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.

1
 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

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 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 decision-

making 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.

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 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.

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 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

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6
 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 company’s operations of using various Capital

budgeting techniques.

 To know how the company gets funds from various resources.

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 OBJECTIVES OF THE STUDY

 To study the relevance of capital budgeting in evaluating the

project.

 To study the techniques of capital budgeting for decision-

making.

 To 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.

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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.

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 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.

 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.

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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 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 Heritage’s 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
13
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.

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.

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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.

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.
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 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:

 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

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  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)

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:
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  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.

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:

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 The total turnover is Rs 341 Crores during the financial year
2006-07 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

2006-07 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 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

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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:

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.
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 CAPITAL BUDGETING

Introduction:
The term Capital Budgeting refers to long term planning for
proposed capital outlay and their financing. It includes raising long-
term funds and their utilization. It may be defined as a firm’s
formal process of acquisition and investment of capital.

Capital Budgeting May also be defined as “The decision making

process by which a firm evaluates the purchase of major fixed
assets. It involves firm’s decision to invest its current funds for
addition, disposition, modification and replacement of fixed assets.

It deals exclusively with investment proposals, which an essentially

long term projects and is concerned with the allocation of firm’s
scarce financial resources among the available market
opportunities.

Some of the examples of Capital Expenditure are

(i) Cost of acquisition of permanent assets as land and
buildings.
(ii) Cost of addition, expansion, improvement or alteration in
the fixed assets.
(iii) R&D project cost, etc.,

Definitions:

“Capital budgeting is long term planning for making and financing

proposed capital outlays”.
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T.HORNGREEN

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

financial resources among the available market opportunities. The
consideration of investment opportunities. The consideration of
investment opportunities involves the comparison of the expected
future streams of earnings from a project with immediate and
subsequent streams of expenditures for it”.
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

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 Capital budgeting decisions involve the exchange of current funds
for the benefits to be achieved in future.
 The futures benefits are expected and are to be realized over a
series of years.
 The funds are invested in non-flexible long-term funds.
 They have a long terms are significant effect on the profitability of
the concern.
 They involve huge funds.
 They are irreversible decisions. They are strategic decisions
associated with high degree of risk.

IMPORTANCE OF CAPITAL BUDGETING:

The importance of capital budgeting can be understood from the

fact that an unsound investment decision may prove to be fatal to
the very existence of the organization.
The importance of capital budgeting arises mainly due to the
following:

1.Large investment:
Capital budgeting decision, generally involves large investment of
funds. But the funds available with the firm are scarce and the
demand for funds for exceeds resources. Hence, it is very
important for a firm to plan and control its capital expenditure.

2. Long term commitment of funds:

Capital expenditure involves not only large amount of funds but also
funds for long-term or an permanent basis. The long-term
commitment of funds increases the financial risk involved in the
investment decision.

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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.

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 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

27
 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:

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(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.

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 (iii) Capital Rationing Decisions: -

In a situation where the firm has unlimited funds all independent

investment proposals yielding return greater than some pre-
determined 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,

30
 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.

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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.

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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.

33
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 doesn’t itself authorize to go
ahead with the implementation of the project. A request for
authority to spend the amount should be made to the capital
expenditure committee, which reviews the profitability of the
project in the changed circumstances. Responsibilities should be
assigned while implementing the project in order to avoid
unnecessary delays and cost overruns. Network techniques like
PERT and CPM can be applied to control and monitor the
implementation of the projects.

Performance Review:

34
 The last stage in the process of capital budgeting is the evaluation
of the performance of the project. The evaluation is made by
comparing actual and budgeted expenditures and also by comparing
actual anticipated returns. The unfavorable variances, if any
should be looked in to and the causes of the same be identified so
that corrective action may be taken in future.

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 Time adjusted methods

1. Pay back 1.N.P.V
2. Accounting rate of return 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:

35
 (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.

Initial Cash Outflow

Pay Back Period = ------------------------------
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.

36
 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

37
 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 ½ 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.

38
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 above-

determined discount rate.

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

rate.

4. Calculate the NPV of the project by subtracting the present

value of cash outflows

From present value of cash inflows.

Decision rule

Accept the project if the NPV of the project is 0 or +ve that is present value of
cash inflows should be equal to or greater than the present value of cash
outflows.

39
 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”.

40
Decision Rule:

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

If IRR>K, accept project. K = cost of capital.

If IRR<K, reject project.

DETERMINANTION OF IRR

a) When annual cash flows are equal over the life of the asset.
Initial Outlay
FACTOR = --------------------------- x 100
Annual Cash Inflow

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

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

IRR = LR + ------------------------------------------------------------- (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.

41
 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.

42
 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
Net profitability index = -----------------------------
Initial Outlay

ADVANTAGES:

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

rank the projects even when the costs of the projects differ
significantly.

43
 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

44
45
 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.
46
 Application of a decision rule for making the choice.

The investment decision rules may be referred to as capital

budgeting techniques or investment criteria. A sound appraisal
technique should be used to measure the economic worth of the
investment project. The essential property of a sound technique is
that it should maximize the shareholder’s wealth.

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:

The pay back period is one of the most popular and widely
recognized traditional methods of evaluating investment proposals.
47
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.

48
 STATEMENT SHOWING CALCULALTION OF PAY BACK
PERIOD

YEAR ROE INC TAX PAT DEP CFAT CCFAT

1 59.64 5.48 0 65.12 170.40 235.52 235.52

2 59.64 5.48 0 65.12 170.40 235.52 471.04

3 59.64 5.48 0 65.12 170.40 235.52 706.56

4 59.64 5.48 0 65.12 170.40 235.52 942.08

5 59.64 5.48 0 65.12 170.40 235.52 1177.60

6 59.64 5.48 0 65.12 170.40 235.52 1413.12

7 59.64 5.48 0 65.12 170.40 235.52 1648.64

8 59.64 5.48 0 65.12 170.40 235.52 1884.16

9 59.64 5.48 0 65.12 170.40 235.52 2119.68

10 59.64 5.48 0 65.12 170.40 235.52 2355.20

11 59.64 5.48 22.8 42.32 14.20 56.52 2411.72

12 59.64 5.48 22.8 42.32 14.20 56.52 2468.24

13 59.64 5.48 22.8 42.32 14.20 56.52 2524.76

14 59.64 5.48 22.8 42.32 14.20 56.52 2581.28

15 59.64 5.48 22.8 42.32 14.20 56.52 2637.80

16 59.64 5.48 22.8 42.32 14.20 56.52 2694.32

17 59.64 5.48 22.8 42.32 14.20 56.52 2750.84

18 59.64 5.48 22.8 42.32 14.20 56.52 2807.36

19 59.64 5.48 22.8 42.32 14.20 56.52 2863.88

20 59.64 5.48 22.8 42.32 14.20 56.52 2920.40

21 59.64 5.48 22.8 42.32 14.20 56.52 2976.92

22 59.64 5.48 22.8 42.32 14.20 56.52 3033.44

23 59.64 5.48 22.8 42.32 14.20 56.52 3089.96

24 59.64 5.48 22.8 42.32 14.20 56.52 3146.48

25 59.64 5.48 22.8 42.32 14.20 56.52 3203.00

49
Base Year = 9th year Required CFAT = 10.32
Next year CFAT = 2355.2

2130 – 2119.68
Pay back period = 9th year + -------------------- = 9th year + .00437yr
2355.2
= 9.004 years.
Interpretation:

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. The
accounting rate of return is found out by dividing the average after
tax profit by the average investment. The average investment
would be equal to half of the original investment, if it is
depreciated constantly. The Accounting rate of return can be
calculated by the following formula i.e.,

Annual Average Profit after Tax

A.R.R. = ---------------------------------------------- X 100
Annual Average Investment

50
STATEMENT SHOWING CALCULATION OF AVERAGE RATE OF RETURN
YEAR ROE INC TAX PAT
1 59.64 5.48 0 65.12
2 59.64 5.48 0 65.12
3 59.64 5.48 0 65.12
4 59.64 5.48 0 65.12
5 59.64 5.48 0 65.12
6 59.64 5.48 0 65.12
7 59.64 5.48 0 65.12
8 59.64 5.48 0 65.12
9 59.64 5.48 0 65.12
10 59.64 5.48 0 65.12
11 59.64 5.48 22.8 42.32
12 59.64 5.48 22.8 42.32
13 59.64 5.48 22.8 42.32
14 59.64 5.48 22.8 42.32
15 59.64 5.48 22.8 42.32
16 59.64 5.48 22.8 42.32
17 59.64 5.48 22.8 42.32
18 59.64 5.48 22.8 42.32
19 59.64 5.48 22.8 42.32
20 59.64 5.48 22.8 42.32
21 59.64 5.48 22.8 42.32
22 59.64 5.48 22.8 42.32
23 59.64 5.48 22.8 42.32
24 59.64 5.48 22.8 42.32
25 59.64 5.48 22.8 42.32
Total 1286.00

CALCULATION OF ARR:

Average NPAT = 1286/25 = 51.44

Average Investment = 2130/2 = 1065

51.44
ARR = ---------- X 100 = 4.83 %
1065

51
 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
52
 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

53
 PV@ PV CASH PV OF
YR ROE INC TAX PAT DEP CFAT
12% CFAT O.F COF
0 1.000 426.0 426.00
1 59.64 5.48 0 65.12 170.4 235.52 0.893 210.32 170.4 152.17
2 59.64 5.48 0 65.12 170.4 235.52 0.797 187.71 170.4 135.81
3 59.64 5.48 0 65.12 170.4 235.52 0.712 167.69 170.4 121.32
4 59.64 5.48 0 65.12 170.4 235.52 0.636 149.79 170.4 108.37
5 59.64 5.48 0 65.12 170.4 235.52 0.567 133.54 170.4 96.62
6 59.64 5.48 0 65.12 170.4 235.52 0.507 119.41 170.4 86.39
7 59.64 5.48 0 65.12 170.4 235.52 0.452 106.46 170.4 77.02
8 59.64 5.48 0 65.12 170.4 235.52 0.404 95.15 170.4 68.84
9 59.64 5.48 0 65.12 170.4 235.52 0.361 85.02 170.4 61.51
10 59.64 5.48 0 65.12 170.4 235.52 0.322 75.84 170.4 54.87
11 59.64 5.48 22.8 42.32 14.2 56.52 0.287 16.22 0 0
12 59.64 5.48 22.8 42.32 14.2 56.52 0.257 14.53 0 0
13 59.64 5.48 22.8 42.32 14.2 56.52 0.229 12.94 0 0
14 59.64 5.48 22.8 42.32 14.2 56.52 0.205 11.59 0 0
15 59.64 5.48 22.8 42.32 14.2 56.52 0.183 10.34 0 0
16 59.64 5.48 22.8 42.32 14.2 56.52 0.163 9.21 0 0
17 59.64 5.48 22.8 42.32 14.2 56.52 0.146 8.25 0 0
18 59.64 5.48 22.8 42.32 14.2 56.52 0.130 7.35 0 0
19 59.64 5.48 22.8 42.32 14.2 56.52 0.116 6.56 0 0
20 59.64 5.48 22.8 42.32 14.2 56.52 0.104 5.88 0 0
21 59.64 5.48 22.8 42.32 14.2 56.52 0.093 5.26 0 0
22 59.64 5.48 22.8 42.32 14.2 56.52 0.083 4.69 0 0
23 59.64 5.48 22.8 42.32 14.2 56.52 0.074 4.18 0 0
24 59.64 5.48 22.8 42.32 14.2 56.52 0.066 3.73 0 0
25 59.64 5.48 22.8 42.32 14.2 56.52 0.059 3.33 0 0
1454.9
1491 137 342 1286 1917 3203 9 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.

54
 PROFITABILITY INDEX:

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

method of evaluating the investing proposals. It is the relationship
between present value of cash inflows and the present value of cash
outflows. Thus

STATEMENT SHOWING CALCULATION OF

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

55
 PV of cash inflows
Profitability Index = --------------------------
PV of cash out flows

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
Profitability Index = -----------------
1388.92

= 1.047

6.07
Net Profitability Index = ---------------
1388.92

= 0.047

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

56
 INTERNAL RATE OF RETURN

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

flow technique, which makes account of the magnitude and timing
of cash flows. Others terms used to describe the IRR Method are
yield on investment, marginal efficiency of capital, rate of return
over cost, time adjusted rate of internal return and so on. The
concept of internal rate of return is quite simple to understand in
the case of one-period projects. The IRR is calculated by
interpolating the two rates with the help of the following formula:

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

IRR = LR+ --------------------------------------------------------------- (hr-lr)
Pv of cash inflows at lower rate-Pv of cash inflows at higher rate

WHERE,

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

inflows have been Calculated.

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

ACCEPTANCE RULE

The accept project rule, using the IRR method, is to accept the
project if its internal rate of return is higher than the opportunity
cost of capital (r>k) note that k is also known as the required rate
of return or cut-off rate. The project shall be rejected if its internal
rate of return is lower than the opportunity cost of capital. Thus
the IRR acceptance rules are:

 Accept if r>k
 Reject if r<k
 May accept if r=k

57
 STATEMENT SHOWING THE CALCULATIONS OF INTERNAL RATE OF RETURN

TA PV @ PV OF PV @ PV OF
YR ROE INC X PAT DEP CFAT 12% CF 13% CF
1 59.64 5.48 0 65.12 170.4 235.52 0.893 210.32 0.885 208.44
2 59.64 5.48 0 65.12 170.4 235.52 0.797 187.71 0.783 184.41
3 59.64 5.48 0 65.12 170.4 235.52 0.712 167.69 0.693 163.22
4 59.64 5.48 0 65.12 170.4 235.52 0.636 149.79 0.613 144.37
5 59.64 5.48 0 65.12 170.4 235.52 0.567 133.54 0.543 127.89
6 59.64 5.48 0 65.12 170.4 235.52 0.507 119.41 0.480 113.05
7 59.64 5.48 0 65.12 170.4 235.52 0.452 106.46 0.425 100.10
8 59.64 5.48 0 65.12 170.4 235.52 0.404 95.15 0.376 88.56
9 59.64 5.48 0 65.12 170.4 235.52 0.361 85.02 0.333 78.43
10 59.64 5.48 0 65.12 170.4 235.52 0.322 75.84 0.295 69.48
22.
11 59.64 5.48 8 42.32 14.2 56.52 0.287 16.22 0.261 14.75
22.
12 59.64 5.48 8 42.32 14.2 56.52 0.257 14.53 0.231 13.06
22.
13 59.64 5.48 8 42.32 14.2 56.52 0.229 12.94 0.204 11.53
22.
14 59.64 5.48 8 42.32 14.2 56.52 0.205 11.59 0.181 10.23
22.
15 59.64 5.48 8 42.32 14.2 56.52 0.183 10.34 0.160 9.04
22.
16 59.64 5.48 8 42.32 14.2 56.52 0.163 9.21 0.141 7.97
22.
17 59.64 5.48 8 42.32 14.2 56.52 0.146 8.25 0.125 7.07
22.
18 59.64 5.48 8 42.32 14.2 56.52 0.130 7.35 0.111 6.27
22.
19 59.64 5.48 8 42.32 14.2 56.52 0.116 6.56 0.098 5.54
22.
20 59.64 5.48 8 42.32 14.2 56.52 0.104 5.88 0.087 4.92
22.
21 59.64 5.48 8 42.32 14.2 56.52 0.093 5.26 0.077 4.35
22.
22 59.64 5.48 8 42.32 14.2 56.52 0.083 4.69 0.068 3.84
22.
23 59.64 5.48 8 42.32 14.2 56.52 0.074 4.18 0.060 3.39
22.
24 59.64 5.48 8 42.32 14.2 56.52 0.066 3.73 0.053 3.00
22.
25 59.64 5.48 8 42.32 14.2 56.52 0.059 3.33 0.047 2.66
1491 137 34 1286 1917 3203 1454.98 1385.55

58
 2

PV @ L R - C O F
Therefore, IRR = 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 = 426 x 14% = 59.64

Incentive= Difference of Standard capacity - Actual capacity x

0.25 Pisa

Installed capacity x Hours x No. Of days in a Year

Standard capacity =-----------------------------------------0000------------- x Std
% 1000

500 MW x 24 x 365
= --------------------------- X 85 % = 3723
1000

Installed capacity x Hours x No. of days in a Year

Actual capacity =--------------------------------------------------------------x
Std % 1000

500 MW x 24 x 365
= --------------------------- X 80 % = 3504
1000
Therefore, Incentive =3723 – 3504 x 0.25 =54.75=5.48
10

Depreciation = 80% of CC = 1704

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

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 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 project’s 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.

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63
 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.

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BIBLIOGRAPHY

65
 BIBLIOGRAPHY

FINANCIAL MANAGEMENT : I.M PANDAY

FINANCIAL MANAGEMENT : M.Y.KHAN & P.K.JAIN

FINANCIAL MANAGEMENT
THEORY &PRACTICE : PRASANNA CHANDRA

FINANCIAL MANAGEMENT : 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

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