welfare programs by adopting ten nearly villages, organizing family
welfare campus, surgical camps, animal health camps blood donation camps, children
immunization camps, seeds, training for farmers etc were arranged.
Welfare and Recreation Facilities:
For the purpose of recreation facilities 2 auditoriums were provided for
playing indoor games, cultural function and activities like drama, music and dance etc.
The industry has provided libraries and reading rooms. About 1000
books are available in the library. All kinds of newspaper, magazines are made available.
Canteen is provided to cater to the needs of the employees for supply of snacks,
tea, coffee and meals etc.
One English medium and one Telugu medium school are provided to meet the
educational requirements.
The company has provided a dispensar with a qualified medical office and
paramedical staff for the benefit of the employees. The employees covered under ESI
scheme have to avail the medical facilities from the ESI hospital.
Competitions in sports and games are conducted ever year for august 15th
Independence Day and January 26th, republic day among the employees.
Electricity:
The power consumption per ton of cement has come down to 108 units
against 113 units last year, due to implementation of various energy saving measures. The
performance of captive power plant of this section continues to be satisfactory. Total
power generation during the year was 84 million units last year. This captive power plant
is a major role in keeping power costs with in economic levels.
The management has introduced various HRD programs for training and
development and has taken various other measures for the betterment of employee’s
efficiency.
21
The section has installed adequate air pollution control system and
equipment and is ISO14001 such as Environment management system is under
implementation.
Awards:
Kesoram cement bagged many prestigious awards including national awards for
productivity, technology, conservation and several state awards since 1984. The following
are the some of important awards.
AWARDS OF KESORAM CEMENT:
No Year Awards
National/
state
1 1989-90 Management award community
Development
State
2 1991 Energy conservation may day award of the
Govt.
State
3 1991 Pandit Jawaharlal Nehru rolling trophy for
best
State
4 1993 National productivity effort indira Gandhi
national award
State
5 1994 Best management award State
6 1994-
1995
Best industrial rebellion award State
7 1995 Rural development by chief minister
Environment and mineral conservation
award
State
8 1995 Best industrial rebellion award State
9 1995-
1996
Best effort of an industrial unit to
development rural economy shri.s.r.rungta
award for social
National
10 1996 Awareness for best rural development State
22
efforts
11 1999 Best workers welfare best family welfare
award
State
12 2001 First prize for mine environment &pollution
control for the 3rd year in succession
State
13 2002 Vana mithra award from AP Govt State
14 2003 Company has got OHSAS-18001 State
15 2005 Certification from DNV, New Delhi. State
16 2006 Award for pollution control and
environmental protection FAPCCI award
for best rural development in the state
State
Products of the organization:
23
24
CHAPTER-III
REVIEW OF LITERATURE
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Factors Affecting Capital Budgeting:
While making capital budgeting investment decision the following factors or
aspects should be considered.
The amount of investment
Minimum rate of return on investment (k)
Return expected from the investments. (R)
Ranking of the investment proposals and
Based on profitability the raking is evaluated I.e., expected rate of return on
investment.
Factors Influencing Capital Budgeting Decisions:
There are many factors, financial as well as non-financial, which influence that
Budget decisions. The crucial factor that influences the capital expenditure decisions is the
profitability of the proposal. There are other factors, which have to be in considerations
such as.
1. Urgency:
Sometimes an investment is to be made due to urgency for the survival of the firm
or to avoid heavy losses. In such circumstances, the proper evaluation of the proposal
cannot be made through profitability tests. The examples of such urgency are breakdown
of some plant and machinery, fire accident etc.
2. Degree of Certainty:
Profitability directly related to risk, higher the profits, Greater is the risk or
uncertainty. Sometimes, a project with some lower profitability may be selected due to
constant flow of income.
3. Intangible Factors:
some times a capital expenditure has to be made due to certain emotional and
intangible factors such as safety and welfare of workers, prestigious project, social
welfare, goodwill of the firm, etc.,
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4. Legal Factors.
Any investment, which is required by the provisions of the law, is solely
influenced by this factor and although the project may not be profitable yet the investment
has to be made.
5. Availability of Funds.
As the capital expenditure generally requires large funds, the availability of funds
is an important factor that influences the capital budgeting decisions. A project, how so
ever profitable, may not be taken for want of funds and a project with a lesser profitability
may be some times preferred due to lesser pay-back period for want of liquidity.
6. Future Earnings
A project may not be profitable as compared to another today but it may promise
better future earnings. In such cases it may be preferred to increase earnings.
7. Obsolescence.
There are certain projects, which have greater risk of obsolescence than others. In
case of projects with high rate of obsolescence, the project with a lesser payback period
may be preferred other than one this may have higher profitability but still longer pay-back
period.
8. Research and Development Projects.
It is necessary for the long-term survival of the business to invest in research and
development project though it may not look to be profitable investment.
9. Cost Consideration.
Cost of the capital project, cost of production, opportunity cost of capital, etc. Are
other considerations involved in the capital budgeting decisions?
RISK AND UNCERTANITY IN CAPITAL BUDGETING
All the techniques of capital budgeting require the estimation of future cash
inflows and cash outflows. The future cash inflows are estimated based on the following
factors.
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1. Expected economic life of the project.
2. Salvage value of the assets at the end of economic life.
3. Capacity of the project.
4. Selling price of the product.
5. Production cost.
6. Depreciation rate.
7. Rate of Taxation
8. Future demand of product, etc.
But due to the uncertainties about the future, the estimates of demand, production,
sales, selling prices, etc. cannot be exact. For example, a product may become obsolete
much earlier than anticipated due to unexpected technological developments. All these
elements of uncertainty have to be take in to account in the form of forcible risk while
taking on investment decision. But some allowances for the elements of the risk have
to provide.
The following methods are suggested for accounting for risk in capital Budgeting.
1. Risk-Adjusted cut off rate or method of varying discount rate:
The simple method of accounting for risk in capital Budgeting is to increase the
cut-off rate or the discount factor by certain percentage on account of risk. The
projects which are more risky and which have greater variability in expected
returns should be discounted at a higher rate as compared to the projects which are
less risky and are expected to have lesser variability in returns.
The greatest drawback of this method is that it is not possible to determine
the premium rate appropriately and more over it is the future cash flow, which is
uncertain and requires adjustment and not the discount rate.
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Risk Adjusted Cut off Rate Decision Tree Analysis
Certainty Equivalent Suggestions Co-Efficient of
Method Accounting risk Variation Method
In Capital Budgeting
Sensitivity Technique Standard Deviation
Method
Profitability Technique
2. Certainty Equivalent Method:
Another simple method of accounting for risk in capital budgeting is to reduce
expected cash flows by certain amounts. It can be employed by multiplying the expected
cash in flows certain cash outflows.
3. Sensitivity Technique:
Where cash inflows are very sensitive under different circumstances, more than
one forecast of the future cash inflows may be made. These inflows may be regards as
“Optimistic”, “Most Likely”, and “Pessimistic”. Further cash inflows may be discounted
to find out the Net present values under these three different situations. If the net present
values under the three situations differ widely it implies that there is a great risk in the
project and the investor’s decision to accept or reject a project will depend upon his risk
bearing abilities.
4. Probability Technique:
A probability is the relative frequency with which an event may occur in the future.
When future estimates of cash inflows have different probabilities the expected monetary
values may be computed by multiplying cash inflow with the probability assigned. The
monetary values of the inflows may further be discounted to find out the present vales.
The project that gives higher net present vale may be accepted.
29
5. Standard Deviation Method:
If two projects have same cost and there net present values are also the same,
standard deviations of the expected cash inflows of the two projects may be calculated to
judge the comparative risk of the projects. The project having a higher standard deviation
is set to be more risky has compared to the other.
6. Coefficient of variation Method:
Coefficient of variation is a relative measure of dispersion. If the projects have the
same cost but different net present values, relative measure, I,e. coefficient of variation
should be computed to judge the relative position of risk involved. It can be calculated as
follows.
Coefficient of Variation = Standard Deviation X100
Mean
7. Decision Tree Analysis:
In modern business there are complex investment decisions which involve a
sequence of decisions over time. Such sequential decisions can be handled by plotting
decisions trees. A decision tree is a graphic representation of the relationship between a
present decision and future events, future decisions and their consequences. The sequences
of event are mapped out over time in a format resembling branches of a tree and hence the
analysis is known as decision tree analysis. The various steps involved in a decision tree
analysis are
1 Identification of the problem
2 Finding out the alternatives;
3 Exhibiting the decision tree indicating the decision points, chance events, and other
relevant date;
4 Specification of probabilities and monetary values for cash inflows;
5 Analysis of the alternatives.
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Limitations of Capital Budgeting
Capital Budgeting Techniques Suffer From the Following Limitations.
1 All the techniques of capital budgeting presume the various investment proposals
under consideration are mutually exclusive which may not practically be true in
some particular circumstances.
2. The techniques of capital budgeting require estimation of future cash inflows and
outflows. The future is always uncertain and the data collected for future may not
be exact. Obviously the results based upon wrong data may not be good.
3. There are certain factors like morale of the employees, goodwill of the firm, etc.,
which cannot be correctly quantified but which otherwise substantially influence
the capital decision.
4. Urgency is another limitation in the evaluation of capital investment decisions.
5. Uncertainty and risk pose the biggest limitation to the techniques of capital
budgeting.
STEPS INVOLVED IN THE CAPITAL EXPENDITURE
The various steps involved in the control of capital expenditure.
1. Preparation of capital expenditure.
2. Proper authorization of capital expenditure.
3. Recording and control of expenditure.
4. Evaluation of performance of the project.
OBJECTIVES OF CONTROL OF CAPITAL EXPENDITURE
In the following all the main objectives are on control of capital expenditure: To
make an estimate of capital expenditure and to see that the total cash outlay is with in the
financial resources of the enterprise.
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1. To ensure timely cash inflows for the projects so that non-availability of cash may
not be a problem in the implementation of the project.
2. To ensure all the capital expenditure is properly sanctioned.
3. To properly co-ordinate the projects of various departments.
4. To fix priorities among various projects and ensure their follow up.
5. To compare periodically actual expenditure with the budgeted ones so as to avoid
any excess expenditure.
6. To measure the performance of the project.
7. To ensure that sufficient amount of capital expenditure is incurred to keep pace
with the rapid technological developments.
8. To prevent over expansion.
CAPITAL BUDGETING PROCESS
Capital Budgeting is a complex process as it involves decisions relating to the
investment of the current funds for the benefit to the achieved in future and the future
always uncertain. However, the following procedure may be adopted in the process of
capital budgeting.
Capital Budgeting Steps:
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1. Identification of Investment Proposals:
The capital budgeting process begins with the identification of investment
proposals. The proposal or idea about potential investment opportunities may
originate from the top management or may come from the rank and file worker of any
department are from any officer of the organization. The departmental head analyses
the various proposals in the light of the corporate strategies and submits the suitable
proposals to the Capital Expenditure Planning Committee in case of large
organizations or to the officers concerned with the process of long-term investment
decisions.
2. Screening the Proposals:
The expenditure Planning Committee Screens the various proposals received from
different departments. The committee views these proposals from various angles to
ensure that these are accordance with the corporate strategies or selection criterion of
the firm and also do not lead to departmental imbalances.
3. Evaluation of Various Proposals:
The next step in the capital budgeting process is to evaluate the profitability of
proposals. There are many methods that may be used for this purpose such as Pay Back
Period methods, Rate of Return method, Net Present Value method, Internal Rate of
Return method etc. All these methods of evaluating profitability of capital investment
proposals have been discussed.
4. Fixing Priorities:
After evaluating various proposals, the unprofitable or uneconomic proposals may
be rejected straight away. But it may not be possible for the firm to invest immediately in
all the acceptable proposals due to limitation of funds. Hence it is very essential to rank the
various proposals and to establish priorities after considering urgency, risk and
profitability involved therein.
5. Final Approval and Preparation of Capital Expenditure Budget:
33
Proposals meeting the evaluation and other criteria are finally approved to be
included in the capital expenditure budget. However, proposals involving smaller
investment may be decided at the lower levels for expeditious action. The capital
expenditure budget lays down the amount of estimated expenditure to be incurred on fixed
assets during the budget period.
6. Implementing Proposal:
Preparation of capital budgeting expenditure budgeting and incorporation of a
particular proposal in the budget does not itself authorized to go ahead with the
implementation of the project. A request for the authority to spend the amount should
further to be made to the capital expenditure committee, which may like to revive the
profitability of the project in the changed circumstances.
Further, while implementing the project, it is better to assign the responsibility for
completing the project within given time frame and cost limit so as to avoid unnecessary
delays and cost over runs. Network techniques used in the project management such as
Pert and CPM can also be applied to control and monitor the implementation of the
project.
7. Performance Review.
The last stage in the process of capital budgeting is the evaluation of the
performance of the project. The evaluation is made through post completion audit
by way of comparison of actual expenditure on the project with the budgeted one,
and also by comparing the actual return from the investment with the anticipated
return. The unfavorable variances, if any should be looked into and the causes of
the same be identified so that corrective action may be taken in future.
KINDS OF CAPITAL BUDGETING DECISIONS
The overall objectives of capital budgeting are to maximize the profitability of a
firm or the return on investment. These objectives can be achieved either by increasing
revenues or by reducing costs. This, capital budgeting decisions can be broadly classified
into two categories.
1. Increase revenue.
2. Reduce costs.
34
The first category of capital budgeting decisions is expected to increase revenue of the
firm through expansion of the production capacity or size of the firm by reducing a new
product line. The second category increases the earning of the firm by reducing costs and
includes decisions relating to replacement of obsolete, outmoded or worn out assets. In
such cases, a firm has to decide whether to continue the same asset or replace it. The firm
takes such a decision by evaluating the benefit from replacement of the asset in the form
or reduction in operating costs and the cost\ cash needed for replacement of the asset.
Both categories of above decision involve investments in fixed assets but the basic
difference between the two decisions are in the fact that increasing revenue investment
decisions are subject to more uncertainty as compared to cost reducing investments
decisions.
Further, in view of the investment proposal under consideration, capital budgeting
decisions may be classified as:
1. Accept Reject Decision:
Accept reject decisions relate independent projects do not compute with one
another. Such decisions are generally taken on the basis of minimum return on investment.
All those proposals which yields a rate of return higher than the minimum required rate of
return of capital are accepted and the rest rejected. If the proposal is accepted the firm
makes investment in it, and the rest are rejected. If the proposal is accepted the firm makes
investment in it, and if it is rejected the firm does not invest in the same.
2. Mutually Exclusive Project Decision:
Such decisions relate to proposals which compete with one another in such away
that acceptance of one automatically excludes the acceptance of the other. Thus one of the
proposals is selected at the cost of the other. For ex: A company has the option of buying
a machine. Or a second hand machine, or taking on old machine hire or selecting a
machine out of more than one brand available in the market. In such a cases the company
can select one best alternative out of the various options by adopting some suitable
technique or method of capital budgeting. Once the alternative is selected the others. are
automatically rejected.
35
3. Capital Rationing Decision:
A firm may have several profitable investment proposals but only limited funds
and, thus, the firm has to rate them. The firm selects the combination of proposals that
will yield the greatest profitability by ranking them in descending order of there
profitability.
METHODS OF CAPITAL BUDGETING AND EVALUATION
TECHNIQUES
Traditional Methods:
i) Average Rate of Return.
ii) Pay-Back Period Method
Time Adjusted Method or Discounted Method:
i) Net Present Value Method
ii) Internal Rate of Return
iii) Net Terminal Value Method
iv) Profitability Index.
CAPITAL BUDGETING METHODS
TRADITIONAL DISCOUNTED CAHS FLOW
METHOD METHOD
PLAY BACK ACCOUNTING RATE
PERIOD OF RETURN
INTERNAL RATE
OF RETURN
NET PRESENT VALUE
36
PROFITABILITY INDEX
TRADITIONAL METHODS
1. Average Rate of Return:
The average rate of return (ARR) method of evaluating proposed capital
expenditure is also know as the accounting rate of return method. It is based upon
accounting information rather than cash flows. There is no unanimity recording the
definition of the rate of return.
ARR = Average annual profits after taxes ____ X 100
Average investment over the life of the project
The average profits after taxes are determined by adding up the after-tax profits
expected for each year of the projects life and dividing by the number of the years. In the
case of annuity, the average after tax profits is equal to any year’s profit.
The average investment is determined by dividing the net investment by two. This
averaging process assumes that the firm is suing straight line depreciation, in which case
the book value of the asset declines at a constant rate from its purchase price to zero at the
end of its depreciable life. This means that, on the average firms will have one-half of their
initial purchase prices in the books. Consequently if the machine has salvage value, then
only the depreciable cost (cost salvage value) of the machine should be divide by two in
ordered to ascertain the average net investment, as the salvage money will be recovered
only at the end of the life of the project.
Therefore an amount equivalent to the salvage value remains tied up in the project
though out its lifetime. Hence no adjustment is required to sum of salvage value to
determine the average investment. Like wise if any additional net working capital is
required in the initial year, which is likely to be released only at the end of the projects
life. The full amount of working capital should be taking determining relevant investment
for the purpose of calculating ARR. Thus,
37
Average investment = Net Working Capital + Salvage Value + ½ (initial cost of machine
value)
Accept – Reject Value:
With the help of ARR, the financial maker can decide whether to accept or
reject the investment proposal. As an accept – reject criterion, the actual ARR would be
compared with a predetermined or a minimum required rate of return or cut – off rate. A
project would qualify to be accepted if the actual ARR is higher than the minimum desired
ARR. Other wise, it is liable to be rejected. Alternatively the ranking method can be used
to select or reject proposals under consideration may be arranged in the descending order
of magnitude, starting with the proposals with the highest ARR and ending with the
proposal with the lowest ARR. Obviously projects having higher ARR would be preferred
with projects with lower ARR.
2. Pay Back Period:
The Pay Back method is the second traditional method of capital budgeting. It is
the simplest and, the most widely employed quantitative method for apprising capital
expenditure decisions. This method answers the question. How many years will it for the
cash benefits to pay the original cost of an investment, normally disregarding salvage
value? Cash benefits represent CFAT ignoring interest payment. Thus the pay back
method measures the number of years required for the CFAT to pay back the original out
lay required in an investment proposal.
There are two ways of calculating the pay back period. The first method can be
applied when the cash flow stream is in the nature if annuity for each year of the projects
life that is CFAT is uniform. In such a situation the initial cost of the investment is divided
by the constant annual cash flow;
Investment
Constant Annual Cash Flow
For example, an investment of Rs. 40,000 in a machine is expected to produce
CFAT of Rs 8,000 for 10 years.
Rs. 40,000
38
Rs. 8,000 PB = ---------------- 5 years.
The second method is used when project cash flows are not uniform (mixed
stream) but vary form year to year. In such a situation, PB is calculated by the process of
cumulating cash flows till the time when cumulative cash flow become equal to the
original investment outlay.
Accept Reject Criteria:
The pay back period can be use as a decision criterion to accept or reject
investment proposals. One application of this technique is to compare the actual pay back
with a predetermined pay back that is the pay back set up by the management in terms of
the maximum period during which the initial investment will be recovered. If the actual
pay back period less than the predetermined pay back, the project would be accepted. If
not, it would be rejected. Alternatively, the pay back can be used as a ranking method.
When mutually exclusive projects are under consideration, then may be ranked according
length of pay back period. Thus, the project has having the shortest pay back may be
assigned rank one followed in that order so that the project with the longest pay back
would be ranked last. Obviously, projects with shorter payback period will be selected.
DISCOUNTED CASH FLOW/ TIME ADJESTED TECHNIQUES:
1. Net Present Value Method:
The net present value is a modern method of evaluating investment proposals. This
method takes into consideration the time value of money and attempts to calculate the
return on investments by introducing the factor of time element. It recognizes the fact that
rupee earned today is worth more than the same rupee earned tomorrow. Net present
values of all inflows and outflows of cash occurring during the life of the project is
determined separately for each year by discounting these flows by the firm’s cost of
capital or a pre – determined rate. The following are the Net Present value method of
evaluating investment proposals:
1) First of all determined an appropriate rate of interest that should be selected as
minimum required rate of return called “ cut – off rate” of interest in the market and the
39
market- on long term loans or it should reflect the opportunity cost of capital of the
investor.
2) Compute the present value of total investment outlay, I,e., cash outflows at the
determined discount rate. If the total investment is to be made in the initial year, the
present value shall be as the cost of investment.
3) Compute the present value of total investment proceeds I,e., inflows (profit before
depreciation and after tax) at the above determined discount rate.
4) Calculate the Net present value of each project by subtracting the present value of cash
inflows from the value of cash outflows for each project.
5)If the Net present value is positive or zero, I.e., when present value of cash inflows
either exceeds or is equal to the present values of cash outflows, the proposal may be
accepted. But in case the present value of inflows is less than the present value of cash
outflows, the proposal should be rejected.
6) To select between mutually exclusive projects, projects should be ranked in order of net
present values, i.e., the first preferences to be given to the project having the maximum net
present value.
The present value of re.1 due in any number of years may be found with the use of
the following the mathematical formula:
PV= 1/(1+r) n
Where,
PV = present value
R = rate of interest/ Discount rate
N = number of years
2. Internal Rate of Return:
The second discounted cash flow or time-adjusted method of appraising capital
investment decisions is the internal rate of return method. This technique is also known as
yield on investment, marginal efficiency of capital, marginal productivity of capital, rate
of return method. This technique is also known a yield on investment, marginal efficiency
of capital, and marginal productivity of capital, rate of return, time-adjusted rate of return
and so an.
Like the present value method the IRR method also considers the time value of
money by case of the net present value method, the discount rate is the required rate of
40
return and being a predetermined rate, usually the cost of capital, its determinants are
external to the proposal under consideration. The IRR, on the other hand it is based on
facts, which are internal to the proposals. In other words while arriving at the required
rate of return for finding out present values the cash inflows as well as outflows are not
considered. But the IRR depends entirely on the initial outlay and the cash proceeds of the
projects, which is been evaluated of acceptance or rejection. It is therefore appropriately
referred to as internal rate of return.
The internal rate of return is usually the rate of return that a project earns. It
is defined as the discount rate ( r ) which equates the aggregate present value of the Net
cash inflows ( CFAT ) with the aggregate present value of cash outflows of a project. In
other words it is that rate which gives the project of Net present value is zero.
Accept Reject Criteria:
The use of the IRR, as a criterion to accept capital investment decisions,
involves a comparison of the actual IRR with the required rate of return also then the cut
off rate or hurdle rate. The project would quality to be accepted if the IRR
(r) Exceeds the cut off rate.
(k). If the IRR and the required rate of return are equal the firm is different as to whether
to accept or reject the project.
3. Net Terminal Method:
The terminal value approach (TV) even mere distinctly separates the timing of the
cash inflows and outflows. The assumption behind the TV approach is that each cash
inflow is reinvested in other asset at a certain rate of return from the moment it is
received until the termination of the project.
Accept – Reject Criteria:
The decision rule is that if the present value of the sum total of the compounded
reinvested cash inflows (PVTS) is greater than the present value of the outflows (PVO),
the proposed project is accepted otherwise not.
PVTS>PVO accept
PVTS<PVO reject.
41
The firm would be indifferent if both the values are equal. A variation of the
terminal value method (TV) is the net terminal value (NTV). Symbolically it can be
represented as NTV = (PVTS – PVO). If the NTV is the positive accept the project, if the
negative reject the project.
4. Profitability Index:
The time adjusted capital budgeting is Profitability Index (P1) or Benefit Cost
Ratio (B / C). It is similar to the approach of NPV. The profitability index approach
measures the present value of returns per rupee invested, while the NPV is based on the
differences between the present value of future cash inflows and the present value of cash
outflows. A major shortcoming of the NPV method is that, being an absolute measure; it is
not reliable method to evaluate project inquiring different initial investments. The PI
method proves a solution to this kind of problem. It is, in other words, a relative measure.
It may be defined as the ratio, which is obtained by dividing the present value of future
cash inflows by the present value of cash inflows.
PI = Present value of cash inflows
Present value of cash outflows
This method is also known as B / C ratio because the numerator measures benefits
and the denominator costs.
Accept Reject Criteria:
Using the B / C ratio or the PI, a project will quality for acceptance if its PI exceeds
one. When PI equals 1 (one), the firm is indifferently to the project.
When PI is greater than, equal to or less than 1 (one), the Net present value is
greater than, equal to or less than zero respectively. In other words, the NPV will be
positive when the PI is greater than 1 (one); will be negative when the PI is less than 1.
Thus, the NPV and PI approach give the same results regarding the investments proposals.
42
Methods of Capital Budgeting
(1) Traditional methods:
Pay back period
Average rate return method
(2) Discount cash flow method
Net present value method
Initial rate return method
Profitability index method
Data collection:
Primary data: - The primary data is the data which is collected, by interviewing
directly with the organizations concerned executives. This is the direct information
gathered from the organization.
\
Secondary data: - The secondary data is the data which is gathered from
publications and websites.
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.
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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
Accept reject decisions
This is a fundamental decision in capital budgeting. If the project is accepted, the
firm invests in it; if the proposal is rejected, the firm does not invest in it. In general,
all those proposals, which yield rate of return greater than a certain required rate of
return or cost of capital, are accreted and rest are rejected. By applying this criterion,
all independent projects all accepted. Independent projects are the projects which do
not compete with one another in such a way that the acceptance of one project under
the possibility of acceptance of another. Under the accept-reject decision, the entire
independent project that satisfies the minimum investment criterion should be
implemented.
(i) Mutually exclusive project decision
Mutually exclusive projects are projects which compete with other
projects in 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) Capital Rationing Decision
Capital rationing is a situation where a firm has more investment proposals
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:
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1) Ranking of projects according to profitability index (PI) or Initial rate of
return (IRR).
2) Selecting of rejects depends upon the profitability subject to the budget
limitations keeping in view the objectives of maximizing the value of
firms.
NATURE OF INVESTMENT DECISSIONS
The investment decisions of a firm are generally known as the capital
budgeting, or capital expenditure decisions. A capital budgeting decision may be defined
as the firm’s decision to invest its current funds most efficiently in the long term assets in
anticipation of an expected flow of benefits over a series of years. The long term assets are
those that affect the firms operations beyond the one year period. The firm’s investment
decisions would generally include expansion, acquisition, modernization and replacement
of the long-term assets.
Sale of a division or business (divestment) is also as an investment
decision. Decisions like the change in the methods of sales distribution, or an
advertisement campaign or a research and development programme have long-term
implications for the firm’s expenditures and benefits, and therefore, they should also be
evaluated as investment decisions. It is important to note that investment in the long-term
assets invariably requires large funds to be tied up in the current assets such as inventories
and receivables. As such, investment in the fixed and current assets is one single activity.
Features of Investment Decisions:- The following are the features of investment decisions:
The exchange of current funds for future benefits.
The funds are invested in long-term assets.
The future benefits will occur to the firm over a series of year.
Importance of Investment Decisions:-
Investment decisions require special attention because of the following reasons.
They influence the firms growth in the long run
They affect the risk of the firm
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They involve commitment of large amount of funds
They are irreversible, or reversible at substantial loss
They are among the most difficult decisions to make.
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
firm’s 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.
Funding
Investment decisions generally involve large amount of funds, which make it
imperative for the firm to plan its investment programmers 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 firm’s 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.
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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 with in 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.
Replacement 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 firm’s revenue
may remain unchanged. Assets become outdated and obsolete with technological changes.
The firm must decide to replace those assets with new assets that operate more
economically.
If a cement company changes from semi-automatic drying equipment to
finally automatic drying equipment, it is an example of modernization and replacement.
Replacement decisions help to introduce more efficient and economical assets
and therefore, are also called as cost reduction investments. However, replacement
decisions that involve substantial modernization and technological improvements expand
revenues as well as reduce costs.
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Yet another useful way to classify investments is as follows:
Mutually exclusive investments
Independent investments
Contingent investments
Mutually Exclusive Investments
Mutually exclusive investments serve the same purpose and compete
with each other. If one investment is undertaken, others will have to be excluded. A
company may, for example, either use a more labour-intensive, semi-automatic
machine, or employ a more capital-intensive, highly automatic machine for
production. Choosing the semi-automatic machine precludes the acceptance of the
highly automatic machine.
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 a 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.
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Investment Evolution Criteria:
Three steps are involved in the evaluation of an investment:
Estimation of cash flows.
Estimation of the required rate of return (the opportunity cost of capital)
Application of a decision rule of making the choice.
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.
Investment decision rule
The investment decision rules may be referred to as capital budgeting
techniques, or investment criteria. A sound appraisal technique should be used to
measure the economic worth of an investment project. The essential property of a
sound technique is that it should maximize the share holder’s wealth. The
following other characteristics should also be possessed by a sound investment
evaluation criterion.
It should consider all cash flows to determine the true profitability of the
project.
It should provide for an objective and unambiguous way of separating
good projects from bad projects.
It should help ranking of projects according to their true profitability.
It should recognize the fact that bigger cash flows are preferable to smaller
ones and early cash flows are preferable to later ones.
it should be a criterion which is applicable to any conceivable investment
project independent of others.
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.
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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)
Net Present Value
The Net Present Value technique involves discounting net cash flows for a
project, then subtracting net investment from the discounted net cash flows. The result is
called the Net Present Value (NPV). If the net present value is positive, adopting the
project would add to the value of the company. Whether the company chooses to do that
will depend on their selection strategies. If they pick all projects that add to the 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.
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Internal Rate of Return
The internal rate of return (IRR) is a Capital budgeting metric used by firms to
decide whether they should make Investments. It is also called discounted cash flow rate
of return (DCFROR) or rate of return (ROR).
It is an indicator of the efficiency or quality of an investment, as opposed to Net present
value (NPV), which indicates value or magnitude.
The IRR is the annualized effective compounded return rate which can be earned on the
invested capital, i.e., the yield on the investment. Put another way, the internal rate of
return for an investment is the discount rate that makes the net present value of the
investment's income stream total to zero.
Another definition of IRR is the interest rate received for an investment consisting of
payments and income that occur at regular periods.
A project is a good investment proposition if its IRR is greater than the rate of return that
could be earned by alternate investments of equal risk (investing in other projects, buying
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.
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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.
Time value it recognizes the time value of money.
Value maximization it is consistent with the share holder value
maximization principle. A project with PI greater than one will have positive
NPV and if accepted it will increase share holders wealth.
Relative profitability in the PI method since the present value of cash in
flows is divided by the initial cash out flow , it is a relative measure of
project’s profitability.
Like NPV method PI criterion also requires calculation of cash flows and
estimate of the discount rate.
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 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 project’s payback
with pre-determined standard pay back. The would be accepted if its payback
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period is less than the maximum or standard pay back 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 pay back period will be selected.
Evolution of payback period;.
Pay back is a popular investment criterion in practice. It is considered to have
certain virtues.
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 analyst’s time and the use of computers.
Short-term
Effects a company can have more favorable short-run effects on
earnings per share by setting up a shorter standard payback period. It should,
however, be remembered that this may not be a wise long-term policy as the
company may have to sacrifice its future growth for current earnings.
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.
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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
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.
Discounted payback period
One of the serious objections to the payback method is that it does not discount the
cash flows for calculating the payback period. We can discount cash flows and then
calculate the payback.
The discounted pay back period is the no. of. Periods taken in recovering the
investment outlay on the present value basis. The discounted payback period still fails to
consider the cash flows occurring after the payback period.
Accounting rate of return
The accounting rate of return (ARR) also known as the return on investment
(ROI) uses accounting information as revealed by financial statements, to measure the
profitability of an investment. The accounting rate of return is the ratio of the average after
tax profit divided by the average investment. The average investment would be equal to
half of the original investment if it were depreciated constantly. Alternatively, it can be
found out by dividing the total if the investment’s book values after depreciation be the life
of the project.
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EVALUATION OF ARR METHOD
The ARR method may claim some merits:
Simplicity the ARR method is simple to understand and use. It does not
involve complicated computations.
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 project’s profitability.
The ARR is a method commonly understood by accountants and
frequently used as a performance measure. As decision criterion, how ever it has
serious short comings.
CASH FLOWS IGNORED
The ARR method uses accounting profits, not cash flows, in appraising
the projects. Accounting profits are based on arbitrary assumptions and choices and
also include non-cash items. It is, there fore in appropriate to relay on them for
measuring the acceptability of the investment projects.
TIME VALUE IGNORED
The averaging income ignores the time value of money. In fact, this
procedure gives more weight age to the distant receipts.
ARBITRARY CUT-OFF
The firm employing the ARR rule uses an arbitrary cut-off yardstick.
Generally, the yardstick is the firm’s current return on its assets (book -value).
Because of this, the growth companies earning very high rates on their existing
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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, crèche 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
improve quality. Replacement projects can be evaluated in a fairly straightforward manner,
through at times the analysis may be quite detailed.
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
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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.
Research and development projects
Traditionally, R&D projects observed a very small proportion of capital budget in
most Indian companies. Things, however, are changing. Companies are now allocating
more funds to R&D projects, more so in knowledge-intensive industries. R&D projects are
characterized by numerous uncertainties and typically involve sequential decision making.
Hence the standard DCF analysis is not applicable to them. Such projects are
decided on the basis of managerial judgment. Firms which rely more on quantitative
methods use decision tree analysis and option analysis to evaluate R&D projects.
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.
Capital Budgeting: eight steps
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Introduction
Until now, this web site has broken one of the cardinal rules of financial management.
This page corrects for that problem and presents now, the first part of the subject of
Capital Budgeting.
Many books and chapters and web pages purport to discuss capital budgeting when in
reality all they do is discuss CAPITAL INVESTMENT APPRAISAL. There's nothing
wrong with a discussion of the CIA methods except that authors have a duty to point out
that CIA methods are only one part of a multi stage process: the capital budgeting process.
A discussion of CIA and nothing else means that capital budgeting decisions are being
discussed out of context. That is, by ignoring the earlier and later parts of capital
budgeting, we are never assess where capital budgeting project come from, how
alternatives are found and evaluated, how we really choose which project to choose … and
then we never review the projects and how they have been implemented.
Definition
Capital budgeting relates to the investment in assets or an organization that is relatively
large. That is, a new asset or project will amount in value to a significant proportion of the
total assets of the organization.
The International Federation of Accountants, IFAC, defines capital expenditures as 58
Investments to acquire fixed or long lived assets from which a stream of benefits is
expected. Such expenditures represent an organization's commitment to produce and sell
future products and engage in other activities. Capital expenditure decisions, therefore,
form a foundation for the future profitability of a company.
Projects don't just fall out of thin air: someone has to have them. The main point here is
that successful, dynamic and growing companies are constantly on the lookout for new
projects to consider. In the largest organizations there are entire departments looking for
alternatives and opportunities.
2 Look for suitable projects
Once someone has had the idea to invest, the next step is to look at suitable projects:
projects that complement current business, projects that are completely different to current
business and so on. Initially, all possibilities will be considered: along the lines of a
brainstorming exercise.
As time goes by, and as corporate objectives allow, the initial list of potential projects will
be whittled down to a more manageable number.
3 Identify and consider alternatives
Having found a few projects to consider, the organization will investigate any number of
different ways of carrying them out. After all, the first idea probably won't either be the
last or the best. Creativity is the order of the day here, as organizations attempt to start off
on the best footing.
As the diagram suggests, at each of these first three stages, we need to consider whether
what we are proposing fits in with corporate objectives. There is no point in thinking of a
project that conflicts with, say, the growth objective or the profitability objective or even
an environmental objective.
A lot of data will be generated in this stage and this data will be fed into stage four: Capital
Investment Appraisal.
4 Capital Investment Appraisal
This is the number crunching stage in which we use some or all of the following methods
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Payback (PB)
accounting rate of return (ARR)
Net present value (NPV)
Internal rate of return (IRR)
Profitability Index (PI)
There are other techniques of course; but the technique to be used will depend on a range
of things, including the knowledge and sophistication of the management of the
organization, the availability of computers and the size and complexity of the project
under review.
For more information here, go to my page on CIA once you have finished this page.
5 Analysis of feasibility
Stage four is the number crunching stage. This stage is where the decision is made as to
which project is to be assessed as acceptable. That is, which project is feasible?
In order to choose the project, management needs some hurdles:
What must the payback be
What rate of ARR is acceptable
What is the NPV cut off
What IRR is the least that we can accept
What PI is the least that we can accept
and so on.
Some projects will be discarded as a result of this stage. For example, if the PB cut off is,
say, 2 years, and a project has a PB of 3 years, it will be rejected. The same is true of the
ARR, NPV, IRR and PI.
Capital rationing might be a problem here, too, if the organization has general cash flow
problems.
Capital Budgeting Policy Manual
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Let's pause at this point to make the point that what we have just said about cut off rates
and so on come from formal procedures and documents. One such formal document is the
Capital Budgeting Policy Manual, in which formal procedures and rules are established to
assure that all proposals are reviewed fairly and consistently. The manual helps to ensure
that managers and supervisors who make proposals need to know what the organization
expects the proposals to contain, and on what basis their proposed projects will be judged.
The managers who have the authority to approve specific projects need to exercise that
responsibility in the context of an overall organizational capital expenditure policy.
In outline, the policy manual should include specifications for:
1. an annually updated forecast of capital expenditures
2. the appropriation steps
3. the appraisal method(s) to be used to evaluate proposals
4. the minimum acceptable rate(s) of return on projects of various risk
5. the limits of authority
6. the control of capital expenditures
7. the procedure to be followed when accepted projects will be subject to an actual
performance review after implementation
(See IFAC document The Capital Expenditure Decision October 1989 for full details of
the manual)
6 Choose the project
Once we have determined the feasible/acceptable projects, we then have to make a
decision of which to accept.
If we have capital rationing problems, we might be restricted to one project only. If we
have no cash problems, we might choose two or more.
Whatever the cash position, we would like to invest in all projects that have a positive
NPV, whose IRR is greater than our cut off rate and so on.
7 Monitor the project
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As with any part of the organization, the project must be monitored as it progresses. If the
project can be kept as a separate part of the business, it might be classed as its own
department or division and it might have its own performance reports prepared for it. If it's
to be absorbed within one or more parts of the organization then it could be difficult to
monitor it separately: this is something that management has to decide as they implement
their new projects.
8 Post completion audit
The final stage: once the project has been up and running for six months or a year or so,
there must be a post completion audit or a post audit. A post audit looks at the project from
start to finish: stages 1 - 7 and looks at how it was thought of, analyzed, chosen,
implemented, and monitored and so on.
The purpose of the post audit is to test whether capital budgeting procedures have been
fully and fairly applied to the project under review.
Of course, any weaknesses that might be found during the post audit might be specific to
one project or they might relate to capital budgeting systems for the organization as a
whole. In the latter case, the auditor will report back to his superiors and to management
that systems need to be overhauled as a result of what has been found.
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CHAPTER-IV
DATA ANALYSIS & INTERPRETATION
63
FINACIAL ANALYSIS
ANALYSIS OF KESORAM
YearsTotal
sales
Total
assets
Fixed
assets
Net
Profit
Capital
Employed
Long
term
funds
Share
holders’
Funds
2006-2007 1,84,773 4,50,411 1,76,781 35,521 3,56,526 1,13,161 78,125
2007-2008 1,94,511 4,93,319 1,98,650 37,540 3,86,343 1,27,090 78,125
2008-2009 2,49,994 5,96,346 2,12,545 58,897 4,58,267 1,49,415 78,125
2009-2010 2,49,179 6,59,483 2,23,148 60,784 5,00,540 1,66,719 82,455
2010-2011 4.75.062 3.30.052 2,30,895 23,734 5,23,572 2,14,254 45,728
TABLE – 2
Years Investment Turn Over
Ratio
Ratio Change
2006-2007 0.41 -
2007-2008 0.39 -0.02
2008-2009 0.42 0.03
2009-2010 0.38 -0.04
2010-2011 1.43 1.05
I. Investment Turn Over Ratio
Formula:
Investment Turn Over Ratio = Total Sales/Total Assets
The effective use of investment is an index of corporate efficiency. Determining
the size and mix of total assets with depend on the nature of the undertaking, scale of
operations, and the resources available. The available assets should be used to generate
maximum productivity. Increasing investment turn over would indicate the efficient use of
assets and a positive contribution to the ROI. The trends in investment turnover of
KESORAM Presented in table-I reveal the following.
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a) The amount of total investment in assets as increased significantly from Rs.4,
50,411 millions to Rs.7, 17,371 millions. This increase in the total assets is an
account of the following reasons.
1) Increasing new projects and capital working progresses.
2) Increase in size of current Assets.
3) Increased operations and expansion of existing Units.
b) The amount of sales has increased from Rs.1, 84,773 millions to Rs.2, 87,507
millions (2009-2010) this increased sales helped the organization to improve its
business turn over in different sectors. The increase in sales is higher than increases
in investment in fixed assets.
c) In view of the above the (total assets turnover ratio of KESORAM recorded
consistent fluctuation ranging 1.43 (2009-2010) the lowest ratio recorded as 0.39
(2006-2007). This decline is an account of lower growth rate sales in those years.
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TABLE - 3
Years Fixed Assets Turn
Over Ratio
Ratio Change
2006-2007 1.04 -
2007-2008 0.97 -0.07
2008-2009 1.17 0.20
2009-2010 1.11 -0.06
2010-2011 2.05 1.14
II. Fixed Assets Turn Over Ratio:
Formula:
Fixed Assets Turn Over Ratio = Sales/Fixed Assets
The installed capacity of the fixed resources has significantly bearing on the
corporate plans of expansion and growth. At the same time fixed assets should be utilized
optimally to reduce the burden of overheads. On the production and sales. Similarly idle
capacity is regarded as an index of the company’s inability in utilizing the fixed resources.
The use of fixed assets will depend on different factors like market potential for its
existing products, new plans for growth and expansion, availability of other working
resources like raw material, power suppliers etc. increased fixed assets turnover would
reduce the fixed costs burden and accelerates the productivity to the investment in fixed
assets. An analysis of fixed assets turnover in KESORAM presented in table reveals the
following.
a) The amount of investment in fixed assets has increased form Rs.1, 76,781 millions
to Rs.2, 30,895 millions. Thus in a period of 5 years fixed assets have increased by
early 50%.
b) During the same period I,e., sales have also increased significantly from
Rs.1,84,773 millions to Rs.2,87,507 millions. It appears that the company has
utilized the fixed assets effectively.
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c) The fixed assets turnover ratio has showing a fluctuating trend and increase from
1.04 times to 2.04 times (2010-2011). This fluctuation any be due to fixed assets
investment.
TABLE - 4
III Return on Investment.
Formula:
Return on Investment = Net Profit
_____________________ X 100
Capital Employed
Return on investment is an overall measure of business efficiently. ROI is
calculated as a percent of net profit to total investment. Functionally it is 9 product of
profit margin and investment turnover. It is proposed to examine the trends in ROI of
KESORAM. This will provide a general idea on the awards profitability of the concern.
a) the amount of total investment increased from Rs.4,50,411 millions to Rs.7,17,371
millions over a period of 5 years.
b) During the same period profit before tax has increased form Rs.35,521 millions to
Rs.60,224 millions.
From the above, it is observed that the increased in profit is not proportionate with
the increase in investment.
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Years Return on Investment
Ratio% Change%
2006-2007 10 -
2007-2008 9 -1
2008-2009 12 3
2009-2010 12 0
2010-2011 11 -1
TABLE – 5
Years Fixed Assets Ratio
Ratio Change
2006-2007 1.56 -
2007-2008 1.56 0
2008-2009 1.42 - 0.14
2009-2010 1.33 - 0.09
2010-2011 0.04 - 1.29
IV. Fixed Assets Ratio.
Formula:
Fixed Assets Ratio = Fixed Assets / Total Long Term Funds.
Fixed assets to total long-term funds, this ratio indicates the proportion fixed assets
that financed by long-term funds. In other words it indicates the amount of external
borrowings invested in fixed assets. Generally more of external funds used for investing in
fixed assets is economical and healthy, the table-5 reveals the following facts.
The ratio of fixed assets to long-term borrowings has not been showing any
consistent trend. It has varied from 1.56 times to -1.29 (2010-2011).
The KESORAM has depended more on equity portion of funds rather than on debt portion
of funds.
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TABLE-6
Years Fixed Assets Ratio
Ratio Change
2006-2007 2.26 -
2007-2008 2.54 0.28
2008-2009 2.72 0.18
2009-2010 2.71 - 0.01
2010-2011 2.80 0.09
V. Fixed Assets to Net Worth Ratio:
Formula:
Fixed Assets to Net Worth Ratio = Fixed Assets/ Shareholders Funds.
The ratio of fixed assets to net worth is another measure of solvency of the firm. It
indicates the extent of fixed assets financed by shareholders funds, generally
dependence on shareholders’ funds for financing of fixed assets is redistricted as cost
of equity is higher than cost external borrowings. The ratio of fixed assets to net worth
of KESORAM reveals the following.
a) The initial ratio’s of the investment are increased from 1,76,781 million to
2,30,895 million (2010-2011) constantly increased period of 5 years.
b) The amount invested by the shareholders funds in the year 78,125 millions to
82,455 millions (2010-2011).
c) The ratio has showing on increasing trend in all the years of observation except in
This shows the KESORAM is depending more on shareholders’ funds for
financing of fixed assets them external borrowings
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CHAPTER -V
FINDINGS & CONCLUSIONS
SUGGESTIONS
BIBLIOGRAPHY
ABBREVIATIONS
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FINDINGS & CONCLUSIONS
The budgeting exercise in KESORAM also covers the long term capital budgets,
including annual planning and provides long term plan for application of internal
resources and debt servicing translated in to the corporate plan.
The scope of capital budgeting also includes expenditure on plant betterment, and
renovation, balancing equipment, capital additions and commissioning expenses on
trial runs generating units.
To establish a close link between physical progress and monitory outlay and to
provide the basis for plan allocation and budgetary support by the government.
The manual recommends the computation of NPV at a cost of capital / discount
rate specified from time to time.
A single discount rate should not be used for all the capacity budgeting projects.
The analysis of relevant facts and quantifications of anticipated results and
benefits, risk factors if any, must be clearly brought out.
Inducting at least three non -official directors the mechanism of the Search
Committee should restructure the Boards of these PSUs.
Feasibility report of the project is prepared on the cost estimates and the cost of
generation.
Scope of capital budgeting in KESORAM are
* Approved and ongoing schemes
New approved schemes
Unapproved schemes
Capital budgets for plant betterment’s
Survey and investigation
Research and development budget.
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SUGGESTIONS
The capital budgeting decision for KESORAM is governed by a manual issued by
the planning Commission. It contains the following important provisions in the
regard: (1) It suggest the use of various project evaluation techniques, such as
return on investment (ROD, payback period, discounted cash flow (DCF)
Evaluation and Review Technique (PERT), Critical path method (CPM), and
strengths, weaknesses, opportunities and Threats (SWOT) Analysis.
The total assets turnover ratio of KESORAM recorded consistent fluctuations from
0.41 (2006-2007) to 01.04 (2010-2011). The lowest recorded as 0.38 (2009-2010).
This decline is an account of lower growth rates sales in those years.
The fixed assets turnover ratio of KESORAM showing a fluctuating trend and
increased from 1.04 times (2006-2007) to 1.25 times (2010-2011). These
fluctuations any be due to fixed assets investment.
The ROI Of KESORAM did not record any consistent trend. It varied from 10%
(2006-2007) to 15% (2010-2011).
The fixed assets ratio shows the fluctuating trends form 1.56 (2006-2007) to (2010-
2011) as 1.15 and the funds were required then continuously declined.
The fixed assets ratio of KESORAM as shown continuously increasing from 2.26
(2006-2007) to (2010-2011) as 2.80.There fluctuations observed.
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BIBLIOGRAPHY
Books:
-Financial Management - Prasanna Chandra
-Management Accounting - R.K.Sharma & Shashi K.Gupta
-Management Accounting -S.N.Maheshwary
-Financial Management -Khan and Jain
-Research Methodology -K.R.Kothari
Internet Sites:
http\\:www.google.com
http\\:www.KESORAM.co.in
http\\:www.googlefinance.com
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ABBREVIATIONS
PI Profitability index.
CB Capital budgeting
CF’S Cash flows.
CCF’S Cumulative cash flows.
EAT Earnings after tax.
EBIT Earnings before investment and tax.
CFAT Cash flows after tax.
PV’S Present value of cash flows.
PVIF Present value of inflows.
PBP Payback period.
ARR Average rate return.
NPV Net present value.
IRR Internal rate return.
B/C Benefit cost ratio.
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