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INTRODUCTION INTRODUCTION OF CAPITAL BUDGETING: Capital budgeting is an essential part of every company’s financial management. Capital budgeting is a required managerial tool. One duty of a financial manager is to choose investment with satisfactory cash flows and rates of return. Therefore a financial manager must be able to decide whether an investment is worth undertaking and be able to choose intelligently between two or more alternatives. To do this, a sound procedure to evaluate, compare, and select Projects is needed. Capital budgeting is represents a long term investment decision, involves the planning of expenditures for project with life of many year, usually requires a large initial cash outflow with the expectation of future cash inflows, uses present value analysis, emphasizes cash flows rather than income Capital budgeting is the planning process used to determine a firm’s long-term investment such as new machinery, replacement machinery, new plants, new products and research and development projects. NEED FOR THE STUDY: Capital budgeting decisions are of paramount importance in financial decision-making. Special care should therefore be taken in making these decisions on account of following reasons. Heavy investments. Long term commitment on funds 1

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INTRODUCTION

INTRODUCTION OF CAPITAL BUDGETING:

Capital budgeting is an essential part of every company’s

financial management. Capital budgeting is a required managerial tool. One

duty of a financial manager is to choose investment with satisfactory cash

flows and rates of return. Therefore a financial manager must be able to

decide whether an investment is worth undertaking and be able to choose

intelligently between two or more alternatives. To do this, a sound

procedure to evaluate, compare, and select Projects is needed.

Capital budgeting is represents a long term investment decision,

involves the planning of expenditures for project with life of many year,

usually requires a large initial cash outflow with the expectation of future

cash inflows, uses present value analysis, emphasizes cash flows rather than

income

Capital budgeting is the planning process used to determine a

firm’s long-term investment such as new machinery, replacement

machinery, new plants, new products and research and development

projects.

NEED FOR THE STUDY:

Capital budgeting decisions are of paramount importance in

financial decision-making. Special care should therefore be taken in making

these decisions on account of following reasons.

Heavy investments.

Long term commitment on funds

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Irreversible decisions

Long term impact of profitability

Most difficult to make.

Wealth maximization of shareholders.

Cash forecast.OBJECTIVES OF THE STUDY

The objectives of the study are:

To understand the need of organizations to identify and invest in high

quality capital projects.

To prepare a list of the main financial variables required for a project

appraisal.

To evaluate capital projects using traditional methods of investment

appraisal and discounted cash flow methods.

To illustrate the important differences, which can arise in evaluating

projects when using net present value (NPV) and internal rate of

returns (IRR).

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SCOPE OF THE STUDY:

The scope of the study is that the following areas:

How money is acquired and from what sources?

How individual capital project alternatives are identified and evaluated?

How minimum requirements of acceptability are set?

How final project selections are made?

How post mortem are conducted?

METHODOLOGY OF THE STUDY

DATABASE:

This study will be based on both primary and secondary data. The

primary data will be collected interact with financial Manager of HAL

company and The secondary data will be collected from various books,

journals, newspapers, websites, reports and other published sources of

company.

PERIOD OF STUDY:

The present study is made during the IVth semester of the

MBA course. i.e., from 17th December 2007 to 10th may 2008.

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CAPITAL BUDGETING DECISIONS

Capital expenditure decisions are of considerable significance as

the future success and growth of the firm depends heavily on them. But they

are best with a number of difficulties.

The benefits from investment are received in some future period.

The future is uncertain. Therefore, an element of risk is involved. Future

revenue involves estimation of the size of his market for product and

expected share of the firm. These estimates depend on the variety of factors,

including price, advertising and promotion, sales effort and so on. The cost

incurred and benefits received from a capital budgeting decision occurred in

different periods. They are the time value of the money.

So a firm must replace worn and obsolete plant and machinery,

acquired fixed assets for current and new products and makes strategic

investment decisions. This will enable the firm to achieve its objectives of

maximizing profits either by the way of increased revenues or cost

reduction. The quality of these decisions is improved by capital budgeting.

Capital budgeting decisions can be of two types and are as follows:

(a) Expanding revenues

(b)Reduce costs

INVESTMENT DECISIONS AFFECTING REVENUES

Investment decisions are expected to bring in additional revenues

there by raising the size of the firms total revenue. That can be the result of

the either expansion of present operations or the development of new

product lion.

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INVESTMENT DECISIONS REDUSING COST

Cost reduction investment decisions are subject to less uncertainty

in comparison to the revenue affecting investment decisions. This is so

because the firm has a better feel for potential cost savings as it can examine

past production and cost data. So it is difficult to precisely estimate the

revenue and cost resolution from a new product line.

KINDS OF DECISIONS

• Accept / reject decision

• Mutually exclusive project decision

• Capital rationing decision

Accept / reject decision:

This is the fundamental decision in capital budgeting. If the project is

accepted the firm would invest it, if the proposal were rejected, the firm does

not invest in it. In general those entire proposal, which yield a rate of return

greater than a certain required rate of return or cost of capital, are accepted

and the rest are rejected. Under accept-reject decision, all independent

projects that satisfy the minimum investment criterion should be

implemented.

Mutually exclusive project decision:

Mutually exclusive project decisions are those, which compete with

other projects in such a way that the acceptance of one will exclude

acceptance of the other projects. The alternatives are mutually exclusive and

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only one may be chosen. Some technique has to be used to determine the

best one. The acceptance of the best alternative automatically eliminates the

other alternatives.

Capital rationing decision:

In a situation where the firm has unlimited funds, all independent

investments proposal-yielding returns greater than some predetermined level

are accepted. However, the situation does not prevail in most of the firms in

actual practice. They have fixed capital budget. A large number of

investment proposals compete for these limited funds. The firm must

therefore ration them. The firm allocates funds to projects in a manner that

maxims long term returns. Thus capital rationing refers to a situation in

which a firm has more acceptable investment that it can finance. It is

concern with the selection of the group of investment proposals out of many

investment proposals accepted under accept or reject decisions. The projects

are ranked in the descending order rate of return

TECHNIQUES OF CAPITAL BUDGETING

Capital budgeting is the process of making investment in capital

expenditures. A capital expenditure may be defined as expenditure and the

benefits of which are expected to be received over a period of time

exceeding one year. The main characteristics of capital expenditure incurred

at a point of time and benefits of expenditure incurred at one point of time in

future are realized. The following are some examples of capital expenditure.

(a) Cost of acquisition of permanent assets i.e. buildings, plant and

machineries etc.

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(b) Cost of replacement of old permanent asset.

Investment decisions required special attention because of the following

reasons:

(a) They influence the firm’s growth path.

(b) They affect the risk of the firm.

(c) They involve large amount of funds of the firm.

(d) They are unchangeable or reversed at high cost.

(e) They are most difficult decisions to make.

Capital expenditure involves non-flexible long-term commitment of funds.

Thus capital expenditure decisions are also called as long-term investment

decision-making, capital expenditure decisions, planning capital expenditure

and analysis of capital expenditure.

DEFINITIONS: -

“Capital budgeting is long term planning for making and

financing proposed capital outlays”.

--Charles T Hangmen.

According to GC Philppatos, “Capital budgeting concern

with allocation of firms scarce financial resources among the available

market opportunities. The considerations of investment opportunities

involve the comparison of the expected future of the streams of earning from

a project, with immediate end subsequent streams of expenditure for it”.

Capital budgeting decision from day to day is: -

Capital budgeting decision involves the exchange of the current

funds for the benefits future.

The future benefits are expected to be realized over a series of years.

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The funds are invested in non-flexible and long-term activities.

They have long-term and significant effect on the probability of the

concern.

They are invariable decisions.

INVESTMENT EVALUATION CRITERIA

Three steps are involved in the evaluation of an investment.

(a) Estimation of cash flows.

(b)Estimation of the required rate of return.

(c) Application of the decision rule for making the choice.

Characteristics:

It should consider all cash flows to determine true value of the project. It

should help in ranking the various projects according to their true benefits.

It should recognize the fact that the bigger cash are preferable than the

smaller ones and early cash flows are preferable than later ones.

It should help to choose among mutually exclusive projects that project

which maximizes the shareholders wealth.

It should be a criterion, which is applicable to many conceivable

investment projects independent of other.

The capital budgeting technique, which has all these characteristics, is

the method to be used for the project appraisal purpose. A number of capital

budgeting techniques are in use in practice. They may be grouped in two

categories that the following chart tries to show:

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EXHIBIT-II.1

INVESTMENT CRITERIA

TRADITIONAL OR NON-DISCOUNTING TECHNIQUES:

1) Payback period:

The payback period is one of the most popular and widely recognized

traditional methods of evaluating investment proposals. It is defined as the

number of years required to recover the original cash outlay invested in a

Investment criteria

Discounting criteria Non-discounting criteria

Net

present

value

Profitability

index

Internal

rate of

return

Payback

period

Accounting

rate of

return

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project. If the project generates constant annual cash flows, the payback

period can be computed by dividing cash outlay by the annual cash inflow.

Acceptance rule:

Payback method is the simplest and easy to understand and easy to

calculate. As a ranking method, it gives highest ranking to the project, which

has the shortest payback period and lowest among two mutually exclusive

projects, the project with shorter payback period.

2) Accounting rate of return (ARR):

The accounting rate of return (ARR) is known as average rate of return and

also returns on investment (ROI). It is found out by dividing the average

after tax profit by the average investment. The average investment would be

equal it half of the original investment if it is depreciated constantly.

Alternatively, it can be found out dividing the total of the investments boo

vales after depreciation by the life of the project.

Accounting rate of return = average income / Average investment.

Average investment = (Original investment – Scrap value)/2

Payback period = Average income / Annual cash flow

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Average income = Total income / Number of years.

Acceptance rule:

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 the minimum rate. This method would rank a

project as number one if it has higher ARR and lowest rank would be

assigned to the project with lowest ARR.

DISCOUNTING TECHNIQUES:

1) Net present value (NPV):

The net present value (NPV) method is the classic economic method of

evaluating the investment proposals. It is a method in which we can convert

future cash profits to today’s cash profit based on the interest rate by which

we can equate today’s value of the future profit. The interest rate is nothing

but cost of capital or the inflation rate or the rate expected by the investor. If

the rate of interest is not given, in India maximum return expected is 10% so

find out the NPV at 10% only. If the NPV is positive(+) we will get profits

on projects. Accordingly accept / reject decision will be taken.

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Net present value = Summation of present value of cash inflows in each year

– The summation of present values of the net present value of two mutually

exclusive projects X and Y.

Acceptance of project:

NPV<0 reject

NPV>0 accept

NPV=0 May accept

2) Internal rate of return (IRR):

The second discounted cash flow or time-adjusted method for apprising

capital investment decisions is the internal rate of return (IRR) method. This

technique is also known as yield on investment, marginal efficiency of

capital, marginal productivity of capital. The internal rate of return is usually

the rate of return that a project earns. It is defined as the aggregate present

value of cash outflows of a project.

Acceptance of project:

Accept – if IRR > cost of capital

Reject - if IRR < cost of capital

3) Profitability Index (PI):

IRR = Lower rate of return + present value of Cash at lower rate – present

value of investment / Different between present values ∗ Different between

the discount rate chosen.

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Another time adjusted capital budgeting technique is profitability index

or benefit cost of ratio. It is similar to the NPV approach. The profitability

index approach means the present value of returns per rupee invested, while

the NPV is a base on the difference between the present value of future cash

in inflows and the present value of cash outlays. A major disadvantage of

NPV method is that being an absolute measure, it is not a reliable method to

evaluate projects requiring different initial investments. The PI method

provides a solution to this kind of problem. It may be defined as the ratio,

which is obtained dividing the present value of future cash in flows by

present value of cash outlays.

PI = Present value cash inflows / Present value of cash outflows

Acceptance of project:

If the present value sum of total of the compounded reinvested cash

inflows (PVTs) is greater than the present value of the outflows (PVO), the

project is accepted if:

PVTs > PVO accepted.

PVTs < PVO rejected

A variation terminal value method (TV) is net terminal value

method (NTV) it can be represented as NTV = PVTs – PVO.

If the NTV is positive, accept the project. If the NTV is negative,

reject the project. The NTV method is similar to NPV method. Initially the

values are compounded, and in the later they are discounted. Both the

methods will give the same results. The same interest rates are used for both

the discounting and compounding.

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EVALUATION OF PROJECT CASH FLOWS

The role of finance manager is to coordinate the different

departments and obtain information from departments, ensure that the

forecast are based on set of consistent economic assumptions, keep the

exercise focused on the relevant variables and minimize the problems in

cash flow fore casting.

(a) Times factors for the analysis.

(b) Physical life of the plant.

(c) Technological life of the plant.

Investment planning horizon of the firm. For the capital budgeting cash

flows have to be estimated. There are certain ingredients of cash flow

streams.

Tax effect:

It has been already observed that cash flows to be considered for the

purpose of capital budgeting are net of taxes. Special consideration needs to

be given to tax effects on cash flows if the firms is incurring losses and,

therefore paying no taxes. The tax laws permit carrying losses forward to set

off against future income. In such cases, therefore, the benefits of tax

savings would accrue in future years.

Effect on other projects:

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Cash flow effects of the projects under the consideration. For

instance if the company is considering the production of new product, which

competes with the existing products in the product line, it is likely that as a

result of new proposal, the cash flows related to the old product will be

affected.

Effect on indirect expenses:

The indirect expenses/overheads are allocated to the different products

on the basis of wages paid, materials used, floor space occupied or some

other similar common factor. The question that arises is should such

allocation of the overheads be taken into the account in the cash flows? If

yes, it should be taken into account. If however the overheads will not

change as a result of the investment decision, they are not relevant.

Effect of depreciation:

Depreciation, although a non-cash item of cost, is deductible

expenditure in determining taxable income. Depreciation provisions are

prescribed by the company’s act for accounting purpose and by the income

tax for taxation purposes. The act that prescribes that rate of depreciation for

various types of depreciable assets. On written down value (WDV) basis as

well as straight-line basis. It also permits companies to charge depreciation

on any other basis provided it has the effect of writing off 95% of the

original cost of the asset on the expiry of the specified period and has the

approval of the government.

Depreciation is the charged with a view to simplify computation, not

on individual assets. A block of assets defined as group of assets, being

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building, machinery, plant or furniture in respect of which the same rate of

depreciation is prescribed.

Depreciation is computed at the block-wise rates on the basis of

written down value (WDV) method only. Presently, the block-wise for plant

and machinery are 25%, 40% and 100%.

The depreciation allowance on office buildings, and furniture and

fitting is 10%. Where the actual cost of plan and machinery does not exceed

Rs.5000 the entire cost is allowed to be written off in the first year of its use.

If an asset acquired during a year has been used for a period less than

180days during the year, depreciation on such assets is allowed only a 50%

of the computed depreciation according to the relevant rate.

Working capital effect:

Working capital constitutes another capital ingredient of the cash flow

stream, which is directly related to an investment proposal. The term

working capital is used here in neatness, i.e. current assets – current

liabilities (Net Working Capital). If investment is expected to increase sales

it is likely that there will be an increase in current assets in the form of

account receivable, inventory and cash. But part of these increases in current

assets will be offset by an increase in current liabilities in the form of current

accounts and notes payable. The difference between these additional current

assets and current liabilities will be needed to carryout the investment

proposal. Sometimes, it may constitute a significant part of the total

investment in the project. The increased working capital forms part of an

initial cash outlay.

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The additional networking capital will however be returned to the

firm at the end of the projects file. Therefore, the recovery of the working

capital becomes the part of the cash in flows stream in the terminal year.

Determination of relevant cash flows:

The data requirements for capital budgeting are cash flows, outflows

and inflows. Their competition becomes on the nature of the proposal.

Capital proposals can be categorized into:

(a) Single proposal.

(b)Replacement situations.

(c) Mutually exclusive.

Single proposal:

The cash outflows, comprising cash outlays required to carryout the

proposal capital expenditure, while the computation of the inflows after

taxes (CFAT).

Format:

Cash outflows of the new project (beginning of the period at ZERO TIME)

Cost of new project xxx

+ Installation of plant and equipment xxx

+/- Working capital requirement xxx

Determination of cash inflows: Single investment proposal (t=n-1)

TABLE – II.1

Single investment proposal format

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Years

Particulars 1 2 3 N Cash sales revenues (-) Cash operating cost Cash inflows before taxes (CFBT) (-) Depreciation taxable income (-) Tax earnings after taxes (+) Depreciation Cash inflows after tax(CFAT) (+) Salvage value (in Nth year) (+) Recovery of the working capital

Replacement situations:

In case of replacement of an existing machine by a new one the

relevant cash outflows are after tax incremental cash flows. If anew machine

is about to replace an existing machine the proceeds so obtained from its

sales reduce cash out flows required to purchase the new machine and part

of relevant cash outflows.

Mutually exclusive:

In case of mutually exclusive proposals the selection of one proposal

preludes the choice of other. The calculation of the cash flows is on lines of

similar to the replacement situations.

Element of cash flows streams:

To evaluate a project, we must determine the relevant cash flows,

which are the incremental after the cash flows associated with the project.

The cash flow stream of the conventional project, a project which involves

cash outflows followed by cash inflows comprises three basic components:

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(a) Initial investment.

(b)Operating cash flows.

(c) Terminal cash flows.

The initial investment is after tax cash outlay on capital expenditure and

networking capital.

The operating cash inflows are the after tax cash inflows resulting

from the operating of the project during the economic life.

The terminal cash inflow is after tax cash flow resulting from the

liquidation of the project at the end of its economic life.

Time horizon for analysis:

This time horizon for cash flow analysis usually established

generally the minimum of the following:

Physical life of the plant:

This refers to the period during which the plant remains in a

physically usable condition. This is the number of years the plant would

perform the function for which it had been acquired. This depends upon the

wear and tear which plant is subjected to. Suppliers of plant may provide the

information of the physical life under normal operating conditions. While

the concept of the physical life may be useful for determining the

depreciation charge, it is not very useful for investment decision-making

process.

Technological life of the plant:

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New technological developments tend to render the existing plant

obsolete. The technological life of the plant refers to the period of the time

for which the present plant would not be rendered obsolete by a new plant. It

is very difficult to estimate the technological life because any law does not

govern the phase of the new development. While it is almost certain that a

new development would occur when it would occur is anybody’s guess. Yet

an estimate of the technological life has to be made.

Product market life of the plant:

A plant may be physically usable, its technology may not be

obsolete, but the market for its products may disappear or shrink and hence

its continuance may not be justified. The product life of the plant refers to

the period for which the product of the plant enjoys reasonable satisfactory

market.

Investment horizon of the firm:

The time period for which a firm wishes to look ahead for the

purposes of investment analysis may be referred to as its investment horizon

planning. It naturally tends to vary with the complexity and size of

investment. For small investments (installation of lathe) it may be five years.

For medium size investments (expansion of the plant capacity) it may be ten

years. For large size investment (setting up a new division) it may be fifteen

years.

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COMPANY PROFILE

Hindustan Aeronautics Limited (HAL) came into existence on

1st October 1964. The Company was formed by the merger of Hindustan

Aircraft Limited with Aeronautics India Limited and Aircraft Manufacturing

Depot, Kanpur.

The Company traces its roots to the pioneering efforts of an

industrialist with extraordinary vision, the late Seth Walchand Hirachand,

who set up Hindustan Aircraft Limited at Bangalore in association with the

erstwhile princely State of Mysore in December 1940. The Government of

India became a shareholder in March 1941 and took over the Management in

1942.

Today, HAL has 16 Production Units and 9 Research and Design

Centers in 7 locations in India. The Company has an impressive product

track record - 12 types of aircraft manufactured with in-house R & D and 14

types produced under license. HAL has manufactured 3550 aircraft (which

includes 11 types designed indigenously), 3600 engines and overhauled over

8150 aircraft and 27300 engines.

HAL has been successful in numerous R & D programs developed

for both Defense and Civil Aviation sectors. HAL has made substantial

progress in its current projects:

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• Dhruv, which is Advanced Light Helicopter (ALH)

• Tejas - Light Combat Aircraft (LCA)

• Intermediate Jet Trainer (IJT)

• Various military and civil upgrades.

Dhruv was delivered to the Indian Army, Navy, Air Force

and the Coast Guard in March 2002, in the very first year of its

production, a unique achievement.

HAL has played a significant role for India's space programs by

participating in the manufacture of structures for Satellite Launch Vehicles

like

• PSLV (Polar Satellite Launch Vehicle)

• GSLV (Geo Stationary Launch Vehicle)

• IRS (Indian Remote Satellite)

• INSAT (Indian National Satellite)

There are three joint venture companies with HAL:

• BAeHAL Software Limited

• Indo-Russian Aviation Limited (IRAL)

• Snecma HAL Aerospace Pvt Ltd

Apart from these three, other major diversification projects are Industrial

Marine Gas Turbine and Airport Services. Several Co-production and Joint

Ventures with international participation are under consideration.

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HAL's supplies / services are mainly to Indian Defense Services, Coast

Guards and Border Security Forces. Transport Aircraft and Helicopters have

also been supplied to Airlines as well as State Governments of India. The

Company has also achieved a foothold in export in more than 30 countries,

having demonstrated its quality and price competitiveness.

HAL has won several International & National Awards for achievements in

R&D, Technology, Managerial Performance, Exports, Energy Conservation,

Quality and Fulfillment of Social Responsibilities.

• HAL was awarded the “INTERNATIONAL GOLD MEDAL

AWARD” for Corporate Achievement in Quality and Efficiency at

the International Summit (Global Rating Leaders 2003), London, UK

by M/s Global Rating and UK in conjunction with the International

Information and Marketing Center (IIMC).

• HAL was presented the International - “ARCH OF EUROPE” Award

in Gold Category in recognition for its commitment to Quality,

Leadership, and Technology and innovation.

• At the National level, HAL won the "GOLD TROPHY" for

excellence in Public Sector Management, instituted by the Standing

Conference of Public Enterprises (SCOPE).

The Company scaled new heights in the financial year 2004-2005 with a

turnover of Rs. 4534 Crores and export over Rs. 150.05 Crores.

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EVOLUTION AND GROWTH OF THE COMPANY

The company’s steady organizational growth over the years with consolidation and enlargement of its operational base by creating sophisticated facilities for manufacture of aircraft / helicopters, aero engines, accessories and avionics is illustrated below.

EXHIBIT-III.1

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HAL MISSION

" To become a globally competitive aerospace industry while working as an

instrument for achieving self-reliance in design, manufacture and

maintenance of aerospace defense equipment and diversifying to related

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areas, managing the business on commercial lines in a climate of growing

professional competence”

HAL VALUES

CUSTOMER SATISFACTION

HAL is dedicated to building a relationship with its customers

where it becomes partners in fulfilling their mission. It strives to understand

our customer’s needs and to deliver products and services that fulfill and

exceed all their requirements.

COMMITMENT TO TOTAL QUALITY

It is committed to continuous improvement of all its activities. It

will supply products and services that conform to highest standards of

design, manufacture, reliability, maintainability and fitness for use as desired

by our customers

COST AND TIME CONSCIOUSNESS

It believes that our success depends on their ability to continually

reduce the cost and shorten the delivery period of its products and services.

It will achieve this by eliminating waste in all activities and continuously

improving all processes in every area of our work.

INNOVATION AND CREATIVITY

It believes that our success depends on our ability to continually

reduce the cost and shorten the delivery period of our products and services.

It will achieve this by eliminating waste in all activities and continuously

improving all processes in every area of our work.

TRUST AND TEAM SPIRIT

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It believes in achieving harmony in work life through mutual

trust, transparency, co-operation, and a sense of belonging. It will strive for

building empowered teams to work towards achieving organizational goals.

RESPECT FOR THE INDIVIDUAL

It values its people. it will treat each other with dignity and

respect and strive for individual growth and realization of everyone's full

potential.

INTEGRITY

It believes in a commitment to be honest, trustworthy, and fair

in all our dealings. It commits to be loyal and devoted to its organization. It

will practice self-discipline and own responsibility for its actions. It will

comply with all requirements so as to ensure that its organization is always

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EXHIBIT-III.2

BOARD OF DIRECTORS

29

CHAIRMAN

PART TIME OFFICIAL

DIRECTORS (2)WHOLE TIME

DIRECTORS (7)PART TIME NON-

OFFICIAL DIRECTORS (6)

MD (MIG COMPLEX)

DIRECTOR (PERSONNEL)

DIRECTOR (CORP PLG & MKG)

MD (ACCYS COMLLEX)

DIRECTOR (DESIGN & DEV)

DIRECTOR (FINANCE)

MD (BANGALOOR COMPLEX)

JOINT SECRETARY (HAL)ADDL.FA (AM) & JS

G P GUPTHA

RATAN NAVAL TATA

R N BHATTACHARYA

M.K.MOITRA

S.RAVI

VICE ADMIRAL

RAMAN PURI (Retd.)

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EXHIBIT-III.3

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TABLE – III.1HAL CUSTOMERS

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International Customers Domestic Customers

• Airbus Industries, France • APPH Bolton, UK • BAE Systems, UK • Chelton, UK • Coast Guard, Mauritius • Corporate Air,

Philippines • Cosmic Air, Nepal • Dassault Aviation,

France • Dowty Aerospace

Hydraulics, UK • EADS, France • ELTA, Israel • Gorkha Airlines, Nepal • Hampson, UK • Honeywell International,

USA • Island Aviation Services,

Maldives • Israel Aircraft Industries,

Israel • Messier Dowty Ltd., UK • Mistubishi Heavy

Industries, Japan • MOOG, USA • Namibian Air Force,

Namibia • Peruvian Air Force , Peru • Rolls Royce Plc, UK • Royal Air Force, Oman • Royal Malaysian Air

Force, Malaysia • Royal Nepal Army,

Nepal • Royal Thai Air Force,

Thailand

• Air India • Air Sahara • Airports Authority of India • Bharat Electronics • Border Security Force • Coal India • Defense Research & Development

Organization • Govt. of Andhra Pradesh • Govt. of Jammu & Kashmir • Govt. of Karnataka • Govt. of Maharashtra • Govt. of Rajasthan • Govt. of Uttar Pradesh • Govt. of West Bengal • Indian Air force • Indian Airlines • Indian Army • Indian Coast Guard • Indian Navy • Indian Space Research Organization • Jet Airways • Kudremukh Iron ore Company ltd. • NALCO • Oil & Natural Gas Corporation Ltd. • Ordnance Factories • Reliance Industries • United Breweries

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• Smiths Industries, UK • Snecma, France • Strong field

Technologies, UK • The Boeing Aircraft

Company, USA • Tran world Aviation,

UAE • Vietnam Air Force,

Vietnam

FINANCIAL HIGHLIGHTS:

Hindustan Aeronautics Limited (HAL) has cruised past the

Rs.7,500-crore mark for the first time with a sales turnover of Rs.7,783.61

crores ($1.82 billion) during the Financial Year 2006-07, The Value of

Production has also gone up by 55.54% to Rs. 9,201.88 crores, while the

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Profit of the Company (Profit Before Tax) soared to Rs.1,743.60 crores,

which is an increase of 54.88% over the previous year's performance.

The highlights are given below:

Rupees in Crores

Particulars 2005-06 2006-07 Growth over Previous Year

Sales 5342 7783 45.69%

VOP 5916 9202 55.54%

Profit before tax 1126 1744 54.88%

Profit after tax 771 1149 49.03%Gross Block 1694 2081 22.85%

Welcome to the Avionics Division, Hyderabad of Hindustan Aeronautic

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s Limited.

In early sixties, it was strongly felt that our defense services

should be more self reliant in defense related equipment, electronics in

particular. This resulted in HAL setting up a full - fledged unit to cater to the

aviation electronics (AVIONICS). Thus Avionics Division, Hyderabad was

born in the year 1965.

To begin with, the Division's dedicated design team took up the task of

indigenising, the following critical avionics.

• Identification of Friend or Foe

• UHF Communication set

• V/UHF Communication System

• Automatic Direction Finder (ADF)

• Radio Altimeter

These systems were developed, qualified, flight tested and inducted

into the various MiG aircraft manufactured under license in India. Later on,

the same equipments were fine tuned to meet the requirement of other

aircraft like Kiran, Jaguar, Dornier, AN-32 and Helicopters.

Today the Division has spread its wings further to meet the

Communication and Navigation requirements of our defiance customers and

the Division is fully geared to enter the international market too.

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Products in Current Manufacturing Range

36

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SI. NO.

EQUIPMENTFUNCTION HIGHLIGHTS SPECIFICATIONS

1. IFF 400Identification of Friend or Foe

More than 2000 in service

Power output: > 350W< (24.5 dbw) PEAK No. of codes available 4096

2. IFF 1410A

Automatic replies to appropriate ground or airborne interrogators

Modular Construction

Additional secure mode

3. ADFAutomatic Direction Finder

About 1000 flying in various aircraft

Accuracy: ± 2%

4. VUC-201 AA combined V /UHF main communication set

More than 2000 in service

100-156 MHz (2240 channels) 225-400 MHz (7000 channels)

5.INCOM-1210A

Integrated Radio Communication System

ECCM FacilityCommunication in AM/FM/Data/ECCM Mode

6. COM-150AUHF standby equipment

Fully solid-stateOperating Freq.: 225-400 MHz 7000 channels, 5 w

7. COM-1150AUHF standby equipment

Hybridized Version

10 Preset Channels

8.COM-104A/105A

VHF Communication Equipment

Fully Solid - state

Operating Freq.: 116-136 MHz 720 channels, 4W

9. HFSSBHF Single Sideband Communication set

Fitted in all military Transport A/C

2 to 27 MHz Channel spacing: 100 HzSensitivity: 100 dbm

10. SPEEDETMeasure speed of moving object

Supplied to many state police departments

Range: 5 to 200 KMPHAccuracy: ±1 KMPH

A combined V/UHF Communication set

More than 150 Operation in various ships

Freq. Range: 100-156 MHz

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ANALYSIS OF THE PROJECTS

This project deals with the analysis of certain running

projects of HAL. The analysis is carried out based on the method of risk

analysis discussed in earlier chapter. Since H.A.L is a organization under the

ministry of the Defense which is engaged in the production of different

Defense products to be supplied to it’s various customers viz. Indian air

force, Indian army, Indian navy etc. The project names that are bean

analyzed in further chapters have been codified for data security.

Accordingly four running projects of H.A.L. have been

selected for analysis and are coded as PROJECT 1, PROJECT 2,

PROJECT 3, and PROJECT 4. Brief description of the project is

discussed below.

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PROJECT-1

This project is for supply of Eqot. For a Helicopter and its total

investment is about Rs.1038 lakhs.

CASH FLOW AFTER TAX FOR PROJECT- 1

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TABLE – IV.1

YearQty

Sale Value

Total Cost

Gross Earnings

Total Dep

Net Earnings

Tax 31% PAT

Add. Dep. CFAT

1 2 3 4 5=3-4 6 7=5-6 8 9=7-8 10 11=9+10

1 3 265.5 238.55 26.538.92 -12.42 -3.85 -8.57

38.92 30.35

2 5 441.75 397.58 44.17 51.9 -7.73 -2.4 -5.33 51.9 46.57

3 151325.25

1192.73 132.52

77.85 54.67 16.95 37.72

77.85 115.57

4 252208.75

1987.88 220.87 98.6 122.27 37.9 84.37 98.6 182.97

5 252208.75

2017.69 191.06

103.8 87.26 27.05 60.21

103.8 164.01

6 30 2650.52047.96 602.54

103.8 498.74

154.61 344.13

103.8 447.93

7 30 2650.52078.68 571.82

103.8 468.02

145.09 322.93

103.8 426.73

8 353092.25

2810.86 281.39

103.8 177.59 55.05 122.54

103.8 226.39

9 353092.25

2853.02 239.23

103.8 135.43 41.98 93.45

103.8 197.25

10 353092.25

2895.82 196.43

103.8 92.63 28.72 63.91

103.8 167.71

11 353092.25

2939.26 152.99

103.8 49.19 15.25 33.94

103.8 137.74

12 252385.45

2266.18 119.27

103.8 75.14 23.29 51.85

44.13 95.98

Total

300

1201.15 2239.15

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PROJECT -2

This project is recording system with a capital investment is a

bout Rs.92.54 lakhs.

CASH FLOW AFTER TAX FOR PROJECT –2

TABLE –IV.2

YearQty

Sale Value

Total Cost

Gross Earnings

Total Dep

Net Earnings

Tax 31% PAT

Add. Dep. CFAT

1 2 3 4 5=3-4 6 7=5-6 8 9=7-8 10 11=9+10

1 3 37.14 33.43 3.71 3.67 0.04 0.01 0.03 3.67 3.7

2 12148.56 133.7 14.86 4.62 10.24 3.17 7.07 4.62 11.69

3 15 185.7167.13 18.57 6.94 11.63 3.61 8.02 6.94 14.96

4 15 185.7169.64 16.06 6.94 9.12 2.83 6.29 6.94 13.23

5 25 309.5278.55 30.95 6.94 24.01 7.44 16.57 6.94 23.51

6 25 309.5282.73 26.77 6.94 19.83 6.15 13.68 6.94 20.62

7 25 309.5278.55 30.95 6.94 24.01 7.44 16.57 6.94 23.51

8 45 557.1501.39 55.71 6.94 48.77

15.12 33.65 6.94 40.59

TOTAL165

101.88 151.81

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PROJECT- 3

This project is Adv. Computer system with a capital investment

about Rs.220.00 lakhs.

CASH FLOW AFTER TAX FOR PROJECT- 3

TABLE – IV.3

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PROJECT – 4

This project is Radar Eqpt. With a capital investment is about

Rs.160 lakhs.

YearQty

Sale Value

Total Cost

Gross Earnings

Total Dep

Net Earnings

Tax 31% PAT

Add. Dep. CFAT

1 2 3 4 5=3-4 6 7=5-6 8 9=7-8 10 11=9+10

1 8 566.56 509.9 56.66 0.85 55.81 17.3 38.51 0.85 39.36

2 25 1770.51593.45 177.05 0.85 176.2

54.62

121.58 0.85 122.43

3 271912.14

1720.93 191.21 0.85 190.36

59.01

131.35 0.85 132.2

TOTAL 60291.44 293.99

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CASH FLOW AFTER TAX FOR PROJECT – 4

TABLE – IV.4

YearQty

Sale Value

Total Cost

Gross Earnings

Total Dep

Net Earnings

Tax 31% PAT

Add. Dep. CFAT

1 2 3 4 5=3-4 6 7=5-6 8 9=7-8 10 11=9+10

1 5 5546.35379.91 166.39 24 142.39

44.14 98.25 24 122.25

2 44437.04

4215.19 221.85 24 197.85

61.33

136.52 24 160.52

3 44437.04

4320.57 116.47 24 92.47

28.67 63.8 24 87.8

4 44437.04

4406.98 30.06 24 6.06 1.88 4.18 24 28.18

TOTAL 17302.75 398.75

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CALCULATION OF PAYBACK PERIOD

Payback period can be computed by dividing cash outlay by the annual cash

flow.

Payback period =Lower year + Original cost of product – AACIF of lower

year / AACIF of upper year – AACIF of lower year

In the case of unequal cash flow, the payback period can be found out by

adding of the cash inflows until the total is equal to the initial cash outlay.

Acceptance rule:

Payback method is the simplest and easy to understand and easy to

calculate. Companies used the payback period to accept or reject or it is used

as a method of ranking the project. 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. If the firm has to choose

among two mutually exclusive projects, the project with shorter payback

period is selected.

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TABLE – IV.5

THE PAYBACK PERIOD OF PROJECT-1

(Rs in lakhs )Year Annual cash inflows Cumulative cash inflows1 30.35 30.352 46.57 76.923 115.57 192.494 182.97 375.465 164.01 539.476 447.93 987.47 426.73 1414.138 226.39 1640.479 197.25 1837.7210 167.71 2005.4311 137.74 2143.1712 95.98 2239.15

Investment is Rs 1038 lakhs.

Payback period =Lower year + Original cost of product – AACIF of lower

year / AACIF of upper year – AACIF of lower year

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Payback period= 6+(1038-984.40)/(1414.13-987.40)

= 6.1 years.

Interpretation:

In this project the initial investment is Rs1038 lakhs are recovered in

6th year of 1st month.

TABLE – IV.6

THE PAYBACK PERIOD OF PROJECT-2

(Rs in lakhs)

Year Annual cash inflows Cumulative cash inflows1 3.7 3.72 11.69 15.393 14.96 30.354 13.23 43.585 23.51 67.096 20.62 87.717 23.51 111.238 40.59 151.81

Investment is Rs 92.54 lakhs.

Payback period =Lower year + Original cost of product – AACIF of lower

year / AACIF of upper year – AACIF of lower year

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Payback period = 6+ (92.54-87.71) / (111.23-87.71)

= 6.2 years.

Interpretation:

In this project the initial investment is Rs 92.54 lakhs are

recovered in the 6th year of 2nd month.

TABLE – IV.7

THE PAYBACK PERIOD OF PROJECT-3

(Rs in lakhs)

Year Annual cash inflows Cumulative cash inflows1 39.36 39.362 122.43 161.793 132.2 293.99

.

Investment is Rs 220.00 lakhs.

Payback period =Lower year + Original cost of product – AACIF of lower

year / AACIF of upper year – AACIF of lower year

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Payback period = 2 + (220 – 161.79) / (293.99 – 161.79)

= 2 + (58.21 / 132.2)

=2 + 0.44

= 2.4 years

Interpretation:

In this project the initial investment is Rs 220.00lakhs are

recovered in the 2nd year of 4th Month

TABLE – IV.8

THE PAYBACK PERIOD OF PROJECT-4

(Rs in lakhs)Year Annual cash inflows Cumulative cash inflows1 122.25 122.252 160.52 287.773 87.8 370.574 28.18 398.75

Investment is Rs 160 lakhs.

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Payback period =Lower year + Original cost of product – AACIF of lower

year / AACIF of upper year – AACIF of lower year

Payback period = 1+ (160-122.25) / (287.77-122.25)

= 1.2years.

Interpretation:

In this project the initial investment is Rs 160.00 lakhs are

recovered in the 1st year of 2nd month.

FIGURE – IV.1

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6.1 6.2

2.4

1.2

0

1

2

3

4

5

6

7

YEARS

1 2 3 4

PROJ ECTS

PAYBACK PERIOD OF DIFFERENT PROJ ECTS

1

2

3

4

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CALCULATION OF ACCOUTING RATE OF RETURN

The accounting rate of return thus is an Average Rate of Return,

which can be determined by the following equation.

Accounting rate of return = average income / Average investment.

Average investment = (Original investment – Scrap value)/2

Average income = Total income / Number of years.

Acceptance rule:

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 the minimum rate. This method would rank a

project as number one if it has higher ARR and lowest rank would be

assigned to the project with lowest ARR. However, in HAL capital

investment in different projects is less since the company has already

established necessary infrastructure facilities. The expected rate of return

expected by the management from the entire project is 10%. Except for

certain exceptional projects such as TOT projects where the probability

values based on nature and Transfer of Technology. Based on this the ARR

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of HAL is always likely to be higher. The ARR of four projects under

analysis is as below:

TABLE – IV.9

THE ARR OF PROJECT-1

(Rs in lakhs)Year NPAT1 -8.572 -5.333 37.724 84.375 60.216 344.17 322.98 122.59 93.4510 63.9111 33.9412 51.85Total 1201.2

Accounting rate of return = average income / Average investment.

Average investment = (Original investment – Scrap value)/2

Average income = Total income / Number of years.

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Investment is Rs1038 lakhs

Average investment = 1038/2=519.

Average income =1201.15/12

=100.10

ARR= (100.10/519) 100

=19.28%

TABLE – IV.10

THE ARR OF PROJECT-2

(Rs in lakhs)Year NPAT1 0.032 7.073 8.024 6.295 16.576 13.687 16.578 33.65Total 101.9

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Accounting rate of return = average income / Average investment.

Average investment = (Original investment – Scrap value)/2

Average income = Total income / Number of years.

Investment is Rs.92.54 lakhs.

Average investment = 92.54/2 = 46.27

Average income = 101.88/8 = 12.73

ARR = (12.73/46.27) 100 = 27.51

ARR = 27.51%

TABLE – IV.11

THE ARR OF PROJECT-3

(Rs in lakhs)

Year NPAT1 38.512 121.63 131.4Total 291.4

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Accounting rate of return = average income / Average investment.

Average investment = (Original investment – Scrap value)/2

Average income = Total income / Number of years.

Investment is Rs220.00 lakhs.

Average investment = 220/2

= 110

Average income = 291.44/3

= 97.14

ARR = (97.14/110) 100

ARR = 88%

TABLE – IV.12

THE ARR OF PROJECT-4

(Rs in lakhs)

Year NPAT

1 98.25

2 136.5

3 63.8

4 4.18

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Total 302.8

Accounting rate of return = average income / Average investment.

Average investment = (Original investment – Scrap value)/2

Average income = Total income / Number of years.

Investment is Rs.160 lakhs.

Average investment = 160/2

= 80

Average income = 302.75/4

= 75.68

ARR = (75.68/80) 100

=94.6%

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FIGURE – IV.2

19.28

27.51

88

94.6

0

10

20

30

40

50

60

70

80

90

100

ARR@%

1 2 3 4PROJ ECTS

ARR OF DIFFERENT PROJ ECTS

1

2

3

4

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CALCULATION OF NET PRESENT VALUE OF HAL:

The following steps are involved in the calculation of NPV. Incase of

NPV is positive accept the project, if the NPV is negative reject the project.

NPV > 0 ACCEPT

NPV < 0 REJECT

NPV = 0 MAY ACCEPT

NPV is the true measure of an investment’s profitability. The NPV

method, therefore, provides the most investment rule. First, it recognizes the

time value of money. A rupee received today is worth more than a rupee

received tomorrow.

It uses all cash flows occurring over the entire of the project in

calculating its worth. The NPV relies on the time value of the estimated cash

flows and the discount rate rather than any arbitrary assumptions or

subjective considerations.

The NPV method can be selected between mutually exclusive

projects; the one with higher NPV should be selected. Using the NPV

method, projects would be ranked in order of net present values; that is, first

rank will be given to the project with the highest positive net present value

and so…on…

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TABLE – IV.13

NET PRESENT VALUE OF THE PROJECT-1

(Rs in lakhs)

Year1

Cash flow2

P.V.factor@10%3

Cash flows of P.V4(2*3)

1 30.35 0.909 27.582 46.57 0.826 38.463 115.57 0.751 86.794 182.97 0.683 124.965 164.01 0.621 101.856 447.93 0.564 252.637 426.73 0.513 218.918 226.39 0.467 105.79 197.25 0.424 83.6310 167.71 0.386 64.7311 137.74 0.35 48.212 95.98 0.319 30.61Total 1184.05

Total CF of PV = 1184.05

(-) Investment = 1038.00

NPV = 146.05

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Interpretation:

NPV of project-1 is positive (+) i.e. Rs 146.05 lakhs, so project is

acceptable for HAL.

TABLE – IV.14

NET PRESENT VALUE OF THE PROJECT-2

(Rs in lakhs)

Year1

Cash flow2

P.V.factor@10%3

Cash flows of P.V4 (2*3)

1 3.7 0.909 3.362 11.69 0.826 9.653 14.96 0.751 11.234 13.23 0.683 9.035 23.51 0.621 14.596 20.62 0.564 11.627 23.51 0.513 12.068 40.59 0.467 18.95Total 90.49

Total CV of PV = 90.49

(-) Investment = 92.54

NPV = -2.05

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Interpretation:

NPV of project-2 is Negative (-) i.e. – Rs 2.05 lakhs, so project is reject

for HAL.

TABLE – IV.15

NET PRESENT VALUE OF THE PROJECT-3

(Rs in lakhs)

Year Cash flow P.V.factor@10% Cash flows of P.V1 39.36 0.909 35.772 122.43 0.826 101.123 132.2 0.751 99.284 Total 236.17

Total CF of PV = 236.17

(-) Investment = 220.00

NPV = 16.17

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Interpretation:

NPV of project-3 is positive (+) i.e. Rs 16.17 lakhs, so project is

acceptable for HAL.

TABLE – IV.16

NET PRESENT VALUE OF THE PROJECT-4

(Rs in lakhs)

Year Cash flow P.V.factor@10% Cash flows of P.V1 122.25 0.909 111.122 160.52 0.826 132.583 87.8 0.751 65.934 28.18 0.683 19.245 Total 328.87

Total CV of PV = 328.87

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(-) Investment = 160.00

NPV = 168.87

Interpretation:

NPV of project-4 is positive (+) i.e. Rs 168.87 lakhs, so project is

acceptable for HAL.

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FIGURE – IV.3

146.05

-2.05

16.17

168.87

-20

0

20

40

60

80

100

120

140

160

180

RUPEES IN LAKHS

1 2 3 4

PROJ ECTS

NPV OF DIFFERENT PROJ ECTS

1

2

3

4

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CALCULATION OF PROFITABILITY INDEX (PI)

The profitability index method provides a solution to this kind of

problem; it may be defined as the ratio, which is obtained dividing the

present value of future cash flows by the present values of cash outlays.

PI = PV of cash inflows / initial cash outlay

ACCEPTANCE OF THE PROJECT:

Using the B/C ratio or the PI, a project will accept if its PI exceeds

one. When the PI = 1, when the PI is greater than, equal to or less than 1, the

net present value is greater than or equal to or less than zero. In other wards,

the NPV will be positive when the PI is greater than one; NPV is negative

when the PI is less the one.

Therefore NPV and PI approaches give the same results regarding

the investment proposals.

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TABLE – IV.17

PROFITABILITY INDEX OF PROJECT-1:

(Rs in lakhs)

Year1

Cash flow2

P.V.factor@10%3

Cash flows of P.V4(2*3)

1 30.35 0.909 27.582 46.57 0.826 38.463 115.57 0.751 86.794 182.97 0.683 124.965 164.01 0.621 101.856 447.93 0.564 252.637 426.73 0.513 218.918 226.39 0.467 105.79 197.25 0.424 83.6310 167.71 0.386 64.7311 137.74 0.35 48.212 95.98 0.319 30.61Total 1184.05

PV of cash inflows = 1184.05

(-) Investment =1038.00

NPV =146.05

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PI = PV of cash inflows / initial cash outlay

PI = 1184.05/1038 = 1.14

Interpretation:

The profitability index value is 1.14, which is more than the value ‘0’,

and also the NPV is positive hence the project is viable to HAL.

TABLE – IV.18

PROFITABILITY INDEX OF PROJECT-2:

(Rs in lakhs)

Year1

Cash flow2

P.V.factor@10%3

Cash flows of P.V4 (2*3)

1 3.7 0.909 3.362 11.69 0.826 9.653 14.96 0.751 11.234 13.23 0.683 9.035 23.51 0.621 14.596 20.62 0.564 11.627 23.51 0.513 12.068 40.59 0.467 18.95Total 90.49

Total CV of PV = 90.49

(-) Investment = 92.54

NPV = -2.05

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PI = PV of cash inflows / initial cash outlay

PI = 90.49/92.54 = 0.97

Interpretation:

The profitability index value is 0.97, which is more than the value ‘0’,

and also the NPV is negative hence the project is not viable to HAL.

TABLE – IV.19

PROFITABILITY INDEX OF PROJECT-3:

(Rs in lakhs)

Year Cash flow P.V.factor@10% Cash flows of P.V1 39.36 0.909 35.772 122.43 0.826 101.123 132.2 0.751 99.284 Total 236.17

Total CF of PV = 236.17

(-) Investment = 220.00

NPV = 16.17

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PI = PV of cash inflows / initial cash outlay

PI = 236.17/220= 1.07

Interpretation:

The profitability index value is 1.07, which is more than the value ‘0’,

and also the NPV is positive hence the project is viable to HAL.

TABLE – IV.20

PROFITABILITY INDEX OF PROJECT-4:

(Rs in lakhs)

Year Cash flow P.V.factor@10% Cash flows of P.V1 122.25 0.909 111.122 160.52 0.826 132.583 87.8 0.751 65.934 28.18 0.683 19.245 Total 328.87

Total CV of PV = 328.87

(-) Investment = 160.00

NPV = 168.87

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PI = PV of cash inflows / initial cash outlay

PI = 328.87/160 =2.05

Interpretation:

The profitability index value is 2.05, which is more than the value ‘0’,

and also the NPV is positive hence the project is viable to HAL.

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FIGURE – IV.4

1.14

0.971.07

2.05

0

0.5

1

1.5

2

2.5

VALUES

1 2 3 4

PROJ ECTS

PROFITABILITY INDEX OF DIFFERENT PROJ ECTS

1

2

3

4

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INTERNAL RATE OF RETURN (IRR):

The second discounted cash flow or time-adjusted method for

apprising capital investment decisions is the internal rate of return (IRR)

method. This technique is also known as yield on investment, marginal

efficiency of capital, marginal productivity of capital. The internal rate of

return is usually the rate of return that a project earns. It is defined as the

aggregate present value of cash outflows of a project.

IRR = Lower rate of return + present value of Cash at lower rate – present

value of investment / Different between present values ∗ Different between

the discount rate chosen.

(OR)

IRR = r – (PBP – DFR) / (DFRL – DFRH)

Where PBP = Pay back period

DFR = Discount factor for interest Rate r

DFRL = Discount factor for Lower interest Rate r

DFRH = Discount factor for Higher interest Rate r

Acceptance of project:

Accept – if IRR > cost of capital

Reject - if IRR < cost of capital

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CALCULATION OF IRR OF PROJECT – 1

Pay Back Period = 6.1 years

Present value of annuity for PBP lies between 12% and 13%

12% ---------------------------- 6.1944

13% ---------------------------- 5.9176

IRR = 13 – (6.1-5.917) / (6.194-5.917)

IRR = 12.3%

Interpretation:

The minimum expected rate of return of HAL is 10%. Since the

IRR of ject-1 i.e 12.3% is grater than expected rate of return, it is observed

that project is viable to HAL.

CALCULATION OF IRR OF PROJECT – 2

Pay Back Period = 6.2 years

Present value of annuity for PBP lies between 6% and 7%

6% ------------------------- 6.2098

7% ------------------------- 5.9713

IRR = 7 – (6.2 –5.9713) / (6.2098 –5.9713)

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IRR = 6%

Interpretation:

The expected rate of return of HAL is 10%. Since the IRR of

project-2 i.e. 6% is less than expected rate of return, so it is observed that

project is not viable to HAL.

CALCULATION OF IRR OF PROJECT – 3

Pay Back Period = 2.4 years

Present value of annuity for PBP lies between 12% and 13%

12% ------------------------- 2.402

13% ------------------------- 2.361

IRR = 13 – (2.4 –2.361) / (2.402 –2.361)

IRR = 11.88%

Interpretation:

The minimum expected rate of return of HAL is 10%. Since the IRR

of ject-3 i.e 11.88% is grater than expected rate of return, it is observed that

project is viable to HAL.

CALCULATION OF IRR OF PROJECT – 4

Invest of Project-3 is Rs.160 Lakhs.

NPV= 0

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(Cash inflow - Investment) = 0

The IRR is the value of ‘r’, which satisfies the following equation.

160 = 122.25 + 160.52 + 87.80 + 28.18 (1+r) (1+r) 2 (1+r) 3 (1+r) 4

The calculation of ’r’ involves a process of trail and error. We try different

values of ‘r’ till we find that the RHS of the above equation is equal to

Rs.160Lakhs. Let us, to began with, try r=62%. This makes the RHS equal

to:

39.36 + 122.43 + 132.20 = 161.37 (1+0.62) (1+0.62) 2 (1+0.62) 3

The value is slightly Higher than our target valueRs.160lakhs. So we

increase the value of ‘r’ from 62% to 63%.

39.36 + 122.43 + 132.20 = 159.68 (1+0.63) (1+0.63) 2 (1+0.63) 3

Since this value is now less than 160, we conclude that value of ‘r’lies

between 62% to 63%. From most of the purposes this indication sufficient.

If a move-refined estimate of ‘r’ is needed, use the following procedure.

(1) Determine the NPV of Two closest rates of return.

(NPV/62%) 1.37

(NPV/63%) 0.32

(2) Find sum of the absolute values of the NPV obtained in step 1:

1.37 + 0.32 = 1.69

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(3) Calculate the ratio of the NPV of the smaller discount rate identified in

step 1: to the sum obtained in step2:

0.32/1.69 = 0.18

(4) Add the number obtained in step3: to the smaller discount rate:

62+0.18 = 62.18%

Interpretation:

The minimum expected rate of return of HAL is 10%. Since the IRR

of ject-4 i.e 62.18% is grater than expected rate of return, it is observed that

project is viable to HAL.

FIGURE – IV.5

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12.36

11.88

62.18

0

10

20

30

40

50

60

70

IRR (%)

1 2 3 4PROJECTS

IRR OF DIFFERENT PROJECTS

1

2

3

4

FINDINGS / CONCLUSIONS

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The study concerned with the capital budgeting with reference to HAL the

data is collected, organized, analyzed and interpreted. HAL has a good

organization culture, excellent working environment and a very precious

asset that is highly dedicated, hardworking, and well-qualified efficient and

knowledgeable workforce.

The following findings are obtained from the analysis of data:

1. The project is for supply of Eqot. For a helicopter and its total investment

is Rs.1038 lakhs.

• The non-discounted pay back period is 6.1 years. The

investment will recover in 6years and 1 month.

• The ARR is 19.28% more than the required rate of return.

Therefore, accept the project on ARR basis.

• NPV is positive (+) i.e.Rs146.05 lakhs, so accept the project.

• The profitability index is 1.14 times > 1.

• The IRR is 12.3% more than the required rate of return

2. The project is recording system with a capital investment is about Rs

92.54 lakhs.

• The non-discounted pay back period is 6.2 years. The

investment will recover in 6years and 2 month.

• The ARR is 27.51% more than the required rate of return.

Therefore, accept the project on ARR basis.

• NPV is negative (-) i.e. –2.05 lakhs, so reject the project on

NPV basis.

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• The profitability index is 0.97 times <1. So reject the project

on PI basis.

• The IRR is 6% less than the required rate of return. So reject

project on IRR basis.

3. The project is adv. Based computer system with a capital investment is

about Rs.8.12lakhs.

• The non-discounted pay back period is 2.4 years. The

investment will recover in 2 year and 4th month only.

• The ARR is 88% more than the required rate of return.

Therefore, accept the project on ARR basis.

• NPV is positive (+) i.e.Rs16.17 lakhs, so accept the project.

• The profitability index is 1.07 times > 1.

• The IRR is 11.88% more than the required rate of return.

4. The project is Radar Eqpt. With a capital investment is about Rs.160lakhs.

• The non-discounted pay back period is 1.2 years. The

investment will recover in 1year and 2 month.

• The ARR is 94.6% more than the required rate of return.

Therefore, accept the project on ARR basis.

• NPV is positive (+) i.e.Rs168.87 lakhs, so accept the project.

• The profitability index is 2.05 times > 1.

• The IRR is 62.18% more than the required rate of return

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TABLE – V.1

ACCEPT / REJECT THE NEW SCHEMES:

Project ARR PBP NPV IRR PI Accept/Reject

1 A A A A A Accept

2 A A R R R Reject

3 A A A A A Accept

4 A A A A A Accept

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TABLE – V.2

COMPARATIVE ANALYSIS OF ALL THE 4 PROJECTS:

Project ARR (%) PBP (Yrs)NPV (Rs in lakhs) IRR (%) PI (Times)

1 19.28 6.1 146.05 12.3 1.14

2 27.51 6.2 -2.05 6 0.97

3 88 2.4 16.17 11.88 1.07

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4 94.6 1.2 168.87 62.8 2.05

The ARR of all the projects is more than the companies minimum

required rate of return.

All projects are recovering the investment in their project duration.

Except the 2nd project, all of them are having positive NPV.

Except the 2nd project, the IRR of all the projects is more than the

companies minimum required rate of return.

The above projects profitability is more than 1 but again the 2nd

project fails and earns a profit of Rs.0.97 at per rupee of

investment.

RECOMMENDATIONS / SUGGESTIONS

1. The advanced computer system project is high quality project. It’s

profitable in all contexts PBP, ARR, NPV, IRR, PI are positive, accept the

project.

2. The recording system is not a profitability project; it is generating losses

at present. Therefore, Reject it.

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3. The project of supply of Eqot. for a Helicopter is having a PBP of 6.1yrs,

NPV, IRR, ARR & PI are indicating a positive sign. Therefore accept the

project.

4. The project of Radar Eqpt is having a PBP of 1.2yrs, NPV, IRR; ARR &

PI are indicating a positive sign. Therefore accept the project.

BIBLIOGRAPHY:

BOOKS:

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1) A Murthy, S Gurusamy, “Management Accounting”, Vijay

Nicole, 2006.

2) I M Pandey, “Financial Management”, 9/e, Vikas publishing,

2004.

3) M Y Khan and P K Jain,“Financial Management”,Tata Mc

Graw-Hill, New Delhi- 2003.

4) S.N.Maheswari, “Financial Management”, Vikas Publishers,

New Delhi-2003.

5) V K Bhalla, “Financial Management and Policies”, Anmol

Publications Pvt.Ltd. New Delhi.

WEB-SITES:

1) www.hal-india.com 2) www.wikipedia.com 3) www.google.com

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