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SUMMER TRAINING REPORT

“A STUDY ON CAPITAL BUDGETING DECISION”


on

“GRASIM BHIWANI TEXTILES LTD. BHIWANI”


Submitted in the partial fulfillment for the award of the degree of
MASTER OF BUSINESS ADMINISTRATION

Submitted to:- Submitted by:-


Mr. Mohit Rewari Sunil
Asst. Professor MBA 3rd sem
Roll No-16000102014

SESSION: 2017-2018

DEPARTMENT OF MANAGEMENT
CH. BANSI LAL UNIVERSITY, BHIWANI
Established by the Government of Haryana under Act No. 25 of 20

CH. BANSI LAL UNIVERSITY, BHIWANI


DEPARTMENT OF MANAGEMENT

CBLU/MBA/2017/……………. DATE:-

DECLARATION

I, Sunil Roll No 16000102014 class MBA of the Department of Management, Ch.


Bansi Lal University, Bhiwani hereby declare that the Summer Training Report
entitled “capital budgeting decision” is an original work and the same has not
been submitted to any other Institute for the award of any other degree. A
presentation of the Summer Training Report was made and the suggestions as
approved by the faculty were duly incorporated.

(Sunil kumar)

Signature of faculty

Countersigned

In-charge, MBA
ACKNOWLEDGEMENT

The project of this nature is arduous task stretching over a period of time and takes
the effort and co-operation of many person. Although this project report is being
brought in my name, it bears an in print of guidance and co-operation of many person.
The contribution made by such person is immeasurable.

First of all I want to express my thanks to management for giving me this


opportunity to work with this esteemed organization. My special and heartly thanks to
Mr. SURESH SARAF, (FINANCE MANAGER), who gave me the opportunity to
complete my summer project at Bhiwani Textile Mill, Bhiwani (Haryana), A unit of
GRASIM INDUSTRY. And also thanks to render me help and advice during the entire
course of training.
I also express my sincere gratitude to all officers and employees to tender their
support during the time of training.
Further I don’t know how to express my grateful appreciation to my parents who
always inspires me towards my goals.

(sunil kumar)
PREFACE

Practical work experience is the integral part of individual learning. An individual who is
learning managerial concepts has to undergo this practical experience for being a future
executive.

aster of Business Administration is a two-year programme that inserts management


knowledge in an individual to make that individual completely professional for which
practical experience is must.

BHIWANI TEXTILE MILL (GRASIM INDUSTRY). is the market leader in Textile


industry. BTM offered me a project on “Working Capital Management” to understand the
current position through dates provided by them.

(Sunil kumar)
CONTENTS

1. INDUSTRY PROFILE

2. COMPANY PROFILE

3. INTRODUCTION TO THE TOPIC

4. OBJETIVES OF STUDY

5. LIMITATION

6. RESEARCH METHODOLOGY

7. DATA ANALYSIS

8. CONCLUSION AND SUGGESTIONS

9. BIBLIOGRAPHY

10. ANNEXURE

CAPITAL BUDGETING

Capital budgeting is tha process of choosing between alternative Investments/projetcts. This


can be both a quantitative and qualitative decisions,and certainly one that is of great
importance to firms of all sizes.The projects / investments
Evaluation methods we will consider are:
1. Net persent value(NPV)
2. Profitability Index (PI)
3. Internal Rate of return (IRR)
4. Playback period

In practices,most companies use more than one methods.By a large,NPV and


IRR are two of the most common.
Net Persent Value
Net present value of a project is the present value of net cash flows resulting from
it,discounted at the firms cost of capital,minus the projects net investment .
NPV=DCF-NINV, DCF is the presents value of all net cash flows,discounted at cost of
capital (required rate).
The net persent value of a projects represents that projects contribution to the firm value, and
therefore the increase in the wealth of shareholders due to it.If the project`s NPV is
positive,that mean the project will earn a return above the required rate, and is therefore
accepted .If the NPV is negative,the project earn less than the required rate.If NPV is equal
to zero, the firm earns just the required rate .The main advantage of using NS, is its
consistency with the share holder wealth maximization.Using NPV,we choose the project that
will contributre the most of the current value of the firm .
The main disadvantage of NPV is that ift favors large project over smaller ones. Imn other
worsds ,NPV is size based.

PROFIABILITY INDEX
Profitabily index is very similar to NPV.Both the methods discount per cash flows to the
present .It is also known as “ benefit costs ratio “.The index no. represents the “bong of the
buck “ of the project ,present value benefit for its dollar of initial investment .If PI is less
than one ,the project earns less than required rate and is rejected.If PI is equal to one the
projects earns just the required rate
PI=DCF/NINV
Note that :
1. When PI = 1,NPV=0
2. When PI > 1,NPV>0

When considering mutually exclusive project of different sizes, NPV methods should be
used , because the project that will contribute most to firm value must be selected. On the
other hand, when capital is scarce,and several independent projects are under consideration
,PI may be a good method. In that case ,using PI would guarantee that we do not over look
smaller, but profitable projects ,in favour of larger but less profitable projects.
Internal rate of return
The internal rate of return is defined as the rate which a projects discounted
net cash flows equal its net investment . As a matter of fact ,IRR for projects
–in most ways –is similar to YTM for bonds .
 When a projects NPV is equal to zero ,then its IRR is equal to the
required rate.
 When a project NPV is negative ,IRR is lower than the required
rate .
 When a project NPV is positive ,its IRR is greater the required rate

IRR is a very widely used method . Its main advantage is that it is easy to interpret . It gives
a percentage return for every project .This is easier to interpret than a dollar amount ,and
makes comparing project easier .If the IRR is more than or equal to required rate ,project is
accepted .Otherwise ,the project is rejected .
The main problem with IRR is that when caqsh flows are uneven ,it can be calculated only by
trial and error , or using a computer. Another disadvantage is that is assumeds that
intermediate cash flows are reinvestested at IRR , As opposed to the required rate .TThis is
not always a realistic assumtions .

Payback period
PB is the amount of time until cumulative net cash flow from a project equal initial
investments. For example, a projects with $50000 initial investments generates $20k in the
first year ,$10k per year for the next five years. The payback period would than be 4 years,
because the sum of all cash flows in the first 4 years equals the initials investments.
PB is hardly ever used as the main criterion for the capital budgeting decisions. Its main
advantages is that it gives an estimateof the amount of time it will take the projects to free up
the initial investments that was laid out for it. This may be important if financial manager is
concerned with liquidity of the firm. The main disadvantage is that it gives equak weight to
all cash flows,regardless of when they are generated .Another disadvantage is that it
essentially ignores all cash flows tjhat will be generated after the payback period.

INDUSTRY PROFILE

ABOUT TEXTILE INDUSTRY

The history of textile is as old as human civilization itself. Initially used for protection against
nature, textile was required increasingly it satisfy men’s aesthetic need for color and
ornamentation in his apparel surroundings.

The transition from the purely functional to the decorative use of textile has been
accompanied by a shift in the manufacture of textile from the highly individualization and
specialization cottage craft to a mechanized and large scale operation. The creative genius of
many person from all walks of life has contributed to this evolution. These change are closely
interlaced with event in other spheres. In the story of mankind, Breath taking invention have
been made, was fought, international rivalries generated, punitive laws passed &personal
triumphs & tragedies enacted, the textile industries has been the cause of some shapes and
has been shaped by others.

TEXTILE INDUSTRY IN INDIA

India has very large textile industry, one of the largest in the world. It is largest organized
industry in India. The Textile industry in India traditionally, after agriculture is the only
industry that has generated huge employment for both skilled and unskilled labor in textiles.
The textile industry continues to be the second largest employment generating sector in India.
It offers direct employment to over 35 million in the country. The share of textiles in total
exports was 11.04% during April–July 2010, as per the Ministry of Textiles. During 2009-
2010, Indian textiles industry was pegged at US$55 billion, 64% of which services domestic
demand. In 2010, there were 2,500 textile weaving factories and 4,135 textile finishing
factories in all of India.

The industry presents an interesting picture of coexistence of four sectors. Which are
khadi handlooms, power looms and organized mills, and cotton textiles, is the source of raw
material for all these industrial firms? Presently the value of cotton textile made in the
country me more than Rs. 3,500 crore per annum. The consumption has been shifting
consistently towards modern blended dyed and printed goods. In general there has an upward
shift in clothing taste and consumers now prefer good quality and durable products. This has
promoted several entrepreneurs in textile industry to change their product mix.

Textile constitutes an important sector in India's exports. Textile and garments are the
single largest category of products exported from garment export industry in particular is
showing penman growth year after year. Realizing its export significance and employment
potential, the government delicensed the cotton textile industry including power looms.

Encouragement to export of cotton textile and garments became an important part of the new
policy. Under new policy sophist Ted garment manufacturing machines, which not
manufactured in India, are now allowed to be important under the open general license
(OGL) Moreover, the new policy has allowed large firms to setup garment-manufacturing
units, provided they export 50% of their production.

History :-

The archaeological surveys and studies have found that the people of Harrapan Civilization
knew weaving and the spinning of cotton four thousand years ago. There was textile trade in
India during the early centuries. A block printed and resist-dyed fabrics, whose origin is from
Gujarat is found in tombs of Fostat, Egypt.
This proves that Indian export of cotton textiles to the Egypt or the Nile Civilization in
medieval times were to a large extent. Large quantity of north Indian silk were traded through
the silk route in China to the western countries.
The Indian silk were often exchanged with the western countries for their spices in the barter
system. During the late 17th and 18th century there were large export of the Indian cotton to
the western countries to meet the need of the European industries during industrial
revolution..
There was also export of Indian silk, Muslin cloth of Bengal, Bihar and Orissa to other
countries by the East Indian company. Bhilwara is known as textile city.

Production in Decentralised sector :-


 Man Made Fibers: These includes manufacturing of clothes using fiber or filamen
synthetic yarns. It is produced in the large power loom factories. They account for the
largest sector of the textile production in India. This sector has a share of 62% of the
India's total production and provides employment to about 4.8 million people.

 The Cotton Sector: It is the second most developed sector in the Indian Textile
industries. It provides employment to huge amount of people but its productions and
employment is seasonal depending upon the seasonal nature of the production.

 The Handloom Sector: It is well developed and is mainly dependent on the SHGs
for their funds. Its market share is 13% of the total cloth produced in India.
 The Woolen Sector: India is the 7th largest producer of the wool in the world. India
also produces 1.8% of the world's total wool.
 The Jute Sector: The jute or the golden fiber in India is mainly produced in the
Eastern states of India like Assam and West Bengal. India is the largest producer of
jute in the world.
 Silk Sector: India is the 2nd largest producer of silk in the world. India produces
18% of the world's total silk. Mulberry, Eri, Tasar, and Muga are the main types of
silk produced in the country. It is a labor-intensive sector.

The Advisory Boards :-

 All India Handlooms Board


 All India Handicrafts Board
 All India Power looms Board
 Advisory Committee under Handlooms Reservation of Articles for Production
 Co-ordination Council of Textiles Research Association
The Textile Research Associations :-
 South India Textiles Research Association (SITRA), Coimbatore
 Ahmedabad Textiles Industry’s Research Association
 Bombay Textiles Research Association, Mumbai
 Indian Jute Industries Research association, Kolkata
 Man-made Textiles Research Association, Surat
 Synthetic and art silk –Mills Research Association, Mumbai
 Wool Research Association, Thane
COMPANY PROFILE

ADITYA BIRLA GROUP PROFILE

US$ 29 billion corporation, the Aditya Birla Group is in the League of Fortune 500. It is
anchored by an extraordinary force of 130,000 employees, belonging to 30 different
nationalities. In the year 2009, the Group was ranked among the top six great places for
leaders in the Asia-Pacific region, in a study conducted by Hewitt Associates, RBL Group
and Fortune magazine. In India, the Group has been adjudged the best employer in India and
among the top 20 in Asia by the Hewitt-Economic Times and Wall Street Journal Study
2007.

Over 60 per cent of the Group's revenues flow from its overseas operations. The Group
operates in 25 countries – India, UK, Germany, Hungary, Brazil, Italy, France, Luxembourg,
Switzerland, Australia, USA, Canada, Egypt, China, Thailand, Laos, Indonesia, Philippines,
Dubai, Singapore, Myanmar, Bangladesh, Vietnam, Malaysia and Korea.

Vision of Aditya Birla Group

“To be a premium global conglomerate with a clear focus on each business.”

2.2.1-GRASIM INDUSTRIES: AN INTRODUCTION

Grasim Industries Limited, a flagship company of the Aditya Birla


Group, ranks among India's largest private sector companies, with
consolidated net revenue of Rs 29324 crore (US$ 4.9 billion) and a
consolidated net profit of Rs.2017.54 crore (FY2015).
Grasim was incorporated on 25 August 1947, exactly 10 days after India achieved
Independence. Grasim is more than an Industrial enterprise. It is the symbol of INDIA surge
for economic and industrial liberation. Grasim is world largest Producer of viscose staple
fiber, edible oil, and textile production. Starting as a textiles manufacturer in 1948, Since
then Grasim has diversified into Viscose Staple Fiber(VSF), cement, sponge iron and
chemicals. today Grasim's businesses comprise viscose staple fibre (VSF), cement, chemicals
and textiles. Its core businesses are VSF and cement, which contribute to over 90 per cent of
its revenues and operating profits.

The Aditya Birla Group is the world’s largest producer of VSF, commanding a 24 per cent
global market share. Grasim, with an aggregate capacity of 333,975 tpa has a global market
share of 11 per cent. It is also the second largest producer of caustic soda (which is used in
the production of VSF) in India.

In cement, Grasim along with its subsidiary UltraTech Cement Ltd. has a capacity of 49
million tpa and is a leading cement player in India. In July 2004, Grasim acquired a majority
stake and management control in UltraTech Cement Limited. One of the largest of its kind in
the cement sector, this acquisition catapulted the Aditya Birla Group to the top of the league
in India.
The cement business of the Group is being restructured in a phased manner. In the first phase,
Grasim's cement business is being demerged into Samruddhi Cement Limited, a subsidiary of
Grasim. In the second phase, Samruddhi Cement Limited will amalgamate with UltraTech.
Upon completion of restructuring, the cement business will be consolidated in UltraTech, a
pure play cement company.

HISTORY
Grasim Industries Limited was incorporated in 1948; Grasim is the largest exporter of
Viscose Rayon Fiber in the country, with exports to over 50 countries. Grasim is
headquartered in Nagda, Madhya Pradesh and also has a plant at Kharach ( Kosamba,
Gujarat) and Harihar, Davangere in the state of Karnataka.
Indo-Thai Synthetics Company Ltd was incorporated in 1969 in Thailand, started operations
in 1970, this was Aditya Birla Group's first foray into international venture. Aditya Birla
Group incorporated P.T. Elegant Textiles in 1973 in Indonesia. In late 1990s and later, the
focus was the textile business following the end of Multi-Fiber Arrangement (MFA). AV Cell
Inc., a joint venture between Aditya Birla Group and Tembec, Canada, established operations
in 1998 to produce softwood and hardwood pulp for the purpose of internal consumption
among different units of the Group.
Together, Aditya Birla Group and Tembec, Canada acquired AV Nackawic Inc., which
produces dissolving pulp. Grasim Industries Ltd. supplies Viscose Staple Fiber (VSP). The
Aditya Birla Group's VSF manufacturing plants are in Thailand, Indonesia, India and China.
The Group's VSF business operates through its three companies – Grasim Industries in India,
Thai Rayon Corporation in Thailand and Indo Bharat Rayon in Indonesia, which also
oversees its Chinese operations at Birla Jingwei Fibres, China.
In 2003, its Chemical Division was awarded the "Best of all" Rajiv Gandhi National Quality
Award.

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”.

Grasim Industries Limited:-

Type : Public company


Industry : Building materials
Founded : Mumbai(1948)
Headquarter : Mumbai, Maharashtra, India
Area : served Global
Key people : Kumar Mangalam Birla (Chairman )
Products : Fibre and pulp, chemicals, cement and textiles
Revenue : Rs 29324 crore (US$ 4.9 billion)(FY2015)
Net income : Rs.2017.54 crore (FY2015)
Total assets : Rs 47,746.60 crore (FY2015)
Employees : 1,20,000
Parent : Aditya Birla Group
Subsidiaries : Ultra Tech Cement Grasim Bhiwani Textiles
Website : www.grasim.com (http://www.grasim.com/)

2.2.2-MANAGEMENT TEAM OF GRASIM INDUSTRY


 BOARD OF DIRECTORS
Mr. Kumar Mangalam Birla - Chairman
Mrs. Rajashree Birla
Mr. M.L. Apte
Mr. B.V. Bhargava
Mr. R.C. Bhargava
Mr. Cyril Shroff
Dr. Thomas M. Connelly
Mr. N. Mohan Raj
Mr. Shailendra K. Jain
Mr. D.D. Rathi
Mr. K.K. Maheshwari, Managing Director
Mr. Adesh Kumar Gupta, Whole-Time Director

2.2.3-CHARACTERISTICS OF GRASIM INDUSTRIES


 Grasim was incorporated on 25 August 1947, exactly 10 days after India achieved
independence.

 Originally a textile manufacturer, Grasim has successfully diversified into VSF, cement
and chemicals.

  Aditya Birla Group is the world's largest producer of VSF

  The Aditya Birla Group is the ninth-largest cement producer in the world

  Second largest producer of caustic soda in India

  Fourth-largest producer of insulators in the world

  Grasim and Graviera range of fabrics signify the 'power of fashion'

 ISO 9002 and ISO 14001 Certified

2.2.4-MISSION OF GRASIM

1. Education for all: to secure them a brighter future.


2. Sustainable Livelihood: through training and education for skill
3. Health care and Hygienic living conditions.
4. Family Welfare
5. Restoring self esteem of the physically handicapped
6. Empowerment of Women
7. Community Development: holistic development of the community including
infrastructure
8. Espousal of social cause

2.3.1-GRASIM BHIWANI TEXTILES MILLS


The organization GRASIM BHIWANI TEXTILE MILLS is a unit of Grasim Industrial
Ltd. It’s head Office at “NAGDA (M.P.)” and working office at “BHIWANI”. This mill is
under dynamic leadership of Mr. KUMAR MANAGLAM BIRLA. It got ISO 9002 and
14001 for its quality and at present undertaking W.C.M. (World Class Manufacturing) in the
organization.
Bhiwani Textile Mill have been transferred to a subsidiary, Grasim Bhiwani Textiles Ltd.
w.e.f. 1st October, 2007. The move is aimed at enabling the new entity to have a more
focused approach to the development of textile business and pursue emerging growth
opportunities in the textile sector.
Grasim Bhiwani Textile Limited, bhiwani is engages in the manufacture and sale of textiles in
India.The company utilizes strong manufacturing facilities comprising of Fibre Dying , Yarn Spinning ,
Weaving , Processing and Folding with state-of-the-art machines , processes. The company sells its
products under the GRASIM & GRAVIERA brands through a network of dealers, agents, and retail
outlets. It also exports its fabric to various reputed brands.

The company is based in Bhiwani, India. Grasim Bhiwani Textiles Limited is a subsidiary of Grasim
Industries Limited.

History:-

The erstwhile Punjab cotton Mills at Bhiwani in Haryana was taken over by Grasim
Industries 1964. Subsiquently, its product mix was changed from cotton to polyester/ viscose
suiting. Today with a capacity of over 40,000 spindles of yarn and over 160 looms of fabric,
Bhiwani Textile Mills (BTM) caters to a large market in India. Its brand- Graviera Suiting- is
well-received in Middle East, South East Asia, Cyprus, latin America and Mauritius as well.
The first to introduce Synthetic Denims and Polyester Jute Suiting, the Unit intends to
diversify into fancy yarn spinning and blended design suiting using fibres like silk, cotton ,
flax and jute. A leader in Yarn and fabric - right from its inception- BTM's brands include
Adonis, and Sumo.
2.3.2-Grasim Bhiwani Textile Ltd. is equipped with:-
 World Class spindles.
 Dornier Looms (Germany) and Sluzer Looms ( Switzerland ).
 Computerised matching systems and sophisticated jet- dyeing machines in its
Processing unit.
 Computer Aided Design packages in its Fabric Developmnt Section.
 GBTL promotes the mega fashion event “Graviera Mr. India"- the winner of this
Event participates in the spublicised event; it has provided a boost to the image of the
compay’s image

Objectives of the Company

Objectives establish the goals and the aims of the business and determine the shape of
future events. Objectives are the way of achieving motives for profit of social service.
Main objectives of GRASIM BHIWANI TEXTILE LTD as in its Memorandum of
Association are:-
1) Increasing Productivity of workforce.
2) To introduce new products and create new markets.
3) Customer service and customer satisfaction.
4) Improving work culture among the employees.
5) Capitalizing on company strength and use of corporate assets.
6) Continuous innovation.
7) To provide growth rate of about 10% p.a.
8) Improve the advertising effectiveness.
9.) To ensure that a large proportion of its sales is directed towards the sectors and
urban sectors

INTRODUCTION TO CAPITAL BUDGETING DECISIONS

CAPITAL BUDGETING
Financial management is largely concerned with financing, dividend and investment
decisions of the firm with some overall goal in mind. Corporate finance theory has developed
around a goal of maximizing the market value of the firm to its shareholders. This is also
known as shareholder wealth maximization.
Financing decision deals with the firm’s optimal capital structure in terms of debt and
equity. Dividend decisions relate to the form in which returns generated by the firm are
passed on the equity holders. Investment decisions deals with the way funds raised in
financial markets are employed in productive activities to achieve the firm’s overall goal; in
other words, how much should be invested and what assets should be invested in.
NATURE OF INVESTMENT DECISIONS

The investment decisions of a firm are generally known as the capital budgeting, or capital
expenditure decisions. A capital budgeting decisions may be defined as the firm’s decision to
invest its current funds most efficiently in the long term assets in anticipation of an flow of
benefits over a series of years.
The firm’s investment decisions would generally include expansion, modernization
and replacement of the long term assets. Sale of a division or business (divestment) is also as
an investment decision.
Decisions on investment, which take time to mature, have to be based on the returns
which that investment will make. Unless the project is for social reason only, if the
investment is unprofitable in the long run, it is unwise to invest in it now.
FEATURES OF CAPITAL BUDGETING DECISIONS
 Capital budgeting decisions involve the exchange of current funds for the benefits to
be achieved in future.
 The future benefits are expected to be realized over a series of years.
 The funds are invested in non-flexible and long term activities.
 They have a long term and significant effect on the profitability of the concern.
 They involve generally huge funds.
 They are irreversible decisions.

RELATIONSHIP BETWEEN FIRM’S OVERALL GOAL AND CAPITAL


BUDGETING

GOAL OF THE FIRM


Maximize shareholder wealth or value of the firm

Financing decision Dividend decision Investment decision


Long – term investment Short – term investment

CAPITAL BUDGETING

Corporate goal, financial management and capital budgeting

IMPORTANCE OF CAPITAL BUDGETING


The need, significance or importance of capital budgeting arises mainly due to the following:
1. Large Investment
Capital budgeting decisions generally, involve large investment of funds. But the
funds available with the firm are always limited and the demand for funds far
exceed the resources. Hence, it is very important for a firm to plan and control its
capital expenditure.
2. Long- term Commitment of Funds
Capital expenditure involves not only large amount of funds but also funds for
long term or more or less on permanent basis. The long term commitment of funds
increases the financial risk involved in the investment decisions.
3. Irreversible Nature
The capital expenditure decisions are of irreversible nature. Once the decision for
acquiring a permanent asset is taken, it becomes very difficult to dispose of these
assets without incurring heavy losses.
4. Long-term Effect on Profitability
Capital budgeting decisions have a long-term and significant effect on the
profitability of a concern. Not only the present earnings of the firm are affected by
the investment in capital assets but also the future growth and profitability of the
firm depends upon the investment decision
5. Difficulties of Investment Decision
The long term investment decisions are difficult to be taken because:
i) Decisions extend to a series of years beyond the current accounting
period.
ii) Uncertainties of future
iii) Higher degree of risk
6. National Importance
Investment decisions though taken by individual concern is of national importance
because it determines employment, economic activities and economic growth.
Thus, we may say that without using capital budgeting techniques a firm may
involve itself in a losing project.

PROCEDURE OF CAPITAL BUDGETING


In capital budgeting process, main points to be borne in mind how much money will be
needed of implementing immediate plans, how much money is available for its completion
and how are the available funds going to be assigned tote various capital projects under
consideration.
The following procedure may be adopted in preparing capital budget:
1. Organisation of Investment Proposal
The first step in capital budgeting process is the conception of a profit making idea.
The proposals may come from rank and file worker of any department or from any
line officer. The department head collects all the investment proposals and reviews
them in the light of financial and risk policies of the organisation in order to send
them to the capital expenditure planning committee for consideration.
2. Screening the Proposals
In large organisations, a capital expenditure planning committee is established for the
screening of various proposals received by it from the heads of various departments
and the line officers of the company. The committee screens the proposals within the
long-range policy frame work of the organisation.
3. Evaluation of Projects
The next step in capital budgeting process is to evaluate the different proposals in
term of the cost of the capital, the expected returns from alternative investment
opportunities and the life of the assets with any of the following evaluation
techniques:
 Degree of Urgency method (Accounting rate of return method)
 Pay-back Method
 Return on Investment Method
 Discounted Cash flow method
4. Establishing Priorities
After proper screening of the proposals, uneconomic or unprofitable proposals are dropped.
The profitable projects or in other words accepted projects are then put in the priority.

5. Final approval
Proposals finally recommended by the committee are sent to the top management
along with the detailed report, both the capital expenditure and source of funds to
meet them.

6 Evaluation
Last but not the least important step in the capital budgeting process is an evaluation
of the programme after it has been fully implemented. Budget proposals and the net
investment in the projects are compared periodically and on the basis of such
evaluation, the budget figures may be reviewer and presented in a more realistic way.
LIMITTION OF CAPITAL BUDGETING
Capital budgeting techniques suffer from the following limitations:
i) All the techniques of capital budgeting presumes that various investment proposals
under consideration are mutually exclusive which may not practically be true in some
particular circumstances.
ii) 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.
iii) 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
decisions.
iv) Urgency is another limitation in the evaluation of capital investment decisions.
v) Uncertainty and risk pose the biggest limitation to the techniques of capital budgeting.

TYPES OF INVESTMENT DECISION


There are many ways to classify investments. One classification is as follows:
 Expansion of existing business or expansion of new business
 Replacement and modernization
Another useful ways to classify investment is as follows:
 Mutually Exclusive Investment
 Independent Investment
 Contingent Investment

Expansion decision:
A decision concerning whether the firm should increase operations by adding new
products, additional machines, and so forth. Such decisions would expand operations.
Diversification decision:
These investments are meant to increase capacity and widen the distribution network.
Such investment call for an explicit forecast of growth. Since this can be risky and
complex, expansion projects normally warrant more careful analysis than replacement
projects. Decisions relating to such projects are taken by the top management.
Replacement decision:
A decision concerning whether an existing asset should replaced by a newer version
of the same machine or even a different type of machine that does the same thing as
the existing machine. Such replacements are generally made to maintain existing levels
of operations, although profitability might change due to changes in expenses (that is,
the new machine might be either more expensive or cheaper to operate than the
existing machine).

Mutually exclusive investment:


In this case, the decision to invest in one project affects other projects because only
one project can be purchased. For example, if in the above example you decided you
were going to buy only one automobile, but you were looking at two different types of
cars, one is a Chevrolet and the other is a Ford. Once you make the decision to buy the
Chevrolet, you have also decided you are not going to buy the Ford.

Independent investment:
The acceptance of an independent project does not affect the acceptance of any other
project that is, the project does not affect other projects. For example, if you have a
large sum of money in the bank that you would like to spend on yourself, say,
$150,000. You decide you are going to buy a car that costs about $30,000 and a new
stereo system for your house that costs less than $5,000. The decision to buy the car
does not affect the decision to buy the stereo—they are independent decisions.
Contingent investment:
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, it may have to invest in houses,
roads, hospitals, schools, etc. for the employees to attract the work force. Thus,
building of factory also requires investment in facilities for employees. The total
expenditure will be treated as one single investment.
Research and development investment:
Traditionally, R&D projects absorbed 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 knowledge intensive industries. R&D are
characterized by numerous uncertainties and typically involve sequential decision on
the basis of managerial judgment.
METHODS OF INVESTMENT EVALUATION
A number of investment criteria (or capital budgeting techniques) are in use in practice. They
may be grouped in the following two categories:
i) Discounted Cash Flow (DCF) Criteria
 Net Present Value (NPV)
 Internal Rate of Return (IRR)
 Profitability index (PI)
ii) Non-discounted Cash Flow Criteria
 Payback
 Discounted Payback
 Accounting Rate of Return

NET PRESENT VALUE


Net present value method (also known as discounted cash flow method) is a popular
capital budgeting technique that takes into account the time value of money. Net Present
Value (NPV) is the difference between the present value of cash inflows and the present
value of cash outflow. NPV is used in capital budgeting to analyze the profitability of a
projected investment or project.
The following is the formula for calculating NPV:
 C1 C2 C3 Cn 
NPV        C0
 (1  k ) (1  k ) (1  k ) (1  k ) n 
2 3

n
Ct
  C0
t 1 (1  k )
t

Where,
Ct = net cash inflow during the period
C0 = total initial investment costs
r = discount rate, and
t = number of time period
NPV may be positive, zero or negative. These three possibilities of net present
value are briefly explained below:
 Positive NPV:
If present value of cash inflows is greater than the present value of the cash outflows,
the net present value is said to be positive and the investment proposal is considered
to be acceptable.
 Zero NPV:
If present value of cash inflow is equal to present value of cash outflow, the net
present value is said to be zero and investment proposal is considered to be
acceptable.
 Negative NPV:
If present value of cash inflow is less then present value of cash outflow, the net
present value is said to be negative and the investment proposal is rejected.

ADVANTGE OF NPV METHOD


NPV is the true measure of an investment’s profitability. It provides the most acceptable
investment rule for the following reasons:
i) Time value
It recognizes the time value of money- A rupee received today is worth more than
a rupee received tomorrow.
ii) Measure of true profitability
It uses all cash outflows occurring over the entire life of the project in calculating
its worth. Hence, it is a measure of the project’s true profitability.
iii) Value additivity
The discounting process facilitates measuring cash flows in terms of present
value; that is, in terms of equivalent, current rupees. Therefore, the NPV (A+B)
=NPV (A) + NPV (B). This is called value additivity principle.
iv) Shareholder value
The NPV method is always consistent with the objective of the shareholder value
maximization. This is the greatest virtue of the method.

LIMITATION OF NPV METHOD


i) Cash flow estimation
The NPV method is easy to use if forecasted cash flow is known. In practice, it is
quite difficult to obtain the estimates of cash flows due to certainty.
ii) Discount rate
It is also difficult in practice to precisely measure the discount rate.
iii) Ranking of projects
It should be noted that the ranking of investment projects as per the NPV rule is
not independent of the discount rates.

INTERNAL RATE OF RETURN

Internal rate of return (IRR) is the interest rate at which the net present value of all the
cash flows (both positive and negative) from a project or investment equal zero. IRR is the
discount rate that sets NPV to zero. The IRR differs from the NPV in that it results in finding
the internal yield of the potential investment. The IRR is calculated by discounting the net
cash flows using different discount rates till it gives a net present value of zero. Internal Rate
of Return or IRR is the investor's required rate of return which equates the initial cash outlay
with the present value of series of expected cash flows. In other words, IRR is the rate at
which the difference between initial cash outlay and present value of cash inflows in zero.
The internal rate of Return (IRR) is the discount rate that equals the present value of a future
steam of cash flows to the initial investment. In simple terms, discount rate is the rate at
which the Net present value of a project equals zero. It can be thought of as the annualized
rate of return (in percent) of an investment using compound interest rate calculations.
Acceptance rule:
The accept or reject rule, using the IRR method, is to accept the project if its internal rate of
return(r) is higher than the opportunity cost of capital (k). The project shall be rejected if its
internal rate is less than the opportunity cost of capital. The decision maker may remain
indifferent if the internal rate of return is equal to opportunity cost of capital.

ADVANTAGES OF IRR METHOD


1) Present value method:
The IRR technique computes the present value of investment opportunities cash
flows and hence takes into account the time value of money. This value states that a
pound today is more valuable than a pound tomorrow. This is a primary condition
in the choice of investment of investment appraisal techniques.
2) Based on cash flows:
The IRR is based on the expected net cash flows from the project. These cash flows
are computed as total cash inflow less total cash outflow. Hence the accounting
practice like depreciation and profits from existing business don’t affect the
decision making process.

3) Easy to understand:
Returns expressed in terms of percentage are easier to understand and communicate
for managers and shareholders compared to NPV, due to unfamiliarity with the
details of the appraisal techniques.
4) Maximum profitability of shareholders:
If there is only project which we have to select, if we check its IRR and it is higher
than its cut off rate, then it will give maximum profitability to shareholders

LIMITATIONS OF IRR METHOD


1) Re-investment assumption:
The IRR assumes that the time value of money is the project specific IRR, as it
doesn’t discount the cash flows at the opportunity cost of capital. The methods
assume that the intermediate cash flows can earn the same rate of return as the
original project, and this creates unrealistic returns to the management and
shareholders. It can be very unreasonable to expect the returns to remain stable over
the life of the project and hence can give a misleading view of a proposed
investment.
2) Not absolute size:
The IRR method is unsuccessful in measuring returns in terms of absolute amounts of
wealth changes. It only gives a percentage measure of return this may cause
difficulties in ranking projects where there are conditions of mutual exclusivity.

3) Additivity not possible:


The IRR technique fails to supports the additivity principle when evaluating
multiple projects as the returns are expressed in percentage terms. The additivity
principle is particularly necessary when evaluating project of different time
horizons.

NPV VS IRR METHOD

Key differences between the most popular methods, the NPV (Net Present Value) Method
and IRR (Internal Rate of Return) Method, include:

 NPV is calculated in terms of currency while IRR is expressed in terms of the


percentage return a firm expects the capital project to return.
 Academic evidence suggests that the NPV Method is preferred over other methods
since it calculates additional wealth and the IRR Method does not.
 The IRR Method cannot be used to evaluate projects where there are changing cash
flows (e.g., an initial outflow followed by in-flows and a later out-flow, such as may
be required in the case of land reclamation by a mining firm).
 However, the IRR Method does have one significant advantage -- managers tend to
better understand the concept of returns stated in percentages and find it easy to
compare to the required cost of capital.
 While both the NPV Method and the IRR Method are both DCF models and can even
reach similar conclusions about a single project, the use of the IRR Method can lead
to the belief that a smaller project with a shorter life and earlier cash inflows is
preferable to a larger project that will generate more cash.
 Applying NPV using different discount rates will result in different recommendations.

PROFITABLITY INDEX

Profitability index is an investment appraisal technique calculated by dividing the present


value of future cash flow of a project by the initial investment required for the project.
Formula:
PI = Present value of future cash flow = PV (Ct)
Initial cash outlay C0

Acceptance rule:
The following are the PI acceptance rules:
 Accept the project when PI is greater than 1.
 Reject the project when PI is less than 1.
 May accept the project when PI is equal to 1.

The profitability index, also known as the benefit-cost ratio, is another measure that
uses a simple rule to evaluate cash flow results for a given project. In this case, the
profitability index rule would tell managers and executives to accept all projects that
have an index value that is equal to or greater than 1.

ADVANTAGES OF PROFITABLE INDEX METHOD


 One of the strengths of profitability index is that it will provide us with the same
result as the net present value method. If the NPV of cash flows is positive, then
Profitability Index will be greater than one.
 May be useful when investment funds are limited.
 Easy to use and communicate
 Correct decisions when evaluating independent investment.

NPV VS PI METHOD
The NPV method and PI yield same accept or reject rules, because PI can be greater than one
only when the project net present value is positive. In case of marginal project, NPV will be
zero and PI will be equal to one. But a conflict may arise between the two methods if a choice
between mutually exclusive projects has to be made.

Consider the following illustration.

Project c Project d
PV cash inflow 100000 50000
Initially cash 50000 20000
outflow
NPV 50000 30000
PI 100000 =2.0 50000 =2.5
500000 20000
Project c should be accepted if we use NPV method, but project d is preferable
according to PI method.

The NPV method should be preferred expect under capital rationing, because the net present
value represent the net increase in the firms wealth. In our illustration, project c contributes
all that project d contributes plus additional net present value of Rs 20000 (Rs50000-
Rs30000) at an incremental cost of Rs 50000 (Rs100000-Rs50000).

PAYBACK (PB)
The payback method of investment appraisal, used for evaluating capital projects,
calculates the annual returns from the initiation of the project until the accumulated
returns are equal to the cost of the investment, at which time the investment is said to
have been paid back. The PB method is generally used as a comparison of two or
more projects and has a wide acceptance as a rule of thumb. The payback period is
defined as the time required recovering the initial investment in a project from
operations.

One of the oldest and most widely used methods to evaluate a capital investment
proposal is the Payback Period, as the name implies it refers to the time required to
recover the initial investment or the initial cash outlay as it is called in financial
terms.

Formula:
Payback = Initial Investment
Annual Cash Flow
Acceptance rule:
Many firms use the payback period as an investment evaluation criterion and a method of
ranking projects. They compare the project’s payback with a predetermined, standard
payback. The project would be accepted if its payback period is less than the maximum or
standard payback period set by management. As a ranking method, it gives highest ranking to
the project with highest payback period. Thus, if the firm has to choose between two
mutually exclusive projects, the project with shorter payback period will be selected.
Example:
Payback Period Example

Let us illustrate finding payback period with an example investment proposal. Let us
say you were offered a series of cash inflows at the end of each of the next four years
as $5000, $4000, $3000, and $1000. Say the initial cash outlay for this proposal is
$10,000.

Initial investment $10000

Year Cash flows Cumulative cash flow

1 5000 5000

2 4000 9000

3 3000 12000

4 1000 13000

Payback Period Step by Step

We add up the cash inflows beginning after the initial cash outlay in the cumulative
cash inflows column

We keep an eye on this last column and track the last year for which the cumulative
total does not exceed the initial cash outlay

We compute the part or fraction of the next year's cash inflow need to payback the
initial cash outlay by taking the initial cash outlay less the cumulative total in the last
step then divide this amount by the next years cash inflow.
E.g., ( $10,000 - $9,000 ) / $3,000 = 0.334

To now obtain the payback period in years , we take the figure from the last step and
add it to the year from the step 2. Thus our payback period is 2 + .334 = 2.334 years
ADVANTAGES OF PAYBACK METHOD
1) Simplicity:
The most significant merit of payback is that it is simple to understand and easy 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 practices.
2) 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.

36
3) Short term effect:
A company can have more favourable short-term effects on earning per share by
setting up a shorter standard payback period.
4) Liquidity:
The emphasis in payback is on the early recovery of the investment. Thus, it gives
an insight into the liquidity of the project. The funds so released can be put to other
uses.

LIMITATION OF PAYBACK METHOD


1) Cash flow ignored:
Payback is not an appropriate method of measuring the profitability of an
investment project as it does not consider all cash inflows yielded by the project.
2) Cash flow after payback:
Payback fails to take account of the cash inflows earned after the payback period.
3) Cash flow patterns:
Payback fails to consider the pattern of cash inflows, i.e., magnitude and timing of
cash inflows. In other words, it gives equal weight to return of equal amounts even
though they occur in different time periods.
4) Administrative difficulties:
A firm may face difficulties in determining the maximum acceptable payback
period. There is no rational basis for setting a maximum payback period. It is
generally a subjective decision.

DISCOUNTED PAYBACK
One of the serious objection to the payback method is that is does not discount the cash flow
calculating the payback period. The discount payback period is the number of period taken in
recovering the investment outlay on the present value basis. The discounted payback period
still to consider the cash flow occurring after the payback period.
Example:

Let us illustrate finding Discounted Payback Period with an example investment proposal.
Let us say you were offered a series of cash inflows at the end of each of the next four years
as Rs 6000, Rs2000, Rs1000, and Rs5000 Say the Initial Cost Outlay for this proposal is
Rs8000

Year Cash flow PV ratio @12 DCF Cumulative


% cash flow

1 6000 0.893 5358 5385

2 2000 0.797 1594 6952

3 1000 0.712 712 7664

4 5000 0.636 3180 10844

Discounted payback period = 3+336


3180
=3.105 years

Discounted payback period step by step:

 We add up the discounted cash inflows beginning after the initial cash outlay in the
cumulative cash inflows column
 We keep an eye on this last column and track the last year for which the cumulative
total does not exceed the initial cash outlay.
 We compute the part or fraction of the next year's cash inflow need to payback the
initial cash outlay by taking the initial cash outlay less the cumulative total in the last
step then divide this amount by the next years cash inflow
 To know obtain the discounted payback period we take the figure from the last step
and add it to the year thus the discounted payback period is 3+.105=3.105yr
 Instead of represent the years as decimal value we could represent the Discounted
Payback Period in years and months this way. We take the fraction o105 and multiply
it by 12 to get the months which is 1.26 months.

ADVANTAGES OF DISCOUNTED PAYBACK PERIOD.

 The DCF method is forward-looking and depends more future expectations rather
than historical results.
 The DCF method is more inward-looking, relying on the fundamental expectations
of the business or asset, and is influenced to a lesser extent by volatile external
factors.
 The DCF analysis is focused on cash flow generation and is less affected by
accounting practices and assumptions.
 The DCF method allows expected (and different) operating strategies to be
factored into the valuation.
 The DCF analysis also allows different components of a business or synergies to
be valued separately.

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 statement, 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 of the investment’s book values after depreciation by the life of the project. The
accounting rate of return is an average rate and can be determined by the following equation:
ARR = Average Income
Average Investment

Case Example
Initial Investment =$8000

Life = 15 years, Cash inflows per year = $1,30

Calculation

Depreciation = [Cost - Salvage Value]/Life = $8,000/15 = $533

ARR = [cash Inflows per year - Depreciation]/Initial Investment


= [$1,300 - $533]/$8,000 = $767/$8,000 = 9.6%

If you use average investment, ARR is:

ARR = $767/[$8,000/2] = $767/$4,000 = 19.2%

Acceptance rule:
As an accept or reject criterion, this method will accept all those projects whose ARR is
higher than the minimum rate established by the management and reject those projects which
have ARR less than minimum rate. This method would rank a project as number one if it has
highest ARR and lowest rank would be assigned to the project with lowest ARR.

ADVANTAGES OF ARR METHOD


1) Simplicity:
The ARR method is simple to understand and use. It does not involve complicated
computations.
2) Accounting data:
The IRR can be readily calculated from the accounting data; unlike in the NPV and
IRR methods, no adjustment is required to arrive at cash flows of the projects.
3) Accounting profitability:
The ARR rule incorporates the entire stream of income in calculating the project’s
profitability.

LIMITATION OF ARR METHOD


1) Cash flow ignored:
The ARR method uses accounting profits, not cash flows, in appraising the projects.
Accounting profits are based on arbitrary assumptions and choices and also and also
includes non cash items.
2) Time value ignored:
Time averaging of income ignores the time value of money. In fact, this procedure
gives more weighted to the distant receipts.
3) Arbitrary cut off:
The firm employing the ARR rules 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 reject
profitable projects and less profitable companies may accept bad projects.
A firm may face difficulties in determining the maximum acceptable payback
period. There is no rational basis for setting a maximum payback period. It is
generally a subjective decision.
The ARR method continues to be used as a performance evaluation and
control measure in practice. But its use as an investment criterion is certainly
undesirable. It may lead to unprofitable allocation of capital.

DETERMINANTES OF CAPITAL BUDGETING


1) Companies tax exposure:
Debt payments are tax deductible. As such, if a company's tax rate is high, using debt
as a means of financing a project is attractive because the tax deductibility of the debt
payments protects some income from taxes.
2) Financial Flexibility:
This is essentially the firm's ability to raise capital in bad times. It should come as
no surprise that companies typically have no problem raising capital when sales are
growing and earnings are strong. However, given a company's strong cash
flow in the good times, raising capital is not as hard. Companies should make an
effort to be prudent when raising capital in the good times, not stretching its
capabilities too far. The lower a company's debt level, the more financial flexibility
a company has.
Example:
The airline industry is a good example. In good times, the industry generate
significant amounts of sales and thus cash flow. However, in bad times, that situation
is reversed and the industry is in a position where it needs to borrow funds. If an
airline becomes too debt ridden, it may have a decreased ability to raise debt capital
during these bad times because investors may doubt the airline's ability to service its
existing debt when it has new debt loaded on the top.
3) Management Style :
Management styles range from aggressive to conservative. The more conservative a
management's approach is, the less inclined it is to use debt to increase profits. An
aggressive management may try to grow the firm quickly, using significant amounts
of debt to ramp up the growth of the company's earnings per share (EPS)
4) Growth Rate:
Firms that are in the growth stage of their cycle typically finance that growth
through debt, borrowing money to grow faster. The conflict that arises with this
method is that the revenues of growth firms are typically unstable and unproven. As
such, a high debt load is usually not appropriate. More stable and mature firms
typically need less debt to finance growth as its revenues are stable and proven.

5) Market Condition:
Market conditions can have a significant impact on a company's capital-structure
condition. Suppose a firm needs to borrow funds for a new plant. If the market is
struggling, meaning investors are limiting companies' access to capital because of
market concerns, the interest rate to borrow may be higher than a company would
want to pay. In that situation, it may be prudent for a company to wait until market
conditions return to a more normal state before the company tries to access funds for
the plant.
6) Sales Stability:
A firm whose sales are relatively stable can safely take on more debt and incur
higher fixed charges than a company with unstable stables; this factor has generally
been observed in terms of sales or earning variability as capital budgeting is
concern.
RESEARCH METHODOLOGY

Research Methodology is a way to systematically solve the research problem. It may be


understood as a science of study how research is done scientifically. In it, we study the
various steps that are generally adopted by the researcher in studying his research problem
along with the logic behind them.
It is a carefully investigation or enquiry especially through search for new facts in any branch
of knowledge.
The purpose of research is to discover answers of the question through application of
scientific procedure.

Research Design
There are four types of research design which are as follows:
1. Exploratory Design.
2. Descriptive Design.
3. Diagnostic Design.
4. Casual & Experimental Design.

The research I have undertaken is of exploratory nature.

DATA COLLECTION

Data collection is a term used to describe a process of preparing and collecting business data
– for example as a part of a process improvement or similar project.
Data collection usually takes place early on in an improvement project, and is often
formalized through a data collection plan which often contains the following activity.
1. Pre collection activity – Agree goals, target data, definitions and methods.
2. Collection – data collection.
3. Present Findings – Usually involves some form of sorting analysis and/or
presentation.

There are mainly two types of collection of data which helps the researcher in studying his
research problem which are discussed below:

DATA COLLECTION

PRIMARY DATA SECONDARY DATA


(Data Collection Technique)

INTERVIEW QUESTIONNAIRE

EXTERNA INTERNET INTERN


L SOURCE AL
UNSTRUCTUR Fig. :-Sources of Data
SOURCE
E
PRIMARY DATA

In primary data collection, we collect the data our self using methods such as interviews and
questionnaires. The key point here is that the data collected is unique to us and our research
and, until we publish, no one else has access to it.
I have tried to collect the data using the methods such as questionnaires and interviews. The
key point here is that the data collected is unique and research and, no one else has access to
it. It is done to get the real scenario and to get the original data of present.

Data Collection Technique


Questionnaire:
Questionnaire is a popular means of collecting data, but is difficult to design and often
require many rewrites before an acceptable questionnaire is produced.

The features included in questionnaires are:


 Theme and covering letter.
 Instruction for completion.
 Types of questions.
 Length.

Interview:
 This technique is primarily used to gain an understanding of the underlying reasons
and motivations for people’s attitudes, preferences or behavior.
 The interview was done by asking a general question. I encourage the respondent to
talk freely.
 I have used an unstructured format, the subsequent direction of the interview being
determined by the respondent’s initial reply, and come to know what is its initial is.

In simply, primary data is the data collected for the first time. It is fresh and originally
collected by the surveyor.

SAMPLING METHODOLOGY

Sampling Technique:
Initially, a rough draft was prepared keeping in mind the objective of the research. A pilot
study was done in order to know the accuracy of questionnaire. The final questionnaire was
arrived only after certain important changes were done.
Thus my sampling came out to be judgmental and continent.
Sampling Unit:
The respondents who were asked to fill out questionnaires are the sampling units. These
comprise of kartvyayogis of corporate HR, Guetermann India Pariwar, who had attended the
personality development workshop.
Sampling Size: A sample size of 45 employees was chosen. It was a non-probability sample.
Sampling Method: Random Sampling
SECONDARY DATA

All methods of data collection can supply quantitative data (numbers, statistics or financial)
or qualitative data (usually words or text). Quantitative data may often be presented in tabular
or graphical form. Secondary data is the data that has already been collected by someone else
for a different purpose to yours.

Need of using Secondary Data

1. Data is of use in the collection of primary data.


2. They are one of the cheapest and easiest means of access to information.
3. Secondary data may actually provided enough information to resolve the problem
being investigated.
4. Secondary data can be a valuable source of new ideas that can be explored later
through primary research.

Limitations of Secondary Data

The limitations of Secondary Data are as follows:


a) May be outdated.
b) No control over data collection.
c) May not be reported in the required form.
d) May not be very accurate.
e) Collection for some other purpose.

These are the types of data which are useful for every researcher while conducting a research
program. I also use both types of data and my research instruments are questionnaires and
interviews.
The limitations of the secondary data are also discussed. These limitations sometime creates
problem for the researcher.

DATA ANALYSIS AND INTERPRETATION

CALCULATION OF NPV (EVEN CASH FLOW)


Calculate the net present value of a project which requires an initial investment of $243,000
and is expected to generate a cash inflow of $50,000 each month for 12 months. Assume that
the salvage value of project is zero. The target rate of return is 12% per anum.
Solution:
We have,
Initial investment = $ 243,000
Net Cash Inflow per Period = $50,000
Number of Period = 12
Discount Rate of Return = 12%Per anum.
According to Formula:
n
Ct
NPV =  (1  k )
t 1
t
 C0

Now,
= $50000 $243000
(1+1%)12

=$50000 * PVF(1%,12) - $243,0000

= $50000 * 11.255 - $243,000

= $562,750 - $243,000

= $319,750
Working note:
 Rate is converted in to monthly basis because rate is given yearly basis and time is
given on monthly basis.
 Present value of cash flow is find out on the basis of present value of annuity table.

CALCULATION OF NPV ( UNEVEN CASH FLOW)


An initial investment of $8,320 thousand on plant and machinery is expected to generate cash
inflows of $3,411 thousand, $4,070 thousand, $5,824 thousand and $2,065 thousand at the
end of the first, second, third and fourth year respectively. At the end of the fourth year, the
machinery will be sold for $900 thousand. Calculate the net present value of the investment if
the discount rate is 18%. Round your answer to nearest thousand dollars.
Calculation:
Initial investment = $8,320 thousand
Cash inflow of first year = $3,411 thousand
Cash flow of second year = $4,070 thousand
Cash flow of third year = $5,824 thousand
Cash flow of fourth year = $2,065 thousand
Rate of return = 18%
According to formula :

= $3,411 $4,070 $5,824 $2,065 $8,320


(1+18%)1 (1+18%)2 (1+18%)3 (1+18%)4

= $3,411 * PVF(18%, 1) + $4,070 * PVF(18%, 2) + $5,824 * PVF(18%, 3) + $2,065 * PVF(18%, 4) -


$8,320

= $3,411( 0.847 ) + $4,070( 0.718 ) + $5,824( 0.609 ) + $2,065( 0.516 ) - $8,320

=$2,889 + $2,922 + $3,547 + $1,066 - $8,320

=$10,451 - $8,320

=$2,131
Since NPV has appositive value there for project should be accepted.

1. Payback Period – Given the cash flows of the four projects, A, B, C, and D, and using the

Payback Period decision model, which projects do you accept and which projects do you

reject with a three year cut-off period for recapturing the initial cash outflow? Assume that

the cash flows are equally distributed over the year for Payback Period calculations.

2.

Projects A B C D
Cost $10,000 $25,000 $45,000 $100,000
Cash Flow Year One $4,000 $2,000 $10,000 $40,000
Cash Flow Year Two $4,000 $8,000 $15,000 $30,000
Cash Flow Year Three $4,000 $14,000 $20,000 $20,000
Cash Flow Year Four $4,000 $20,000 $20,000 $10,000
Cash Flow year Five $4,000 $26,000 $15,000 $0
Cash Flow Year Six $4,000 $32,000 $10,000 $0
Solution

Project A: Year One: -$10,000 + $4,000 = $6,000 left to recover

Year Two: -$6,000 + $4,000 = $2,000 left to recover

Year Three: -$2,000 + $4,000 = fully recovered

Year Three: $2,000 / $4,000 = ½ year needed for recovery

Payback Period for Project A: 2 and ½ years, ACCEPT!

Project B: Year One: -$25,000 + $2,000 = $23,000 left to recover

Year Two: -$23,000 + $8,000 = $15,000 left to recover

Year Three: -$15,000 + $14,000 = $1,000 left to recover

Year Four: -$1,000 + $20,000 = fully recovered

Year Four: $1,000 / $20,000 = 1/20 year needed for recovery

Payback Period for Project B: 3 and 1/20 years, REJECT!

Project C: Year One: -$45,000 + $10,000 = $35,000 left to recover

Year Two: -$35,000 + $15,000 = $20,000 left to recover

Year Three: -$20,000 + $20,000 = fully recovered

Year Three: $20,000 / $20,000 = full year needed

Payback Period for Project B: 3 years, ACCEPT!

Project D: Year One: -$100,000 + $40,000 = $60,000 left to recover

Year Two: -$60,000 + $30,000 = $30,000 left to recover

Year Three: -$30,000 + $20,000 = $10,000 left to recover

Year Four: -$10,000 + $10,000 = fully recovered

Year Four: $10,000 / $10,000 = full year needed

Payback Period for Project B: 4 years, REJECT!


3. Discounted Payback Period – Graham Incorporated uses discounted payback period for

projects under $25,000 and has a cut off period of 4 years for these small value projects. Two

projects, R and S are under consideration. The anticipated cash flows for these two projects

are listed below. If Graham Incorporated uses an 8% discount rate on these projects are they

accepted or rejected? If they use 12% discount rate? If they use a 16% discount rate? Why is

it necessary to only look at the first four years of the projects’ cash flows?

Cash Flows Project R Project S


Initial Cost $24,000 $18,000
Cash flow year one $6,000 $9,000
Cash flow year two $8,000 $6,000
Cash flow year three $10,000 $6,000
Cash flow year four $12,000 $3,000

Solution at 8%

Project R: PV Cash flow year one -- $6,000 / 1.08 = $5,555.56

PV Cash flow year two -- $8,000 / 1.082 = $6,858.71

PV Cash flow year three -- $10,000 / 1.083 = $7,938.32

PV Cash flow year four -- $12,000 / 1.084 = $8,820.36

Discounted Payback Period: -$24,000 + $5,555.56 + $6,858.71 + $7,938.32 + $8,820.36 =

$5,172.95 and initial cost is in first four years, project accepted.

Project S: PV Cash flow year one -- $9,000 / 1.08 = $8,333.33

PV Cash flow year two -- $6,000 / 1.082 = $5,144.03

PV Cash flow year three -- $6,000 / 1.083 = $4,762.99

PV Cash flow year four -- $3,000 / 1.084 = $2,205.09

Discounted Payback Period: -$18,000 + $8,333.33 + $5,144.03 + $4,762.99 + $2,205.09 =

$2,445.44 and initial cost is in first four years, project accepted.


Solution at 12%

Project R: PV Cash flow year one -- $6,000 / 1.12 = $5,357.14

PV Cash flow year two -- $8,000 / 1.122 = $6,377.55

PV Cash flow year three -- $10,000 / 1.123 = $8,541.36

PV Cash flow year four -- $12,000 / 1.124 = $7,626.22

Discounted Payback Period: -$24,000 + $5,357.14 + $6,377.55 + $8,541.36 + $7,626.22 =

$3,902.27 and initial cost is in first four years, project accepted.

Project S: PV Cash flow year one -- $9,000 / 1.12 = $8,035.71

PV Cash flow year two -- $6,000 / 1.122 = $4,783.16

PV Cash flow year three -- $6,000 / 1.123 = $4,270.68

PV Cash flow year four -- $3,000 / 1.124 = $1,906.55

Discounted Payback Period: -$18,000 + $8,035.71 + $4,783.16 + $4,270.68 + $1,906.55 =

$996.10 and initial cost is in first four years, project accepted.

Solution at 16%

Project R: PV Cash flow year one -- $6,000 / 1.16 = $5,172.41

PV Cash flow year two -- $8,000 / 1.162 = $5,945.30

PV Cash flow year three -- $10,000 / 1.163 = $6,406.58

PV Cash flow year four -- $12,000 / 1.164 = $6,627.49

Discounted Payback Period: -$24,000 + $5,172.41 + $5,945.30 + $6,406.58 + $6,627.49 =

$151.78 and initial cost is in first four years, project accepted.

Project S: PV Cash flow year one -- $9,000 / 1.16 = $7,758.62


PV Cash flow year two -- $6,000 / 1.162 = $4,458.98

PV Cash flow year three -- $6,000 / 1.163 = $3,843.95

PV Cash flow year four -- $3,000 / 1.164 = $1,656.87

Discounted Payback Period: -$18,000 + $7,758.62 + $4,458.98 + $3,843.95 + $1,656.87 = -

$251.58 and initial cost is not recovered in first four years, project rejected.

Because Graham Incorporated is using a four year cut-off period, only the first four years of

cash flow matter. If the first four years of anticipated cash flows are insufficient to cover the

initial outlay of cash, the project is rejected regardless of the cash flows in years five and

forward.

4. Comparing Payback Period and Discounted Payback Period – Mathew Incorporated is

debating using Payback Period versus Discounted Payback Period for small dollar projects.

The Information Officer has submitted a new computer project of $15,000 cost. The cash

flows will be $5,000 each year for the next five years. The cut-off period used by Mathew

Incorporated is three years. The Information Officer states it doesn’t matter what model the

company uses for the decision, it is clearly an acceptable project. Demonstrate for the IO that

the selection of the model does matter!

Solution

Calculate the Payback Period for the project:

Payback Period = -$15,000 + $5,000 + $5,000 + $5,000 = 0 so the payback

period is 3 years and the project is a go!

Calculate the Discounted Payback Period for the project at any positive discount rate,

say 1%...

Present Value of cash flow year one = $5,000 / 1.01 = $4,950.50

Present Value of cash flow year two = $5,000 / 1.012 = $4,901.48


Present Value of cash flow year three = $5,000 / 1.013 = $4,852.95

Discounted Payback Period = -$15,000 + $4,950.50 + $4,901.48 + $4,852.95

= -$295.04 so the payback period is over 3 years and the project is a no-go!

5. Comparing Payback Period and Discounted Payback Period – Neilsen Incorporated is

switching from Payback Period to Discounted Payback Period for small dollar projects. The

cut-off period will remain at 3 years. Given the following four projects cash flows and using

a 10% discount rate, which projects that would have been accepted under Payback Period

will now be rejected under Discounted Payback Period?

Project Project
Cash Flows Project One Project Two Three Four
Initial cost $10,000 $15,000 $8,000 $18,000
Year One $4,000 $7,000 $3,000 $10,000
Year Two $4,000 $5,500 $3,500 $11,000
Year Three $4,000 $4,000 $4,000 $0

Solution

Calculate the Discounted Payback Periods of each project at 10% discount rate:

Project One

Present Value of cash flow year one = $4,000 / 1.10 = $3,636.36

Present Value of cash flow year two = $4,000 / 1.102 = $3,305.78

Present Value of cash flow year three = $4,000 / 1.103 = $3,005.26

Discounted Payback Period = -$10,000 + $3,636.36 + $3,305.78 + $3,005.26

= -$52.60 so the discount payback period is over 3 years and the project is a no-go!

Project Two

Present Value of cash flow year one = $7,000 / 1.10 = $6,930.69

Present Value of cash flow year two = $5,500 / 1.102 = $5,391.63

Present Value of cash flow year three = $4,000 / 1.103 = $3,005.26


Discounted Payback Period = -$15,000 + $6,930.69 + $5,391.63 + $3,005.26

= $327.58 so the discount payback period is 3 years and the project is a go!

Project Three

Present Value of cash flow year one = $2,500 / 1.10 = $2,272.73

Present Value of cash flow year two = $3,000 / 1.102 = $2,479.34

Present Value of cash flow year three = $3,500 / 1.103 = $2,629.60

Discounted Payback Period = -$8,000 + $2,272.73+ $2,479.34 + $2,629.20 = -

$618.33 so the discount payback period is over 3 years and the project is a no-go!

Project Four

Present Value of cash flow year one = $10,000 / 1.10 = $9,090.91

Present Value of cash flow year two = $11,000 / 1.102 = $9,090.91

Present Value of cash flow year three = $0 / 1.103 = $0

Discounted Payback Period = -$18,000 + $9,090.91 + $9,090.91 + $0 = $181.82 so

the discount payback period is 3 years and the project is a go!

Projects one and three will now be rejected using discounted payback period with a

discount rate of 10%.

6. Net Present Value – Swanson Industries has a project with the following projected cash

flows:

Initial Cost, Year 0: $240,000

Cash flow year one: $25,000

Cash flow year two: $75,000

Cash flow year three: $150,000

Cash flow year four: $150,000

a. Using a 10% discount rate for this project and the NPV model should this

project be accepted or rejected?


b. Using a 15% discount rate?

c. Using a 20% discount rate?

Solution

a. NPV = -$240,000 + $25,000/1.10 + $75,000/1.102 + $150,000/1.103 +

$150,000/1.104

NPV = -$240,000 + $22,727.27 + $61,983.47 + $112,697.22 + $102,452.02

NPV = $59,859.98 and accept the project.

b. NPV = -$240,000 + $25,000/1.15 + $75,000/1.152 + $150,000/1.153 +

$150,000/1.154

NPV = -$240,000 + $21,739.13 + $56,710.76 + $98,627.43 + $85,762.99

NPV = $22,840.31 and accept the project.

c. NPV = -$240,000 + $25,000/1.20 + $75,000/1.202 + $150,000/1.203 +

$150,000/1.204

NPV = -$240,000 + $20,833.33 + $52,083.33 + $86,805.56 + $72,337.96

NPV = -$7,939.82 and reject the project.

7. Net Present Value – Campbell Industries has a project with the following projected cash

flows:

Initial Cost, Year 0: $468,000

Cash flow year one: $135,000

Cash flow year two: $240,000

Cash flow year three: $185,000

Cash flow year four: $135,000

a. Using an 8% discount rate for this project and the NPV model should this

project be accepted or rejected?

b. Using a 14% discount rate?


c. Using a 20% discount rate?

Solution

a. NPV = -$468,000 + $135,000/1.08 + $240,000/1.082 + $185,000/1.083 +

$135,000/1.084

NPV = -$468,000 + $125,000.00 + $205,761.32 + $146,858.96 + $99,229.03

NPV = $108,849.31 and accept the project.

b. NPV = -$468,000 + $135,000/1.14 + $240,000/1.142 + $185,000/1.143 +

$135,000/1.144

NPV = -$468,000 + $118,421.05 + $184,672.21 + $124,869.73 + $79,930.84

NPV = $39,893.83 and accept the project.

c. NPV = -$468,000 + $135,000/1.20 + $240,000/1.202 + $185,000/1.203 +

$135,000/1.204

NPV = -$468,000 + $112,500.00 + $166,666.67 + $107,060.19 + $65,104.17

NPV = -$16,668.97 and reject the project.

8. Net Present Value – Swanson Industries has four potential projects all with an initial cost

of $2,000,000. The capital budget for the year will only allow Swanson industries to accept

one of the four projects. Given the discount rates and the future cash flows of each project,

which project should they accept?

Cash Flows Project M Project N Project O Project P


Year one $500,000 $600,000 $1,000,000 $300,000
Year two $500,000 $600,000 $800,000 $500,000
Year three $500,000 $600,000 $600,000 $700,000
Year four $500,000 $600,000 $400,000 $900,000
Year five $500,000 $600,000 $200,000 $1,100,000
Discount Rate 6% 9% 15% 22%

Solution, find the NPV of each project and compare the NPVs.

Project M’s NPV = -$2,000,000 + $500,000/1.05 + $500,000/1.052 +

$500,000/1.053 + $500,000/1.054 + $500,000/1.055


Project M’s NPV = -$2,000,000 + $476,190.48 + $453,514.74 + $431,918.80 +

$411,351.24 + $391,763.08

Project N’s NPV = $164,738.34

Project N’s NPV = -$2,000,000 + $600,000/1.09 + $600,000/1.092 +

$600,000/1.093 + $600,000/1.094 + $600,000/1.095

Project N’s NPV = -$2,000,000 + $550,458.72 + $505,008.00 + $463,331.09 +

$425,055.13 + $389,958.83

Project N’s NPV = $333,790.77

Project O’s NPV = -$2,000,000 + $1,000,000/1.15 + $800,000/1.152 +

$600,000/1.153 + $400,000/1.154 + $200,000/1.155

Project O’s NPV = -$2,000,000 + $869,565.22 + $604,914.93 + $394,509.74 +

$228,701.30 + $99,435.34

Project O’s NPV = $197,126.53

Project P’s NPV = -$2,000,000 + $300,000/1.22 + $500,000/1.222 +

$700,000/1.223 + $900,000/1.224 + $1,100,000/1.225

Project P’s NPV = -$2,000,000 + $245,901.64 + $335,931.20 + $385,494.82 +

$406,259.18 + $406,999.18

Project P’s NPV =-$219,413.98 (would reject project regardless of budget)

And the ranking order based on NPVs is,

Project N – NPV of $333,790.77

Project O – NPV of $197,126.53

Project M – NPV of $164,738.34

Project P – NPV of -$219,413.98

Swanson Industries should pick Project N.


CONCLUSION

Capital budgeting is one of the important techniques of Financial Management to evaluate


the project efficiency. In a capital budgeting, there are a number of different approaches that
can be used to evaluate any given project, and each approach has its own distinct advantages
and disadvantages.
Comparatively modern method is more effective over the traditional method because
the modern method is considering the time value of money. After the study of all the methods
I find discounted method is more effective over the non- discount method.
Important and effective method of capital budgeting is :
i. Net present value
ii. Internal rate of return
iii. payback
The use of method is depending upon the nature of the project for example:
 If the cash flow of project is estimated accurately than the net present value method is
effective.
 If the discounted rate of a project is not known than the use of internal rate of return
is effective.
 If the project is small then payback method is good because it measure accurate time
period of recovery of cost of investment.

Capital budgeting methods in practice:


 In a study of capital budgeting practices of fourteen medium to large size companies
in India, it was found that all companies, except one, used payback. With payback
and/or techniques, about two third of companies used IRR and about two-fifth NPV.
IRR was found to be the second most popular method.
 The reasons for the popularity of payback in order of significance were stated to be its
simplicity to use and understand its emphasis on the early recovery of investment and
focus on risk.
 It was also found that one-third of companies always insisted on the computation of
payback for all projects, one-third of minority of project and remaining for some of
the projects. For about two-third of companies standard payback ranged between 3
and 5 years.
 Reason for secondary role of discounted cash flow techniques in India included
difficulty in understanding and using these techniques, lack of qualified
professionals and unwillingness of top management to use DCF techniques. One
large manufacturing and marketing organisation mentioned that conditions of its
business were such that DCF techniques were not needed. Yet another company
stated that replacement projects were very frequent in the company, and it was not
considered necessary to use DCF techniques for evaluating such projects.
Source: Pandey, I.M., Capital Budgeting Practices of Indian Companies, MDI
Management Journal, Vol. 2, No. 1 (Jan. 1989).

REFERNCES:
 Financial management

by I.M. Pandey

 Business research

by C.R. Kothari

 Annual data of 2013-14 and 2014-15.


 Auditors report of 2014-2015

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