A STUDY ON CAPITAL BUDGETING

WITH REFERENCE TO
YES BANK

Yes Bank
Address: Shop No.31/2, Mayank Towers,
Near YES BANKBank, Raj Bhavan Rd,
Lumbini Classic Apartment, Somajiguda,
Hyderabad, Telangana 500082
Phone:

040 6673 9000

TABLE OF CONTENTS
CHAPTER
1
2

TITLE
INTRODUCTION
INDUSTRY PROFILE & COMPANY

3
4

PROFILE
REVIEW OF LITERATURE
RESEARCH METHODOLOGY
NEED OF THE STUDY
LIMITATIONS OF THE STUDY

RESEARCH DESIGN
DATA ANALYSIS &

6
7

INTERPRETATIOIN
OBSERVATIONS & CONCLUSION
BIBLIOGRAPHY

.INTRODUCTION:

An efficient allocation of capital is the most important finance function in the modern
times. It involves decisions to commit the firms funds to the long term assets. Such
decisions are of considerable importance to the firm since they tend to determine its
size by influencing its growth, profitability and risk.
MEANING:
Capital budgeting is a required managerial tool. One duty of a financial manager is to
choose investments with satisfactory cash flows and rates of return. Therefore, a
financial manager must be able to decide whether an investment is worth undertaking
and be able to choose intelligently between two or more alternatives. To do this, a
sound procedure to evaluate, compare, and select projects is needed. This procedure
is called capital budgeting.
capital budgeting is also known as Investment Decision Making, Capital Expenditure
Decision, Planning Capital Expenditure and Analysis of Capital Expenditure.
DEFINITION:
According to Charles T.Horngreen, Capital budgeting is long term planning for
making and financing proposed capital outlays.
According to Lynch, Capital budgeting consists in planning development of
available capital for the purpose of maximizing the long term profitability of the
concern.
NATURE OF INVESTMENTS:
The investment decisions of a firm are generally known as the capital budgeting, or
capital expenditure decisions. A capital budgeting decision may be defined as the
firms decisions to invest its current funds most efficiently in the long term assets in
anticipation of an expected flow of benefits over a series of years. The long term
assets are those which affect the firms operations beyond the one year period
CONCEPT OF CAPITAL BUDGETING:
The term capital budgeting refers to long term planning for proposed capital outlays
and their financing. Thus, it includes both rising of long term funds as well as their
utilization. It is the decision making process by which the firm evaluate the purchase
of major fixed assets firms decision to invest its current funds of. It involves addition,
disposition, modification and replacement of long term or fixed assets. However, it
should be noted that investment in current assets necessitated on account of
investment in a fixed asset, it also to be taken as a capital budgeting decision.
Capital budgeting is a many sided activity. It includes searching for new and
more profitable investment proposals, investigating engineering and marketing
considerations predict and making economic analysis to determine the potential of
each investment proposal.

CHARACTERISTICS OF CAPITAL BUDGETING:

 GROWTH: A firms decision to invest in long term assets has a decisive

influence on the rate and the direction of growths. A wrong decision can prove
disastrous for the continued survival of the firm. Unwanted or profitable
expansion of assets will result in heavy operating costs to the firm. On the
other hand, inadequate investment in assets would make it difficult for the
firm to compete successfully and maintain its market share.
RISK: A long term commitment of funds may also change the risk complexity
of the firm. If the adoption of the investment increases average gain but causes
frequent fluctuations in its earnings the firm will become more risky. Thus
investment decisions shape the basic risk character of the firm.
FUNDING: Investment decisions generally involve large amount of funds
which make it necessary for the firm to plan its investment programmes very
carefully and make an advance arrangement for procuring finances internally
or externally.
IRREVERSIBILITY: Most investment decisions are irreversible. It is
difficult to find a market for such capital items once they have been acquired.
The firm will incur heavy losses if such assets are scrapped. Investments
decisions once made cannot be reversed or may be reversed but a substantial
loss.
COMPLEXITY: Another important characteristic feature of capital
investment decision is that it is the most difficult decision to make. Such
decisions are an assessment of future events which are difficult to predict. It is
really a complex problem to correctly estimate the future cash flow of an
investment. The uncertainty in cash flow is caused by economic, political and
technological forces.
NEED AND IMPORTANCE OF CAPITAL BUDGETING
The capital budgeting decisions are often said to be the most important part of
corporate financial management. Any decision that requires the use of resources is a
capital budgeting decision; thus the capital budgeting cover everything from abroad
strategic decisions at one extreme to say computerization of the office, at the other.
The capital budgeting decisions affect the profitability of a firm for a long period,
therefore the importance of these decisions are obvious. There are several factors and
considerations which make the capital budgeting decisions as the most important
decisions of a finance manager. The need and importance of capital budgeting may be
stated as follows:
LONG TERM EFFECTS : perhaps, the most important features of a capital
budgeting decisions and make the capital budgeting so significant is that these
decisions have long term effects on the risk and return composition of the
firm. These decisions affect of the firm to a considerable extent as the capital
budgeting decisions have long term implications and consequences. By taking
a capital budgeting decision, a finance manager in fact makes a commitment
to its future implications.

SUBSTANTIAL COMMITMENTS: The capital budgeting decisions

generally involve large commitment of funds as a result substantial portion of
capital are blocked in the capital budgeting decisions. In relative terms
therefore, more attention is required for capital budgeting decisions, otherwise
the firm may suffer from the heavy capital losses in time to come. It is also
possible that the return from a projects may not be sufficient enough to justify
the capital budgeting decision.

IRREVERSIBLE DECISIONS: Most of the capital budgeting decisions are

irreversible decisions. Once taken, the firm may not be in a position to revert
back unless it is ready to absorb heavy losses which may result due to
abandoning a project in midway. Therefore, the capital budgeting decisions
should be taken only after considering and evaluating each and every minute
detail of the project, otherwise the financial consequences may be far
reaching.
AFFECT CAPACITY AND STRENGTH TO COMPETE: The capital
budgeting decisions affect the capacity and strength of a firm to face the
competition. A firm may loose competitiveness if the decision to modernize is
delayed or not rightly taken. Similarly, a timely decision to take over a minor
competitor may ultimately result even in the monopolistic position of the firm.

Thus the capital budgeting decisions involve a largely irreversible

commitment of Resources i.e., subject to a significant degree of risk. These
decisions may have far reaching effects on the profitability of the firm. These
decisions making process and strategy based on a reliable forecasting system.
LARGE INVESTMENTS: Capital budgeting decisions, generally, involves
large investment of funds. But the funds available with the firm are always
limited and the demand for funds far exceeds the resources. Hence, it is very
important for a firm to plan and control its expenditure.

NATIONAL IMPORTANCE: Investment decision though taken by

individual concern is of national importance because it determined
employment, economic activities and economic growth.
Thus, we may say that without using capital budgeting techniques a firm
involve itself in a losing project. Proper timing of purchase, replacement,
Expansion and alteration of assets is essential

CAPITAL BUDGETING PROCESS:

Capital budgeting is a complex process as it involves decisions relating to the
investment of current funds for the benefit to the achieved in future and the future is
always uncertain. However, the following procedure may be adopted in the process of
capital budgeting:

1
Identify
Investment
Proposals

2
Screen
Proposals

7
Review
Performance

CAPITAL
BUDGETING
PROCESS
6
Implement
The
Proposals

3
Evaluate
Various
Proposals

4
Fix
Priorities
5
Final
Approval

1. IDENTI FICATION OF INVESTMENT PROPOSALS:

The capital budgeting process begins with the identification of investment proposals.
Investment opportunities have to be identified or created; they do not occur
automatically. Investment proposal of various types may originate at different levels
within a firm. Most proposals, in the nature of cost reduction or replacement or
process or product improvement takes place at plant level. The contribution of top
management in generating investment ideas is generally confined to expansion or
diversification projects. The proposal may originate systematically in a firm.
In view of the fact that enough investment proposals should be generated to
employ the firms funds fully well and efficiently, a systematic procedure for

generating proposal may be evolved by a firm. In a number of Indian companies,

more than 50% of the investment ideas are generated at the plant level. Indian
companies uses a variety of methods to encourage idea generation.
2. SCREENING THE PROPOSALS: The expenditure planning committee screens
the various proposals received from different departments. The committee views these
proposals from various angles to ensure that these are in accordance with the
corporate strategies, selection criterion of the firm and also do not lead to
departmental imbalances.
3. EVALUATION OF VARIOUS PROPOSALS: The evaluation of projects should
be performed by group of experts who have no axe to grind. For example, the
production people may generally interested in having the most modern type of
equipment and increased production even of productivity is expected to be low and
goods cannot be sold this attitude can bias their estimates of cash flows of the
proposed projects.
Similarly, marketing executives may be too optimistic about the sales
prospects of goods manufactured, and overestimate the benefits of a proposed new
product. It is therefore, necessary to ensure that projects are scrutinized by an
impartial group and that objectivity is maintained in the evaluation process.
A company in practice should take all care in selecting a method or methods of
investment evaluation. The criterion or criteria selected should be a true measure of
evaluating if the investment is profitable(in terms of cash flows), and it should lead
the net increase in the companys wealth(that is, its benefits should exceeds its costs
adjusted for time value and risk).
4. FIXING PRIORITIES: After evaluating various proposals, the unprofitable or
uneconomic proposals may be rejected straight away. But it may not be possible for
the firm to invest immediately in all the acceptable proposals due to limitation of
funds. Hence, it is very essential to rank the various proposals and to establish
priorities after considering urgency, risk and profitability involved therein.
5. FINAL APPROVAL AND PREPARATION OF CAPITAL EXPENDITURE
BUDGET: Proposals meeting the evaluation and criteria are finally approved to be
included in the capital expenditure budget. However, proposals involving smaller
investment may be decided at the lower for expenditure action. The capital
expenditure budget lays down the amount of estimated expenditure to be incurred on
fixed assets during the budget period.
6. IMPLEMENTING PROPOSAL: Preparation of a capital expenditure budgeting
and incorporation of a particular proposal in the budget does not itself authorize to go
ahead with the implementation of the project a request for authority to spend the
amount should further be made to the capital expenditure committee which may like
to review the profitability of the project, in the changed circumstances.
Further, while implementing the project, it is better to assign responsibilities
for completing the project within the given time frame and cost limit so as to avoid
unnecessary delays and cost over runs. Network techniques used in the project
management such as PRRT and CPM can also be applied to control and monitor the
implementing of the projects.

7. PERFORMANCE REVIEW: A capital projects reporting system is required to

review and monitor the performance of investment projects after the completion and
during their life. The follow up comparison of the actual performance with original
estimate not only ensure better forecasting. Based on the follow up feedback, the
company may reappraise its projects and take remedial action. Indian companys
practices control of capital expenditure through the use of regular project reports.
Some companies required quarterly reporting, monthly, half yearly and yet a few
companies require continuous reporting. In most of the companies the evaluation
reports include information on expenditure to date stage of physical completion, and
revised total cost.

CHAPTER 2
INDUSTRY PROFILE
&
COMPANY PROFILE

INDUSTRY PROFILE:

Banking in India in the modern sense originated in the last decades of the 18th
century. Among the first banks were the Bank of Hindustan, which was
established in 1770 and liquidated in 1829-32; and the General Bank of India,
established in 1786 but failed in 1791.
The largest bank, and the oldest still in existence, is the State Bank of
India (S.B.I). It originated as the Bank of Calcutta in June 1806. In 1809, it was
renamed as the Bank of Bengal. This was one of the three banks funded by
a presidency government, the other two were the Bank of Bombay and
the Bank of Madras. The three banks were merged in 1921 to form the Imperial
Bank of India, which upon India's independence, became the State Bank of
India in 1955. For many years the presidency banks had acted as quasi-central
banks, as did their successors, until the Reserve Bank of India was established
in 1935, under the Reserve Bank of India Act, 1934
In 1960, the State Banks of India was given control of eight state-associated
banks under the State Bank of India (Subsidiary Banks) Act, 1959. These are
now called its associate banks. In 1969 the Indian government nationalised 14
major private banks. In 1980, 6 more private banks were nationalised. These
nationalised banks are the majority of lenders in the Indian economy. They
dominate the banking sector because of their large size and widespread
networks.
The Indian banking sector is broadly classified into scheduled banks and nonscheduled banks. The scheduled banks are those which are included under the
2nd Schedule of the Reserve Bank of India Act, 1934. The scheduled banks are
further classified into: nationalised banks; State Bank of India and its
associates; Regional Rural Banks (RRBs); foreign banks; and other Indian
private sector banks.[6] The term commercial banks refers to both scheduled and
non-scheduled commercial banks which are regulated under the Banking
Regulation Act, 1949.
Generally banking in India is fairly mature in terms of supply, product range
and reach-even though reach in rural India and to the poor still remains a
challenge. The government has developed initiatives to address this through the

10

State Bank of India expanding its branch network and through the National
Bank for Agriculture and Rural Development with facilities likemicrofinance.

Adoption of banking technology

The IT revolution has had a great impact on the Indian banking system. The use
of computers has led to the introduction of online banking in India. The use of
computers in the banking sector in India has increased many fold after the
economic liberalisation of 1991 as the country's banking sector has been
exposed to the world's market. Indian banks were finding it difficult to compete
with the international banks in terms of customer service, without the use of
information technology.
The RBI set up a number of committees to define and co-ordinate banking
technology. These have included:

In 1984 was formed the Committee on Mechanisation in the Banking

Industry (1984)[27] whose chairman was Dr. C Rangarajan, Deputy
Governor, Reserve Bank of India. The major recommendations of this
committee were introducing MICR technology in all the banks in the
metropolises in India.[28] This provided for the use of standardized cheque
forms and encoders.

In 1988, the RBI set up the Committee on Computerisation in Banks

(1988)[29] headed by Dr. C Rangarajan. It emphasised that settlement
operation must be computerised in the clearing houses of RBI
in Bhubaneshwar, Guwahati, Jaipur, Patna and Thiruvananthapuram. It
further stated that there should be National Clearing of intercity chequesat Kolkata, Mumbai, Delhi, Chennai and MICR should be
made operational. It also focused on computerisation of branches and
increasing connectivity among branches through computers. It also
suggested modalities for implementing on-line banking. The committee
submitted its reports in 1989 and computerisation began from 1993 with the
settlement between IBA and bank employees' associations.

In 1994, the Committee on Technology Issues relating to Payment

systems, Cheque Clearing and Securities Settlement in the Banking

11

Industry (1994)[31] was set up under Chairman W S Saraf. It

emphasised Electronic Funds Transfer (EFT) system, with the BANKNET
communications network as its carrier. It also said that MICR clearing
should be set up in all branches of all those banks with more than 100
branches.

In 1995, the Committee for proposing Legislation on Electronic Funds

Transfer and other Electronic Payments (1995) again emphasised EFT
system.

Automated teller machine growth

The total number of automated teller machines (ATMs) installed in India by
various banks as of end June 2012 was 99,218. The new private sector banks in
India have the most ATMs, followed by off-site ATMs belonging to SBI and its
subsidiaries and then by nationalised banks and foreign banks, while on-site is
highest for the nationalised banks of India.

12

Branches and ATMs of Scheduled Commercial Banks as of end December,

2014

Bank type

Nationalised
banks

State Bank of
India

Number of
branches

Off-site
ATMs

Total ATMs

33,627

38,606

22,265

60,871

13,661

28,926

22,827

51,753

4,511

4,761

4,624

9,385

1,685

12,546

26,839

39,385

242

295

854

1,149

Old private sector

banks

New private
sector banks

Foreign banks

TOTAL

On-site ATMs

53,726

85,134

13

77,409

1,62,543

Cheque truncation initiative

In 2008 the Reserve Bank of India introduced a system to allow cheque
truncation in India, the cheque truncation system as it was known was first
rolled out in the National Capital Region and then rolled out nationally.

Expansion of banking infrastructure

Physical as well as virtual expansion of banking through mobile banking,
internet banking, tele banking, bio-metric and mobile ATMs is taking
place since last decade and has gained momentum in last few years.

14

COMPANY PROFILE:
INTRODUCTION:
Yes Bank, incorporated in 2004 by Rana Kapoor and Late Ashok Kapur, is a new age
private sector bank. Since inception Yes Bank has fructified into a Full Service
Commercial Bank that has steadily built Corporate and Institutional Banking,
Financial Markets, Investment Banking, Corporate Finance, Branch Banking,
Business and Transaction Banking, and Wealth Management business lines across
the country, and is well equipped to offer a range of products and services to
corporate and retail customers.
YES BANK offers a fullrange of clientfocused corporate banking services,
including working capital finance, specialized corporate finance, trade and
transactional services, treasury risk management services, investment banking
solutions and liquidity management solutions among others to a highly focused client
base.
The bank is part of global thought leadership forums like the Clinton Global Initiative
(CGI), Triple Bottom Line Investing (TBLI) and Tallberg Forum. Recently, it became
the first Indian Bank to become a signatory with the United Nations Environment
Programme (Financial Initiative).
As part of the differentiated strategy, Yes Bank has had a strong focus on
Development Banking, as is evident from the cuttingedge work that the Bank has
done in the area of Food & Agribusiness, Infrastructure, Microfinance, and
Sustainability which in most cases has been firstofits kind in India
Yes Bank has partnered with various companies for delivering quality products and
services namely Cash Tech, Cisco Systems, Gartner, Intel, iflex, Reuters, VSNL,
Wipro, De La Rue, Murex, Wincor Nixdorf and Sanovi.
The bank also has a widespread branch network of over 331 branches across 200
cities, with over 420 ATM's and 2 National Operating Centres in Mumbai and
Gurgaon.
Business Areas
Corporate and Institutional Banking The bank offers a broad range of financial and
risk management solutions to clients such as large Indian corporates and groups,
multinational companies, central and state governments, government bodies and
public sector enterprises.
Business Banking Yes Bank offers a range of products, services and resources to
small and medium businesses.
Corporate Finance It offers corporate finance solutions to various clients such as
local corporates, multinational companies, financial institutions and public sector
undertakings.

15

Retail Banking Under this, the bank offers wide range of products and services
such as saving account, current account, fixed deposit, retail loan, depository
services and many more.
Investment Banking Yes Bank offers investment banking services in area of
mergers and acquisitions, divestitures, private equity syndication and IPO advisory.
Awards & Recognitions :
In March 2014 The Bank was awarded the Ramkrishna Bajaj National Quality
(RBNQ) Business Excellence Award 2013 in the Services Category. Organized by
Indian Merchants Chamber, YES BANK is the only bank to win this prestigious
award in the history of the RBNQ Award.
Outstanding Business Sustainability Achievement Karlsruhe Sustainable Finance
Awards Germany, 2013
Jamnalal Bajaj Uchit Vyavahar Puraskar (Service EnterprisesLarge) Council for Fair
Business Practices (CFBP) 2012
Financial Institutions Syndicated Deal of the Year, Asia Pacific Region Asia Pacific
Loan Market Association (APLMA) 2012
Global Business Excellence Award, Dubai, 2013
Sustainability Award, London, 2012 Golden Peacock
Institutional Excellence

YES BANK receives the 'Fastest Growing Bank' Award third year in a row at

the Business world Best Bank Awards 2011

YES BANK receives the Best Private Sector Bank Award at Dun & Bradstreet

Polaris Software Banking Awards 2011

YES BANK receives Sustainable Bank of the Year (Asia/Pacific) Award at
FT/IFC Sustainable Finance Awards 2011, London
Business Excellence
1) YES BANK won seven awards at Asias Best Employer Brand Awards and the
CMO Asia Awards for

Excellence in Branding and Marketing that were held on July

22, 2011 in Singapore. The bank received awards in the following categories:

Continuous Innovation in HR Strategy at Work

Talent Management

Best HR Strategy in Line with Business

Excellence in HR through Technology

CEO of the Year Award to Mr. Rana Kapoor

Brand Excellence in Banking, Financial Services & Insurance

Best Corporate Social Responsibility Practice (Overall)

2) YES BANK received 'The Asian Banker Technology Implementation Awards 2011'

Won the Best Multichannel Capability Project Award for increasing its
distribution and optimizing its mobile banking services

16

Won the Best Financial Supply Chain Project Award for streamlining a clients
business processes into a single work flow, automating remittances and allowing
for faster and more accurate reconciliation
3) YES BANKs Chief Information Security Officer ranked as one of the Top 100
CISOs at the TOP 100 CISO Awards 2011.
4) YES BANK receives significant recognition at The Banker Technology Awards
2011

Won the Commercial Banking Project of the Year Award

Innovation in Cash and Treasury Technology

17

CHAPTER 3
REVIEW OF LITERATURE

18

CAPITAL BUDGETING APPRAISAL METHODS/TECHNIQUES:

There are several methods for evaluating and ranking the capital investment
proposals. In case of all these method the main emphasis is on the return which will
be derived on the capital invested in the projects. In other words, the basic approach is
to compare the investment in the project with the benefits derived there from.

Capital Budgeting
Techniques

Traditional or nondiscounting

Time- adjusted or discounted

cash flows

Net present value

Profitability index
Internal rate of return

Pay back period

Accounting rate of return

TRADITIONAL OR NON-DISCOUNTING:
A. PAY BACK PERIOD:
The payback is one of the most popular and widely recognized traditional methods of
evaluating investment proposals. It is defined as the number of years required to
recover the original cash outlay invested in a project. If the project generates constant
annual cash inflows, the payback period can be computed by dividing cash outlay by
the annual cash inflows.
Payback period = Initial investment
Annual cash flow

19

Accept reject rule:

Many firms use the payback period as accept/reject criterion as well as a method of
ranking projects.
If the payback period calculated for the project is less than the maximum or standard
payback period set by the management, it would be accepted, If not it would be
rejected.
As a ranking method it gives highest to the project which has the shortest payback
period and lowest ranking to the project with highest payback period.
In case of two mutually exclusive projects, the project with the shortest payback
period will be selected
EVALUATION OF PAYBACK PERIOD:
It is simple to understand and easy to calculate
It is costless than most of the sophisticated techniques which require a lot of the time
the use of computers
ADVANTAGES:
Simple to understand and easy to calculate.
It saves in cost; it requires lesser time and labour as compared to other
methods of capital budgeting.
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- time approach, this method is particularly suited to a firm
which has shortage of cash or whose liquidity position is not good.
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 decision.
It is difficult to determine the minimum acceptable payback period, which is
subjective decision.
It treats each assets individual in isolation with other assets, which is not
feasible in real practice.
B. ACCOUNTING RATE OF RETURN METHOD:
The accounting rate of return (ARR), also known as the return on investment (ROI),
used 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.

20

Alternatively, it can be found out dividing the total of the investments book value
after depreciation by the life of the project. The accounting rate of return, thus, is an
average rate and can be determined by the following equation:
ARR=Average annual income (after tax & depreciation)
Average investment
Where,
Average investment = Original investment
2
ACCEPT OR REJECT CRITERION
As an accept or reject criterion, this method will accept all those projects whose ARR
is higher than the minimum rate established by the management and reject those
projects which have ARR less than the minimum rate.
This method would rank a project as number one if it has highest ARR and lowest
rank would be signed to the project with lowest ARR.
EVALUATION OF ARR METHOD
It is simple to understand and use
The ARR can be readily calculated form the accounting data; unlike in the
NPV and IRR methods, no adjustments are required to arrive at cash flows of
the project.
The ARR rule incorporates the entire stream of in calculating the projects
profitability.
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 profit are earned as a 20% rate of return in 2
years is considered to be better than 18%rate of return in 12 years.
This method cannot be applied to a situation where investment in project is to be
made in parts.
DISCOUNTED CASH FLOW METHOD:
Discounted cash flow method or time adjusted technique is an improvement over pay
back method and ARR. In evaluating investment projects, it is important to consider
the timing of returns on investment. Discounted cash flow technique takes into
account both the interest factor and the return after the pay back period. Following are
the methods of discounted cash flow method:

21

NET PRESENT VALUE METHOD:

Net present value method is the classic economic method of evaluating the investment
proposals. It is considered as the best method of evaluating the capital investment
proposal. It is widely used in practice. The cash inflow to be received at different
period of time will be discounted at a particular discount rate.
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 are comparable only when their equivalent present values
are found out.
The following steps are involved in the calculation of NPV:
An appropriate rate of interest should be selected to discount cash flows. Generally it
is referred to the cost of capital.
The present value of cash inflow will the calculated by using this discounted rate.
Net present value should be found out by subtracting present value of cash out flows
from present value of cash inflows.
The net present value is the difference between the total present value of future cash
inflows and the present value of future cash outflows.
ACCEPT OR REJECT CRITERION:
Net present value is used as an accept or reject criteria.
In case NPV is positive (NPV0) the project is selected for investment
If NPV is negative (NPV<0) the project is rejected
A project may be accepted if NPV=0
The positive net present value is contribute to the net wealth of the shareholders
which should result in the increased price of a firms share.
The NPV method can be used to select between mutually exclusive projects the one
with the higher NPV should be selected. Using the NPV method, project would be
ranked in order of net present values; that is first rank will be given to the project with
highest positive present value and so on.
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 if 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.
INTERNAL RATE OF RETURN METHOD:
The internal rate of return (IRR) method is another discounted cash flow technique
which takes account of the magnitude and timing of cash flows. Internal rate of return
is that rate at which the sum of discounted cash inflows equals the sum of discounted
cash outflows.

22

It is the rate of discount which reduces the net present value of an investment to zero.
It is called internal rate because it depends mainly on the outlay and proceeds
associated with the project and not on any rate determined outside the investment.
Other terms used to describe the IRR method are yield of an investment, marginal
efficiency of capital, rate of return over cost, time adjusted rate of return and so on.
The concept of internal rate of return is quite simple to understand in the case of a one
period project.
CALCULATION OF INTERNAL RATE OF RETURN:
Calculate cash flow after tax
Calculate fake payback period or factor by dividing the initial investment by average
cash flows.
Look for the factor in the present value annuity table in the years column until you
arrive at a figure which is closest to the fake payback period.
Calculate NPV at that percentage
If NPV is positive take a rate higher and if NPV is negative take a rate lower and once
again calculate NPV
Continue step4 until you arrive two rates, one giving positive NPV and another
negative NPV.
Use interpolating to arrive at the actual IRR i.e.. actual IRR can be calculated by
using the following formula.
IRR

Present value _
Cash
at lower rate
out flow X diff. in the rates
Present value _ present value
at lower rate
at higher rate

The more simple words, IRR can be calculated by trial an error method
Which means the unknown discount factor which makes NPV=0 con be calculated by
substituting various values which is tedious process. Therefore the above method may
be used.
ACCEPT OR REJECT CRITERION:
The accept or reject 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 k is also known
as the required rate of return, or cutoff, or hurdle rate.
The project shall be rejected if its internal rate of return is lower than the opportunity
cost of capital (r<k). The decision maker may be indifferent if the internal rate of
return is equal to opportunity cost of capital.
Thus, the IRR rule is
Accept if r>k
Reject if r<k
May accept if r=k
EVALUATION OF IRR METHOD:
It recognizes the time value of money
It considers all cash flows occurring over the entire life of the project to
calculate its rate of return

23

 It is consistent with the share holders wealth maximization objective

ADVANTAGES:
It takes into account, the time value of money and can be applied in situation
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 provide for uniform ranking of 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.

PROFITABILITY INDEX:
Yet another time adjusted method of evaluating the investment proposals is the benefit
cost ratio or profitability index (PI).
It is the ratio of the present value of cash inflows, at the required rate of return, to the
initial cash out flow of the investment. It may be the gross or net. Net=gross-1
The formula to calculate benefit cost ratio or profitability index is as follows:
PI= PRESENT VALUE OF CASH INFLOWS
INITIAL CASH OUTLAY
ACCEPT OR REJECT CRITERION:
The following are the PI acceptance rules:
Accept if PI>1
Reject if PI<1
May accept if PI=1
When PI is greater than one, then the project will have net present value.
EVALUATION OF PI METHOD:
It recognizes the time value of money
It is a variation of the NPV method, and requires the same computation as the NPV
method.
In the PI method, since the present value of cash inflows is divided by the initial cash
out flows, it is a relative measure of projects profitability.
ADVANTAGES:
Unlike net present value, the profitability index method is used to rank the
projects even when the costs of the projects differ significantly.

24

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

with uniform cash outflow and uneven cash inflows.
It takes into 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 objectives 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.
PROBLEMS AND DIFFICULTIES IN CAPITAL BUDGETING:
The capital budgeting decisions are not critical and analytical in nature, but also
involve various difficulties which a finance manger may come across. The problems
in capital budgeting decision may be as follows:
FUTURE UNCERTAINTY:
All capital budgeting decisions involve long term which is uncertain. Even if every
care is taken and the project is evaluated to every minute detail, still 100% correct and
certain forecast is not possible. The finance manager dealing with the capital
budgeting decision, therefore, should try to be as analytical as possible. The
uncertainty of the capital budgeting decisions may be with reference to cost of the
project, future expected returns from the project, future competition, expected demand
in future, legal provisions, political situation etc.
TIME ELEMENT:
The implication of a capital budgeting decision are scattered over a long period, the
cost and benefit of a decision may occur at different point of time. As a result, the cost
and benefits of a capital budgeting decision are generally not comparable unless
adjusted for time value of money. These total returns may be than the cost incurred,
still the net benefit cannot be ascertained unless the future benefits are adjusted to
make them comparable with cost. Moreover, the longer the time period involved, the
greater would be the uncertainty.
MEASUREMENT PROBLEM:
Some times a finance manager may also face difficulties in measuring the cost and
benefits of a projects in quantitative terms. For example, the new 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. This is very difficult to ascertain because the
sales of other products may increase or decrease due to other factors also.
ASSUMPTION IN CAPITAL BUDGETING:

25

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 condition 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 estimate 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 decision in the present chapter
assumes that there is no scarcity of capital. It assumes that a proposal will be
accepted or rejected in the strength of its merits alone. The proposal will not
be considered in combination with other proposals to the maximum utilization
of available funds.

TYPES OF CAPITAL BUDGETING DECISIONS

FROM THE POINT OF VIEW OF FIRMS EXISTENCE:
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.
EXISTING FIRM: A firm which is already existing may also required to take
various decisions from time to time to meet the challenges of competition or changing
environment. These decisions may
REPLACEMENT AND MODERNIZATION DECISION:
The main objective of modernization and replacement is to improve operating
efficiency and reduce costs. Cost savings will reflect in the increased profits, but the
firms revenue may remain unchanged. Assets become outdated and obsolete with
technological changes. The firm must decide to replace those asserts with new assets
that operate more economically.
If Cement Company changes from semi automatic drying equipment to fully
automatic drying equipment, it is an example of modernization and replacement.
Replacement decisions help to introduce more efficient and economical assets and
therefore, are also called reduction investments. However, replacement decisions
which involve substantial modernization and technological improvements expand
revenues as well as reduced costs.
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.

26

DIVERSIFICATION: Some times, the firm may be interested to diversify into new
product lines, markets, production of spare parts etc. in such 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.
2. FROM THE POINT OF VIEW OF DECISION SITUATION:
The capital budgeting decision may also be classified from the point of view of the
decision situation as follows:
MUTUALLY EXCLUSIVE DECISIONS:
Two or more alternative proposals are said to be mutually exclusive when acceptance
of one alternative result in automatic rejection of all other proposals. The mutually
exclusive decisions occur when a firm has more than one alternative but competitive
proposal before it. For example, if a company is considering investment in one of two
temperature control system, acceptance of one system will rule out the acceptance of
another.
Thus, two or more mutually exclusive proposals cannot both or all be accepted. Some
technique has to be used for selecting the better or the one. Once this is done, other
alternative automatically get eliminated.
CONTINGENT DECISIONS OR DEPENDENT PROPOSALS:
These are proposals whose acceptance depends on the acceptance of one or more
other proposals. For example a new machine may have to be purchased on account of
substantial expansion of plant.
In this case investment in the machine is dependent upon expansion of plant. When a
contingent investment proposal is made, it should also contain the proposal on which
it is dependent in order to have a better perspective of the situation. Any capital
budgeting decision must be evaluated by the finance manager in its totality. The
contingent decision, if any, must be considered and evaluated simultaneously.
INDEPENDENT PROPOSALS:
These are proposals which do not compete with one another in a way that acceptance
of one precludes the possibility of acceptance of another. In case of such proposals the
firm may straight accept or reject a proposal on the basis of a maximum return on
investment required.
ACCEPT-REJECT DECISIONS:
An accept-reject decision occurs when a proposal is independently accepted or
rejected with out regard any other alternative proposal. This type of decision is made
when (i) proposals cost and benefit neither affect nor are affected by the cost and
benefits of other proposals, and (ii) accepting or rejecting one proposal has not impact
on the desirability of other proposals, and (iii) the different proposals being
considered are competitive.
RATIONALE FOR CAPITAL EXPENDITURE:
Efficiency is the rationale underlying all capital decisions. A firm has to continuously
invest in new plant or machinery for expansion of its operations or replace worn-out
machinery for maintaining and improving its efficiency. The overall objectives are to
maximize the profits and thus optimizing the return on investment. Thus capital
expenditure can be of two types:

27

EXPENDITURE INCREASING REVENUE:

Such a capital expenditure brings mire revenue to the firm either by expansion of
present operations or development of a new product line. In both the cases new fixed
assets are required.
EXPENDITURE REDUCING COSTS:
Such capital expenditure reduces the total cost and there by adds to the total earnings
of the firm. For example, when an asset is worn out becomes obsolete, the firm has to
decide whether to continue with it or replace it by a new machine.
While taking such a decision the firm compares the required cash outflows for the
new machine with the benefit in the form of reduction in operating costs as a result of
replacement of the old machine by a new one. The firm will replace the machine only
when it finds it beneficial.

CAPITAL RATIONING DECISION:

In situations where the firm has unlimited funds, all independent investment proposals
yielding return greater than some predetermined level are accepted. However this
situation does not occur in the practical business scenario. They have fixed capital
budget, a large number of projects compete for these limited funds and the firms try to
ration them. The firm allocates the funds to the projects in a manner that maximizes
long-run returns. Thus, capital rationing refers to a situation in which a firm has more
acceptable investments than it can finance. It is concerned with the selection of the
proposal among various projects based on their accept-reject decision.
Capital rationing employs ranking of the acceptable investment 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.
Capital rationing involves choice of combination of available projects in a way to
maximize the total net present value, given the capital budget constraint. The ranking
of the project can be done on the basis of profitability index or IRR. The procedure to
select the package of projects will relate to whether the project is divisible or
indivisible, the objective being the maximization of total NPV by exhausting the
capital budget is as far as possible.
INVESTMENT EVALUATION CRITERIA:
The three steps are involved in the evaluation of an investment:
Estimation of cash flows
Estimation of 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

28

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

technique is that it should maximize the shareholders wealth.
The following are characteristics should be possessed by the sound investment
criterion:
It should consider all the cash flows to determine the true profitability of the
project.
It should provide for an objective and unambiguous way of separating good
projects from bad projects
It should help ranking of projects according to their profitability.
It should recognize the fact that bigger cash flows are preferable to smaller
ones and early cash flows are preferable to later ones.
It should help to choose among mutually exclusive projects that project which
maximizes the shareholders wealth.
It should be a criterion which is applicable to any conceivable investment
project independent of others.
Choosing among several alternatives.
A criterion which is applicable to any conceivable project.
DATA ANALYSIS
Various methods are used for ascertainment of profitability of capital expenditure. The
practical usages of these methods are discussed here under:
PAY BACK METHOD:
This method tells us the number of years required to recover the initial investment of
that asset. It is calculated
Payback period = Initial Investment
Annual cash flow
The shorter the payback period, lesser the risk of investment and greater its liquidity.
TO ILLUSTRATE:
YEAR
1
2
3
4
5
PROJECT X
10000
20000
40000
50000
80000
PROJECT Y
20000
40000
60000
80000
These cash flows are earned from investment of Rs.200000 for each project.
The annual cash inflows are not constant so we calculate cumulative cash inflows in
order to compute the payback period.
Project-X:
Year
1
2
3
4
5

Cash inflows
20000
30000
40000
50000
80000
Initial investment = 200000
Amount received up to the 4th year = 140000
Amount to be received in 5th year = 60000
(200000-140000)

29

Cumulative cash inflows

20000
(20000+30000)
(50000+40000)
(90000+50000)
(140000+80000)

Cash flows after taxes in 5th year = 80000

PBP = 4Yrs + 60000
80000
= 4 + 0.75 years
= 4 years and 9 months

Project-Y:
Year
1
2
3
4
5

Cash inflows
20000
40000
50000
70000
40000

Cumulative cash inflows

20000
(20000+40000)
(60000+50000)
(110000+70000)
(180000+40000)

Initial investment = 200000

Amount received up to the 4th year = 180000
Amount to be received in 5th year = 20000
(200000-180000)
Cash flows after taxes in 5th year = 40000
PBP = 4Yrs + 20000
40000
= 4 + 0.50 years
= 4 years and 6 months
Hence, from the above given projects, project-Y has to be selected. As it payback
period is less than project-X.
AVERAGE RATE OF RETURN:
This method represents the ratio of average annual profit (after taxes) to the average
investment in the project. It is calculated
ARR= Average Annual Profit after taxes X100
Annual Average investment
TO ILLUSTRATE:
A project requires an investment of Rs.1200000 and has a scrap value of Rs.200000
after five years. It is expected to yield profits after depreciation and taxes during the
five years amounting to Rs.250000, Rs.300000, Rs.350000, Rs.400000 and
Rs.200000. Calculate the average rate of return on the investment.
SOLUTION:
Total profit = Rs. 250000+300000+350000+400000+200000
= Rs. 1500000
Average profit = 1500000
5
= Rs. 300000
New investment in the project = Rs. 1500000 200000 (Scrap value)
= Rs. 1300000
Average rate of return =
Average Annual profit
X 100
Net Investment in the Project

30

300000 X100
1300000

= 23.076%
This method is based on accounting information rather upon cash flows. This method
is simple and makes use of readily available accounting information. Once average
return is expected it can be readily compared with the expected return, to determine
whether a particular proposal for capital expenditure should be accepted or rejected.
DISCOUNTED PAY BACK PERIOD
Discounted cash flow method or time adjusted technique is an improvement over pay
back method and ARR. In evaluating investment projects, it is important to consider
the timing of returns on investment. Discounted cash flow technique takes into
account both the interest factor and the return after the payback period.
TO ILLUSTRATE:
The Alpha Company Ltd. is considering the purchase of a new machine. Two
alternative machines (A and B) have been suggested each costing Rs.400000. Earning
after taxation is expected to be as follows:
YEAR
1
2
3
4
5

CASH FLOW OF MACHINE-A

40000
120000
160000
240000
160000

CASH FLOW OF MACHINE-B

120000
160000
200000
120000
80000

The company has a target of return on capital of 10% and on this basis. You are
required to compare the probability of the machines and state which alternative you
consider financially preferable.

SOLUTION:
The profitability of the machine can be compared on the basis of net present value of
cash inflows as follows:
Year
1
2
3
4
5

PRESENT VALUE OF CASH FLOWS

Discount
Cash inflow
Present
Cash
value
inflows
0.91
40000
36400
120000
0.83
120000
99600
160000
0.75
160000
120000
200000
0.68
240000
163200
120000
0.62
160000
99200
80000
518400
Machine-A
518400

Net present value

31

Present
value
109200
132000
150000
81600
49600
523200
Machine-B
523200

(-) Initial Investment

(400000)
118400

P.I=Present Value of Cash Inflows

Initial Investments

518400
400000

(400000)
123200

= 523200
400000

1.29

= 1.30

The net present values as well as the profitability index are higher in case of Machine
B and hence Machine B will be preferred.

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 equivalent
present values are found out.
NPV = PRESENT VALUE OF CASH INFLOWS
PRESENT VALUE OF CASH OUTFLOW
TO ILLUSTRATE:
A company is considering investment in a project that costs Rs.200000. The project
has an expected life of 5 years and zero salvage value. The company uses straight line
method of depreciation. The companys tax rate is 40%. The estimated earnings
before depreciation and before tax from the project are as follows:
Year
CFBT
PVCF

1
70000
0.909

2
80000
0.826

3
120000
0.751

4
90000
0.683

5
60000
0.621

You are required to calculate the present value at 10% and advise the company

SOLUTION:
Years

Earnings
before
dep.& tax

1
2
3
4
5

70000
80000
120000
90000
60000

Calculation of Cash Flows

Depreciation
EBT
Tax
EAT

40000
40000
40000
40000
40000

30000
40000
80000
50000
20000

32

12000
16000
32000
20000
8000

18000
24000
48000
30000
12000

Cash
Flows
(EAT+
Dep.)
58000
64000
88000
70000
52000

PV
@
10%
0.909
0.826
0.751
0.683
0.621

PV
of
Cash
Flow
52722
52864
66088
47810
32292

Total present value of cash inflows

Less: present of Initial cost

= 251776
= (200000)
= 51776

The net present value of the project is 51776.

PROFITABILITY INDEX 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
Profitability index =

PV of cash inflows
PV of cash outflows

TO ILLUSTRATE:
The initial cash outlay of a project is Rs.50000 and it generates cash inflows of
Rs.20000, Rs.15000, Rs.25000 and Rs.10000 in four years. Using present value index
method, appraise profitability of the proposed investment assuming 10% rate of
discount.
SOLUTION:
Calculations of present values and profitability index:
Year
Cash Inflows
Present Value Factor @10%
1
20000
0.909
2
15000
0.826
3
25000
0.751
4
10000
0.683
Profitability Index = Present value of Cash Inflows
Initial Cash Outlay
= 56175
50000
Profitability Index = 1.1235
As the P.I is higher than 1, the proposal can be accepted.

INTERNAL RATE OF RETURN (IRR):

33

Present Value
18180
12390
18775
6830
56175

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 and so on. The concept of internal rate of return is quite simple to
understand in the case of one-period projects.
TO ILLUSTRATE:
Initial Investment
Life of the Asset

Rs.60000
4 years

Estimated Net Annual Cash Flows:

1st Year
2nd Year
3rd Year
4th Year
Calculate Internal Rate of Return.

15000
20000
30000
20000

SOLUTION:
Cash Flow Table at various Assumed Discount Rates of 10%, 12%, 14% & 15%
Year
1
2
3
4

Annual
Cash
Flow
15000
20000
30000
20000

Dis rate 10%

P.V.F
P.V
Rs.
0.909 13635
0.826 16520
0.751 22530
0.683 13660
66345

Dis rate 12%

P.V.F
P.V
Rs.
0.892 13380
0.797 15940
0.711 21330
0.635 12700
63350

Dis rate 14%

P.V.F
P.V
Rs.
0.877 13155
0.769 15380
0.674 20220
0.592 11840
60595

Dis rate 15%

P.V.F
P.V
Rs.
0.869 13035
0.756 15120
0.657 19710
0.571 11420
59285

The present value of net cash flows at 14% rate of discount is Rs.60595 and at 15%
rate of discount it is Rs.59285. So the initial cost of investment which is Rs.60000
falls in between these two discount rates. At 14% the NPV is +595 but at 15% the
NPV is -715, we may say that
IRR=

Present value _
at lower rate
Present value
_
at lower rate

IRR= 14% +

Cash
out flow X diff. in the rates
present value
at higher rate

595
X (15% - 14 %)
595 + 715

= 14.45%

34

CHAPTER 4
RESEARCH METHODOLOGY

35

NEED FOR THE STUDY

Analyze the proposal for expansion or creating additional capacities.
Whether or not funds should be invested in long term projects such as
setting of an industry, purchase of plant and machinery etc.
To decide replacement of permanent asset such as building and
equipments.

To make financial analysis of various proposals regarding capital

investments so as to choose the best out of many alternative proposals.

To know how the company gets funds from various resources.

36

OBJECTIVES OF THE STUDY

To study the technique of capital budgeting for decision- making in YES
BANK.
To understand the practical usage of capital budgeting techniques
To study the relevance of capital budgeting in evaluating the project for
project finance in YES BANK.
To measure the present value of rupee invested.
To understand the nature of risk and uncertainty
To understand an item wise study of the company financial performance of
YES BANK.
To make suggestion if any for improving the financial position if the
company.

37

RESEARCH DESIGN:
To achieve aforesaid 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 interview with officials. By asking question with
the accountants and other persons in the financial department. A part from these some
information is collected through the seminars, which were held by YES BANK.
Secondary sources
Secondary data has been collected from various sources such as:

Publications of the company

Business magazines

Journals, text books

Websites

Annual reports

In order to gain information on current practices and problems, the area chosen for
study are the emerging and competitive companies in and around Hyderabad City.

38

LIMITATION OF THE STUDY:

Lack of time is another limiting factor, i.e., the schedule period of 8 weeks
are not sufficient to make the study independently regarding Capital
Budgeting in YES BANK.
The busy schedule of the officials in the YES BANKis another limiting
factor. Due to the busy schedule 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.
All the techniques of capital budgeting are not used in YES BANK.
Therefore it was possible to explain only few methods of capital budgeting.

39

CHAPTER 4
DATA ANALYSIS
&
INTERPRETATION

40

YES BANK involved in industrial financing. They extend term loans for acquiring
fixed assets and also working capital term loans. When they are to extend term loans
for acquiring fixed assets like land building, machinery etc they appraise the project to
establish the financial, economic and technically viability of the project while
extending long term loans YES BANKuse capital budgeting techniques. The basic
idea of using capital budgeting is to compare ,whether, the amount invested on the
project at certain rate of return is more or less when compared to the required rate of
return
At YES BANK internal rate of return method is used to appraise an industrial
project. The internal rate of return calculated is compared with the required rate of
return. If the internal rate of return calculated is more than the required rate of return,
the project is accepted if not, it should be rejected. Here it needs to be explained the
meaning of required rate of return. Generally, the concerns required rate of return is
the concerns cost of capital and the cost of capital is the rate of return on a project
that will have unchanged the market price of shares. Thus, the cost of capital is the
required rate of return needed to justify the use of capital.
The cost of capital on term loans is the interest rate that is changed on
disbursal of funds. YES BANKchange interest rates ranging from 11% to 14.5%
depends upon the nature of the project and scheme of financial assistance. Therefore
the cost of capital on loans and advances is the interest rate changed by the term
lending institutions. Hence, the required rate of return is the interest rate changed by
the financial institutions for extending term loan assistance. For example, if the YES
BANKchanges interest at 14%, then the concerns cost of capital or required rate of
return is 14%. This required rate is compared at the concerns internal rate of returns.
Extending or rejecting the proposal depends upon the more or less of the IRR over the
cost of capital. Therefore the viability of the project is determined among other
parameters with reference to the rate of earnings over the desired rate of return that is
the earnings expected over the cost of capital of the project that is interest rate. It is
always seen that the earnings made by the project is more than the interest rate to
accept the project other wise the project is rejected.
USE OF IRR TECHNIQUE IS EXPLAINED WITH THE HELP OF THE
FOLLOWING EXAMPLE
M/S ventech private limited has approached YES BANKfor a term loan RS. 1500
lakhs for expansion of their existing paper mill at Hyderabad. The total project cost of
the expansion is worked at RS.2060 lakhs and the overall project cost is worked at
RS.3003 lakhs as given below:
(RS in lakhs)
Project cost
Existing
Proposed
Total
Land
70.00
--70.00
Buildings
233.00
200.00
433.00
Plant & machinery
518.00
1580.00
2098.00

41

Factory equipment
Electrical
Computers & furniture
Vehicles
Deposits
Working capital margin

4.00
20.00
7.00
21.00
30.00
40.00
943.00

----------280.00
2060.00

4.00
20.00
7.00
21.00
30.00
320.00
3003.00

The project has been appraised by YES BANK and worked out the following
economics for the project:
Capacity utilisation = 90%
Sales = RS.3314 lakhs
MANUFACTURING EXPENSES (A)
(RS. In lakhs)
Raw materials
1553.00
Con
31.00
Power & fuel
303.00
Wages
50.00
Repairs & maintenance
54.00
Taxes
42.00
Other inputs
42.00
2076.00
ADMINISTRATIVE EXPENSES (B)
(RS. In lakhs)
Management remunerating
Salaries
Other expenses
Total cost of production (A+B)
Gross profit
FINANCIAL EXPENSES
Interest on term loans
Interest on bank borrowing

12.00
22.00
42.00
76.00
2151.00
1163.00
230.00
65.00

Depreciation
Operating profit
Provision for taxation
Profit after tax
Net profit before taxes
Interest added back, but after depreciation

295.00
868.00
355.00
513.00
173.00
340.00
808.00

The project cost is met as under:

Equity share capital
Reserves & surplus

Existing
175.00
76.00

proposed
407.00
153.00

42

(RS. In lakhs)
Total
582.00
229.00

Term loan fromNTPC

Unsecured loans

494.00
198.00
943.00

1500.00
--2060.00

1994.00
198.00
3003.00

The cash flows are generated for 8years at follows:

CASH INFLOW
E.B.I.T
DEPRECIATION
TOTAL

1ST
YR
808
355
1163

2ND
YR
914
311
1225.

3RD
YR
937
267
1204

4TH
YR
963
229
1191

5TH
YR
981.01
196.35
1177.37

6TH
YR
995
169
1163

(RS. In lakhs)
7TH 8TH
YR
YR
1003 1008
145
124
1148 1132

The procedure adopted for calculating IRR is as given:

The project cost is arrived at, which consists of both fixed and current assets. In the
instant case, the fixed assets comprised of RS.2683.00 lakhs and current assets
comprised of RS.320.00 lakhs.
The following assumptions are made:
The life of the project is assumed at 15 years
The residual value of fixed assets at the end of 15 years is taken as NIL excluding
cost at land.
The realizable value of current assets is at 100%
The interest rate changed for the term loan being sanctioned is assumed at 12%.
The term loan being sanctioned is expected to be repaid in a period of 8 years.
The outlay is expected to be spent in a period of 3 years as Follows:

O year
1st year
3rd year

(RS. In lakhs)
2683
920
52
3655

43

IRR can be calculated manually or by using computers. The IRR is calculated by

using computer as follows is as under:
Year

Capital out lay

benefits

Net benefits

construction
1st
2nd
3rd
4th
5th
6th
7th
8th
9th
10th
11th
12th
13th
14th
15th

2683.25
920.00
51.00
0.00
0.00
0.00
0.00
0.00
0.00
0.00
0.00
0.00
0.00
0.00
0.00
0.00

0.00
1162.57
1225.45
1203.76
1190.87
1177.37
1163.16
1148.28
1132.62
1132.62
1132.62
1132.62
1132.62
1132.62
1132.62
2333.21

-2683.25
242.57
1174.34
1203.76
1190.87
1177.37
1163.16
1148.28
1132.62
1132.62
1132.62
1132.62
1132.62
1132.62
1132.62
2333.21

Re projects IRR is worked at 34.5%

44

Discounted
benefits
-2683.25
180.34
649.05
494.62
363.78
267.38
196.38
144.13
105.69
78.57
58.41
43.43
32.39
24.00
17.84
27.33

CHAPTER 5
OBSERVATIONS
&
CONCLUSIONS

45

OBSERVATIONS:
The IRR for the instant project proposal is worked out at 34.5%
The cost of capital or cut off rate is interest rate charged by YES BANK that is 12%
Since the IRR is more than the cost of capital the project is accepted for financial
assistance
Suitability of IRR technique to project finance:
One of the discounted capital budgeting techniques, the IRR is widely used in project
finance proposals because of its suitability. It is defined rate of discount at which the
present values of inflows are equal to present value of out flows.
In project finance decisions it is easy to determine the cost of capital,
which is equivalent to the interest rate charged. Therefore it is easy to calculate the
present values of inflows and outflows by discounting the values at the cost of capital.
The projects whose IRR is more than the cut off rate is accepted and vice versa. The
data required for arriving at the cash flows are easily calculated and thus the decision
making is fast.
Where as another model, capital budgeting technique net present value
methods is most suitable for decisions involved buying machinery items etc. Selection
of automatic or manual machinery.
In view of the above YES BANK is using IRR technique for their project finance
proposals.

YES BANK has been instrumental in industrial development of Andhra Pradesh.

During the 25th of its long saga, the corporation has financed above RS6000 cr to
nearly 86000 cr enterprises.
The corporation has generated direct and indirect employment.
The corporation has completed 25 years of service and to mark this occasion Golden
Jubilee Celebration was conducted during 2006-2007
YES BANK has achieved tremendous results during 2006-2007 in its key areas of
operation. There is a 26% growth in sanction, 21% in disbursements over the previous
year.
The performance of the corporation is highest among all in the country. As a result the
corporation has attained No. one position in the country for the 5th year
The evaluation techniques are broadly classified into two types i.e traditional
technique and discounted cash flow technique.
The traditional technique includes net pay back period, average rate of return

46

The discounted cash flow technique includes Net Present Value, Internal Rate Of
Return, Profitability Index.
In YES BANK a project is appraised to examine the financial viability of the project.
YES BANKworks out Internal Rate Of Return in appraisal of the project among the
capital budgeting technique.
An accept-reject criterion has been applied for all the capital budgeting methods.
The result in this case study suggests that the project can be accepted.
The corporation may consider using of other capital budgeting techniques like Pay
Back Period, Average Rate Of Return, Net Present Value, Profitability Index in the
appraisal of the project, which will enhance the quality of the appraisal.

47

CONCLUSIONS
All the techniques of capital budgeting presume that various investment
proposals under consideration are mutually exclusive which may not
practically be true in some particular circumstances.
The techniques of capital budgeting require estimation of future cash inflows
and outflows. The future is always uncertain and the data collected for future
may not be exact. Obviously the results based upon wrong data may not be
good.
There are certain factors like morale of the employees, goodwill of the firm,
etc., which cannot be correctly quantified but which otherwise substantially
influence the capital decision.
Urgency is another limitation in the evaluation of capital investment decisions.
Uncertainty and risk pose the biggest limitation to the techniques of capital
budgeting.

48

CHAPTER 7
BIBLOGRAPHY

49

BIBLOGRAPHY:
Financial Management
Management Accountancy
Financial Management
Advanced Accountancy
Financial Management
Management Accountancy

-------

I.M. Pandey
Khan & Jain
S.N. Maheshwari
S.P. Jain & K.V. Narayana
Prasanna Chandra
Sharma & Shashi K. Gupta

YES BANK Annual reports

WWW.YESBANK.IN
WWW.YESBANK.COM

50