You are on page 1of 67

A PROJECT REPORT ON CAPITAL BUDGETING ON HERITAGE FOODS (INDIA) LTD

BY AZIZ CHARANIYA MASTER OF BUSINESS ADMINISTRATION

Submitted in partial fulfillment of the requirement for the award of the degree of MASTER OF BUSINESS ADMINISTRATION DECCAN SCHOOL OF MANAGEMENT (Affiliated to Osmania University) Hyderabad 2009-2011.

DECLARATION

I hereby declare that this project report titled CAPITAL BUDGETING ON carried out in HERITAGE has been undertaken and prepared by me in partial fulfillment of academic requirement for the MASTER OF BUSINESS ADMINISTRATION by OSMANIA University. This project is a result of my efforts and the matter embodied in this report has not been submitted by any one, to date, for award of any degree of any university.

(U.LAKSHMI)

ABSTRACT
2

The term capital budgeting refers to long term planning for purposed capital outlays and their financing. It is the decision making process by which the firm evaluate the capital investment The objective is to know the relevance of capital budgeting in evaluating the project. And understand the techniques of capital budgeting for decisionmaking with to measure the present value of rupee invested in HERITAGE. There are two types of techniques traditional (average rate of returns, pay back period) and time adjusted method (net present value, internal rate of returns and the profitability index) has intensified as methodology The data collected in the past records of HERITAGE. In this analysis I have come to know as the net present value of HERITAGE is satisfactory. The internal rate of return of HERITAGE is considerably high. The HERITAGE will take long period to recover the initial investment as findings. For the society with lower income levels or below poverty line company should go for subscribed rates and for industries it should increase its rate marginally to cover the losses. As I was suggested form HERITAGE better to adopt.

ACKNOWLEDGEMENT
The work of undertaking a project involves many helping hands. This study would not have been possible without their extreme co

operation and encouragement of some esteemed personalities, without the help of whom a beginner like me could not have carried out this project successfully. I owe my special thanks to Mr. MOHAN KUMAR, FA & CCA(A/Cs), for his encouragement and granting permission to do this project work in their company, and I express my thanks to Mr.G.SATHI RAJU, SAO(A/Cs) and Mr. SATYANARAYANA, AO(A/Cs) for their valuable guidance and support. I express my gratitude to , Principal.I

Was vary thankful to my guide, Assistant professor in Finance and Head of the Department of Business Administration and other faculty members of, Hyderabad, for providing their valuable guidance. I am short of words to express my gratitude to my beloved parents for their kind wishes and gracious support, and not to mention, my friends for extending their help at every level or stage of the project work.

CONTENTS
CHAPTER I INTRODUCTION Need for the study Objectives of the study Methodology of the study Limitations of the study CHAPTER II CONCEPTUAL AND THEORETICAL FRAMEWORK Methods & techniques of Capital Budgeting Sources & Collection of Data CHAPTER III COMPANY PROFILE CHAPTER IV DATA ANALYSIS & INTERPRETATION FINDINGS SUGGESTIONS & CONCLUSIONS BIBLIOGRAPHY

NEED FOR THE STUDY

The project study is undertaken to analyze and understand the Capital Budgeting process in food sector, which gives mean exposure to practical implication of theory knowledge.

To know about the companys operations of using various Capital budgeting techniques.

To know how the company gets funds from various resources.

OBJECTIVES OF THE STUDY


To study the relevance of capital budgeting in evaluating the project. To study the techniques of capital budgeting for decisionmaking. To measure the present value of rupee invested. To understand an item wise study of the company of financial performance of the company. To make suggestions if any for improving the financial positions of the company.

METHODOLOGY 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 HERITAGE. 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 HERITAGE Ltd., HERITAGE website, and other publications of HERITAGE.

LIMITATIONS OF THE STUDY Lack of awareness of food generation sector of HERITAGE 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 HERITAGE Ltd.

10

The busy schedule of the officials in the HERITAGE 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.

11

12

COMPANY PROFILE
Heritage at a Glance:
The Heritage Group, founded in 1992 by Sri Nara Chandra Babu Naidu, is one of the fastest growing Private Sector Enterprises in India, with three-business divisions viz., Dairy, Retail and Agri under its flagship Company Heritage Foods (India) Limited (HFIL), one infrastructure subsidiary - Heritage Infra Developers Limited and other associate Companies viz., Heritage Finlease Limited, Heritage International Limited and Heritage Agro Merine 13

Private Limited. The annual turnover of Heritage Foods crossed Rs.347 crores in 2006-07 and is aiming for Rs.700 crores during 2007-08. Presently Heritages milk products have market presence in Andhra Pradesh, Karnataka, Kerala, Tamil Nadu and Maharastra and its retail stores across Bangalore, Chennai and Hyderabad. Integrated agri operations are in Chittoor and Medak Districts and these are backbone to retail operations. In the year 1994, HFIL went to Public Issue to raise resources, which was oversubscribed 54 times and its shares are listed under B1 Category on BSE (Stock Code: 519552) and NSE (Stock Code: HERITGFOOD)

About the founder:


Sri Chandra Babu Naidu is one of the greatest Dynamic, Pragmatic, Progressive and Visionary Leaders of the 21st Century. With an objective of bringing prosperity in to the rural families through co-operative efforts, he along with his relatives, friends and associates promoted Heritage Foods in the year 1992 taking opportunity from the Industrial Policy, 1991 of the Government of India and he has been successful in his endeavour. At present, Heritage has market presence in all the states of South India. More than three thousand villages and five lakh farmers are being benefited in these states. On the other side, Heritage is serving more than 6 lakh customers needs, employing more than 700 employees and generating indirectly employment opportunity to more than 5000 people. Beginning with a humble annual turnover of just Rs.4.38 crores in 1993-94, the sales turnover has reached close to Rs.300 crores during the financial year 2005-2006. Sri Naidu held various coveted and honorable positions including Chief Minister of Andhra Pradesh, Minister for Finance & Revenue, Minister for Archives & Cinematography, Member of the A.P. Legislative Assembly, Director of A.P. Small Industries Development Corporation, and Chairman of Karshaka Parishad.

14

Sri Naidu has won numerous awards including " Member of the World Economic Forum's Dream Cabinet" (Time Asia ), "South Asian of the Year " (Time Asia ), " Business Person of the Year " (Economic Times), and " IT Indian of the Millennium " ( India Today). Sri Naidu was chosen as one of 50 leaders at the forefront of change in the year 2000 by the Business Week magazine for being an unflinching proponent of technology and for his drive to transform the State of Andhra Pradesh .

Forward looking statements:


We have grown, and intended to grow, focusing on harnessing our willingness to experiment and innovate our ability to transform our drive towards excellence in quality, our people first attitude and our strategic direction.

Mission:
Bringing prosperity into rural families of India through co-operative efforts and providing customers with hygienic, affordable and convenient supply of " Fresh and Healthy " food products.

Vision:
To be a progressive billion dollar organization with a pan India foot print by 2012.To achieve this by delighting customers with "Fresh and Healthy" food products, those are a benchmark for quality in the industry. We are committed to enhanced prosperity and the emfoodment of the farming community through our unique "Relationship Farming" Model. To be a preferred employer by nurturing entrepreneurship, managing career aspirations and providing innovative avenues for enhanced employee prosperity. 15

Heritage Slogan:
When you are healthy, we are healthy When you are happy, we are happy We live for your "HEALTH & HAPPINESS"

Quality policy of HFIL:


We are committed to achieve customer satisfaction through hygienically processed and packed Milk and Milk Products. We strive to continually improve the quality of our products and services through upgradation of technologies and systems. Heritage's soul has always been imbibed with an unwritten perpetual commitment to itself, to always produce and provide quality products with continuous efforts to improve the process and environment. Adhering to its moral commitment and its continuous drive to achieve excellence in quality of Milk, Milk products & Systems, Heritage has always been laying emphasis on not only reviewing & re-defining quality standards, but also in implementing them successfully. All activities of Processing, Quality control, Purchase, Stores, Marketing and Training have been documented with detailed quality plans in each of the departments. Today Heritage feels that the ISO certificate is not only an epitome of achieved targets, but also a scale to identify & reckon, what is yet to be achieved on a continuous basis. Though, it is a beginning, Heritage has initiated the process of standardizing and adopting similar quality systems at most of its other plants.

Commitments: Milk Producers:


Change in life styles of rural families in terms of: 16

Regular high income through co-operative efforts. Women participation in income generation . Saved from price exploitation by un-organized sector . Remunerative prices for milk . Increase of milk productivity through input and extension activities Shift from risky agriculture to dairy farming Heritage Financial support for purchase of cattle; insuring cattle Establishment of Cattle Health Care Centers Supplying high quality Cattle feed Organizing "Rythu Sadasu" and Video programmes for educating the farmers in dairy farming

Customers:
Timely Supply of Quality & Healthy Products Supply high quality milk and milk products at affordable prices Focused on Nutritional Foods More than 4 lakh happy customers High customer satisfaction 24 hours help lines ( <10 complaints a day)

Employees:
Enhancing the Technical and Managerial skills of Employees through continuous training and development Best appraisal systems to motivate employees Incentive, bonus and reward systems to encourage employees Heritage forges ahead with a motto "add value to everything you do"

Shareholders:
Returns: Consistent Dividend Payment since Public Issue (January 1995) 17

Service: Highest impotence to investor service; no notice from any regulatory authority since 2001 in respect of investor service Very transparent disclosures

Suppliers:
Doehlar: technical collaboration in Milk drinks, yogurts drinks and fruit flavoured drinks Alfa-Laval: supplier of high-end machinery and technical support Focusing on Tetra pack association for products package.

Society:
Potential Employment Generation more than 3500 employees are working with heritage more than 9500 procurement agents got self employment in rural areas more than 5000 sales agents associated with the company Employment for the youth by providing financial and animal husbandry support for establishing MINI DAIRIES Producing highly health conscious products for the society

Qualities of management principles:


1. Customer focus to understand and meet the changing needs and expectations of customers. 2. People involvement to promote team work and tap the potential of people. 3. Leadership to set constancy of purpose and promote quality culture trough out the organization. 18

4. Process approach to assess the efficiency and effectiveness of each process. 5. Systems approach to understand the sequence and interaction of process. 6. Factual approach to decision making to ensure its accuracy. 7. Continual improvement processes for improved business results. 8. Development of suppliers to get right product and services in right time at right place.

Product/Market wise performance:


The total turnover is Rs 341 Crores during the financial year 200607 against the turnover of 292.02 Crores in 2005-06. Today Heritage distributes quality milk & milk products in the states of A.P, Karnataka, Kerala & Tamil nadu. During the year 2006-07 liquid milk sales was Rs.28329.79 lakhs against Rs.24525.23 lakhs in the previous year. The sales of miik products including bulk sales of cream, ghee and butter were recorded Rs 5781.59 lakhs against Rs 4677.21 lakhs.

Milk sales:
23% growth was recorded in AP 2.38 lakhs litres per day(LLPD) in 200607 against 1.93 LLPD in 2005-06. 13% growth was recorded in Tamilnadu-1.53 LLPD in 2006-07 against 1.35 LLPD in 2005-06. Over all growth of 6% was recorded- 5.49 LLPD in 2006-07 against 5.16 LLPD. Flavoured milk sales recorded a growth rate of 77% over 2005-06. Butter milk sales have gone up by 45% over 2005-06.

Outlook:
Considering the growth potential in the liquid milk market, the company has drawn plans to increase its market share in the existing markets and to enter into new markets there by doubling revenues in dairy business in the next 3 years. To achieve this object, company is undertaking major 19

expansion in dairy business by inverting over Rs20 crores during 2006-07 and over Rs10 crores during the current year to strengthen the milk procurement.

BRANCHES OF HFIL:
HFIL has 3 wings. They are 1. Dairy 2. Retail 3. Agribusiness

1. Dairy:
It is the major wing among all. The dairy products manufactured by HFIL are Milk, curd, butter, ghee, flavoured milk, paneer, doodhpeda, ice cream.

2. Retail:
In the retail sector HFIL has outlets namely Fresh@. In those stores the products sold are vegetables, milk& milk products, grocery, pulses, fruits etc. In Hyderabad 19 retail shops are there. In Bangalore& Chennai, 3&4 respectively are there. Totally there are 26 retail shops are there. Fresh@ is a unique chain of retail stores, designed to meet the needs of the modern Indian consumer. The store rediscovers the taste of nature every day making grocery shopping a never before experience. The unique& distinctive feature of Fresh@ is that it offers the

widest range of fresh fruits and vegetables which are directly hand picked from the farms. Freshness lies in their merchandise and the customers are always welcomed with fresh fruits and vegetables no matter what what time they walk in.

3. Agri Business:
20

In this business HFIL employees will go to farmers and have a deal with them. Those farmers will sell their goods like vegetables, pulses to HFIL only. And HFIL will transport the goods to retail outlets. The agricultural professors will examine which area is suitable to import vegetables from and also examine the vegetables, pulses and fruits in the lab. And finally they report to the Head-Agribusiness. Representatives as per the instructions given by the agri professors will approach the farmers directly and make a deal with them. It is the process of registering the farmers.

21

22

23

CAPITAL BUDGETING
Introduction: The term Capital Budgeting refers to long term planning for proposed capital outlay and their financing. It includes raising longterm funds and their utilization. It may be defined as a firms 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 firms 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 firms 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.
24

T.HORNGREEN Capital budgeting is concerned with allocation of the firms 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. 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. Features of Capital Budgeting: The important features, which distinguish capital budgeting decisions in other Day-to-day decisions, are

25

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. 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: 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. They are strategic decisions

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. investment decision.
26

The long-term

commitment of funds increases the financial risk involved in the

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.

6. Notional Importance: Investment decision though taken by individual concern is of national importance because it determines employment, economic activities and economic growth.

27

KINDS OF CAPITAL BUDGETING: Every capital budgeting decision is a specific decision in the given situation, for a given firm and with given parameters and therefore, an almost infinite number of types or forms of capital budgeting decisions may occur. Even if the same decision being considered by the same firm at two different points of time, the decision considerations may change as a result of change in any of the variables. However, the different types of capital budgeting decisions undertaken from time to time by different firms can be classified on a number of dimensions. Some projects affect other projects the firm is considering and analyzing. At the other extreme, some proposals are pre-requisite for other projects. The projects may also be classified as revenue generating projects or cost reducing projects. In general, the projects can be categorized as follows: 1. From the point of view of firm's existence: The capital budgeting decisions may be taken by a newly incorporated firm or by an already existing firm.
a)

New Firm: A newly incorporated firm may be required to take different decisions such as selection of a plant to be installed, capacity utilization at initial stages, to set up or not simultaneously the ancillary unit etc.

b)

Existing: Firm: A firm which is already existing may also be required to take various decisions from time to time to meet the challenges of competition or changing environment. These decision may be :
(i)

Replacement and Modernization Decision: This is a common type


28

of a capital budgeting decision. All types of plant and machineries eventually require replacement. If the existing plant is to be replaced because the economic life of the plant is over, then the decisions may be known as a replacement decision. However, if an existing plant is to be replaced because it has become technologically outdated (though the economic life may not be over), the decision may be known as a modernization decision. In case of a replacement decision, the objective is to restore the same or higher capacity, whereas in case of modernization decision, the objective is to increase the efficiency and/or cost reduction. In general, the replacement decision and the modernization decisions are also known as cost reduction decisions. (ii) Expansion: Some times, the firm may be interested in increasing the installed production capacity so as to increase the market share. In such a case, the finance manager is required to evaluate the expansion program in terms of marginal costs and marginal benefits.
(ii)

Diversification: Some times, the firm may be interested to

diversify into new product lines, new markets, production of spare parts etc. In such a case, the finance manager is required to evaluate not only the marginal cost and benefits, but also the effect of diversification on the existing market share and profitability. Both the expansion and diversification decisions may also be known as revenue increasing decisions. From the point of view of decision situation: The capital budgeting decisions may also be classified from the point of view of the decision situation as follows:

29

(i) Independent Project Decision:This is a fundamental decision in Capital Budgeting. It is also called as accept- reject criterion. If the project is accepted the firm does not invest in it. In general all these proposals, which yield a rate of return greater, than ascertain required rate of return on cost of capital, are accepted and the rest are rejected. By applying this criterion all independent project with one another in such a way that the acceptance of one precludes the possibility of acceptance of another. Under the accept-reject decision all independent projects that satisfy the minimum investment criterion should be implemented.

(ii) Mutually Exclusive Projects Decision:Mutually Exclusive projects are those, which compete with other projects in such a way that the acceptance of one will exclude the acceptance of the other projects. The alternatives are mutually exclusive and only one may be chosen. Suppose a company is intending to buy a new machine. There are three competing brands, each with a different initial investment adopting costs. The three machines represent mutually exclusive alternatives as only one of these can be selected. It may be noted that the mutually exclusive alternatives, as only one of these can be selected. It may be noted here that the mutually exclusive projects decisions are not independent of the accept reject decisions.

30

(iii) Capital Rationing Decisions: In a situation where the firm has unlimited funds all independent investment proposals yielding return greater than some predetermined levels are accepted. However this situation does not prevail in most of the business firms in actual practice. They have a 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 it maximizes long run returns this, capital rationing refers to a situation in which a firm has more acceptance investment than it can finance. It is concerned with the selection of a group of investment proposals acceptable. Under the accept-reject decision capital rationing employees ranking of the acceptable investments projects. The projects can be ranked on the basis of a predetermined criterion such as the rate of return. The projects are ranked in the descending order of the rate of return.

PROBLEMS AND DIFFICULTIES IN CAPITAL BUDGETNG:

The problems in capital budgeting decisions may be as follows: a) Future uncertainty: Capital budgeting decisions involve long term commitments. However there is lot of uncertainty in the long term. The uncertainty may be with reference to cost of the project,

31

future expected returns, future competition, legal provisions, political situation etc. b) Time Element: The implications of a Capital Budgeting decision are scattered over a long period. The cost and benefits of a decision may occur at different points of time. The cost and benefits of a decision may occur at different points of time. The cost of a project is incurred immediately. However, the investment is recovered over a number of years. The future benefits have to be adjusted to make them comparable with the cost. Longer the time period involved, greater would be the uncertainty. c) Difficulty in Quantification of impact. The finance manager may face difficulties in measuring the cost and benefits of projects in quantitative terms. For example, the new products proposed to be launched by a firm may result in increase or decrease in sales of other product proposed to be launched by a firm may result in increase or decrease in sales of other products already being sold by the same firm. It is very difficult to ascertain the extent of impact as the sales of other products may also be influenced by factors other than the launch of the new products.

32

ASSUMPTIONS IN CAPITAL BUDGETING:

The capital budgeting decision process is a multi-faceted and analytical process. A number of assumptions are required to be made. These assumptions constitute a general set of conditions within which the financial aspects of different proposals are to be evaluated. Some of these assumptions are: 1. Certainty with respect to cost and benefits: It is very difficult to estimate the cost and benefits of a proposal beyond 2-3 years in future. However, for a capital budgeting decision, It is assumed that the estimates of cost and benefits are reasonably accurate and certain. 2. Profit motive: Another assumption is that the capital budgeting decisions are taken with a primary motive of increasing the profit of the firm. No other motive or goal influences the decision of the finance manager. 3. No Capital Rationing: The Capital Budgeting decisions in the present chapter assume that there is no scarcity of capital. It assumes that a proposal will be accepted or rejected on the strength of its merits alone. The proposal will not be considered in combination with other proposals to consider the maximum utilization of available funds.

33

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. 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, pay back period method, Rate of return method, N.P.V and I.R.R etc.

34

Fixing 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.
Implementing Proposals:

Preparation of a capital expenditure budget and incorporation of a particular proposal in the budget doesnt 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. implementation of the projects. Network techniques like PERT and CPM can be applied to control and monitor the

Performance Review:

35

The last stage in the process of capital budgeting is the evaluation of the performance of the project. actual anticipated returns. The evaluation is made by comparing actual and budgeted expenditures and also by comparing 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.

METHODS OR TECHNIQUES OF CAPITAL BUDGETING: There are many methods for evaluating the profitability of investment proposals. The various commonly used methods are TECHNIQUES OF CAPITAL BUDGETING

Traditional Methods 1. Pay back 2. Accounting rate of return

Time adjusted methods 1.N.P.V 2.I.R.R 3.P.I

Traditional methods: (I) Payback period method (P.B.P) (II) Accounting Rate of return method (A.R.R) Time adjusted or discounting techniques: 36

(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 some times 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 with in 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. It saves in cost; it requires lesser time and labour as compared to other methods capital budgeting. In this method, as a project with a shorter pay back 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.

37

DISADVANTAGES:

It does not take into account the cash inflows earned after the pay back 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. It is difficult to determine the minimum acceptable pay back period, which is subjective decision. It treats each asset individually in isolation with other assets, which is not feasible in real practice.

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
38

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 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. It ignores the period in which the profits are earned as a 20% rate of return in 2 years is considered to be better than 18% rate if return in 12 years. This method cannot be applied to a situation where investment in project is to be made in parts.

39

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. 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 abovedetermined 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.

40

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.

4. 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.

41

Decision Rule: Accept the proposal having the higher rate of return and vice versa. If IRR>K, accept project. If IRR<K, reject project. K = cost of capital.

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 + ------------------------------------------------------------- (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.

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

42

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.

43

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 = -----------------------------PV of cash outflows NPV ----------------------------Initial Outlay

Net profitability index =

ADVANTAGES:

Unlike net present value, the profitability index method is used to rank the projects even when the costs of the projects differ significantly.

44

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:

More difficult to understand and operate. 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

45

46

DATA ANALYSIS
INVESTMENT EVALUATION CRITERIA

Three steps are involved in the evaluation of an investment: Estimation of Cash Flows. Estimation of the required rate of return.
47

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 shareholders wealth. A number of capital budgeting techniques are used in practice. They may be grouped as follows:

Pay back period Average rate of return (ARR) Net Present Value (NPV) Internal rate of return (IRR) Profitability Index All these methods of capital budgeting techniques are explained in detail below:

PAY BACK PERIOD:

48

The pay back 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 pay back period can be computed by calculating the cumulative cash inflow and checking weather 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 CFAT ACCEPTANCE RULE:

Many firms use the payback period as an accept for reject criterion as well as a method of ranking projects. If the payback period calculated for a project is less than the maximum or standard pay back period set by management, it would be accepted, if not, it would be rejected. 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.

49

STATEMENT SHOWING CALCULALTION OF PAY BACK PERIOD YEAR 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 ROE 59.64 59.64 59.64 59.64 59.64 59.64 59.64 59.64 59.64 59.64 59.64 59.64 59.64 59.64 59.64 59.64 59.64 59.64 59.64 59.64 59.64 59.64 59.64 59.64 59.64 INC 5.48 5.48 5.48 5.48 5.48 5.48 5.48 5.48 5.48 5.48 5.48 5.48 5.48 5.48 5.48 5.48 5.48 5.48 5.48 5.48 5.48 5.48 5.48 5.48 5.48 TAX 0 0 0 0 0 0 0 0 0 0 22.8 22.8 22.8 22.8 22.8 22.8 22.8 22.8 22.8 22.8 22.8 22.8 22.8 22.8 22.8 PAT 65.12 65.12 65.12 65.12 65.12 65.12 65.12 65.12 65.12 65.12 42.32 42.32 42.32 42.32 42.32 42.32 42.32 42.32 42.32 42.32 42.32 42.32 42.32 42.32 42.32 DEP 170.40 170.40 170.40 170.40 170.40 170.40 170.40 170.40 170.40 170.40 14.20 14.20 14.20 14.20 14.20 14.20 14.20 14.20 14.20 14.20 14.20 14.20 14.20 14.20 14.20 CFAT 235.52 235.52 235.52 235.52 235.52 235.52 235.52 235.52 235.52 235.52 56.52 56.52 56.52 56.52 56.52 56.52 56.52 56.52 56.52 56.52 56.52 56.52 56.52 56.52 56.52 CCFAT 235.52 471.04 706.56 942.08 1177.60 1413.12 1648.64 1884.16 2119.68 2355.20 2411.72 2468.24 2524.76 2581.28 2637.80 2694.32 2750.84 2807.36 2863.88 2920.40 2976.92 3033.44 3089.96 3146.48 3203.00

50

Base Year = 9th year Next year CFAT = 2355.2

Required CFAT = 10.32

2130 2119.68 Pay back period = 9th year + -------------------2355.2 = 9.004 years. Interpretation:

= 9th year + .00437yr

As per pay back period, the project is accepted because to get the initial investment of 2130 crores, it is taking a time of 9.004 years. 2.AVERAGE RATE OF RETURN:

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. tax profit by the average investment. depreciated constantly. The accounting rate of return is found out by dividing the average after The average investment would be equal to half of the original investment, if it is The Accounting rate of return can be calculated by the following formula i.e.,
Annual Average Profit after Tax A.R.R. = ---------------------------------------------- X 100 Annual Average Investment

51

STATEMENT SHOWING CALCULATION OF AVERAGE RATE OF RETURN YEAR 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 Total ROE 59.64 59.64 59.64 59.64 59.64 59.64 59.64 59.64 59.64 59.64 59.64 59.64 59.64 59.64 59.64 59.64 59.64 59.64 59.64 59.64 59.64 59.64 59.64 59.64 59.64 INC 5.48 5.48 5.48 5.48 5.48 5.48 5.48 5.48 5.48 5.48 5.48 5.48 5.48 5.48 5.48 5.48 5.48 5.48 5.48 5.48 5.48 5.48 5.48 5.48 5.48 TAX 0 0 0 0 0 0 0 0 0 0 22.8 22.8 22.8 22.8 22.8 22.8 22.8 22.8 22.8 22.8 22.8 22.8 22.8 22.8 22.8 PAT 65.12 65.12 65.12 65.12 65.12 65.12 65.12 65.12 65.12 65.12 42.32 42.32 42.32 42.32 42.32 42.32 42.32 42.32 42.32 42.32 42.32 42.32 42.32 42.32 42.32 1286.00

CALCULATION OF ARR: Average NPAT Average Investment ARR = = 1286/25 = 2130/2 = = = 4.83 % 51.44 1065

51.44 ---------- X 100 1065

52

Interpretation:

From the point of ARR method, project should be accepted, as its ARR is less than the required rate return (4.83% < 12%).

NET PRESENT VALUE:

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. The following steps are involved in the calculation of NPV. Cash flows of the investment project should be forecasted based on realistic assumptions. Appropriate discount rate should be identified to discount the forecasted cash flow. The appropriate discount rate is the firms opportunity cost capital, which is equal to the required rate of return, expected by investors on investments of equivalent risk. Present value of cash flows should be calculated using opportunity cast of capital as the discount rate. Net present value should be found out by subtracting present value of cash outflow present value of cash inflow. Acceptance Rule: The project should be accepted if NPV is positive it should be clear that the acceptance rule using NPV method is to accept the investment project if its net present value is negative (NPV CASH
53

OUTFLOW). The positive net present value will result only if the project generates cash inflows at rate higher than the opportunity cost of capital.

A project may be accepted in NPV = 0. Thus, the NPV acceptance rules are: Accept if NPV >0 Reject if NPV <0 Ill-defined if NPV = 0.
STATEMENT SHOWING CALCULATION OF NET PRESENT VALUE

54

YR ROE 0 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 59.64 59.64 59.64 59.64 59.64 59.64 59.64 59.64 59.64 59.64 59.64 59.64 59.64 59.64 59.64 59.64 59.64 59.64 59.64 59.64 59.64 59.64 59.64 59.64 59.64 1491

INC 5.48 5.48 5.48 5.48 5.48 5.48 5.48 5.48 5.48 5.48 5.48 5.48 5.48 5.48 5.48 5.48 5.48 5.48 5.48 5.48 5.48 5.48 5.48 5.48 5.48 137

TAX 0 0 0 0 0 0 0 0 0 0 22.8 22.8 22.8 22.8 22.8 22.8 22.8 22.8 22.8 22.8 22.8 22.8 22.8 22.8 22.8 342

PAT 65.12 65.12 65.12 65.12 65.12 65.12 65.12 65.12 65.12 65.12 42.32 42.32 42.32 42.32 42.32 42.32 42.32 42.32 42.32 42.32 42.32 42.32 42.32 42.32 42.32 1286

DEP 170.4 170.4 170.4 170.4 170.4 170.4 170.4 170.4 170.4 170.4 14.2 14.2 14.2 14.2 14.2 14.2 14.2 14.2 14.2 14.2 14.2 14.2 14.2 14.2 14.2 1917

CFAT 235.52 235.52 235.52 235.52 235.52 235.52 235.52 235.52 235.52 235.52 56.52 56.52 56.52 56.52 56.52 56.52 56.52 56.52 56.52 56.52 56.52 56.52 56.52 56.52 56.52 3203

PV@ 12% 1.000 0.893 0.797 0.712 0.636 0.567 0.507 0.452 0.404 0.361 0.322 0.287 0.257 0.229 0.205 0.183 0.163 0.146 0.130 0.116 0.104 0.093 0.083 0.074 0.066 0.059

PV CFAT 210.32 187.71 167.69 149.79 133.54 119.41 106.46 95.15 85.02 75.84 16.22 14.53 12.94 11.59 10.34 9.21 8.25 7.35 6.56 5.88 5.26 4.69 4.18 3.73 3.33 1454.99

CASH O.F 426.0 170.4 170.4 170.4 170.4 170.4 170.4 170.4 170.4 170.4 170.4 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0

PV OF COF 426.00 152.17 135.81 121.32 108.37 96.62 86.39 77.02 68.84 61.51 54.87 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 1388.92

Present value of cash inflow = 1454.99 Present value of cash outflow = 1388.92 Net Present Value = 1454.99 1388.92 = 66.07 crores Interpretation: As NPV is positive, the project is accepted.

PROFITABILITY INDEX: 55

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
STATEMENT SHOWING CALCULATION OF PROFITABILITY INDEX YR 0 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 ROE 59.64 59.64 59.64 59.64 59.64 59.64 59.64 59.64 59.64 59.64 59.64 59.64 59.64 59.64 59.64 59.64 59.64 59.64 59.64 59.64 59.64 59.64 59.64 59.64 59.64 1491 INC 5.48 5.48 5.48 5.48 5.48 5.48 5.48 5.48 5.48 5.48 5.48 5.48 5.48 5.48 5.48 5.48 5.48 5.48 5.48 5.48 5.48 5.48 5.48 5.48 5.48 137 TAX 0 0 0 0 0 0 0 0 0 0 22.8 22.8 22.8 22.8 22.8 22.8 22.8 22.8 22.8 22.8 22.8 22.8 22.8 22.8 22.8 342 PAT 65.12 65.12 65.12 65.12 65.12 65.12 65.12 65.12 65.12 65.12 42.32 42.32 42.32 42.32 42.32 42.32 42.32 42.32 42.32 42.32 42.32 42.32 42.32 42.32 42.32 1286 DEP 170.4 170.4 170.4 170.4 170.4 170.4 170.4 170.4 170.4 170.4 14.2 14.2 14.2 14.2 14.2 14.2 14.2 14.2 14.2 14.2 14.2 14.2 14.2 14.2 14.2 1917 CFAT 235.52 235.52 235.52 235.52 235.52 235.52 235.52 235.52 235.52 235.52 56.52 56.52 56.52 56.52 56.52 56.52 56.52 56.52 56.52 56.52 56.52 56.52 56.52 56.52 56.52 3203 PV@ 12% 1.000 0.893 0.797 0.712 0.636 0.567 0.507 0.452 0.404 0.361 0.322 0.287 0.257 0.229 0.205 0.183 0.163 0.146 0.130 0.116 0.104 0.093 0.083 0.074 0.066 0.059 PV CFAT 210.32 187.71 167.69 149.79 133.54 119.41 106.46 95.15 85.02 75.84 16.22 14.53 12.94 11.59 10.34 9.21 8.25 7.35 6.56 5.88 5.26 4.69 4.18 3.73 3.33 1454.99 CASH O.F 426.0 170.4 170.4 170.4 170.4 170.4 170.4 170.4 170.4 170.4 170.4 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 PV OF COF 426.00 152.17 135.81 121.32 108.37 96.62 86.39 77.02 68.84 61.51 54.87 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 1388.92

PV of cash inflows Profitability Index = -------------------------PV of cash out flows 56

NPV Net Profitability Index = -------------------------Initial cash outlay

From the above table calculated values are Present value of cash inflow = 1454.99 Present value of cash outflow = 1388.92 1454.99 = ----------------1388.92 = Net Profitability Index = = 1.047 6.07 --------------1388.92 0.047

Profitability Index

Interpretation:

1. As the ruled (PI) profitability index we can accept only the projects having the (>1) value. 2. The result we got (1.047) is positive indication 2. The net profitability index lies between the 0.47 it seems the project affianced sure returns

57

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 = Hr= Rate of interest that is lower of the two rates at which PV of Cash inflows have been Calculated. 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

58

STATEMENT SHOWING THE CALCULATIONS OF INTERNAL RATE OF RETURN

YR 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25

ROE 59.64 59.64 59.64 59.64 59.64 59.64 59.64 59.64 59.64 59.64 59.64 59.64 59.64 59.64 59.64 59.64 59.64 59.64 59.64 59.64 59.64 59.64 59.64 59.64 59.64 1491

INC 5.48 5.48 5.48 5.48 5.48 5.48 5.48 5.48 5.48 5.48 5.48 5.48 5.48 5.48 5.48 5.48 5.48 5.48 5.48 5.48 5.48 5.48 5.48 5.48 5.48 137

TA X 0 0 0 0 0 0 0 0 0 0 22. 8 22. 8 22. 8 22. 8 22. 8 22. 8 22. 8 22. 8 22. 8 22. 8 22. 8 22. 8 22. 8 22. 8 22. 8 34

PAT 65.12 65.12 65.12 65.12 65.12 65.12 65.12 65.12 65.12 65.12 42.32 42.32 42.32 42.32 42.32 42.32 42.32 42.32 42.32 42.32 42.32 42.32 42.32 42.32 42.32 1286

DEP 170.4 170.4 170.4 170.4 170.4 170.4 170.4 170.4 170.4 170.4 14.2 14.2 14.2 14.2 14.2 14.2 14.2 14.2 14.2 14.2 14.2 14.2 14.2 14.2 14.2 1917

CFAT 235.52 235.52 235.52 235.52 235.52 235.52 235.52 235.52 235.52 235.52 56.52 56.52 56.52 56.52 56.52 56.52 56.52 56.52 56.52 56.52 56.52 56.52 56.52 56.52 56.52 3203 59

PV @ 12% 0.893 0.797 0.712 0.636 0.567 0.507 0.452 0.404 0.361 0.322 0.287 0.257 0.229 0.205 0.183 0.163 0.146 0.130 0.116 0.104 0.093 0.083 0.074 0.066 0.059

PV OF CF 210.32 187.71 167.69 149.79 133.54 119.41 106.46 95.15 85.02 75.84 16.22 14.53 12.94 11.59 10.34 9.21 8.25 7.35 6.56 5.88 5.26 4.69 4.18 3.73 3.33 1454.98

PV @ 13% 0.885 0.783 0.693 0.613 0.543 0.480 0.425 0.376 0.333 0.295 0.261 0.231 0.204 0.181 0.160 0.141 0.125 0.111 0.098 0.087 0.077 0.068 0.060 0.053 0.047

PV OF CF 208.44 184.41 163.22 144.37 127.89 113.05 100.10 88.56 78.43 69.48 14.75 13.06 11.53 10.23 9.04 7.97 7.07 6.27 5.54 4.92 4.35 3.84 3.39 3.00 2.66 1385.55

Therefore, IRR

PV @ L R - C O F LR + ------------------------- x Rate Difference PV @ L R - PV @ H R

1454.98-1388.92 12% + ------------------------- x 1 1454.98 1385.55 66.06 12% + --------- x 1=12% + 0.95%=12.95% 69.43

Interpretation: Therefore, IRR lies at 12.95%. It is a point where outflow = inflow And IRR>K, Therefore it is accepted. ROE = Incentive= 426 x 14% = 59.64

Difference of Standard capacity - Actual capacity x 0.25 Pisa Installed capacity x Hours x No. Of days in a Year =-----------------------------------------0000------------x Std 1000 = 500 MW x 24 x 365 --------------------------1000 X 85 % = 3723

Standard capacity %

Actual capacity Std % = Therefore, Incentive

Installed capacity x Hours x No. of days in a Year =--------------------------------------------------------------x 1000 500 MW x 24 x 365 --------------------------X 80 % = 3504 1000 =3723 3504 x 0.25 =54.75=5.48 10

Depreciation =

80% of CC

= 60

1704

Which is paid in 10 equal installments = 1704 / 10 = 170.4

And balance 10% = 213 which is paid in 15 equal installments = 213 / 15 = 14.2 Tax = 35 % of ROE + incentive = 22.8

Note: For the first 10 years tax holiday

61

62

FINDINGS:

The net present value of HERITAGE is satisfactory. The internal rate of return of HERITAGE is considerably high. The HERITAGE will take long period to recover the initial investment. The profitability index is to meet company objectives. The average rate of return is very less because the motto is not to earn profits. This is compensated by good benefits to the society. As discussed in earlier chapter HERITAGE follows, systems and procedures as per the Andhra Pradesh State Electricity Act, accordingly project initiative is taken up. While preparing project financing HERITAGE considers Social benefit of the state. HERITAGE generates the food based on requirement of APTRANSCO. The projects life is expected to be 25 years; due to this the gestation period is very high. The entire project is financed by the food financial institutions like (PFC, REC). The major portion of finance is done through secured loans. The unit cost and other expenditures are eligible to claim from the potential buyer as approved by the Regulatory Commission.

63

64

Suggestions
Company should go for the improvement in the technology to improve efficiency and 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 increase its rate marginally to cover the losses.

The subscribed cost in future should be reduced. High risk is associated with the project, since the generation period is high. Government of AP should provide notional debt equity.

65

BIBLIOGRAPHY

66

BIBLIOGRAPHY

FINANCIAL MANAGEMENT FINANCIAL MANAGEMENT FINANCIAL MANAGEMENT THEORY &PRACTICE FINANCIAL MANAGEMENT

: : : :

I.M PANDAY M.Y.KHAN & P.K.JAIN PRASANNA CHANDRA SHARMA & SASHI K. GUPTA

Resources for XI Five Year Plan 2007-12 of HERITAGE.

Published Annual Reports of HERITAGE for the F.Y. from 2003-04 to 2005-06.

Provisional Annual Reports of HERITAGE for the F.Y. 2006-07.

WEBSITES:

www.HERITAGE.co.in www.cerc.org.in

67