INTRODUCTION

The term Capital Budgeting refers to long term planning for proposed capital

outlay and their financing. It includes raising long-term funds and their utilization. It

may be defined as a firm’s formal process of acquisition and investment of capital.

Capital Budgeting May also be defined as “The decision making process by

which a firm evaluates the purchase of major fixed assets. It involves firm’s decision to

invest its current funds for addition, disposition, modification and replacement of fixed

assets.

It deals exclusively with investment proposals, which an essentially long term

projects and is concerned with the allocation of firm’s scarce financial resources among

the available market opportunities.

Some of the examples of Capital Expenditure are

(i) Cost of acquisition of permanent assets as land and buildings.

(ii) Cost of addition, expansion, improvement or alteration in the fixed assets.

(iii) R&D project cost, etc.,

Definitions:

“Capital budgeting is long term planning for making and financing proposed

capital outlays

T.HORNGREEN

“Capital budgeting is concerned with allocation of the firm’s scarce financial

resources among the available market opportunities. The consideration of investment

opportunities. The consideration of investment opportunities involves the comparison

of the expected future streams of earnings from a project with immediate and

subsequent streams of expenditures for it”.

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In any growing concern, capital budgeting is more or less a continuous process

and it is carried out by different functional areas of management such as production,

marketing, engineering, financial management etc. All the relevant functional

departments play a crucial role in the capital budgeting decision process of any

organization, yet for the time being, only the financial aspects of capital budgeting

decision are considered.

The role of a finance manager in the capital budgeting basically lies in the

process of critically and in-depth analysis and evaluation of various alternative

proposals and then to select one out of these. As already stated, the basic objectives of

financial management is to maximize the wealth of the share holders, therefore the

objectives of capital budgeting is to select those long term investment projects that are

expected to make maximum contribution to the wealth of the shareholders in the long

run.

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REVIEW OF LITERATURE

Introduction

One of the three major decisions made by managers is the decision to invest in

fixed assets. Investments in fixed assets involve large capital outlays and the

consequences of these investments decisions impact a firm’s operations for a very long

time. Therefore a variety of quantitative and analytical techniques are applied by

managers in project selection to enable them to make good decisions in this area.

2. Literature

It is widely accepted that discounted cash flow methods are the best way to

evaluate capital budgeting proposals. While several decades ago discounted cash flow

methods may not have been widely used (Istvan, 1961) more recent studies (Kim, Crick

and Kim, 1986) suggest that increasingly firms are adopting discounted cash flow

analysis. Much of the empirical research on capital budgeting practices adopted by

corporate managers is based on US data (See for example Mukherjee and Hingorani,

1999.) A few studies such as those by Payne, Heath, and Gale (1999), Jog and

Srivastava (1995) and Keste et. al (1999), examine capital budgeting practices followed

by firms in different countries such as Canada, Australia, Hong Kong, Indonesia,

Malaysia, Philippines and Singapore. This study examines managerial behavior and

preferences with respect to the capital budgeting decision using a sample of German

firms. Our unique sample and the results of our analysis help to fill a gap in finance

literature and provide useful information to managers contemplating German

collaborations.

Capital budgeting is the process by which firms determine how to invest their

capital. Included in this process are the decisions to invest in new projects, reassess the

amount of capital already invested in existing projects, allocate and ration capital across

divisions, and acquire other firms. In essence, the capital budgeting process defines the

set and size of a firm’s real assets, which in turn generate the cash flows that ultimately

determine its profitability, value, and viability.

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In principle, a firm’s decision to invest in a new project should be made

according to whether the project increases the wealth of the firm’s shareholders. For

example, the Net Present value (NPV) rule specifies an objective process by which

firms can assess the value that new capital investments are expected to create. As

Graham and Harvey (2001) document, this rule has steadily gained in popularity since

Dean (1951) formally introduced it, but its widespread use has not eliminated the

human element in capital budgeting. Because the estimation of a project’s future cash

flows and the rate at which they should be discounted is still a relatively subjective

process, the behavioral traits of managers still affect this process.

Studies of the calibration of subjective probabilities find that individuals are

overconfident in that they tend to overestimate the precision of their knowledge and

information (Fischhoff, Slovic, and Lichtenstein, 1977; Alpert and Raffia, 1982). In

fact, research shows that professionals from many fields exhibit overconfidence in their

judgments, including investment bankers (Stael von Holstein, 1972), engineers (Kidd,

1970), entrepreneurs (Cooper, Woo, and Dunkelberg, 1988), lawyers (Wagenaar and

Keren, 1986), negotiators (Neale and Bazerman,1990), and managers (Russo and

Schoemaker, 1992).

Several factors may explain why managers may also be expected to be

overconfident, especially in a capital budgeting context. First, capital budgeting

decisions can be complex. They often require projecting cash flows for a wide range of

uncertain outcomes.

Second, capital budgeting decisions are not well suited for learning.

As Kahneman and Lovallo (1993, p. 18) note, learning occurs “when closely similar

problems are frequently encountered, especially if the outcomes of decisions are

quickly known and provide unequivocal feedback.” In most firms, managers

infrequently encounter major investment policy decisions, experience long delays

before learning the outcomes of projects, and usually receive noisy feedback.

Furthermore, managers often have difficulty rejecting the notion that every situation is

new in important ways, allowing them to ignore feedback from past decisions

altogether. Learning from experience is highly unlikely under these circumstances

(Einhorn and Hogarth,1978; Brehmer, 1980).

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Third, unsuccessful managers are less likely to retain their jobs and be

promoted. Those who succeed may become overconfident because of a self-attribution

bias. Most people overestimate the degree to which they are responsible for their own

success (Miller and Ross, 1975; Langer and Roth, 1975; Nisbett and Ross, 1980). This

self-attribution bias causes successful managers to become overconfident (Daniel,

Hirshleifer, and Subrahmanyam, 1998; Gervais and Odean, 2001).

Fourth, managers may be more overconfident than the general population

because of a selection bias. Those who are overconfident and optimistic about their

prospects as managers are more likely to apply for these jobs. Moreover, as Goel and

Takor (2008) show, firms may endogenously select and promote on the basis of

overconfidence, as overconfident individuals are more likely to have generated

extremely good outcomes in the past. Finally, as Gervais, Heaton, and Odean (2009)

argue, overconfident managers may simply be easier to motivate than their rational

counterparts and so hiring them is more appealing to firms.

Reviews and Appeals of Capital Budgeting

In the corporate finance capital budgeting survey literature the capital

budgeting process has been described in terms of four stages: (1) identification, (2)

development, (3) selection, and (4) control. The identification stage comprises the

overall process of project idea generation including sources and submission procedures

and the incentives/reward system, if any. The development stage involves the initial

screening process relying primarily upon cash flow estimation and early screening

criteria. The selection stage includes the detailed project analysis that results in

acceptance or rejection of the project for funding. Finally, the control stage involves the

evaluation of project performance for both control purposes and continuous

improvement for future decisions.

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All four stages have common areas of interest including personnel, procedures,

and methods involved, along with the rationale for each. All four stages are critical to

the overall process, but the selection stage is arguably the most involved since it

includes the choices of analytical methods/techniques used, how the cost of capital is

determined, how adjustments for projects risks are assessed and reflected, and how, if

relevant, capital rationing affects project choice. The selection stage has also been the

most investigated by survey researchers, particularly in the area of selection techniques,

resulting in a relative neglect of the other stages. This in turn has led to appeals to

future researchers to consider the other stages in their survey research efforts

As Gordon and Pinches (1984) View:

Most of the literature on the subject of capital budgeting has emphasized the

selection phase, giving little coverage to the other phases. Instead, it is usually assumed

that a set of well-defined capital investment opportunities, with all of the informational

needs clearly specified suddenly appears on an executive’s desk and all that is needed is

for the manager to choose the project (s) with the highest expected payoff. However, as

most managers quickly learn, this is not the case. Further, once projects are chosen, the

evaluation of an individual project’s subsequent performance is usually either ignored

or often inappropriately handled. Our contention is that the capital budgeting process

must be viewed in its entirety, and the informational needs to support effective

decisions must be built into the firm’s decision support system

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THEROTICAL FRAME WORK

Introduction

Capital Budgeting May also be defined as “The decision making process by

which a firm evaluates the purchase of major fixed assets. It involves firm’s decision to

invest its current funds for addition, disposition, modification and replacement of fixed

assets.

Features of Capital Budgeting:

The important features, which distinguish capital budgeting decisions in other

Day-to-day decisions, are

Capital budgeting decisions involve the exchange of current funds for the

benefits to be achieved in future.

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

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

They have a long terms are significant effect on the profitability of the concern.

They involve huge funds.

They are irreversible decisions. They are strategic decisions associated with

high degree of risk.

IMPORTANCE OF CAPITAL BUDGETING:

The importance of capital budgeting can be understood from the fact that an

unsound investment decision may prove to be fatal to the very existence of the

organization.

The importance of capital budgeting arises mainly due to the following:

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1. Large investment:

Capital budgeting decision, generally involves large investment of funds. But

the funds available with the firm are scarce and the demand for funds for exceeds

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 an permanent basis. The long-term commitment of funds increases the

financial risk involved in the investment decision.

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 terms effect on profitability:

Capital budgeting decision has a long term and significant effect on the

profitability of a concern. Not only the present earnings of the firm are affected by the

investments in capital assets but also the future growth and profitability of the firm

depends up to the investment decision taken today. Capital budgeting decision has

utmost importance to avoid over or under investment in fixed assets.

5. Difficulties of investment decision:

The long terms investment decisions are difficult to be taken because

uncertainties of future and higher degree of risk.

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6. Notional Importance:

Investment decision though taken by individual concern is of national

importance because it determines employment, economic activities and economic

growth.

FACTORS INFLUENCING CAPITAL EXPENDITURE DECISIONS:

There are many, factors financial as well as non financial which influence the

capital expenditure decisions and the profitability of the proposal yet, there are many

other factors which have to be taken into consideration while taking a capital

expenditure decision. They are:

1. URGENCY: sometimes, an investment is to be made due to urgency for the

survival of the firm or to avoid heavy losses. In such circumstances, proper

evaluation cannot be made through profitability tests. Examples of such urgency are

breakdown of some plant and machinery, fire accidents etc.

2. DEGREE OF UNCERTAINITY: profitability is directly related to risk, higher the

profits, greater is the risk or uncertainty Sometimes, a project with some lower

profitability may be selected due to constant flow of income as compared to another

project with an irregular and uncertain inflow of income.

3. INTANGIBLE FACTORS: sometimes, a capital expenditure has to be made due

to certain emotional and intangible factors such as safety and welfare of the

workers, prestigious project, social welfare, goodwill of the firm etc.

4. AVAILABILITY OF FUNDS: as the capital expenditure generally requires the

provisions of law is solely influenced by this factor and although the project may

not be profitable, yet the investment has to be made.

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5. AVAILABILITY OF FUNDS: as the capital expenditure generally requires large

funds the availability of funds is an important factor that influences the capital

budgeting decisions. A project howsoever profitable may not be taken for want of

funds and a project with lesser profitability may sometimes be preferred due to

lesser pay back period for want of liquidity.

6. FUTURE EARNINGS: a project may not be profitable as compared to another

today, but it may promise better future earnings. In such cases, it may be preferred

to increase future earnings

RISK AND UNCERTAINITY IN CAPTIAL BUDGETING:

All the techniques of Capital Budgeting require the estimation of future cash

inflow and cash outflow. The cash flows are estimated, based on the following factors.

Expected economic life of the project

Salvage value of the asset at the end of the economic life

Capacity of the project

Selling price of the product

Production cost

Depreciation rate

Rate of taxation

Future demand of the product, etc.,

But, due to uncertainties about the future, the estimates of demand, production,

sales, costs, selling price, etc cannot be exact. For example a product may become

obsolete much earlier than anticipated due to unexpected technological developments

all these elements of uncertainties have to be taken into account in the form of forcible

risk while taking a decision on investment proposals. It is perhaps the most difficult

task while making an investment decision. But some allowances for the element of risk

has to be provided.

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CAPITAL EXPENDITURE CONTROL:

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

success of an enterprise in the long run depends upon the effectiveness with which the

management makes capital expenditure decisions. Capital expenditure decisions are

very important as their impact is more or less permanent on the well being and

economic health of the enterprise. Because, of its large scale mechanization and

automation and importance of capital expenditure for increase in the profitability of a

concern. It has become essential to maintain an effective system of capital expenditure

control.

OBJECTIVES OF CONTROL OF CAPITAL EXPENDITURE:

To make an estimate of capital expenditure and to see that the total cash outlay

is within the financial resources of the enterprise.

To ensure timely cash inflows for the projects so that non availability of cash

may not be a problem in the implementation of the problem.

To ensure that all capital expenditure is properly sanctioned.

To properly co-ordinate the projects of various departments.

To measure the performance of the project.

To ensure that sufficient amount of capital expenditure is incurred to keep pace

with the rapid technological development.

To prevent over expansion.

LONG TERM SOURCES OF FINANCE

It is natural phenomenon that the firm is always in deficit of funds. There are two

methods of raising funds.

1) Long term sources

2) Short term sources.

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Capital budgeting decisions involve long term funds. The different long term

sources of finance generally followed by companies are:

1) Shares

2) Debentures

3) Term Loans.

SHARES:

Shares include ordinary or common shares and preference shares. Ordinary or

common shares are the source of permanent capital since they do not have a maturity

date. The holders of ordinary shares are share holders or stock holders are the legal

owners of the company.

Preference share is considered to be hybrid security as it has many features of

both ordinary shares and debentures. Preference shares may be issued with or without

maturity date. The holders of preference shares get dividend at a fixed rate and have

preference over ordinary share holders.

DEBENTURES:

Debentures are a long term promissory note for raising loan capital. The

debenture trust deed defines the legal relationship between the issuing company and the

debenture trustee who represent the debenture holders.

TERM LOANS:

Term loans for more than a year maturity. It is generally available for a period

of 10 years. Interest on term loans is tax deductable. They are obtained from banks and

specially created financial institutions like IFCI, ICICI IDBI etc. the purpose of term

loans is mostly to finance the company’s capital expenditure. They are generally

obtained for financing large expansion, modernization or diversification projects.

Hence, this method of financing is also called pro0ject financing. This is the most

widely used source of financing.

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LEASE FINANCING:

A lease is an agreement for the use of an asset for a specified rental. The owner

of the asset is called the lesser and the user the lessee. Two important categories of

lease are:

1) Operating leases

2) Financial leases

Operating leases are short term cancelable leases where the risk of obsolescence

is born by the lesser.

Financial leases are long tern non-cancellable leases where any risk in the use of

asset is borne by the lessee and he enjoys the return too.

BUYING OR PROCURING:

Buying or procurement involves purchasing an asset permanently in the form of

cash or credit.

LEASING (VS) BUYING:

Leasing equipment has the tax advantage of depreciation which can mutually

benefit both the lesser and lessee. Other advantages of leasing include convenience and

flexibility as well as specialized services to the lessee. Lease proves handy to those

firms to those firms which cannot obtain loan capital from normal sources. The pros

and cons of leasing and buying are to be examined thoroughly before deciding the

method of procurement i.e., leasing or buying.

CAPITAL BUDGETING PROCESS:

Capital budgeting is a complex process as it involves decisions relating to the

investment of current funds for the benefit to be achieved in future and the future is

always uncertain. However, the following procedure may be adopted in the process of

Capital Budgeting.

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Identification of investment proposals:

The capital budgeting process begins with the identification of investment

proposals. The proposal about potential investment opportunities may originate either

from top management or from any officer of the organization. The departmental head

analysis the various proposals in the light of the corporate strategies and submits the

suitable proposals to the capital expenditure planning.

Screening Proposals:

The expenditure planning committee screens the various proposals received

from different departments. The committee views these proposals from various angles

to ensure that these are in accordance with the corporate strategies or selection criterion

of the firm and also do not lead departmental imbalances.

Evaluation of Various Proposals:

The next step in the capital budgeting process is to various proposals. The

methods, which may be used for this purpose such as, payback period method, Rate of

return method, N.P.V and I.R.R etc.

Priorities:

After evaluating various proposals, the unprofitable uneconomical proposal may

be rejected but may not be possible for the firm to invest immediately in all the

acceptable proposals due to limitation of funds. Therefore, it essential to rank the

projects/proposals after considering urgency, risk and profitability involved there in.

FINAL APPROVAL AND PREPERATION OF CAPITAL EXPENDITURE

BUDGET:

Proposals meeting the evaluation and other criteria are finally approved to be

included in the capital expenditure budget. The expenditure budget lays down the

amount of estimated expenditure to be incurred on fixed assets during the budget

period.

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Implementing Proposals:

Preparation of a capital expenditure budget and incorporation of a particular

proposal in the budget doesn’t itself authorize to go ahead with the implementation of

the project. A request for authority to spend the amount should be made to the capital

expenditure committee, which reviews the profitability of the project in the changed

circumstances. Responsibilities should be assigned while implementing the project in

order to avoid unnecessary delays and cost overruns. Network techniques like PERT

and CPM can be applied to control and monitor the implementation of the projects.

Performance Review:

The last stage in the process of capital budgeting is the evaluation of the

performance of the project. The evaluation is made by comparing actual and budgeted

expenditures and also by comparing actual anticipated returns. The unfavorable

variances, if any should be looked in to and the causes of the same be identified so that

corrective action may be taken in future.

KINDS OF CAPITAL BUDGETING DECISIONS

The overall objectives of capital budgeting are to maximize the

profitability of a firm or the return on investment. These objectives can be achieved

either by increasing revenues or by reducing costs. This, capital budgeting decisions

can be broadly classified into two categories. 1. Increase revenue, 2. Reduce costs

The first category of capital budgeting decisions is expected to increase revenue

of the firm through expansion of the production capacity or size of the firm by reducing

a new product line. The second category increases the earning of the firm by reducing

costs and includes decisions relating to replacement of obsolete, outmoded or worn out

assets. In such cases, a firm has to decide whether to continue the same asset or replace

it. The firm takes such a decision by evaluating the benefit from replacement of the

asset in the form or reduction in operating costs and the cost\ cash needed for

replacement of the asset. Both categories of above decision involve investments in

fixed assets but the basic difference between the two decisions are in the fact that

increasing revenue investment decisions are subject to more uncertainty as compared to

cost reducing investments decisions.

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Further, in view of the investment proposal under consideration, capital

budgeting decisions may be classified as:

1. Accept Reject Decision:

Accept reject decisions relate independent projects do not compute with

one another. Such decisions are generally taken on the basis of minimum return on

investment. All those proposals which yield a rate of return higher than the minimum

required rate of return of capital are accepted and the rest rejected. If the proposal is

accepted the firm makes investment in it, and the rest are rejected. If the proposal is

accepted the firm makes investment in it, and if it is rejected the firm does not invest

in the same.

2. Mutually Exclusive Project Decision:

Such decisions relate to proposals which compete with one another in such a

way that acceptance of one automatically excludes the acceptance of the other. Thus

one of the proposals is selected at the cost of the other. For ex: A company has the

option of buying a machine. Or a second hand machine, or taking on old machine hire

or selecting a machine out of more than one brand available in the market. In such a

cases the company can select one best alternative out of the various options by adopting

some suitable technique or method of capital budgeting. Once the alternative is selected

the others. Are automatically rejected.

Capital Rationing Decision:

A firm may have several profitable investment proposals but only limited funds

and, thus, the firm has to rate them. The firm selects the combination of proposals that

will yield the greatest profitability by ranking them in descending order of their

profitability.

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METHODS OR TECHNIQUES OF CAPITAL BUDGETING:

There are many methods for evaluating the profitability of investment

proposals. The various commonly used methods are

Traditional methods:

(I) Payback period method (P.B.P)

(II) Accounting Rate of return method (A.R.R)

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Time adjusted or discounting techniques:

(I) Net Present value method (N.P.V)

(II) Internal rate of return method (I.R.R)

(III) Profitability index method (P.I)

1. PAY-BACK PERIOD METHOD:

The pay back sometimes called as payout or pay off period method represents

the period in which total investment in permanent assets pay back itself. This method

is based on the principle that every capital expenditure pays itself back within a certain

period out of the additional earnings generated from the capital assets.

Decision rule:

A project is accepted if its payback period is less than the period specific decision rule.

A project is accepted if its payback period is less than the period specified by the

management and vice-versa.

Pay Back Period

Initial Cash Outflow

=

Annual Cash Inflows

ADVANTAGES:

Simple to understand and easy to calculate.

In this method, as a project with a shorter payback period is preferred to the

one having a longer pay back period, it reduces the loss through obsolescence.

Due to its short-term approach, this method is particularly suited to a firm

which has shortage of cash or whose liquidity position is not good.

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DISADVANTAGES:

It does not take into account the cash inflows earned after the payback period

and hence the true profitability of the project cannot be correctly assessed.

This method ignores the time value of the money and does not consider the

magnitude and timing of cash inflows.

It does not take into account the cost of capital, which is very important in

making sound investment decisions.

2. ACCOUNTING RATE OF RETURN METHOD:

This method takes into account the earnings from the investment over the whole

life. It is known as average rate of return method because under this method the concept

of accounting profit (NP after tax and depreciation) is used rather than cash inflows.

According to this method, various projects are ranked in order of the rate of earnings or

rate of return.

Decision rule:

The project with higher rate of return is selected and vice – versa.

The return on investment method can be used in several ways, as

Average Rate of Return Method:

Under this method average profit after tax and depreciation is calculated and

then it is divided by the total capital out lay.

Average Annual profits (after dep. & tax)

Average rate of return = x 100

Net Investment

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ADVANTAGES:

It is very simple to understand and easy to calculate.

It uses the entire earnings of a project in calculating rate of return and hence

gives a true view of profitability.

As this method is based upon accounting profit, it can be readily calculated

from the financial data.

DISADVANTAGES:

It ignores the time value of money.

It does not take in to account the cash flows, which are more important than

the accounting profits.

This method cannot be applied to a situation where investment in project is

to be made in parts.

3. NET PRESENT VALUE METHOD:

The NPV method is a modern method of evaluating investment proposals. This

method takes in to consideration the time value of money and attempts to calculate the

return on investments by introducing time element. The net present values of all

inflows and outflows of cash during the entire life of the project is determined

separately for each year by discounting these flows with firms cost of capital or

predetermined rate.

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The steps in this method are:

1. Determine an appropriate rate of interest known as cut off rate.

2. Compute the present value of cash outflows at the above-determined discount rate.

3. Compute the present value of cash inflows at the predetermined rate.

4. Calculate the NPV of the project by subtracting the present value of cash outflows

From, present value of cash inflows.

Decision rule

Accept the project if the NPV of the project is 0 or +ve that is present value

of cash inflows should be equal to or greater than the present value of cash outflows.

ADVANTAGES:

It recognizes the time value of money and is suitable to apply in a situation

with uniform cash outflows and uneven cash inflows.

It takes in to account the earnings over the entire life of the project and gives

the true view of the profitability of the investment

Takes in to consideration the objective of maximum profitability.

DISADVANTAGES:

More difficult to understand and operate.

It may not give good results while comparing projects with unequal

investment of funds.

It is not easy to determine an appropriate discount rate.

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4. PROFITABILITY INDEX METHOD OR BENEFIT COST RATIO

METHOD:-

It is also a time-adjusted method of evaluating the investment proposals. PI also

called benefit cost ratio or desirability factor is the relationship between present value

of cash inflows and the present values of cash outflows. Thus

PV of cash inflows

Profitability index =

Initial Investment or cash outflows

Net profitability index = Profitability index - 1

ADVANTAGES:

Unlike net present value, the profitability index method is used to rank the

projects even when the costs of the projects differ significantly.

It recognizes the time value of money and is suitable to applied in a situation

with uniform cash outflows and uneven cash inflows.

It takes into an account the earnings over the entire life of the project and gives

the true view of the profitability of the investment.

Takes into consideration the objective of maximum profitability.

DISADVANTAGES:

It may not give good results while comparing projects with Unequal investment

funds.

It is not easy to determine and appropriate discount rate.

It may not give good results while comparing projects with unequal lives as the

project having higher NPV but have a longer life span may not be as desirable

as a project having some what lesser NPV achieved in a much shorter span of

life of the asset.

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5. INTERNAL RATE OF RETURN METHOD

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

budgeting that takes in to account the time value of money. It is also known as time-

adjusted rate of return or trial and error yield method. Under this method the cash

flows of a project are discounted at a suitable rate by hit and trial method, which

equates the net present value so calculated to the amount of the investment. The internal

rate of return can be defined as “that rate of discount at which the present value of cash

inflows is equal to the present value of cash outflows”.

Decision Rule:

Accept the proposal having the higher rate of return and vice versa.

If IRR>K, accept project.

K = cost of capital.

If IRR<K, reject project.

DETERMINANTION OF IRR

a) When annual cash flows are equal over the life of the asset.

Initial Outlay

FACTOR = x 100

Annual Cash Inflow

b) When the annual cash flows are unequal over the life of the asset:

PV of cash inflows at lower rate - PV of cash outflows

IRR = LR + x (Hr-Lr)

PV of cash inflows at lower rate-PV of cash inflows at higher rate

The steps are involved here are

1. Prepare the cash flow table using assumed discount rate to discount the net

cash Flows to the present value.

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2. Find out the NPV, & if the NPV is positive, apply higher rate of discount.

3. If the higher discount rate still gives a positive NPV, increase the discount rate

further. Until, the NPV becomes zero.

If the NPV is negative, at a higher rate, NPV lies between these two rates.

ADVANTAGES:

It takes into account, the time value of money and can be applied in situations

with even and even cash flows.

It considers the profitability of the projects for its entire economic life.

The determination of cost of capital is not a pre-requisite for the use of this

method.

It provides for uniform ranking of various proposals due to the percentage rate

of return.

This method is also compatible with the objective of maximum profitability.

DISADVANTAGES:

It is difficult to understand and operate.

The results of NPV and IRR methods may differ when the projects under

evaluation differ in their size, life and timings of cash flows.

This method is based on the assumption that the earnings are reinvested at the

IRR for the remaining life of the project, which is not a justified assumption.

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NEED FOR THE STUDY

The project study is undertaken to analyze and understand the Capital

Budgeting process in ANANTHA PVC PIPES PVT LTD, which gives mean

exposure to practical implication of theory knowledge.

To know about the company’s operations of using various Capital budgeting

techniques.

To know how the company gets funds from various resources.

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OBJECTIVES OF THE STUDY

To study the relevance of capital budgeting in evaluating the project.

To study the techniques of capital budgeting for decision-making.

To analyse the present value of rupee invested.

To understand transaction wise study of the company

To make suggestions if any for improving the financial positions of the

company.

26

SCOPE OF THE STUDY

Capital budgeting is the method of calculations of inflows of the project

undertaken by the company and investment recovers position of the company. For, the

evaluation of the profitability position use discounting and non-discounting techniques

like IRR, NPV and Pay Back Period. So I choose the concept for the study on capital

budgeting for expansion (or) replacement of the business.

27

LIMITATIONS OF THE STUDY

Lack of awareness of ANANTHA PVC PIPES PVT. LTD.

Lack of time is another limiting factor the schedule period 6 weeks are not

sufficient to make the study independently regarding Capital budgeting in

ANANTHA PVC PIPES PVT LTD

The busy schedule of the officials in the ANANTHA PVC PIPES PVT LTD is

another limiting factor. Due to the busy schedule of officials restricted me to

collect the complete information about organization.

Non-availability of confidential financial data.

The study is conducted in a short period, which was not detailed in all aspects.

28

RESEARCH METHODOLOGY

SOURCES OF DATA:

To achieve a fore said objective the following methodology has been adopted.

The information for this report has been collected through the primary and secondary

sources.

Primary sources:

It is also called as first handed information the data is collected through the

observation in the organization and interviews with officials. By asking, questions with

the accounts and other persons in the financial department. A part from these some

information is collected through the seminars, which were held by ANANTHA PVC

PIPES PVT LTD.

Secondary sources:

These secondary data is existing data which is collected data which is collected

by others that is sources are financial journals, annual reports of the ANANTHA PVC

PIPES PVT LTD.,

Research Design:

Research design - Analytical

Analytical tools- - Capital Budgeting, analysing the capital

budgeting,techniques

Traditional and Modern methods

Data Sources - Secondary data has been collected from

Company records, annual reports

Period of study - 2007 to 2011

29

INDUSTRY PROFILE

Introduction:

Plastic have become synonymous with modern living. It is undoubtedly a

product, which has penetrated extensively into the common man’s life. No wonder the

industry has achieved in terms of supply of raw material expansion and diversification

of processing capabilities and manufacturing of processing machinery and equipment.

This versatile material with its superior qualities such as light weight, easy

process ability corrosion resistance, energy conservation, no toxicity etc. many

substitute to a large extent many conventional and costly industrial materials like wood,

metal, glass, jute, lather etc., in the future. The manifold applications of plastics in the

field of automobiles, electronics, electrical, packaging and agriculture give enough

evidence of the immense utility of plastics.

At 80 percent of total requirement for raw material and almost all types of

plastic machines required for the industry are indigenously available. The present

investment in all the three segments of the industry namely production of raw materials,

expansion and diversification of processing capacities, manufacturing of processing

machinery and ancillary equipment is Rs.1250 crores and it provides employment to

more than eight lakh people.

On account of their inherent advantage in properties and versatility in adoption

and use, plastics have come to play a vital role in a variety of applications, the world

over. In our country, plastics are used in making essential consumer goods of daily use

for common man such as baskets, shopping bags, water bags, water bottles, school

bags, tiffen boxes, hair combs, tooth brushes, spectacle frames and fountain pens, they

also find applications in field like packaging, automobiles, and transportation,

engineering, electronics, telecommunications, defense, medicine, and building and

construction. Plastics are growing in importance in agriculture and water management.

30

The Govt. of India recognizing the importance of plastics in agriculture

appointed on March 7th, 1981 a National Committee on the use of plastics in agriculture

under the chairmanship of Dr.G.V.K.Rao. This committee has forecast a tremendous

growth of drip irrigation through a net work of plastic pipes and tubes. In its opinion

large scale adoption of irrigation would lead to sports in demand for PVC pipes,

L.D.P.E tubes and polypropylene emitters. The committee made a number of

recommendations for promoting the use of plastics. The implementation of

recommendations would go along away in increasing the consumption of plastics,

which at present is very low. The rigid pipes, flexible pipes and sheeting, which are

being used for agricultural operations to carry out water place to place and also lining

of ponds and reservoirs to reduce seepage and most important in drip irrigation system.

Export of plastics goods:

Plastics have excellent potentialities. Our country is equipped with all kind of

processing machinery and skilled labor and undoable, and extra to boost export,

finished plastics products will yield rich divided.

Today India exports plastic products to as many as 80 countries all over the

world. The exports, which were stagnant at around rest 60-70 cores per annum double

to 129 craters. The Plastic industry has taken up the challenge of achieving an export

target of Rs.17 cores.

Major export markets for plastic products and linoleum are Australia,

Bangladesh, Canada, Egypt, Hong Kong, Italy, Kuwait, Federal Republic of Germany,

Sri Lanka, Sweden, Taiwan, U.K., U.S.A., and Russia.

With view to boosting the export, the plastics and linoleum’s export promotion

council has urged the government to reduce import duty of plastic raw material, supply

indigenous raw materials at international prices, fix duty, draw backs on weighted

average basis and charge freight rate on plastic products on weights basis instead of

volume basis.

31

Prospects:

The Production of various plastics a raw materials in the country is expected to

double by the end of seventh plan, the consumption of commodity plastics including

LDPE, HDPE, PP, PS AND PVC is immense scope for the use of plastics in

agriculture, electronics, automobile, telecommunications and irrigation and thus, the

plastic industry is on the threshold of an explosive growth.

Role of plastics in national economy

Plastics are got perceived as just simple colorful household products in the mind so

common person. A dominant part of the plastics of the percent and future find their

utilization in the areas.

Agriculture, forestry and water-management.

Automobile and transportation

Electronics and telecommunications, buildings, construction and.

Food processing and packaging

Power and gas distributor.

Importance of Pipes Industry

We shall look at the basic data about plastics and particularly those properties,

which are so, fuse in practical working with plastics. Plastics are man-made materials.

The oldest raw material for producing plastics is carbonaceous material obtained from

coal tar (benzene, phenol).

Today the majority of raw materials are obtained from petrol chemical source

and they can be economically produced in large quantities.

Plastics have changed our world and day-by-day they are becoming important.

They own their success to whole series of advantage, which they have over

conventional materials such as:

32

Lightweight

Excellent mould ability

Attractive colors

Low energy requirements for convention

Low labor and cost of manufacture

Low maintenance & High strength weight ratio

Economic role:

Agriculture is the chief occupation in India. For the developing countries like

India modernization of the agriculture practices assumes pivotal places in improving

the economic status and the process of modernization. Includes, usage of higher

productive plastics supplement to greater extent manufacturing of tools required for

new agricultural practices.

The usage of poly vinyl chloride pipes in agricultural fields, lesser water

seepage, which was predominant in earlier practices, with services of P.V.C pipes,

water can be transported efficiently with lesser from the place of higher potential to the

place of lower water potential.

Presently the revolutionary tried in water management speaks much about drip

irrigation, which is developed in Israel and is practiced by all agricultural based nations

in the world. Drip irrigation greatly P.V.C pipes as core tools of implementation with

the services of this sort, P.V.C pipes one way or the other strengthening the hands of

country’s economy.

A part with the referred P.V.C pipes supplemented with fitting is used in houses

for electrical connection and other domestic purposes. Apart from these two

applications it has got wide applications even in industrial sectors. P.V.C pipes with

much unique heart, chemical and physical characteristics serve many industrial

purposes.

33

Even characteristics of weight and low price attract many more applications.

Rigid PVC pipes have been manufactured in India from the 60’s on imported extrusion

lines and there after indigenous plan were few pipes manufactures up to 1979-83. When

many extrusion lines were imported from batten field, Cincinnati, kraaus-maffi etc. the

Govt. allowed the imports of sophisticated and high output plants, which were not

available indigenously.

PVC PIPES IN INDIA

Pipes products have found wide acceptance in India and abroad. PVC is one of

the more versatile plastics. It can be extruded, molded, calendared and thermoformed

into a multitude of furnished products. The PVC resin can be formulated to give a wide

range of properties ranging from hand, tough materials for load bearing application

lime pipes, windows and doors to flexible materials for products a due as wire and

cable insulation and shooting and flooring.

PVC products cater to both interiors and exteriors. In interiors it can be used for

flooring, profile and cable tray, wall covering modular office systems, houses and

furniture. For exteriors it is used for doors and windows, fencing partitions and

paneling, roofing and rain systems.

The other external applications are in the field of irrigation, portable water

supplies. In the field of irrigation there are several methods to irrigate the fields. There

are minor irrigation projects and major irrigation projects apart from individual sources

like wells, tube wells, bore wells. Major irrigation sector small projects will have canals

and lift irrigation schemes etc., will have canals and lift irrigation schemes etc., will

have pipelines. Cement and GI pipes were the pipes used in conventional methods of

irrigation. Now-a-days PVC pipes replaced the conventional pipes and they constituted

almost 90% in this respect.

34

Drip irrigation popular in the agricultural sector especially in the field of

horticulture commercial cropping and green ply houses. The drip irrigation concept is

becoming more popular with its advantages like highly yield, water conversion, less

labour cost, less fertilizer, less past management costs, less power costs and many more

advantages. The demand for this concept is increasing at a place of 30%-40% per

annum.

Agriculture a sunrise industry in the Indian economy is mainly dependent on the

PVC pipes for the seawater sector and pumping to their aqua ponds. They are using

pipelines of four to five kilometers of 10-16 diameters pipes.

The state Govt. of A.P is using rigid PVC pipes for the irrigation water supplies

for the past few years. The state Govt. is producing PVC pipes through APSIDC

(Andhra Pradesh State Irrigation Development Corporation) for its lift irrigation

schemes. The panchayatraj department is producing pipes for public water supply

schemes. These pipes can be used for the main distributors, sub-distributors and

individual connections.

35

COMPANY PROFILE

Introduction:

A dynamic entrepreneur Sri S P Y Reddy was established a black pipes

manufacturing company in 1977 and the name of the company is Nandi Pipes Pvt Ltd

at Nandyal, Kurnool district. Anita PVC Pipes Pvt Ltd was incorporated in the year

2002. The factory is situated at NH-7, Hampapuram village, Raptadu mandal, and

Anantapur district and it was taken over by Nandi Group Company. The company is

managed by team of professionals under the guidance of young, experienced, and well

qualified dynamic managing director Mr. S. Sreedhar Reddy.

Origin:

Rayalaseema is economically backward area in Andhra Pradesh, was rare field

region for industries. A dynamic entrepreneur sir S.P.Y.Reddy who is basically

mechanical engineer started a unit at Nandyal, which manufactures black pipes in 1977.

The determination and hard work of Sri S.P.Y.Reddy helped him to overcome the

problems faced by the company in the initial years, and with financial assistance from

local commercial banks. The company could overcome the problems of the merger and

now it is running smoothly.

Later the company started manufacturing of PVC pipes which terminated the

manufacturing of black pipes. This resulted in the formation of a Pvt. Ltd. company

called “SUJALA PIPES PVT.LTD.” with Sri S.P.Y.Reddy as the Managing Director.

The only major competitors to the company are Sudhakar pipes, Maharaja

Pipes. The only backdrop to it is the competition from local brands. As the majority of

the customers belong to farmers, they consider the quality. The company has to make

aware of the company’s quality standards to them.

36

Board of directors:

S.P.Y.Reddy:

Sri S.P.Y.Reddy locally well known industrialist with the base at Nandyal, Kurnool

district who has been successful entrepreneur, he is technically qualified person with

B.E (MEC) from R.E.C (Warangal) and with work experience at BAARC (Bombay).

He has daringly ventured and established industries in and around Nandyal from 70’s.

As years went of he has established most successfully the following Nandi group of

companies:

Nandi Milk

Maha Nandi Mineral Water

Nandi Infosys

Nandi Online Services

ANANTHA PVC PIPES PVT LTD.

Integrated Thermos Plastic Ltd.

Nandi PVC Projects.

Promoter:

Sri S Sreedhar Reddy, a computer engineer and a student of IIM, Ahemadabad

has been entrusted the management of ANANTHA PVC PIPES PVT LTD.,

Hampapuram and great assistance and a great upcoming engineer and industrialist.

Branches:

Pondicherry

Bellary

Sangli

Vellore

Goa

Kerala

Coverage:

37

At present Andhra Pradesh, parts of southern states of Karnataka, Tamilnadu

and Kerala are ambit of Sujala Pipes Pvt Ltd.

The company extended their sales in the below regions are shown below:

1979 Nandyal Region(polyphone pipes)

1984-85 Rayalaseema Region (PVC pipes)

1985-86 Telangana Region

1986-87 Karnataka and Andhra Pradesh

1988-91 Tamilnadu and Karnataka

1991-94 Kerala

Sizes:

Various sizes ranging from ½ to 10 are offered to customers. Even pipes with

different gauges and sizes are manufactured to suit specified conditions.

Packing:

Packing plays less important role into the products like PVC pipes because the

hallow space inside can be utilized. For, the purpose of cubic space utilization in trucks

while transport, organization is adopting the technique like pipes in pipes.

Payment period:

` For monarch brand the company adopts zero credit policy and goods are not

delivered unless cash remittances are made. For monarch and sagar brands credit is

entitled up to a week. The difference between these brands is due to brand image.

Technical details about PVC pipes:

38

Ingredients:

PVC resin

D.B.L.S

T.B.L.S

L.S

C.S

Satiric Acid

Hydro Carbon

Calcium Carbonate

Manufacturing process:

The main raw materials are HDPE granules and PP granules. The

manufacturing process for pipes consists of mixing various resins along with the

coloring materials in a mixture and the prepared material is fed to the extruder. In the

extruder, the material is heated to the required politicizing temperature (190deg.

centigrade to 230deg. centigrade) the extruder through the die hard to form the pipe.

The hot pipe coming out of the extruder is cooled in a water bath to retain the final

shape.

The pipe coming out of the extruder is guided through the water bath suitable

transaction system. The temperature of the water is maintained by circulating through

the cooling towards and with the help of a chilling plant.

` The required length of the pipe is cut with a planetary saw. The cut lengths are

titled by titling units and get corrected in the pipe rack attached to the titling frames.

Later they are stocked separately. The company has entered into a technical with its

own processing technology.

Channels of distribution:

39

ANANTHA PVC PIPES PVT LTD. has got zero level and single level channel

of distribution.

ANANTHA PVC PIPES PVT LTD. has an extensive network of 350 dealers in

Andhra Pradesh and who are directly serviced by company sales force and 620 dealers

in South India.

Transportation:

Transportation vehicles of ANANTHA PVC PIPES PVT LTD. outnumber the

fleet of the competitor’s vehicle. This unique strength of the organization enables the

delivery system to be efficient. This event helps the dealers to reduce inventory levels

to the minimum. The dealers are also supplemented with the benefit of the lower paid

up capital in the form of inventory.

ANANTHA PVC PIPES PVT LTD:

ANANTHA PVC PIPES PVT LTD. was incorporated in the year Feb 2002.

The factory is situated at NH-7, Hampapuram village, Raptadu mandal, and Anantapur

district. It was taken over by Nandi group company, and it is one of the sister company

among the Nandi groups.

Its annual production capacity is 18,000 mts. And it is one of the leading

manufacturers of PVC pipes in south India. This company is equipped with technical

collaboration from Batten field of West Germany. It has made possible few other small

ventures. Pipes are sold under the brand names of MONARCH, KOHINOOR and

KRISHNA.

40

MANUFACTURER CONSUMER

MANUFACTURER DEALER CONSUMER

ANANTHA PVC PIPES with their good quality, trouble free services, durability

and commercial use are a better choice than mild steel, galvanized steel, cast iron and

plastic pipes.

The company is managed by a term of professionals under the guidance of a

young, experienced and well qualified dynamic managing director Mr. Sreedhar Reddy.

Mission Statement:

The mission statement of ANANTHA PVC PIPES PVT LTD. is as follows:

To be preferred supply chain partner to out customer.

To be recognized as the best in the world at we do.

To create new values in the quality for our customers and employees.

Vision Statement:

The vision statement of ANANTHA PVC PIPES PVT LTD. is as follows:

“Creating new values in quality by working together for you”

Functional departments of the company:

Financial department:

Through initially the company approached the external source for financial aid,

now the financial status of the company is very sound and is being run only with self

finance excepting for loans taken for hypothecation of machinery and stock from SBI

Nandyal.

41

The company follows cash and carry policy for monarch brand. The product is

not delivered until the cash is paid and financial department with the help of marketing

department looks after these transactions.

Marketing department:

Marketing Department is headed by the Executive Director. Marketing Manager

is in charge of all operations who reports to the Executive Director. Marketing Manager

and 35 Sales Representatives are under the control of Executive Director. There are

also 20 salesmen who have to report to the sales representatives above them.

Personal Department:

The Personal department consists the details of the executives and workers of

the organization. The organization is formed with Sri.S.P.Y.Reddy as the managing

Director. Two Marketing managers, financial managers, public relations officer and

quality control officer who all reports to executive director. Other, than executives there

are thousands workers in the organization.

Panel consisting of managing director, executive director and managers of

concerned departments makes the recruitment and selections of persons. Apart from the

attractive salaries company provides health card facilities.

Purchasing department:

The perplexing situation i.e. conformed by the manufactures of the PVC pipes is

scarcity of resin. Though the government of India has taken various steps to improve

the supply conditions of PVC resin, the Indian manufactures could meet only 50

percent of demand and remaining 50 percent is met from imports. The major

petrochemical company is Reliance Petrochemical Ltd. The lead time for the

acquisition of raw materials is 4 days.

42

The following lines highlight the human resources policies and practices:

Effective utilization of manpower.

To provide good working condition.

To promote industrial development.

Application of PVC pipes:

Agriculture and irrigation schemes.

Rural and urban water supplies scheme.

Tube well casing.

Gas and oil supply lines.

Industrial effluent disposal.

Sewerage and drainage scheme.

Air-condition ducting.

Building installations.

Industrial ducting.

PRODUCT PROFILE

43

Pipe hollow structure usually cylindrical, for conducting materials. It is used

primarily to convey liquids, gases or solid suspended in a liquid for e.g. slurry and also

used for electric wires. The earliest pipes were probably made of bamboo. Used by the

Chinese to carry water c.5000 BC. The Egyptians made the first metal pipe of copper

c.3000 BC until the cost iron became relatively, Copper or bronze. Modern materials

include cast iron weight iron, steel, copper, brass, bead, concrete, wood, and glass,

plastic. In lying an oil pipeline, 40’ft (12-m) sections of seamless steel pipe are

electrically welded together while held over a trench. Before being lowered into place

the pipe is coated with a protective paint and wrapped with a substance composed of

treated asbestos felt and fiberglass. 

Pumping section located 50 to 75 ml (80-120km). A part boosts the dwindling

pressure backup as much as 1500’lb per inch. The piping must be kept clean either by

applying a negative electronic charge to the pipe or by regular use of a “pig”, or

scrubbing ball, inserted at one end and carried along by the current. An oil pipe line 6

inches (15 cm) to 24 inches (60 cm) in diameter will move it contents at about 3 to 6 ml

(5-10) per hr. Water has moved since ancient times in pipelines called aqueducts.

44

DATA ANALYSIS AND INTERPRETATION

INVESTMENT EVALUATION CRITERIA

Three steps are involved in the evaluation of an investment:

Estimation of Cash Flows.

Estimation of the required rate of return.

Application of a decision rule for making the choice.

The investment decision rules may be referred to as capital budgeting techniques

or investment criteria. A sound appraisal technique should be used to measure the

economic worth of the investment project. The essential property of a sound technique

is that it should maximize the shareholder’s wealth.

“Here, in the data analysis the financial Manager to suggest their information to

taking the initial investment from the year 2007. Because, the company registered in

the year before, the 2006 on that year the company is a proprietary company”.

A number of capital budgeting techniques are used in practice. They may be

grouped as follows:

Payback period (PBP)

Average rate of return (ARR)

Net Present Value (NPV)

Profitability Index(PI)

Internal Rate of Return(IRR)

All these methods of capital budgeting techniques are explained in detail below

Initial Investment 2,00,00,000 Rs. Tax percentage 25% (such as 10%) and the

depreciation the company will be provided in the Balance Sheet. these are all the based

to calculate the Profit after Tax and cash flows.

45

PAY BACK 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 in a project. If the project generates constant annual cash inflows, the

payback period can be computed by the following formulae:

Initial Investment

Pay Back period =

Annual Cash Flows

In case of unequal cash inflows, the payback period can be computed by

calculating the cumulative cash inflow and checking whether the values are recovered

to the original outlay and taking the remaining amount and apply the formulae i.e.,

Required CFAT

PBP = base year +

Next year

ACCEPTANCE RULE:

1. Many firms use the payback period as acceptance for reject criterion as

well as a method of ranking projects.

2. If the payback period calculated for a project is less than the maximum

or standard payback period set by management, it would be accepted, if

not, it would be rejected.

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

the shortest payback period and lowest ranking to the project, which has

highest payback period.

46

Initial Investment is Rs.2, 00, 00,000.

SHOWING THE CALCULATIONS OF PAYBACK PERIOD

(In Rupees)

Year Profit after tax Depreciation Cash flow after

tax

Cumulative

cash flows

2007 374540 2432956 2807496 2807496

2008 3049546 2167152 5216698 8024195

2009 4380048 2437146 6817194 14841389

2010 5300374 3102096 8402470 23243860

2011 7567635 5611603 13179238 36423098

Base Year = 3rd Year; Required CFAT = 51, 58,610.07;

Next Year CFAT = 2, 32, 43,860.28

2, 00, 00,000-1, 48, 41,389.93

Payback Period = 3 +

2, 32, 43,860.28

= 3 + 0.2219 = 3.2219 years (0.2219 X 365 days)

= 3 years 2 months 20days.

47

SHOWING THE CALCULATIONS OF PAYBACK PERIOD

Inference:

From the point of Pay Back Period the project can be accepted, because to get

the initial investment of Rs. 2, 00, 00,000, it is taking a time of 3 years 2months 20

days.

48

Average Rate of Return (ARR):

The Average Rate of Return (ARR) is also known as Accounting Rate of Return

using accounting information, as revealed by financial statements, to measure the

profitability of an investment. The accounting rate of return is found out by dividing

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

be equal to half of the original investment, if it is depreciated constantly. The

Accounting rate of return can be calculated by the following formula i.e.,

Profit after Tax

A.R.R. = X 100

Book Value of the Investment

SHOWING CALCULATION OF AVERAGE RATE OF RETURN

( in Rupees)

Year

Profit before

tax

Tax25% (include

10%surcharge

Profit after tax

2007 483278 108737 374540

2008 3934898 885352 3049546

2009 5651675 1271626 4380048

2010 6839192 1538818 5300374

2011 9829346 2261711 7567635

49

Calculation of A.R.R:

Total Net Profit after Tax

Average Net Profit after Tax =

Number of years

2,06,72,143

= = 41,34,428.6

5

Initial Investment

Book Value of Investment =

2

2,00,00,000

= = 1,00,00,000

2

41,34,428.6

Average Rate of Return = X 100

1, 00, 00,000

= 41.34%

Inferences:

From the point of ARR method, project should be accepted, the initial

investment we can get with in less time.

50

Net Present Value (NPV):

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

evaluating the investment proposals. It is one of the discounted cash flow techniques

explicitly recognizing the time value of money. It correctly postulates that cash flows

arising at different time periods differ in value and the comparable only when their

equivalents present values are found out.

Acceptance Rule:

Accept if NPV >0

Reject if NPV <0

In differences if NPV = 0

Cash flow 0 cash flow 1 cash flow n cash flow t

NPV= ---------------+ ------------- +……. + ---------------- = - C0

SHOWING CALCULATION OF NET PRESENT VALUE

(In Rupees)

YEAR

S

PROFIT

AFTER

TAX DEPRICIATION

AFTER

TAX NPV @5%

PRESENT

VALUE

CASH FLOW

2007 374540.91 2432956 2807496.91 0.9523809523 2673806

2008 3049546.32 2167152 5216698.32 0.9070294784 4731699

2009 4380048.12 2437146 6817194.12 0.8638375985 5889075

2010 5300374.35 3102096 8402470.35 0.8227024747 6912768

2011 7567635 5611603 13179238 0.783526165 10326277

Total 30533625

51

Calculations of Net Present Value:

Net Present Value = Present Value Cash Inflows - Initial Investment or cash outflows

= 3,05,33,625 - 2, 00, 00,000

= 1,05,33,625 Rs.

Inferences:

As NPV is positive, the project is accepted.

52

Profitability Index:

It is also called as Benefit Cost Ratio. It is also a time-adjusted method of

evaluating the investing proposals. It is the relationship between present value of cash

inflows and the present value of cash outflows. Thus

Present Value of cash inflows

Profitability Index =

Initial Investment of or cash out flows

SHOWING CALCULATION OF PROBILITTY INDEX

Years

Profit after

Tax Depreciation After Tax NPV @5%

Present

Value Cash

flow

2007 374540.91 2432956 2807496.91 0.9523809523 2673806.58

2008 3049546.32 2167152 5216698.32 0.9070294784 4731699.15

2009 4380048.12 2437146 6817194.12 0.8638375985 5889075.77

2010 5300374.35 3102096 8402470.35 0.8227024747 6912768.69

2011  7567635  5611603  13179238  0.783526165 10326277

Total 30533625

(In Rupees)

From the above table calculated values are

Present value of cash inflow = 3,05,33,625

Initial Investment cash outflow = 2, 00, 00,000

53

3,05,33,625

Profitability Index =

2, 00, 00,000

= 1.5266

Net Profitability Index = PI -1

=1.5266 – 1

=0.5266

Inferences:

As the profitability Index is >1, the project should be accepted

54

Internal Rate of Return:

The internal rate of return (IRR) method is another discounted cash flow

technique, which makes account of the magnitude and timing of cash flows. Others

terms used to describe the IRR Method are yield on investment, marginal efficiency of

capital, rate of return over cost, time adjusted rate of internal return and so on. The

concept of internal rate of return is quite simple to understand in the case of one-period

projects. The IRR is calculated by interpolating the two rates with the help of the

following formula:

PV of cash inflows at lower rate - PV of cash outflows

IRR = LR+ (Hr - Lr)

PV of cash inflows at lower rate-PV of cash inflows at higher rate

Where,

Lr = Rate of interest that is lower of the two rates at which PV of Cash

inflows have been Calculated.

Hr= Rate of interest that is higher of the two rates at which PV of Cash

inflows have been Calculated.

ACCEPTANCE RULE

The accept project rule, using the IRR method, is to accept the project if its internal

rate of return is higher than the opportunity cost of capital (r>k) note that k is also

known as the required rate of return or cut-off rate. The project shall be rejected if its

internal rate of return is lower than the opportunity cost of capital. Thus the IRR

acceptance rules are:

Accept if r>k

Reject if r<k

May accept if r=k

55

SHOWING THE CALCULATIONS OF INTERNAL RATE OF RETURN

(In Rupees)

YEARS

PROFIT

AFTER

TAX

DEPRI-

CIATION

CASH

FLOW

AFTER

TAX NPV @10%

PRESENT

VALUE

CASH

FLOW

NPV

@20%

PRESENT

VALUE

CASH

FLOW

2007 374540.91 2432956 2807496.91 0.9090909 2552269 0.83333 2339580

2008 3049546.38 2167152 5216698.32 0.8264462 4311320 0.69444 3622706

2009 4380048.64 2437146 6817194.12 0.7513447 5121858 0.57870 3945135

2010 5300374.35 3102096 8402470.35 0.6830134 5739000 0.48422 4052117

2011  7567635  5611603  13179238  0.6209213 8183270 0.40187 5296440

Total 25907717 Total 19255978

From the above table calculated values are:

Net Present Value of cash flow of LOWER RATE (LR) = 2,59,07,717

Net Present Value of cash flow of HIGHER RATE (HR) = 1,92,55,978

Therefore,

Present value @ L R – Initial Investment

IRR = LR+ x Rate Difference

Present value @ L R – Present value @ H R

59,07,717

= 10% + x 10

66,51,739

= 10% + 0.889 x 10

56

= 18.89%

Inferences:

Therefore, IRR lies at 18.89%. It is a point where outflow = inflow

And IRR>K, Therefore it is accepted.

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FINDINGS

The company had taken longer period i.e., payback period is 3 years 2 months

20 days to recover its initial investment.

The average rate of return is not good i.e., ARR = 41.34% as it was just to

compensate the marginal profits.

The net present value of ANANTHA PVC PIPES PVT. Ltd is satisfactory as

NPV = 3,05,33,625.

The internal rate of return i.e., IRR= 18.89% is fairly good.

The profitability index is fairly good is it was gradually increasing in each year

as shown graphically.

The unit cost and other expenditures are eligible to claim from the potential

buyer as approved by the Regulatory Commission

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SUGGESTIONS

Company should go for the improvement in the technology to improve

efficiency.

The Company can go for different projects as it has huge reserves and surplus,

to expand its operations.

The Company is beneficial enough to expand its business by utilizing reserves

and surplus.

The firm has to decrease the cost of production per unit.

For society with lower income levels or below poverty line Company should go

for subscribed rates and for industries it should increases its rate marginally to

cover the losses.

In order to diversify its operations it has to invest in more products so that NPV

will be fairly high.

59

CONCLUSION

Under the light of inferences drawn from the analysis the company has to

concentrate on Pay Back Period and NPV for acceptance of the project. The

discounting methods are most preferable as the rate of returns is depending on the

present values. All the techniques which was used for the project resulted positively

expect on Pay Back Period. Finally it is concluded that firm can generate huge profits

by investing in more projects diversifying its operations.

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BIBLOGRAPHY

1. M. PANDEY: Financial Management: vikas publishing house pvt ltd, 9th edition.

2. PRASANNA CHANDRA: Financial Management: Tata McGraw-Hill, 7th edition.

3. I.M. PANDEY: Financial Management: Tata McGraw-Hill, 4th edition.

WEBSITES

www.google.co.in

www.nandi pipes.com

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