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 there 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.

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

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since they send to determine its value and size by influencing its growth,

probability and growth.

.

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 Ultra Tech Cements Limited – A case

study” is based on the following objectives.

1. To evaluate the capital budgeting practices relating to various projects of

Ultra Tech Cements Limited Hyderabad

2. To Asses the long term requirements of funds and plan for application of

internal resources and debt servicing.

3. To Assess the effectiveness of long term investment decisions of Ultra Tech

Cements Limited

4. To offer conclusion derived from the study and give suitable suggestions for

the efficient utilization of capital expenditure decisions.

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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.

.

LIMITATIONS OF THE STUDY:

1. The study is limited to Ultra Tech Cements Limited only.

2. The study is limited to certain projects of Ultra Tech Cements Limited.

3. Period of the study is restricted to five years only.

4. The present study cannot be used for inter firm comparison.

5. Limited span of time is a major limitation for this project.

6. The act and figures of the study is limited to the period of FIVE years i.e.

2008-2012.

7. The data used in reports are taken from the annual reports, published at the

end of the years.

8. The result does not reflect the day-to-day transactions.

9. It is also impossible to the study of day-to-day transactions in cash

management.

10. The analysis of the capital is taken FIVE years.

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CHAPTER-II

INDUSTRY PROFILE

&

COMPANY PROFILE

5

INDUSTRY PROFILE

In the most general sense of the word, 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.

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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 climatesHydraulic mortars for

masonry construction of harbor works etc, in contact with sea water.

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

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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 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

8

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

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 blast furnace 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

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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.

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.

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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, 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.

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COMPANY PROFILE

ULTRATECH CEMENT:

UltraTech Cement Limited has an annual capacity of 18.2 million tonnes. It

manufactures and markets Ordinary Portland Cement, Portland Blast Furnace Slag

Cement and Portland Pozzalana Cement. It also manufactures ready mix concrete

(RMC).

UltraTech Cement Limited has five integrated plants, six grinding units and three

terminals — two in India and one in Sri Lanka.

UltraTech Cement is the country’s largest exporter of cement clinker. The export

markets span countries around the Indian Ocean, Africa, Europe and the Middle East.

UltraTech’s subsidiaries are Dakshin Cement Limited and UltraTech Ceylinco (P)

Limited.

The roots of the Aditya Birla Group date back to the 19th century in the picturesque

town of Pilani, set amidst the Rajasthan desert. It was here that Seth Shiv Narayan

Birla started trading in cotton, laying the foundation for the House of Birlas.

Through India's arduous times of the 1850s, the Birla business expanded rapidly. In

the early part of the 20th century, our Group's founding father, Ghanshyamdas Birla,

set up industries in critical sectors such as textiles and fibre, aluminium, cement and

chemicals. As a close confidante of Mahatma Gandhi, he played an active role in the

Indian freedom struggle. He represented India at the first and second round-table

conference in London, along with Gandhiji. It was at "Birla House" in Delhi that the

luminaries of the Indian freedom struggle often met to plot the downfall of the British

Raj.

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Ghanshyamdas Birla found no contradiction in pursuing business goals with the

dedication of a saint, emerging as one of the foremost industrialists of pre-

independence India. The principles by which he lived were soaked up by his

grandson, Aditya Vikram Birla, our Group's legendary leader.

Aditya Vikram Birla: putting India on the world map

A formidable force in Indian industry, Mr. Aditya Birla dared to dream of setting up a

global business empire at the age of 24. He was the first to put Indian business on the

world map, as far back as 1969, long before globalisation became a buzzword in

India.

In the then vibrant and free market South East Asian countries, he ventured to set up

world-class production bases. He had foreseen the winds of change and staked the

future of his business on a competitive, free market driven economy order. He put

Indian business on the globe, 22 years before economic liberalisation was formally

introduced by the former Prime Minister, Mr. Narasimha Rao and the former Union

Finance Minister, Dr. Manmohan Singh. He set up 19 companies outside India, in

Thailand, Malaysia, Indonesia, the Philippines and Egypt.

Interestingly, for Mr. Aditya Birla, globalisation meant more than just geographic

reach. He believed that a business could be global even whilst being based in India.

Therefore, back in his home-territory, he drove single-mindedly to put together the

building blocks to make our Indian business a global force.

Under his stewardship, his companies rose to be the world's largest producer of

viscose staple fibre, the largest refiner of palm oil, the third largest producer of

insulators and the sixth largest producer of carbon black. In India, they attained the

status of the largest single producer of viscose filament yarn, apart from being a

producer of cement, grey cement and rayon grade pulp. The Group is also the largest

producer of aluminium in the private sector, the lowest first cost producers in the

world and the only producer of linen in the textile industry in India.

At the time of his untimely demise, the Group's revenues crossed Rs.8,000 crore

globally, with assets of over Rs.9,000 crore, comprising of 55 benchmark quality

plants, an employee strength of 75,000 and a shareholder community of 600,000.

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Most importantly, his companies earned respect and admiration of the people, as one

of India's finest business houses, and the first Indian International Group globally.

Through this outstanding record of enterprise, he helped create enormous wealth for

the nation, and respect for Indian entrepreneurship in South East Asia. In his time, his

success was unmatched by any other industrialist in India.

That India attains respectable rank among the developed nations, was a dream he

forever cherished. He was proud of India and took equal pride in being an Indian.

Under the leadership of our Chairman, Mr. Kumar Mangalam Birla, the Group has

sustained and established a leadership position in its key businesses through

continuous value-creation. Spearheaded by Grasim, Hindalco, Aditya Birla Nuvo,

Indo Gulf Fertilisers and companies in Thailand, Malaysia, Indonesia, the Philippines

and Egypt, the Aditya Birla Group is a leader in a swathe of products — viscose

staple fibre, aluminium, cement, copper, carbon black, palm oil, insulators, garments.

And with successful forays into financial services, telecom, software and BPO, the

Group is today one of Asia's most diversified business groups.

Board of Directors

:: Mr. Kumar Mangalam Birla, Chairman

:: Mrs. Rajashree Birla

:: Mr. R. C. Bhargava

:: Mr. G. M. Dave

:: Mr. N. J. Jhaveri

:: Mr. S. B. Mathur

:: Mr. V. T. Moorthy

:: Mr. O. P. Puranmalka

:: Mr. S. Rajgopal

:: Mr. D. D. Rathi

:: Mr. S. Misra, Managing Director

Executive President & Chief Financial Officer

:: Mr. K. C. Birla

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Chief Manufacturing Officer

:: R.K. Shah

Chief Marketing Officer

:: Mr. O. P. Puranmalka

Company Secretary

:: Mr. S. K. Chatterjee

Our vision

"To actively contribute to the social and economic development of the

communities in which we operate. In so doing, build a better, sustainable way of

life for the weaker sections of society and raise the country's human development

index."

— Mrs. Rajashree Birla, Chairperson,

The Aditya Birla Centre for Community Initiatives and Rural Development

Awards won

Year Award

2011-2012ASSOCHAM CSR Excellence Award for its "truly outstanding"

CSR activities

2010-2011 Subh Karan Sarawagi Environment Award

2010-2011 Business World FICCI-SEDF CSR Award

2010 Greentech Environment Excellence Gold Award

2010 IMC Ramkrishna Bajaj National Quality Award

2010 Asian CSR Award

2009-2010 National Award for Prevention of Pollution

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2009-2010 Rajiv Gandhi Environment Award for Clean Technology

2009-2010 State Level Environment Award (Plant)

Making a difference

Before Corporate Social Responsibility found a place in corporate lexion, it was

already textured into our Group's value systems. As early as the 1940s, our founding

father Shri G.D Birla espoused the trusteeship concept of management. Simply stated,

this entails that the wealth that one generates and holds is to be held as in a trust for

our multiple stakeholders. With regard to CSR, this means investing part of our

profits beyond business, for the larger good of society.

While carrying forward this philosophy, his grandson, Aditya Birla weaved in the

concept of 'sustainable livelihood', which transcended cheque book philanthropy. In

his view, it was unwise to keep on giving endlessly. Instead, he felt that channelising

resources to ensure that people have the wherewithal to make both ends meet would

be more productive. He would say, "Give a hungry man fish for a day, he will eat it

and the next day, he would be hungry again. Instead if you taught him how to fish, he

would be able to feed himself and his family for a lifetime."

Taking these practices forward, our chairman

Mr. Kumar Mangalam Birla institutionalised the concept of triple bottom line

accountability represented by economic success, environmental responsibility and

social commitment. In a holistic way thus, the interests of all the stakeholders have

been textured into our Group's fabric.

The footprint of our social work today straddles over 3,700 villages, reaching out to

more than 7 million people annually. Our community work is a way of telling the

people among whom we operate that We Care.

Our strategy:

Our projects are carried out under the aegis of the "Aditya Birla Centre for

Community Initiatives and Rural Development", led by Mrs. Rajashree Birla. The

Centre provides the strategic direction, and the thrust areas for our work ensuring

16

performance management as well.

Our focus is on the all-round development of the communities around our plants

located mostly in distant rural areas and tribal belts. All our Group companies —-

Grasim, Hindalco, Aditya Birla Nuvo, Indo Gulf and UltraTech have Rural

Development Cells which are the implementation bodies.

Projects are planned after a participatory need assessment of the communities around

the plants. Each project has a one-year and a three-year rolling plan, with milestones

and measurable targets. The objective is to phase out our presence over a period of

time and hand over the reins of further development to the people. This also enables

us to widen our reach. Along with internal performance assessment mechanisms, our

projects are audited by reputed external agencies, who measure it on qualitative and

quantitative parameters, helping us gauge the effectiveness and providing excellent

inputs.

Our partners in development are government bodies, district authorities, village

panchayats and the end beneficiaries -- the villagers. The Government has, in their 5-

year plans, special funds earmarked for human development and we recourse to many

of these. At the same time, we network and collaborate with like-minded bilateral and

unilateral agencies to share ideas, draw from each other's experiences, and ensure that

efforts are not duplicated. At another level, this provides a platform for advocacy.

Some of the agencies we have collaborated with are UNFPA, SIFSA, CARE India,

Habitat for Humanity International, Unicef and the World Bank.

Our focus areas:

Our rural development activities span five key areas and our single-minded goal here

is to help build model villages that can stand on their own feet. Our focus areas are

healthcare, education, sustainable livelihood, infrastructure and espousing social

causes.

The name “Aditya Birla” evokes all that is positive in business and in life. It

exemplifies integrity, quality, performance, perfection and above all character.

17

Our logo is the symbolic reflection of these traits. It is the cornerstone of our

corporate identity. It helps us leverage the unique Aditya Birla brand and endows us

with a distinctive visual image.

Depicted in vibrant, earthy colours, it is very arresting and shows the sun rising over

two circles. An inner circle symbolising the internal universe of the Aditya Birla

Group, an outer circle symbolising the external universe, and a dynamic meeting of

rays converging and diverging between the two.

Through its wide usage, we create a consistent, impact-oriented Group image. This

undoubtedly enhances our profile among our internal and external stakeholders.

Our corporate logo thus serves as an umbrella for our Group. It signals the common

values and beliefs that guide our behaviour in all our entrepreneurial activities. It

embeds a sense of pride, unity and belonging in all of our 130,000 colleagues

spanning 25 countries and 30 nationalities across the globe. Our logo is our best

calling card that opens the gateway to the world.

Group companies:

:: Grasim Industries Ltd.

:: Hindalco Industries Ltd.

:: Aditya Birla Nuvo Ltd.

:: UltraTech Cement Ltd.

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GROUP COMPANIES:

Indian companies:

:: Aditya Birla Minacs IT Services Ltd.

:: Aditya Birla Minacs Worldwide Limited

:: Essel Mining & Industries Ltd

:: Idea Cellular Ltd.

:: Aditya Birla Insulators

:: Aditya Birla Retail Limited

:: Aditya Birla Chemicals (India) Limited

International companies:

Thailand

:: Thai Rayon

:: Indo Thai Synthetics

:: Thai Acrylic Fibre

:: Thai Carbon Black

:: Aditya Birla Chemicals (Thailand) Ltd.

:: Thai Peroxide

Philippines

:: Pan Century Surfactants Inc.

Indonesia

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:: PT Indo Bharat Rayon

:: PT Elegant Textile Industry

:: PT Sunrise Bumi Textiles

:: PT Indo Liberty Textiles

:: PT Indo Raya Kimia

Egypt

:: Alexandria Carbon Black Company S.A.E

:: Alexandria Fiber Company S.A.E

China

:: Liaoning Birla Carbon

:: Birla Jingwei Fibres Company Limited

:: Aditya Birla Grasun Chemicals (Fangchenggang) Ltd.

Canada

:: A.V. Group

Australia

:: Aditya Birla Minerals Ltd.

Laos

:: Birla Laos Pulp & Plantations Company Limited

North and South America, Europe and Asia

:: Novelis Inc.

Singapore

:: Swiss Singapore Overseas Enterprises Pte Ltd. (SSOE)

Joint ventures

:: Birla Sun Life Insurance Company

:: Birla Sun Life Asset Management Company

:: Aditya Birla Money Mart Limited

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UltraTech is India's largest exporter of cement clinker. The company's production

facilities are spread across eleven integrated plants, one white cement plant, one

clinkerisation plant in UAE, fifteen grinding units, and five terminals — four in India

and one in Sri Lanka. Most of the plants have ISO 9001, ISO 14001 and OHSAS

18001 certification. In addition, two plants have received ISO 27001 certification and

four have received SA 8000 certification. The process is currently underway for the

remaining plants. The company exports over 2.5 million tonnes per annum, which is

about 30 per cent of the country's total exports. The export market comprises of

countries around the Indian Ocean, Africa, Europe and the Middle East. Export is a

thrust area in the company's strategy for growth.

UltraTech's products include Ordinary Portland cement, Portland Pozzolana cement

and Portland blast furnace slag cement.

Ordinary Portland cement

Portland blast furnace slag cement

Portland Pozzolana cement

Cement to European and Sri Lankan norms

Ordinary Portland cement:

Ordinary portland cement is the most commonly used cement for a wide range of

applications. These applications cover dry-lean mixes, general-purpose ready-mixes,

and even high strength pre-cast and pre-stressed concrete.

Portland blast furnace slag cement:

Portland blast-furnace slag cement contains up to 70 per cent of finely ground,

21

granulated blast-furnace slag, a nonmetallic product consisting essentially of silicates

and alumino-silicates of calcium. Slag brings with it the advantage of the energy

invested in the slag making. Grinding slag for cement replacement takes only 25 per

cent of the energy needed to manufacture portland cement. Using slag cement to

replace a portion of portland cement in a concrete mixture is a useful method to make

concrete better and more consistent. Portland blast-furnace slag cement has a lighter

colour, better concrete workability, easier finishability, higher compressive and

flexural strength, lower permeability, improved resistance to aggressive chemicals

and more consistent plastic and hardened consistency.

Portland Pozzolana cement:

Portland pozzolana cement is ordinary portland cement blended with pozzolanic

materials (power-station fly ash, burnt clays, ash from burnt plant material or silicious

earths), either together or separately. Portland clinker is ground with gypsum and

pozzolanic materials which, though they do not have cementing properties in

themselves, combine chemically with portland cement in the presence of water to

form extra strong cementing material which resists wet cracking, thermal cracking

and has a high degree of cohesion and workability in concrete and mortar.

"As a Group we have always operated and continue to operate our businesses as

Trustees with a deep rooted obligation to synergise growth with responsibility."

— Mr Kumar Mangalam Birla, Chairman, Aditya Birla Group

The cement industry relies heavily on natural resources to fuel its operations. As these

dwindle, the imperative is clear — alternative sources of energy have to be sought out

and the use of existing resources has to be reduced, or eliminated altogether. Only

then can sustainable business be carried out, and a corporate can truly say it is

contributing to the preservation of the environment.

UltraTech takes its responsibility to conserve the environment very seriously, and its

eco-friendly approach is evident across all spheres of its operations. Its major thrust

has been to identify alternatives to achieve set objectives and thereby reduce its

carbon footprint. These are done through:

:: Waste management

22

:: Energy management

:: Water conservation

:: Biodiversity management

:: Afforestation

:: Reduction in emissions

Importantly, UltraTech has set a target of 2.96 per cent reduction in CO2 emission

intensity, at a rate of 0.5 per cent annually, up to 2015-16, with 2009-10 as the

baseline year. This will also include CO2 emissions from the recently acquired ETA

Star Cement and upcoming projects.

Ourstrategy:

Our projects are carried out under the aegis of the "Aditya Birla Centre for

Community Initiatives and Rural Development", led by Mrs. Rajashree Birla. The

Centre provides the strategic direction, and the thrust areas for our work ensuring

performance management as well.

Our focus is on the all-round development of the communities around our plants

located mostly in distant rural areas and tribal belts. All our Group companies —-

Grasim, Hindalco, Aditya Birla Nuvo and UltraTech have Rural Development Cells

which are the implementation bodies.

Projects are planned after a participatory need assessment of the communities around

the plants. Each project has a one-year and a three-year rolling plan, with milestones

and measurable targets. The objective is to phase out our presence over a period of

time and hand over the reins of further development to the people. This also enables

us to widen our reach. Along with internal performance assessment mechanisms, our

projects are audited by reputed external agencies, who measure it on qualitative and

quantitative parameters, helping us gauge the effectiveness and providing excellent

inputs.

23

Our partners in development are government bodies, district authorities, village

panchayats and the end beneficiaries — the villagers. The Government has, in their 5-

year plans, special funds earmarked for human development and we recourse to many

of these. At the same time, we network and collaborate with like-minded bilateral and

unilateral agencies to share ideas, draw from each other's experiences, and ensure that

efforts are not duplicated. At another level, this provides a platform for advocacy.

Some of the agencies we have collaborated with are UNFPA, SIFSA, CARE India,

Habitat for Humanity International, Unicef and the World Bank.

Our vision:

"To actively contribute to the social and economic development of the

communities in which we operate. In so doing, build a better, sustainable way of

life for the weaker sections of society and raise the country's human development

index."

— Mrs. Rajashree Birla, Chairperson,

The Aditya Birla Centre for Community Initiatives and Rural Development

Making a difference:

Before Corporate Social Responsibility found a place in corporate lexicon, it was

already textured into our Group's value systems. As early as the 1940s, our founding

father Shri G.D Birla espoused the trusteeship concept of management. Simply stated,

this entails that the wealth that one generates and holds is to be held as in a trust for

our multiple stakeholders. With regard to CSR, this means investing part of our

profits beyond business, for the larger good of society.

While carrying forward this philosophy, our legendary leader, Mr. Aditya Birla,

weaved in the concept of 'sustainable livelihood', which transcended cheque book

philanthropy. In his view, it was unwise to keep on giving endlessly. Instead, he felt

that channelising resources to ensure that people have the wherewithal to make both

ends meet would be more productive. He would say, "Give a hungry man fish for a

day, he will eat it and the next day, he would be hungry again. Instead if you taught

him how to fish, he would be able to feed himself and his family for a lifetime."

24

Taking these practices forward, our chairman

Mr. Kumar Mangalam Birla institutionalised the concept of triple bottom line

accountability represented by economic success, environmental responsibility and

social commitment. In a holistic way thus, the interests of all the stakeholders have

been textured into our Group's fabric.

The footprint of our social work today spans 2,500 villages in India, reaching out to

seven million people annually. Our community work is a way of telling the people

among whom we operate that We Care.

QUALITY :

Six strong benefits that make 43, 53 Grade, Super fine, Premium and Shakti

the ideal cement

Higher compressive strength.

Better soundness.

Lesser consumption of cement for M-20 Concrete Grade and above.

Faster de shuttering of formwork.

Reduced construction time with a superior and wide range of cement catering

to every conceivable building need, ULTRA TECH CEMENTS is a

formidable player in the cement market.

Here just a few reasons why ULTRA TECH CEMENTS chosen by millions of

India.

Ideal raw material

Low lime and magnesia content and high proportion of silicates.

Greater fineness.

25

CHAPTER-III

LITERATURE REVIEW

26

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.

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

27

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.,

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

28

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.

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.

29

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.

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

30

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.

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:

31

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.

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.

32

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.

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.

33

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:

34

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:

35

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.

36

1. Increase revenue.

2. Reduce costs.

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

37

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.

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.

38

CAPITAL BUDGETING METHODS

TRADITIONAL DISCOUNTED CAHS FLOW

METHOD METHOD

PLAY BACK ACCOUNTING RATE

PERIOD OF RETURN

INTERNAL RATE

OF RETURN

NET PRESENT VALUE

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

39

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,

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

40

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

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:

41

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 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.

42

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 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

43

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.

44

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.

45

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.

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

46

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:

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

47

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

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

48

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.

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.

49

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.

Yet another useful way to classify investments is as follows:

Mutually exclusive investments

50

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.

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)

51

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.

1. Discounted cash flow criteria

Net present value(NPV)

Internal rate return(IRR)

52

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.

53

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,

54

IRR overstates returns. IRR is best used for projects with singular positive cash flows

at the end of the project period.

Profitability index

Yet another time adjusted method of evaluating the investment proposals is

the benefit-cost (B/C) ratio or profitability index. Profitability index is the ratio of the

present value of cash inflows at the required rate of return, to the initial cash out flow

of the investment.

Evaluation of PI method

Like the NPV and IRR rules, PI is a conceptually sound method of arising

investment projects. It is a variation of the NPV method and requires the same

computations as the NPV method.

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

55

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 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,

56

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 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.

57

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.

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

58

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 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.

59

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:

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:

60

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:

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.

61

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

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:

62

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

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?

63

In order to choose the project, management needs some hurdles:

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

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

64

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

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.

65

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.

66

CHAPTER-IV

DATA ANALYSES AND INTERPRETATION

67

FINACIAL ANALYSIS:

ANALYSIS OF ULTRATECH CEMENTS LIMITED

YearsTotal

sales

Total

assets

Fixed

assets

Net

Profit

Capital

Employed

Long

term

funds

Share

holders’

Funds

2007-

20085512.43 4437.49

3120.00

1007.6

1 1173.21982.66 124.49

2008-

20096385.50 5743.73

4365.38977.02

2289.361175.80

124.49

2009-

20107042.82 6213.17

4716.99

1093.2

4 3232.23854.19

124.49

2010-

2011

13205.6

4

14810.6

4

10890.3

3

1404.2

3 4145.562789.76

274.04

2011-

2012

18270.6

9

16667.9

5

12166.1

3

2446.1

9 2812.992012.09

274.07

TRADITIONAL CAPITAL BUDGETING APPRISAL METHODSRELATED TO RDTK Project

1.PAY BACK PERIOD METHOD:

Payback period method is a traditional method of evaluation of capital

budgeting decision. The term payback or pay out or payoff refers to the period in

which the project will generate the necessary cash and recoup the initial investment or

the cash out flows.

To calculate the pay period, the cumulative cash flows will be calculated

and by using interpolation the exact period may be calculated.

68

The Kesoram Cements limited has Rs. 7683.708 lacks of initial

investment and the annual cash flows for the years 2006 to 2010. Then the payback

period is calculated as follows:

CALCULATION OF PAY BACK PERIOD OF Heritage Foods (India) Limited

(Rs. In crorers)SI .NO YEAR CASH INFLOW CUMULATIVE

CASH FLOWWS

1 2007-2008 1244.84 1244.84

2 2008-2009 1300.02 2544.86

3 2009-2010 1481.32 4026.18

4 2010-2011 2169.96 6196.14

5 2011-2012 3348.75 9544.89

The above table shows that, the initial investment RS.2687.87 Cr… lies between

second and third years with Rs. 2544.86 and 4026.18 Cr

Difference in cash flowsPBP = Actual (Base) year + ---------------------------------- Next year cash flows

1481.32PBP = 2 + ------------- 6196.14

= 2 + 0.23

= 2.239 year

Payback period (PBP) = 2.239 year.

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ACCEPT-REJECT CRITERION:

PBP can be used as a criterion to accept or reject an investment

proposal. A proposal whose actual payback period is more than what is pre-

determined by the management.

PBP thus, is useful for the management to accept the investment

decision on the Heritage Foods (India) Limited and also to assist the management to

know that the initial investment is recovered in 1.1884years.

II. ACCOUNTING OR AVERAGE RATE OF RETURN METHOD:

It is another traditional method of capital budgeting evaluation.

According to this method the capital investment proposals are judged on the basis of

their relative profitability. The capital employed and related incomes are determined

according to the commonly accepted accounting principles and practices over the

certain life of project and the average yield is calculated. Such a rate is called the

accounting rate of return or the average return or ARR.

It may be calculated according to any one of the following methods:

(i) Annual average net earnings---------------------------------- X 100

Original investment

(ii) Annual average net earnings----------------------------------- X 100 Average investment

(iii) Increase in expected future annual net earnings ----------------------------------------------------------- X 100 Initial increase in required investment

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The term average annual net earnings are the average of the earnings after

depreciation and tax. Over the whole of the economic life of the project order and

these giving on ARR above the required rate may be accepted.

The amount of average investment can be calculated according to any of the

following methods:

(a) Original investment------------------------

2

(b) Original investment +scrap value------------------------------------------

2

(c) Original investment +scrap value + net additional + scrap value Working capital ---------------------------------------------------------------------------------

2

Cash flows of the Ultratech cements Limited are shown in cash flow statement. ARR is calculated as follows:

Statement showing calculation of ARR \ (Rs. In lakes)

YEARS EARNINGS AFTER TAX (EAT)

2007-2008 1244.84

2008-2009 1300.02

2009-2010 1481.32

2010-2011 2169.96

2011-2012 3348.75

TOTAL 9544.89

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Average annual EAT’S ARR = ------------------------------- x 100 Average investment

Total amount Average Annual EAT’S = ---------------------

No.of years

9544.89 = ------------------ = 1908.97 5

Average investment =1908.97

9544.89ARR = ---------------- X 100 = 50.02 % 1908.97

Average Rate of Return = 50.02 %

ACCEPT-REJECT critters method allows Ultratech cements Limited to fix a

minimum rate of return. Any project expected to give a return below it will be straight

away rejected. The average rate of return is as good as 50.02 % of ultratech cements

Limited depicts the prospects of management efficiency.

TIME ADJUSTED (OR) DISCOUNTED CASH FLOW METHOD:

The time adjusted or discounted cash flow methods take into accounts the

profitability time value of money. These methods are also called the modern methods

of capital budget

1.NET PRESENT VALUE METHOD: (NPV)

72

Net present value method or NPV is one of the discounted cash flows

methods. The method is considered to be one of the best of evaluating the capital

investment proposals. Under this method cash inflows and outflows associated with

each project are first calculated.

ROLE OF DISCOUNTING FACTOR:

The cash inflows and out flows are converted to the present values using discounting

factor which is the actuary discount factor of Regulated display tool kit project of

Kesoram cements limited is 10%.

The rate of return is considered as cut off rate or required rate or rate generally

determined on the basis of cost of capital to allow for the risk element involved in the

project.

STEPS FOR CALCULATION OF NPV:

1) Calculation of each cash flows after taxes of three years, which is arrived

at by deducting depreciation, interest and tax from earning before tax and

interest (EBIT). This residue is profit after tax to arrive at cash flow after

tax.

2) This cash flow after tax are multiplied with the values obtained from the

Table (the present value annuity table against the 8% actuary discount

Rate i.e. in the case of project.

3) NPV is derived by deducting the sum of present values from the initial

Investment.

4) Initial investments are the sum of cash flows of three years shown in

Capital expenditure table

Let us assume the discount rate be 10%:

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YEARS CFAT’S PVIF @ 10% PV’S

2007-2008 1244.840.909

1131.55

2008-2009 1300.02 0.8261073.81

2009-2010 1481.32 0.7511112.47

2010-2011 2169.96 0.6831482.08

2011-2012 3348.75 0.6202076.22

TOTAL: 6876.13

LESS: Initial Investment: 2687.87

NPV: 4188.26

ACCEPT-REJECT CRITERION:

The accept -reject decision of NPV is very simple. If the NPV is positive then the

project should be accepted and if NPV is negative then the project should be rejected

i.e .If NPV > 0 (ACCEPT)

and NPV < 0 (REJECT)

Hence in the case of Ultratech cements Limited project it is visible that the positive

NPV shows the acceptance and importance of the project.

1.INTERNAL RATE OF RETURN METHOD: (IRR)

The internal rate of return method is also a modern technique of capital

budgeting that takes into account the time value of money. It is also known as

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“TIME ADGUSTED RATE OF RETURN”, “DISCOUNTED CASH FLOW”,

“DISCOUNTED RATE OF RETURN”, “YIELD METHOD” and “TRAIL AND

ERROR YIELD METHOD”.

IRR is the rate the sum of discounted cash inflows equals the sum of discounted cash

outflows. It equals the present value of cash inflow to present value of cash outflows.

In this method discount rate is not known, but the cash

inflows and cash out flows are known. It is the rate of return, which equates the

present value of cash inflows to out flows or it, is the rate of return, which

renders NPV TO ZERO.

STEPS INVOLVED IN THE CALCULATION OF IRR:

1) Calculation of NPV with given discount rate

2) Calculation of NPV with assumed discount rate

3) Select the higher NPV of both

4) Let R be the higher discount rate

5) Let R1 be the difference of discount rates

6) Calculation of difference of P Vs (Always higher NPV-lower NPV)

Higher NP IRR= R + ---------------------------- XR1

Difference of P V s.

8) Decision making(Accepting- Rejecting the proposal)

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FORMULATION OF STEPS:

STATEMENT OF SHOWING CALCULATION NPV @88%,89%,90% UNDER IRR METHOD ( Rs corers)

YEARS Annual CFA Ts

Discount Discount DiscountRate-88% Rate-89% Rate-90%PVF PV PVF PV PVF PV

2007-20081244.8

4

0.531 661.01 0.529 658.52 0.526 654.78

2008-20091300.0

2

0.2921 379.73 0.2799 362.87 0.277 360.10

2009-20101481.3

2

0.1579 223.90 0.1481 219.38 0.145 214.79

2010-20112169.9

6

0.0858 186.18 0.0783 169.90 0.076 164.91

2011-20123348.7

5

0.0461 154.37 0.0414 138.63 0.04 133.95

1605.19 1550.3 1528.53

From the above calculations the following can be observed.

PV 0f net cash flows at 88% is: 1602.19crPV 0f net cash flows at 89% is: 1548.98 cr

DECISION:

Since the initial investment RS.2687.87 cr is lies between 75% and 80% the company APTDC can determine the IRR as 76.51% Hence IRR=76.51%

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ACCEPT-REJECT CRITERION:

IRR is the maximum rate of interest, which an organization can afford to pay on

capital, invested in, is accepted if IRR exceeds the cutoff rates and rejected if it is

below the cutoff rate.

The cutoff rate of ultratech Limited is 10%, which is less than the IRR i.e 76.51%

hence the acceptance of ultratech Limited is quiet a good investment decision taken

by management.

3. PROFITABILITY INDEX: (BCR OR PI)

Profitability index method is also known as time adjusted method of

evaluating the investment proposals. Profitability also called as benefit cost ratio (B\

C) in relationship between present value of cash inflows and the present value of cash

out flows. Thus

Present value of cash inflows

Profitability index = -------------------------------------- Present value of cash outflows.

(OR)

Present value of cash inflows Profitability index = - ---------------------------------------- Initial cash outlay

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CALCULATIONS OF BCR:

STEP1: Calculations of cash flows after taxes

STEP2: Calculations of Present values of cash inflows @10%.

STEP3: Application of the formula.

Statement for calculating of benefit cost ratio

YEARS CFAT’S PVIF @ 10% PV’S

2007-2008 1244.84 0.909 1131.55

2008-2009 1300.02 0.826 1073.81

2009-2010 1481.32 0.751 1112.47

2010-2011 2169.96 0.683 1482.08

2011-2012 3348.75 0.620 2076.22

TOTAL: 6876.13

YEARS CFAT’S PVIF @ 10% PV’S

2007-2008 1244.84 0.909 1131.55

2008-2009 1300.02 0.826 1073.81

2009-2010 1481.32 0.751 1112.47

2010-2011 2169.96 0.683 1482.08

2011-2012 3348.75 0.620 2076.22

TOTAL: 6876.13

Present value of cash inflows Profitability index = -------------------------------------- Initial Investment

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6876.13 = ------------------ = 2.55 2687.87 Hence PI = 3

ACCEPT-REJECT CRITERION:

There is a slight difference between present value index method and

profitability index method. Under profitability index method the present value of cash

inflows and cash outflows are taken as accept-reject decision.

I.e. the accept reject criterion is:

If Profitability Index > 1 (ACCEPT).

Profitability Index < 1 (REJECT).

The acceptance of by the management is evaluated through Profitability

Index method of as the PI > 1 (i.e.3years)

79

CHAPTER-V

FINDINGS

SUGGESSIONS

CONCLUSIONS

BIBLIOGRAPHY

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FINDINGS

The capital budgeting decision for Ultratech cements limited 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 of Ultratech cements limited recorded consistent fluctuations

from 1.24 (2007-2008) to 1.87 (2011-2012). The lowest recorded as 1.14

(2009-2010). This decline is an account of lower growth rates sales in those

years.

The fixed assets of Ultratech cements limited showing a fluctuating trend

and increased from 2.57 times (2007-2008) to 3.65 times (2011-2012). These

fluctuations any be due to fixed assets investment.

The fixed assets shows the fluctuating trends form 0.76 (2007-2008) to (2011-

2012) as 1.15 and the funds were required then continuously declined.

The fixed assets ratio of Ultratech cements limited as shown continuously

increasing from 0.58 (2006-2007) to 0.97 (2011-2012) as. There fluctuations

observed.

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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 Ultratech cements limited 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

As large sum of money is involved which influences the profitability of the firm

making capital budgeting an important task.

Long term investment once made cannot be reversed without significance loss of

invested capital. The investment becomes sunk and mistakes, rather than being readily

rectified, must often be born until the firm can be withdrawn through depreciation

charges or liquidation. It influences the whole conduct of the business for the years to

come.

Investment decision are the base on which the profit will be earned and probably

measured through the return on the capital. A proper mix of capital investment is

quite important to ensure adequate rate of return on investment, calling for the need of

capital budgeting.

The implication of long term investment decisions are more extensive than those

of short run decisions because of time factor involved, capital budgeting decisions are

subject to the higher degree of risk and uncertainty than short run decision.

83

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

Web Sites:

http\\:www.google.com

http\\:www.ultratech.co.in

http\\:www.googlefinance.com

http://www.investopedia.com

http://www.zenwealth.com

http://www.cliffnotes.com

http://www.capitalbudgetingtechniques.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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