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ORIGINAL ARTICLE
International Multidisciplinary
Research Journal
Indian Streams
Research Journal
Editorial Board
Pratap Vyamktrao Naikwade Iresh Swami Rajendra Shendge
ASP College Devrukh,Ratnagiri,MS India Ex - VC. Solapur University, Solapur Director, B.C.U.D. Solapur University,
Solapur
R. R. Patil N.S. Dhaygude
Head Geology Department Solapur Ex. Prin. Dayanand College, Solapur R. R. Yalikar
University,Solapur Director Managment Institute, Solapur
Narendra Kadu
Rama Bhosale Jt. Director Higher Education, Pune Umesh Rajderkar
Prin. and Jt. Director Higher Education, Head Humanities & Social Science
Panvel K. M. Bhandarkar YCMOU,Nashik
Praful Patel College of Education, Gondia
Salve R. N. S. R. Pandya
Department of Sociology, Shivaji Sonal Singh Head Education Dept. Mumbai University,
University,Kolhapur Vikram University, Ujjain Mumbai
Address:-Ashok Yakkaldevi 258/34, Raviwar Peth, Solapur - 413 005 Maharashtra, India
Cell : 9595 359 435, Ph No: 02172372010 Email: ayisrj@yahoo.in Website: www.isrj.org
Indian Streams Research Journal
ISSN 2230-7850
Impact Factor : 3.1560(UIF)
Volume-5 | Issue-1 | Feb-2015
Available online at www.isrj.org
INTRODUCTION:
Capital Budgeting is the planning of long-term financial projects relating to investments funded through
long term sources of capital. Capital budgeting is a decision-making process that facilitates managers to evaluate
and identify projects that are beneficial to the company. It is the most important task for managers for the following
reasons.
Firstly, capital budgeting helps the company to take its strategic decisions and directs the company in
undertaking new product, new service, new technology. Second, capital budgeting decisions are less flexible and
have long lasting effect on the company. Third, serious consequences may arise from poor capital budgeting
decisions. For example, if a company devoted too much capital to one project, the company’s capital would be
unnecessarily spent on excess production capacity. On the other hand, investment of inadequate capital by the
company results in low productivity and would suffer by the simple fact that its equipment, computer hardware and
software might not be cutting-edge to improve production. These poor capital budgeting decisions may provide the
rival companies an opportunity to steal market share by taking advantage of a lower cost structure or production
capabilities matching demand.
The goal with capital budgeting is to select the projects that bring the most value to the firm. Ideally, one
would like to select all of the projects that add value, and avoid those that lose value. Making optimal capital
budgeting decisions requires recognizing and correctly accounting the flexibilities associated with the project.
The Capital Budget reflects the continuing need to replace existing infrastructure along with making
investments to achieve efficient, effective and sustainable utilization of available resources.
REVIEW OF LITERATURE
Chandra, P(1975): conducted a study on 20 companies and his observations were “payback period method
Pooja K. Jahagirdar1 and Pradeep K. Gupta2 , “CASE STUDY ON CAPITAL BUDGETING WITH SPECIAL REFERENCE TO HOTEL MADHUVAN
INTERNAL PRIVATE LIMITED” Indian Streams Research Journal | Volume 5 | Issue 1 | Feb 2015 | Online & Print
1
.Case Study On Capital Budgeting With Special Reference To Hotel Madhuvan Internal Private Limited
was used for evaluating the investments of small size and accounting rate of return method was used as primary
criterion and payback period method as supplementary criterion for evaluating the investments of large size.
Discounted cash flow technique though not commonly used, are gaining importance, particularly in the evaluation
of large investments.”
Porwal L.S. (1976): An empirical study was conducted by Porwal L.S. on the organizational, quantitative,
qualitative, behavioural and control aspects of capital budgeting. He had selected 118 companies out of which 52
companies (44%) provided usable responses. He states “ 44% of the respondents ranked first preference for DCF
techniques, however, most companies were using combination of traditional and ‘theoretically correct’ economic
evaluation techniques of capital expenditure proposals. New product line preferred IRR and existing product line
preferred ARR and PBP continues to be the next preferred technique. Competitive position is the main non-financial
factor that is given due consideration for the capital budgeting decision. Most companies in India are using one or
more methods for incorporating risk. The shorter payback period and higher cut-off rate are the popular techniques
used by companies in India.”
Wong, K. A., Farragher, E. J., and Leung, R. K. C. (1987) conducted a survey of large corporations in Hong
Kong, Malaysia and Singapore in 1985. They found that “in Malaysia, payback period was the most popular primary
technique for evaluating and ranking projects. In Hong Kong, payback period and accounting rate of return are
equally popular. They concluded that, in contrast to US companies where discounted cash flow techniques are
significantly more popular than non-discounted cash flow techniques as primary evaluation measures, companies in
Hong Kong, Malaysia and Singapore prefer to use several methods as primary measures in evaluating and ranking
proposed investment projects.”
Pandey, I. M. (1989):In his survey and found that “all companies, except one, used payback period method
and payback period method gained importance because of its simplicity to use and understand, its emphasis on the
early recovery of the investment, its focus on risk. DCF techniques in India plays secondary role because of its
difficulty in understanding and using these techniques, lack of qualified professionals and unwillingness of top
management to use DCF techniques.”
Ken, L. K., and Cherukuri, U. R.(1991): In their study on US companies observed "Internal rate of return is
the number one choice of 66%, while 33% selected net present value as their most preferred (Primary) method."
Pike Richard(1992): had conducted a longitudinal capital budgeting study based on surveys between 1975
and 1992 on 100 large United Kingdom’s companies and observed “firms size influenced the usage of DCF methods
but not the traditional methods of capital budgeting techniques ( PBP & ARR). Large organizations ranked Internal
Rate of Return (IRR) first, followed by Net Present Valueand Pay Back Period whereas smaller organizations ranked
PBP first, Accounting Rate of Returnsecond and adjusted PBP and IRR third.”
Dhankar R. S.(1995): examined methods of evaluating investments and uncertainty in Indian companies.
He selected a sample of 75 firms. His findings revealed that “non-discounted methods like PBP and ARR were used
by 33% of firms whereas 16% of firms used modern DCF techniques. Moreover, almost 50% of the companies
incorporated risk by ‘Adjusting the Discount Rate’ and ‘Capital Asset Pricing Model’
Gupta, S., Batra, R.,and Sharma, M.(2007): they made an attempt to explore which capital budgeting
techniques is used by industries in Punjab and they found “non-discounted cash flow techniques like PBP and ARR
were used by majority of the sample companies. Only a few companies used DCF, and among them very negligible
number use NPV technique to evaluate a new project”
OBJECTIVES OF STUDY
This research paper is based on “Capital Budgeting with special reference to Hotel Madhuvan International
Private Limited, Vijayapur”. It’s a service firm with hotel and lodging facilities. Madhuvan hotel has decided to
modernize its lodging department investing 2.5 lakh on each room; there are 36 rooms i.e., Rs. 90,00,000
investments. This research paper will analyze the viability of the new proposal by using different capital budgeting
techniques and suggest the Hotel Madhuvan International Private Limited to undertake the project or not.
RESEARCH METHODOLOGY
For the purpose of the study secondary data was collected from the books of Hotel Madhuvanand capital
budgeting techniques have been used to achieve the objective. The capital budgeting can be categorised as given
below:
Traditional techniques
l
v Payback period
v Accounting rate of return
l
Modern techniques
Discounted payback period
v
Net present value
v
Profitability index
v
Internal rate of return
v
Formula used
Payback period= No. of years + Amount to recover/ total cash inflow of next year
w
ARR = Average Profits After Tax/ Net investment x 100
w
NPV= Present value of cash inflows – Initial investment
w
Profitability index = Present value of cash inflows/ Initial investment
w
Existing project
Note:
It is assumed that 70% of capacity is utilized. Hence 70% of Rs. 1,20,45,000 is Rs. 84,31,500.
v
Expenses incurred are assumed to be around 25% of computed receipts i.e., 25% of 84,31,500 are 21,07,875
v
Proposed project
Note:
Booking of the rooms in a year is approximately 70%. Hence 70% of 2, 16, 81,000 are1, 51, 76,700.
v
Expenses incurred are assumed to be increased to 40% of total income i.e.,40% of 1,51,76,700 are 60,70,680
v
Net income
v
The project is about Hotel Madhuvan International Private Limited who has undertaken modernization and
the details are as follows:
Calculations: Depreciation
ASSET DEPRECIATION RATE(WDV)
Building 10%
Plant and machinery 13.91%
Furniture and fixture 18.10%
Computer and peripherals 40%
Office equipment 13.91%
Electrical installation 13.91%
DEPRECIATION
Year Building Plant Furniture Computer & Office Electric Total
&machinery & fixture peripherals equipment installation
1 3,24,000 1,62,747 52,128 72,000 1,12,671 1,00,152 8,23,698
2 2,91,600 1,40,108.89 51,184.48 43,200 96,998.46 86,220.86 7,09,312.7
3 2,62,440 1,20,619.75 50,258.04 25,920 83,505.98 74,227.54 66,16,971.3
4 2,36,196 1,03,841.54 49,348.37 15,552 71,890.3 63,902.49 5,40,730.69
5 21,2,576.4 89,397.18 48,455.17 9,331.2 61,890.36 55,013.65 4,76,663.95
INCREMENTAL
YEAR DEPRECIATION PADBT TAX PADAT PATNBD
CASH FLOW
1 27,82,395 8,23,698 19,58,697 98,745.79 18,59,951.21 26,83,649.21
2 27,82,395 7,09,312.7 20,73,082.3 1,10,527.48 19,62,554.83 26,71,867.52
3 27,82,395 6,16,971.3 21,65,423.7 1,20,038.64 20,45,385.06 26,62,356.36
4 27,82,395 5,40,730.69 22,41,664.31 1,27,891.42 21,13,772.88 26,54,503.58
5 27,82,395 4,76,663.95 23,05,731.05 1,34,490.3 21,71,240.75 26,47,904.7
PROFITABILITY INDEX
91,53,926.21
PI =
90,00,000
PI =
1.02
18,59,951.21 +
19,62,554.83 +
20,45,385.06 +
21,13,772.88 +
21,71,240.75
APAT =
5
1,01,52,904.72
APAT =
5
APAT =
20,30,580.94
20,30,580.94
ARR = *100
90,00,000
ARR =
22.5%
NPV @ 14% =
1,53,926.2
NPV @ 15% =
-
61,336.11
Find the absolute sum of the NPV obtained in step1.
1,53,926.2 +
61,336.11 =
2,51,262.31
Calculate the ratio of NPV of smallest rate and sum obtained in step 2
1,53,926.2
=
.71
2,15,262.31
Add the number obtained in step 3 to smallest NPV
14 +
.71 =
14.71%
Payback period= No. of years + Amount to recover/ total cash of next year’s
9,82,106.91
=
3+
26,54,503.58
=
3.37 years
CUMULATIVE
DISCOUNTED CASH
YEAR CASH FLOW DISCOUNTED CASH
FLOW
FLOW
1 2683649.21 2354078.25 2354078.25
2 2671867.52 2055915.3 4409993.55
3 2662356.36 1797014.71 6207008.26
4 2654503.58 1571679.21 7778687.47
5 3717567.59 1930788.11
12,21,312.53
=
4+
19,30,788.11
=
4.63 years
FINDINGS
The points observed from the capital budgeting process are as follows:
CONCLUSION
The capital budgeting helps management to choose the most profitable alternative for long term
investment. The existing capital budgeting proposal is found to be clear and comprehensive.Capital budgeting
influences managerial action for long-term implications and it effects the growth and profitability of the firm.
Since, Net present value is greater than 0, Profitability index is greater than 1, Accounting rate of return is
higher than the target rate, Internal rate of return is greater than cost of capital, Payback period is less than target
period, the proposed project has to be considered for investment.
BIBLIOGRAPHY
1.www.studyfinance.com
2.www.wikipedia.org/wiki/capital_budgeting
3.http://shodhganga.inflibnet.ac.in:8080/jspui/bitstream/10603/7277/10/09_chapter%203.pdf
4.http://journal.asci.org.in/Vol.25(1996)/v25_1_pra.htm
5.http://www.ku.ac.ke/schools/business/images/stories/research/capital_budgeting_procedures.pdf
6.Chandra, P., (1975), “Capital Expenditure Analysis in Practice”, Indian Management, July, p 10-13.
7.Porwal, L. S., (1976), “Capital Budgeting in India”, Sultan Chand and Sons, New Delhi.
8.Wong, K. A., Farragher, E. J., and Leung, R. K. C.,(1987), “Capital Investment Practices: A Survey of Large
Corporations in Malaysia, Singapore and Hong Kong”, Asia Pacific Journal of Management, January, pp 112-123
9.Pandey, I. M.,(1989),“Capital Budgeting Practices of Indian Companies”,MDI Management Journal, January ,
Vol. 2, No.1
10.Ken, L. K., and Cherukuri, U. R., (1991), “CurrentPractices in Capital Budgeting, Cost of Capital and Risk
Adjustment”, ASCI Journal of Management, June, Vol. 2 1, (1).
11.Pike Richard,(1996),“A longitudinal survey on capital budgeting practices”, Journal of Business Finance &
Accounting, 23(1), January, 0306-686X, pp79-92
12.Dhankar, R. S., (1995), “An Appraisal of Capital Budgeting Decision Mechanism in Indian Corporates”,
Management Review, July-December, pp. 22-34
13.Gupta, S., Batra, R.,and Sharma, M.,( 2007 ),“Capital Budgeting Practices in Punjab-based Companies”, The
Icfai Journal of APPLIED FINANCE, February, Vol. 13, No.2, pp. 57-70
Pooja K. Jahagirdar
Student, BLDEA's, A. S. Patil College of Commerce, (BBA Programme), Vijayapur, Karnataka .
Pradeep K. Gupta
2
Asst. Professor, BLDEA's, A. S. Patil College of Commerce, (MBA Programme), Vijayapur, Karnataka.
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