Captial budgiting in itl

INTRODUCTION
The term Capital Budgeting refers to long term planning for proposed capital
outlay and their financing. It includes raising long-term funds and their utilization. It
may be defined as a firm’s formal process of acquisition and investment of capital.
Capital Budgeting May also be defined as “The decision making process by
which a firm evaluates the purchase of major fixed assets. It involves firm’s decision to
invest its current funds for addition, disposition, modification and replacement of fixed
assets.
It deals exclusively with investment proposals, which an essentially long term
projects and is concerned with the allocation of firm’s scarce financial resources among
the available market opportunities.
Some of the examples of Capital Expenditure are
(i) Cost of acquisition of permanent assets as land and buildings.
(ii) Cost of addition, expansion, improvement or alteration in the fixed assets.
(iii) R&D project cost, etc.,
Definitions:
“Capital budgeting is long term planning for making and financing proposed
capital outlays
T.HORNGREEN
“Capital budgeting is concerned with allocation of the firm’s scarce financial
resources among the available market opportunities. The consideration of investment
opportunities. The consideration of investment opportunities involves the comparison
of the expected future streams of earnings from a project with immediate and
subsequent streams of expenditures for it”.
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In any growing concern, capital budgeting is more or less a continuous process
and it is carried out by different functional areas of management such as production,
marketing, engineering, financial management etc. All the relevant functional
departments play a crucial role in the capital budgeting decision process of any
organization, yet for the time being, only the financial aspects of capital budgeting
decision are considered.
The role of a finance manager in the capital budgeting basically lies in the
process of critically and in-depth analysis and evaluation of various alternative
proposals and then to select one out of these. As already stated, the basic objectives of
financial management is to maximize the wealth of the share holders, therefore the
objectives of capital budgeting is to select those long term investment projects that are
expected to make maximum contribution to the wealth of the shareholders in the long
run.
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REVIEW OF LITERATURE
Introduction
One of the three major decisions made by managers is the decision to invest in
fixed assets. Investments in fixed assets involve large capital outlays and the
consequences of these investments decisions impact a firm’s operations for a very long
time. Therefore a variety of quantitative and analytical techniques are applied by
managers in project selection to enable them to make good decisions in this area.
2. Literature
It is widely accepted that discounted cash flow methods are the best way to
evaluate capital budgeting proposals. While several decades ago discounted cash flow
methods may not have been widely used (Istvan, 1961) more recent studies (Kim, Crick
and Kim, 1986) suggest that increasingly firms are adopting discounted cash flow
analysis. Much of the empirical research on capital budgeting practices adopted by
corporate managers is based on US data (See for example Mukherjee and Hingorani,
1999.) A few studies such as those by Payne, Heath, and Gale (1999), Jog and
Srivastava (1995) and Keste et. al (1999), examine capital budgeting practices followed
by firms in different countries such as Canada, Australia, Hong Kong, Indonesia,
Malaysia, Philippines and Singapore. This study examines managerial behavior and
preferences with respect to the capital budgeting decision using a sample of German
firms. Our unique sample and the results of our analysis help to fill a gap in finance
literature and provide useful information to managers contemplating German
collaborations.
Capital budgeting is the process by which firms determine how to invest their
capital. Included in this process are the decisions to invest in new projects, reassess the
amount of capital already invested in existing projects, allocate and ration capital across
divisions, and acquire other firms. In essence, the capital budgeting process defines the
set and size of a firm’s real assets, which in turn generate the cash flows that ultimately
determine its profitability, value, and viability.
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In principle, a firm’s decision to invest in a new project should be made
according to whether the project increases the wealth of the firm’s shareholders. For
example, the Net Present value (NPV) rule specifies an objective process by which
firms can assess the value that new capital investments are expected to create. As
Graham and Harvey (2001) document, this rule has steadily gained in popularity since
Dean (1951) formally introduced it, but its widespread use has not eliminated the
human element in capital budgeting. Because the estimation of a project’s future cash
flows and the rate at which they should be discounted is still a relatively subjective
process, the behavioral traits of managers still affect this process.
Studies of the calibration of subjective probabilities find that individuals are
overconfident in that they tend to overestimate the precision of their knowledge and
information (Fischhoff, Slovic, and Lichtenstein, 1977; Alpert and Raffia, 1982). In
fact, research shows that professionals from many fields exhibit overconfidence in their
judgments, including investment bankers (Stael von Holstein, 1972), engineers (Kidd,
1970), entrepreneurs (Cooper, Woo, and Dunkelberg, 1988), lawyers (Wagenaar and
Keren, 1986), negotiators (Neale and Bazerman,1990), and managers (Russo and
Schoemaker, 1992).
Several factors may explain why managers may also be expected to be
overconfident, especially in a capital budgeting context. First, capital budgeting
decisions can be complex. They often require projecting cash flows for a wide range of
uncertain outcomes.
Second, capital budgeting decisions are not well suited for learning.
As Kahneman and Lovallo (1993, p. 18) note, learning occurs “when closely similar
problems are frequently encountered, especially if the outcomes of decisions are
quickly known and provide unequivocal feedback.” In most firms, managers
infrequently encounter major investment policy decisions, experience long delays
before learning the outcomes of projects, and usually receive noisy feedback.
Furthermore, managers often have difficulty rejecting the notion that every situation is
new in important ways, allowing them to ignore feedback from past decisions
altogether. Learning from experience is highly unlikely under these circumstances
(Einhorn and Hogarth,1978; Brehmer, 1980).
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Third, unsuccessful managers are less likely to retain their jobs and be
promoted. Those who succeed may become overconfident because of a self-attribution
bias. Most people overestimate the degree to which they are responsible for their own
success (Miller and Ross, 1975; Langer and Roth, 1975; Nisbett and Ross, 1980). This
self-attribution bias causes successful managers to become overconfident (Daniel,
Hirshleifer, and Subrahmanyam, 1998; Gervais and Odean, 2001).
Fourth, managers may be more overconfident than the general population
because of a selection bias. Those who are overconfident and optimistic about their
prospects as managers are more likely to apply for these jobs. Moreover, as Goel and
Takor (2008) show, firms may endogenously select and promote on the basis of
overconfidence, as overconfident individuals are more likely to have generated
extremely good outcomes in the past. Finally, as Gervais, Heaton, and Odean (2009)
argue, overconfident managers may simply be easier to motivate than their rational
counterparts and so hiring them is more appealing to firms.
Reviews and Appeals of Capital Budgeting
In the corporate finance capital budgeting survey literature the capital
budgeting process has been described in terms of four stages: (1) identification, (2)
development, (3) selection, and (4) control. The identification stage comprises the
overall process of project idea generation including sources and submission procedures
and the incentives/reward system, if any. The development stage involves the initial
screening process relying primarily upon cash flow estimation and early screening
criteria. The selection stage includes the detailed project analysis that results in
acceptance or rejection of the project for funding. Finally, the control stage involves the
evaluation of project performance for both control purposes and continuous
improvement for future decisions.
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All four stages have common areas of interest including personnel, procedures,
and methods involved, along with the rationale for each. All four stages are critical to
the overall process, but the selection stage is arguably the most involved since it
includes the choices of analytical methods/techniques used, how the cost of capital is
determined, how adjustments for projects risks are assessed and reflected, and how, if
relevant, capital rationing affects project choice. The selection stage has also been the
most investigated by survey researchers, particularly in the area of selection techniques,
resulting in a relative neglect of the other stages. This in turn has led to appeals to
future researchers to consider the other stages in their survey research efforts
As Gordon and Pinches (1984) View:
Most of the literature on the subject of capital budgeting has emphasized the
selection phase, giving little coverage to the other phases. Instead, it is usually assumed
that a set of well-defined capital investment opportunities, with all of the informational
needs clearly specified suddenly appears on an executive’s desk and all that is needed is
for the manager to choose the project (s) with the highest expected payoff. However, as
most managers quickly learn, this is not the case. Further, once projects are chosen, the
evaluation of an individual project’s subsequent performance is usually either ignored
or often inappropriately handled. Our contention is that the capital budgeting process
must be viewed in its entirety, and the informational needs to support effective
decisions must be built into the firm’s decision support system
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THEROTICAL FRAME WORK
Introduction
Capital Budgeting May also be defined as “The decision making process by
which a firm evaluates the purchase of major fixed assets. It involves firm’s decision to
invest its current funds for addition, disposition, modification and replacement of fixed
assets.
Features of Capital Budgeting:
 The important features, which distinguish capital budgeting decisions in other
Day-to-day decisions, are
 Capital budgeting decisions involve the exchange of current funds for the
benefits to be achieved in future.
 The futures benefits are expected and are to be realized over a series of years.
 The funds are invested in non-flexible long-term funds.
 They have a long terms are significant effect on the profitability of the concern.
 They involve huge funds.
 They are irreversible decisions. They are strategic decisions associated with
high degree of risk.
IMPORTANCE OF CAPITAL BUDGETING:
The importance of capital budgeting can be understood from the fact that an
unsound investment decision may prove to be fatal to the very existence of the
organization.
The importance of capital budgeting arises mainly due to the following:
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1. Large investment:
Capital budgeting decision, generally involves large investment of funds. But
the funds available with the firm are scarce and the demand for funds for exceeds
resources. Hence, it is very important for a firm to plan and control its capital
expenditure.
2. Long term commitment of funds:
Capital expenditure involves not only large amount of funds but also funds for
long-term or an permanent basis. The long-term commitment of funds increases the
financial risk involved in the investment decision.
3. Irreversible nature:
The Capital expenditure decisions are of irreversible nature. Once, the decision
for acquiring a permanent asset is taken, it becomes very difficult to dispose of these
assets without incurring heavy losses.
4. Long terms effect on profitability:
Capital budgeting decision has a long term and significant effect on the
profitability of a concern. Not only the present earnings of the firm are affected by the
investments in capital assets but also the future growth and profitability of the firm
depends up to the investment decision taken today. Capital budgeting decision has
utmost importance to avoid over or under investment in fixed assets.
5. Difficulties of investment decision:
The long terms investment decisions are difficult to be taken because
uncertainties of future and higher degree of risk.
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6. Notional Importance:
Investment decision though taken by individual concern is of national
importance because it determines employment, economic activities and economic
growth.
FACTORS INFLUENCING CAPITAL EXPENDITURE DECISIONS:
There are many, factors financial as well as non financial which influence the
capital expenditure decisions and the profitability of the proposal yet, there are many
other factors which have to be taken into consideration while taking a capital
expenditure decision. They are:
1. URGENCY: sometimes, an investment is to be made due to urgency for the
survival of the firm or to avoid heavy losses. In such circumstances, proper
evaluation cannot be made through profitability tests. Examples of such urgency are
breakdown of some plant and machinery, fire accidents etc.
2. DEGREE OF UNCERTAINITY: profitability is directly related to risk, higher
the profits, greater is the risk or uncertainty Sometimes, a project with some lower
profitability may be selected due to constant flow of income as compared to another
project with an irregular and uncertain inflow of income.
3. INTANGIBLE FACTORS: sometimes, a capital expenditure has to be made due
to certain emotional and intangible factors such as safety and welfare of the
workers, prestigious project, social welfare, goodwill of the firm etc.
4. AVAILABILITY OF FUNDS: as the capital expenditure generally requires the
provisions of law is solely influenced by this factor and although the project may
not be profitable, yet the investment has to be made.
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5. AVAILABILITY OF FUNDS: as the capital expenditure generally requires large
funds the availability of funds is an important factor that influences the capital
budgeting decisions. A project howsoever profitable may not be taken for want of
funds and a project with lesser profitability may sometimes be preferred due to
lesser pay back period for want of liquidity.
6. FUTURE EARNINGS: a project may not be profitable as compared to another
today, but it may promise better future earnings. In such cases, it may be preferred
to increase future earnings
RISK AND UNCERTAINITY IN CAPTIAL BUDGETING:
All the techniques of Capital Budgeting require the estimation of future cash
inflow and cash outflow. The cash flows are estimated, based on the following factors.
 Expected economic life of the project
 Salvage value of the asset at the end of the economic life
 Capacity of the project
 Selling price of the product
 Production cost
 Depreciation rate
 Rate of taxation
 Future demand of the product, etc.,
But, due to uncertainties about the future, the estimates of demand, production,
sales, costs, selling price, etc cannot be exact. For example a product may become
obsolete much earlier than anticipated due to unexpected technological developments
all these elements of uncertainties have to be taken into account in the form of forcible
risk while taking a decision on investment proposals. It is perhaps the most difficult
task while making an investment decision. But some allowances for the element of risk
has to be provided.
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CAPITAL EXPENDITURE CONTROL:
Capital expenditure involves non-flexible long term commitment of funds. The
success of an enterprise in the long run depends upon the effectiveness with which the
management makes capital expenditure decisions. Capital expenditure decisions are
very important as their impact is more or less permanent on the well being and
economic health of the enterprise. Because, of its large scale mechanization and
automation and importance of capital expenditure for increase in the profitability of a
concern. It has become essential to maintain an effective system of capital expenditure
control.
OBJECTIVES OF CONTROL OF CAPITAL EXPENDITURE:
 To make an estimate of capital expenditure and to see that the total cash outlay
is within the financial resources of the enterprise.
 To ensure timely cash inflows for the projects so that non availability of cash
may not be a problem in the implementation of the problem.
 To ensure that all capital expenditure is properly sanctioned.
 To properly co-ordinate the projects of various departments.
 To measure the performance of the project.
 To ensure that sufficient amount of capital expenditure is incurred to keep pace
with the rapid technological development.
 To prevent over expansion.
LONG TERM SOURCES OF FINANCE
It is natural phenomenon that the firm is always in deficit of funds. There are two
methods of raising funds.
1) Long term sources
2) Short term sources.
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Capital budgeting decisions involve long term funds. The different long term
sources of finance generally followed by companies are:
1) Shares
2) Debentures
3) Term Loans.
SHARES:
Shares include ordinary or common shares and preference shares. Ordinary or
common shares are the source of permanent capital since they do not have a maturity
date. The holders of ordinary shares are share holders or stock holders are the legal
owners of the company.
Preference share is considered to be hybrid security as it has many features of
both ordinary shares and debentures. Preference shares may be issued with or without
maturity date. The holders of preference shares get dividend at a fixed rate and have
preference over ordinary share holders.
DEBENTURES:
Debentures are a long term promissory note for raising loan capital. The
debenture trust deed defines the legal relationship between the issuing company and the
debenture trustee who represent the debenture holders.
TERM LOANS:
Term loans for more than a year maturity. It is generally available for a period
of 10 years. Interest on term loans is tax deductable. They are obtained from banks and
specially created financial institutions like IFCI, ICICI IDBI etc. the purpose of term
loans is mostly to finance the company’s capital expenditure. They are generally
obtained for financing large expansion, modernization or diversification projects.
Hence, this method of financing is also called pro0ject financing. This is the most
widely used source of financing.
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LEASE FINANCING:
A lease is an agreement for the use of an asset for a specified rental. The owner
of the asset is called the lesser and the user the lessee. Two important categories of
lease are:
1) Operating leases
2) Financial leases
Operating leases are short term cancelable leases where the risk of obsolescence
is born by the lesser.
Financial leases are long tern non-cancellable leases where any risk in the use of
asset is borne by the lessee and he enjoys the return too.
BUYING OR PROCURING:
Buying or procurement involves purchasing an asset permanently in the form of
cash or credit.
LEASING (VS) BUYING:
Leasing equipment has the tax advantage of depreciation which can mutually
benefit both the lesser and lessee. Other advantages of leasing include convenience and
flexibility as well as specialized services to the lessee. Lease proves handy to those
firms to those firms which cannot obtain loan capital from normal sources. The pros
and cons of leasing and buying are to be examined thoroughly before deciding the
method of procurement i.e., leasing or buying.
CAPITAL BUDGETING PROCESS:
Capital budgeting is a complex process as it involves decisions relating to the
investment of current funds for the benefit to be achieved in future and the future is
always uncertain. However, the following procedure may be adopted in the process of
Capital Budgeting.
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Identification of investment proposals:
The capital budgeting process begins with the identification of investment
proposals. The proposal about potential investment opportunities may originate either
from top management or from any officer of the organization. The departmental head
analysis the various proposals in the light of the corporate strategies and submits the
suitable proposals to the capital expenditure planning.
Screening Proposals:
The expenditure planning committee screens the various proposals received
from different departments. The committee views these proposals from various angles
to ensure that these are in accordance with the corporate strategies or selection criterion
of the firm and also do not lead departmental imbalances.
Evaluation of Various Proposals:
The next step in the capital budgeting process is to various proposals. The
methods, which may be used for this purpose such as, payback period method, Rate of
return method, N.P.V and I.R.R etc.
Priorities:
After evaluating various proposals, the unprofitable uneconomical proposal may
be rejected but may not be possible for the firm to invest immediately in all the
acceptable proposals due to limitation of funds. Therefore, it essential to rank the
projects/proposals after considering urgency, risk and profitability involved there in.
FINAL APPROVAL AND PREPERATION OF CAPITAL EXPENDITURE
BUDGET:
Proposals meeting the evaluation and other criteria are finally approved to be
included in the capital expenditure budget. The expenditure budget lays down the
amount of estimated expenditure to be incurred on fixed assets during the budget
period.
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Implementing Proposals:
Preparation of a capital expenditure budget and incorporation of a particular
proposal in the budget doesn’t itself authorize to go ahead with the implementation of
the project. A request for authority to spend the amount should be made to the capital
expenditure committee, which reviews the profitability of the project in the changed
circumstances. Responsibilities should be assigned while implementing the project in
order to avoid unnecessary delays and cost overruns. Network techniques like PERT
and CPM can be applied to control and monitor the implementation of the projects.
Performance Review:
The last stage in the process of capital budgeting is the evaluation of the
performance of the project. The evaluation is made by comparing actual and budgeted
expenditures and also by comparing actual anticipated returns. The unfavorable
variances, if any should be looked in to and the causes of the same be identified so that
corrective action may be taken in future.
KINDS OF CAPITAL BUDGETING DECISIONS
The overall objectives of capital budgeting are to maximize the
profitability of a firm or the return on investment. These objectives can be achieved
either by increasing revenues or by reducing costs. This, capital budgeting decisions
can be broadly classified into two categories. 1. Increase revenue, 2. Reduce costs
The first category of capital budgeting decisions is expected to increase revenue
of the firm through expansion of the production capacity or size of the firm by reducing
a new product line. The second category increases the earning of the firm by reducing
costs and includes decisions relating to replacement of obsolete, outmoded or worn out
assets. In such cases, a firm has to decide whether to continue the same asset or replace
it. The firm takes such a decision by evaluating the benefit from replacement of the
asset in the form or reduction in operating costs and the cost cash needed for
replacement of the asset. Both categories of above decision involve investments in
fixed assets but the basic difference between the two decisions are in the fact that
increasing revenue investment decisions are subject to more uncertainty as compared to
cost reducing investments decisions.
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Further, in view of the investment proposal under consideration, capital
budgeting decisions may be classified as:
1. Accept Reject Decision:
Accept reject decisions relate independent projects do not compute with
one another. Such decisions are generally taken on the basis of minimum return on
investment. All those proposals which yield a rate of return higher than the minimum
required rate of return of capital are accepted and the rest rejected. If the proposal is
accepted the firm makes investment in it, and the rest are rejected. If the proposal is
accepted the firm makes investment in it, and if it is rejected the firm does not invest
in the same.
2. Mutually Exclusive Project Decision:
Such decisions relate to proposals which compete with one another in such a
way that acceptance of one automatically excludes the acceptance of the other. Thus
one of the proposals is selected at the cost of the other. For ex: A company has the
option of buying a machine. Or a second hand machine, or taking on old machine hire
or selecting a machine out of more than one brand available in the market. In such a
cases the company can select one best alternative out of the various options by adopting
some suitable technique or method of capital budgeting. Once the alternative is selected
the others. Are automatically rejected.
Capital Rationing Decision:
A firm may have several profitable investment proposals but only limited funds
and, thus, the firm has to rate them. The firm selects the combination of proposals that
will yield the greatest profitability by ranking them in descending order of their
profitability.
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METHODS OR TECHNIQUES OF CAPITAL BUDGETING:
There are many methods for evaluating the profitability of investment
proposals. The various commonly used methods are
Traditional methods:
(I) Payback period method (P.B.P)
(II) Accounting Rate of return method (A.R.R)
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Time adjusted or discounting techniques:
(I) Net Present value method (N.P.V)
(II) Internal rate of return method (I.R.R)
(III) Profitability index method (P.I)
1. PAY-BACK PERIOD METHOD:
The pay back sometimes called as payout or pay off period method represents
the period in which total investment in permanent assets pay back itself. This method
is based on the principle that every capital expenditure pays itself back within a certain
period out of the additional earnings generated from the capital assets.
Decision rule:
A project is accepted if its payback period is less than the period specific decision rule.
A project is accepted if its payback period is less than the period specified by the
management and vice-versa.
Pay Back Period
Initial Cash Outflow
=
Annual Cash Inflows
ADVANTAGES:
 Simple to understand and easy to calculate.
 In this method, as a project with a shorter payback period is preferred to the
one having a longer pay back period, it reduces the loss through obsolescence.
 Due to its short-term approach, this method is particularly suited to a firm
which has shortage of cash or whose liquidity position is not good.
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DISADVANTAGES:
 It does not take into account the cash inflows earned after the payback period
and hence the true profitability of the project cannot be correctly assessed.
 This method ignores the time value of the money and does not consider the
magnitude and timing of cash inflows.
 It does not take into account the cost of capital, which is very important in
making sound investment decisions.
2. ACCOUNTING RATE OF RETURN METHOD:
This method takes into account the earnings from the investment over the whole
life. It is known as average rate of return method because under this method the concept
of accounting profit (NP after tax and depreciation) is used rather than cash inflows.
According to this method, various projects are ranked in order of the rate of earnings or
rate of return.
Decision rule:
The project with higher rate of return is selected and vice – versa.
The return on investment method can be used in several ways, as
Average Rate of Return Method:
Under this method average profit after tax and depreciation is calculated and
then it is divided by the total capital out lay.
Average Annual profits (after dep. & tax)
Average rate of return= x 100
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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.
 This method cannot be applied to a situation where investment in project is
to be made in parts.
3. NET PRESENT VALUE METHOD:
The NPV method is a modern method of evaluating investment proposals. This
method takes in to consideration the time value of money and attempts to calculate the
return on investments by introducing time element. The net present values of all
inflows and outflows of cash during the entire life of the project is determined
separately for each year by discounting these flows with firms cost of capital or
predetermined rate.
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The steps in this method are:
1. Determine an appropriate rate of interest known as cut off rate.
2. Compute the present value of cash outflows at the above-determined discount rate.
3. Compute the present value of cash inflows at the predetermined rate.
4. Calculate the NPV of the project by subtracting the present value of cash outflows
From, present value of cash inflows.
Decision rule
Accept the project if the NPV of the project is 0 or +ve that is present value
of cash inflows should be equal to or greater than the present value of cash outflows.
ADVANTAGES:
 It recognizes the time value of money and is suitable to apply in a situation
with uniform cash outflows and uneven cash inflows.
 It takes in to account the earnings over the entire life of the project and gives
the true view of the profitability of the investment
 Takes in to consideration the objective of maximum profitability.
DISADVANTAGES:
 More difficult to understand and operate.
 It may not give good results while comparing projects with unequal
investment of funds.
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 It is not easy to determine an appropriate discount rate.
4. PROFITABILITY INDEX METHOD OR BENEFIT COST RATIO
METHOD:-
It is also a time-adjusted method of evaluating the investment proposals. PI also
called benefit cost ratio or desirability factor is the relationship between present value
of cash inflows and the present values of cash outflows. Thus
PV of cash inflows
Profitability index =
Initial Investment or cash outflows
Net profitability index = Profitability index - 1
ADVANTAGES:
 Unlike net present value, the profitability index method is used to rank the
projects even when the costs of the projects differ significantly.
 It recognizes the time value of money and is suitable to applied in a situation
with uniform cash outflows and uneven cash inflows.
 It takes into an account the earnings over the entire life of the project and gives
the true view of the profitability of the investment.
 Takes into consideration the objective of maximum profitability.
DISADVANTAGES:
 It may not give good results while comparing projects with Unequal investment
funds.
 It is not easy to determine and appropriate discount rate.
 It may not give good results while comparing projects with unequal lives as the
project having higher NPV but have a longer life span may not be as desirable
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as a project having some what lesser NPV achieved in a much shorter span of
life of the asset.
5. INTERNAL RATE OF RETURN METHOD
The internal rate of return method is also a modern technique of capital
budgeting that takes in to account the time value of money. It is also known as time-
adjusted rate of return or trial and error yield method. Under this method the cash
flows of a project are discounted at a suitable rate by hit and trial method, which
equates the net present value so calculated to the amount of the investment. The internal
rate of return can be defined as “that rate of discount at which the present value of cash
inflows is equal to the present value of cash outflows”.
Decision Rule:
Accept the proposal having the higher rate of return and vice versa.
If IRR>K, accept project.
K = cost of capital.
If IRR<K, reject project.
DETERMINANTION OF IRR
a) When annual cash flows are equal over the life of the asset.
Initial Outlay
FACTOR = x 100
Annual Cash Inflow
b) When the annual cash flows are unequal over the life of the asset:
PV of cash inflows at lower rate - PV of cash outflows
IRR = LR + x (Hr-Lr)
PV of cash inflows at lower rate-PV of cash inflows at higher rate
The steps are involved here are
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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.
If the NPV is negative, at a higher rate, NPV lies between these two rates.
ADVANTAGES:
 It takes into account, the time value of money and can be applied in situations
with even and even cash flows.
 It considers the profitability of the projects for its entire economic life.
 The determination of cost of capital is not a pre-requisite for the use of this
method.
 It provides for uniform ranking of various proposals due to the percentage rate
of return.
 This method is also compatible with the objective of maximum profitability.
DISADVANTAGES:
 It is difficult to understand and operate.
 The results of NPV and IRR methods may differ when the projects under
evaluation differ in their size, life and timings of cash flows.
 This method is based on the assumption that the earnings are reinvested at the
IRR for the remaining life of the project, which is not a justified assumption.
24

NEED FOR THE STUDY
 The project study is undertaken to analyze and understand the Capital
Budgeting process in ITL PVC PIPES PVT LTD, which gives mean exposure to
practical implication of theory knowledge.
 To know about the company’s operations of using various Capital budgeting
techniques.
 To know how the company gets funds from various resources.
25

OBJECTIVES OF THE STUDY
 To study the relevance of capital budgeting in evaluating the project.
 To study the techniques of capital budgeting for decision-making.
 To analyse the present value of rupee invested.
 To understand transaction wise study of the company
 To make suggestions if any for improving the financial positions of the
company.
26

SCOPE OF THE STUDY
Capital budgeting is the method of calculations of inflows of the project
undertaken by the company and investment recovers position of the company. For, the
evaluation of the profitability position use discounting and non-discounting techniques
like IRR, NPV and Pay Back Period. So I choose the concept for the study on capital
budgeting for expansion (or) replacement of the business.
27

LIMITATIONS OF THE STUDY
 Lack of awareness of ITL PVC PIPES PVT. LTD.
 Lack of time is another limiting factor the schedule period 6 weeks are not
sufficient to make the study independently regarding Capital budgeting in ITL
PVC PIPES PVT LTD
 The busy schedule of the officials in the ITL PVC PIPES PVT LTD is another
limiting factor. Due to the busy schedule of officials restricted me to collect the
complete information about organization.
 Non-availability of confidential financial data.
 The study is conducted in a short period, which was not detailed in all aspects.
28

RESEARCH METHODOLOGY
SOURCES OF DATA:
To achieve a fore said objective the following methodology has been adopted.
The information for this report has been collected through the primary and secondary
sources.
Primary sources:
It is also called as first handed information the data is collected through the
observation in the organization and interviews with officials. By asking, questions with
the accounts and other persons in the financial department. A part from these some
information is collected through the seminars, which were held by ITL PVC PIPES
PVT LTD.
Secondary sources:
These secondary data is existing data which is collected data which is collected
by others that is sources are financial journals, annual reports of the ITL PVC PIPES
PVT LTD.,
Research Design:
Research design - Analytical
Analytical tools- - Capital Budgeting, analysing the capital
budgeting,techniques
Traditional and Modern methods
Data Sources - Secondary data has been collected from
Company records, annual reports
29

Period of study - 2012 to 2016
INDUSTRY PROFILE
Introduction:
Plastic have become synonymous with modern living. It is undoubtedly a
product, which has penetrated extensively into the common man’s life. No wonder the
industry has achieved in terms of supply of raw material expansion and diversification
of processing capabilities and manufacturing of processing machinery and equipment.
This versatile material with its superior qualities such as light weight, easy
process ability corrosion resistance, energy conservation, no toxicity etc. many
substitute to a large extent many conventional and costly industrial materials like wood,
metal, glass, jute, lather etc., in the future. The manifold applications of plastics in the
field of automobiles, electronics, electrical, packaging and agriculture give enough
evidence of the immense utility of plastics.
At 80 percent of total requirement for raw material and almost all types of
plastic machines required for the industry are indigenously available. The present
investment in all the three segments of the industry namely production of raw materials,
expansion and diversification of processing capacities, manufacturing of processing
machinery and ancillary equipment is Rs.1250 crores and it provides employment to
more than eight lakh people.
On account of their inherent advantage in properties and versatility in adoption
and use, plastics have come to play a vital role in a variety of applications, the world
over. In our country, plastics are used in making essential consumer goods of daily use
for common man such as baskets, shopping bags, water bags, water bottles, school
bags, tiffen boxes, hair combs, tooth brushes, spectacle frames and fountain pens, they
also find applications in field like packaging, automobiles, and transportation,
30

engineering, electronics, telecommunications, defense, medicine, and building and
construction. Plastics are growing in importance in agriculture and water management.
The Govt. of India recognizing the importance of plastics in agriculture
appointed on March 7th
, 1981 a National Committee on the use of plastics in agriculture
under the chairmanship of Dr.G.V.K.Rao. This committee has forecast a tremendous
growth of drip irrigation through a net work of plastic pipes and tubes. In its opinion
large scale adoption of irrigation would lead to sports in demand for PVC pipes,
L.D.P.E tubes and polypropylene emitters. The committee made a number of
recommendations for promoting the use of plastics. The implementation of
recommendations would go along away in increasing the consumption of plastics,
which at present is very low. The rigid pipes, flexible pipes and sheeting, which are
being used for agricultural operations to carry out water place to place and also lining
of ponds and reservoirs to reduce seepage and most important in drip irrigation system.
Export of plastics goods:
Plastics have excellent potentialities. Our country is equipped with all kind of
processing machinery and skilled labor and undoable, and extra to boost export,
finished plastics products will yield rich divided.
Today India exports plastic products to as many as 80 countries all over the
world. The exports, which were stagnant at around rest 60-70 cores per annum double
to 129 craters. The Plastic industry has taken up the challenge of achieving an export
target of Rs.17 cores.
Major export markets for plastic products and linoleum are Australia,
Bangladesh, Canada, Egypt, Hong Kong, Italy, Kuwait, Federal Republic of Germany,
Sri Lanka, Sweden, Taiwan, U.K., U.S.A., and Russia.
With view to boosting the export, the plastics and linoleum’s export promotion
council has urged the government to reduce import duty of plastic raw material, supply
indigenous raw materials at international prices, fix duty, draw backs on weighted
31

average basis and charge freight rate on plastic products on weights basis instead of
volume basis.
Prospects:
The Production of various plastics a raw materials in the country is expected to
double by the end of seventh plan, the consumption of commodity plastics including
LDPE, HDPE, PP, PS AND PVC is immense scope for the use of plastics in
agriculture, electronics, automobile, telecommunications and irrigation and thus, the
plastic industry is on the threshold of an explosive growth.
Role of plastics in national economy
Plastics are got perceived as just simple colorful household products in the mind so
common person. A dominant part of the plastics of the percent and future find their
utilization in the areas.
 Agriculture, forestry and water-management.
 Automobile and transportation
 Electronics and telecommunications, buildings, construction and.
 Food processing and packaging
 Power and gas distributor.
Importance of Pipes Industry
We shall look at the basic data about plastics and particularly those properties,
which are so, fuse in practical working with plastics. Plastics are man-made materials.
The oldest raw material for producing plastics is carbonaceous material obtained from
coal tar (benzene, phenol).
Today the majority of raw materials are obtained from petrol chemical source
and they can be economically produced in large quantities.
32

Plastics have changed our world and day-by-day they are becoming important.
They own their success to whole series of advantage, which they have over
conventional materials such as:
 Lightweight
 Excellent mould ability
 Attractive colors
 Low energy requirements for convention
 Low labor and cost of manufacture
 Low maintenance & High strength weight ratio
Economic role:
Agriculture is the chief occupation in India. For the developing countries like
India modernization of the agriculture practices assumes pivotal places in improving
the economic status and the process of modernization. Includes, usage of higher
productive plastics supplement to greater extent manufacturing of tools required for
new agricultural practices.
The usage of poly vinyl chloride pipes in agricultural fields, lesser water
seepage, which was predominant in earlier practices, with services of P.V.C pipes,
water can be transported efficiently with lesser from the place of higher potential to the
place of lower water potential.
Presently the revolutionary tried in water management speaks much about drip
irrigation, which is developed in Israel and is practiced by all agricultural based nations
in the world. Drip irrigation greatly P.V.C pipes as core tools of implementation with
the services of this sort, P.V.C pipes one way or the other strengthening the hands of
country’s economy.
A part with the referred P.V.C pipes supplemented with fitting is used in houses
for electrical connection and other domestic purposes. Apart from these two
applications it has got wide applications even in industrial sectors. P.V.C pipes with
33

much unique heart, chemical and physical characteristics serve many industrial
purposes.
Even characteristics of weight and low price attract many more applications.
Rigid PVC pipes have been manufactured in India from the 60’s on imported extrusion
lines and there after indigenous plan were few pipes manufactures up to 1979-83. When
many extrusion lines were imported from batten field, Cincinnati, kraaus-maffi etc. the
Govt. allowed the imports of sophisticated and high output plants, which were not
available indigenously.
PVC PIPES IN INDIA
Pipes products have found wide acceptance in India and abroad. PVC is one of
the more versatile plastics. It can be extruded, molded, calendared and thermoformed
into a multitude of furnished products. The PVC resin can be formulated to give a wide
range of properties ranging from hand, tough materials for load bearing application
lime pipes, windows and doors to flexible materials for products a due as wire and
cable insulation and shooting and flooring.
PVC products cater to both interiors and exteriors. In interiors it can be used for
flooring, profile and cable tray, wall covering modular office systems, houses and
furniture. For exteriors it is used for doors and windows, fencing partitions and
paneling, roofing and rain systems.
The other external applications are in the field of irrigation, portable water
supplies. In the field of irrigation there are several methods to irrigate the fields. There
are minor irrigation projects and major irrigation projects apart from individual sources
like wells, tube wells, bore wells. Major irrigation sector small projects will have canals
and lift irrigation schemes etc., will have canals and lift irrigation schemes etc., will
have pipelines. Cement and GI pipes were the pipes used in conventional methods of
34

irrigation. Now-a-days PVC pipes replaced the conventional pipes and they constituted
almost 90% in this respect.
Drip irrigation popular in the agricultural sector especially in the field of
horticulture commercial cropping and green ply houses. The drip irrigation concept is
becoming more popular with its advantages like highly yield, water conversion, less
labour cost, less fertilizer, less past management costs, less power costs and many more
advantages. The demand for this concept is increasing at a place of 30%-40% per
annum.
Agriculture a sunrise industry in the Indian economy is mainly dependent on the
PVC pipes for the seawater sector and pumping to their aqua ponds. They are using
pipelines of four to five kilometers of 10-16 diameters pipes.
The state Govt. of A.P is using rigid PVC pipes for the irrigation water supplies
for the past few years. The state Govt. is producing PVC pipes through APSIDC
(Andhra Pradesh State Irrigation Development Corporation) for its lift irrigation
schemes. The panchayatraj department is producing pipes for public water supply
schemes. These pipes can be used for the main distributors, sub-distributors and
individual connections.
35

COMPANY PROFILE
Introduction:
A dynamic entrepreneur Sri S P Y Reddy was established a black pipes
manufacturing company in 1977 and the name of the company is Nandi Pipes Pvt Ltd
at Nandyal, Kurnool district. ITL PVC Pipes Pvt Ltd was incorporated in the year 1994.
The factory is situated at Survey No:375, Manoharabad,Toopran mandal, and Medak
district and it was taken over by Nandi Group Company. The company is managed by
team of professionals under the guidance of young, experienced, and well qualified
dynamic managing director Mr. S. Sreedhar Reddy.
Origin:
Rayalaseema is economically backward area in Andhra Pradesh, was rare field
region for industries. A dynamic entrepreneur sir S.P.Y.Reddy who is basically
mechanical engineer started a unit at Nandyal, which manufactures black pipes in 1977.
The determination and hard work of Sri S.P.Y.Reddy helped him to overcome the
problems faced by the company in the initial years, and with financial assistance from
local commercial banks. The company could overcome the problems of the merger and
now it is running smoothly.
Later the company started manufacturing of PVC pipes which terminated the
manufacturing of black pipes. This resulted in the formation of a Pvt. Ltd. company
called “SUJALA PIPES PVT.LTD.” with Sri S.P.Y.Reddy as the Managing Director.
36

The only major competitors to the company are Sudhakar pipes, Maharaja
Pipes. The only backdrop to it is the competition from local brands. As the majority of
the customers belong to farmers, they consider the quality. The company has to make
aware of the company’s quality standards to them.
Board of directors:
S.P.Y.Reddy:
Sri S.P.Y.Reddy locally well known industrialist with the base at Nandyal, Kurnool
district who has been successful entrepreneur, he is technically qualified person with
B.E (MEC) from R.E.C (Warangal) and with work experience at BAARC (Bombay).
He has daringly ventured and established industries in and around Nandyal from 70’s.
As years went of he has established most successfully the following Nandi group of
companies:
• Nandi Milk
• Maha Nandi Mineral Water
• Nandi Infosys
• Nandi Online Services
• ITL PVC PIPES PVT LTD.
• Integrated Thermos Plastic Ltd.
• Nandi PVC Projects.
Promoter:
Sri S Sreedhar Reddy, a computer engineer and a student of IIM, Ahemadabad
has been entrusted the management of ITL PVC PIPES PVT LTD., and great
assistance and a great upcoming engineer and industrialist.
Branches:
37

• Pondicherry
• Bellary
• Sangli
• Vellore
• Goa
• Kerala
Coverage:
At present Andhra Pradesh, parts of southern states of Karnataka, Tamilnadu
and Kerala are ambit of Sujala Pipes Pvt Ltd.
The company extended their sales in the below regions are shown below:
1979 Nandyal Region(polyphone pipes)
1984.85 Rayalaseema Region (PVC pipes)
1985.86 Telangana Region
1986.87 Karnataka and Andhra Pradesh
1988.91 Tamilnadu and Karnataka
1991.94 Kerala
Sizes:
Various sizes ranging from ½ to 10 are offered to customers. Even pipes with
different gauges and sizes are manufactured to suit specified conditions.
Packing:
Packing plays less important role into the products like PVC pipes because the
hallow space inside can be utilized. For, the purpose of cubic space utilization in trucks
while transport, organization is adopting the technique like pipes in pipes.
Payment period:
38

` For monarch brand the company adopts zero credit policy and goods are not
delivered unless cash remittances are made. For monarch and sagar brands credit is
entitled up to a week. The difference between these brands is due to brand image.
Technical details about PVC pipes:
Ingredients:
 PVC resin
 D.B.L.S
 T.B.L.S
 L.S
 C.S
 Satiric Acid
 Hydro Carbon
 Calcium Carbonate
Manufacturing process:
The main raw materials are HDPE granules and PP granules. The
manufacturing process for pipes consists of mixing various resins along with the
coloring materials in a mixture and the prepared material is fed to the extruder. In the
extruder, the material is heated to the required politicizing temperature (190deg.
centigrade to 230deg. centigrade) the extruder through the die hard to form the pipe.
The hot pipe coming out of the extruder is cooled in a water bath to retain the final
shape.
39

The pipe coming out of the extruder is guided through the water bath suitable
transaction system. The temperature of the water is maintained by circulating through
the cooling towards and with the help of a chilling plant.
` The required length of the pipe is cut with a planetary saw. The cut lengths are
titled by titling units and get corrected in the pipe rack attached to the titling frames.
Later they are stocked separately. The company has entered into a technical with its
own processing technology.
Channels of distribution:
ITL PVC PIPES PVT LTD. has got zero level and single level channel of
distribution.
ITL PVC PIPES PVT LTD. has an extensive network of 350 dealers in Andhra
Pradesh and who are directly serviced by company sales force and 620 dealers in South
India.
Transportation:
Transportation vehicles of ITL PVC PIPES PVT LTD. outnumber the fleet of
the competitor’s vehicle. This unique strength of the organization enables the delivery
system to be efficient. This event helps the dealers to reduce inventory levels to the
minimum. The dealers are also supplemented with the benefit of the lower paid up
capital in the form of inventory.
ITL PVC PIPES PVT LTD:
40
MANUFACTURER CONSUMER
MANUFACTURER DEALER CONSUMER

ITL PVC PIPES PVT LTD. was incorporated in the year Feb 1994. The factory
is situated at Survey No:375,Manoharabad,Toopran Mandal and Medak district. It was
taken over by Nandi group company, and it is one of the sister company among the
Nandi groups.
Its annual production capacity is 18,000 mts. And it is one of the leading
manufacturers of PVC pipes in south India. This company is equipped with technical
collaboration from Batten field of West Germany. It has made possible few other small
ventures. Pipes are sold under the brand names of MONARCH, KOHINOOR and
KRISHNA.
ITL PVC PIPES with their good quality, trouble free services, durability and
commercial use are a better choice than mild steel, galvanized steel, cast iron and
plastic pipes.
The company is managed by a term of professionals under the guidance of a
young, experienced and well qualified dynamic managing director Mr. Sreedhar Reddy.
Mission Statement:
The mission statement of ITL PVC PIPES PVT LTD. is as follows:
• To be preferred supply chain partner to out customer.
• To be recognized as the best in the world at we do.
• To create new values in the quality for our customers and employees.
Vision Statement:
The vision statement of ITL PVC PIPES PVT LTD. is as follows:
“Creating new values in quality by working together for you”
Functional departments of the company:
41

Financial department:
Through initially the company approached the external source for financial aid,
now the financial status of the company is very sound and is being run only with self
finance excepting for loans taken for hypothecation of machinery and stock from SBI
Nandyal.
The company follows cash and carry policy for monarch brand. The product is
not delivered until the cash is paid and financial department with the help of marketing
department looks after these transactions.
Marketing department:
Marketing Department is headed by the Executive Director. Marketing Manager
is in charge of all operations who reports to the Executive Director. Marketing Manager
and 35 Sales Representatives are under the control of Executive Director. There are
also 20 salesmen who have to report to the sales representatives above them.
Personal Department:
The Personal department consists the details of the executives and workers of
the organization. The organization is formed with Sri.S.P.Y.Reddy as the managing
Director. Two Marketing managers, financial managers, public relations officer and
quality control officer who all reports to executive director. Other, than executives there
are thousands workers in the organization.
Panel consisting of managing director, executive director and managers of
concerned departments makes the recruitment and selections of persons. Apart from the
attractive salaries company provides health card facilities.
42

Purchasing department:
The perplexing situation i.e. conformed by the manufactures of the PVC pipes is
scarcity of resin. Though the government of India has taken various steps to improve
the supply conditions of PVC resin, the Indian manufactures could meet only 50
percent of demand and remaining 50 percent is met from imports. The major
petrochemical company is Reliance Petrochemical Ltd. The lead time for the
acquisition of raw materials is 4 days.
The following lines highlight the human resources policies and practices:
 Effective utilization of manpower.
 To provide good working condition.
 To promote industrial development.
Application of PVC pipes:
• Agriculture and irrigation schemes.
• Rural and urban water supplies scheme.
• Tube well casing.
• Gas and oil supply lines.
• Industrial effluent disposal.
• Sewerage and drainage scheme.
• Air-condition ducting.
• Building installations.
• Industrial ducting.
43

PRODUCT PROFILE
Pipe hollow structure usually cylindrical, for conducting materials. It is used
primarily to convey liquids, gases or solid suspended in a liquid for e.g. slurry and also
used for electric wires. The earliest pipes were probably made of bamboo. Used by the
Chinese to carry water c.5000 BC. The Egyptians made the first metal pipe of copper
c.3000 BC until the cost iron became relatively, Copper or bronze. Modern materials
include cast iron weight iron, steel, copper, brass, bead, concrete, wood, and glass,
plastic. In lying an oil pipeline, 40’ft (12-m) sections of seamless steel pipe are
electrically welded together while held over a trench. Before being lowered into place
the pipe is coated with a protective paint and wrapped with a substance composed of
treated asbestos felt and fiberglass.
Pumping section located 50 to 75 ml (80-120km). A part boosts the dwindling
pressure backup as much as 1500’lb per inch. The piping must be kept clean either by
applying a negative electronic charge to the pipe or by regular use of a “pig”, or
scrubbing ball, inserted at one end and carried along by the current. An oil pipe line 6
inches (15 cm) to 24 inches (60 cm) in diameter will move it contents at about 3 to 6 ml
(5-10) per hr. Water has moved since ancient times in pipelines called aqueducts.
44

DATA ANALYSIS AND INTERPRETATION
INVESTMENT EVALUATION CRITERIA
Three steps are involved in the evaluation of an investment:
 Estimation of Cash Flows.
 Estimation of the required rate of return.
 Application of a decision rule for making the choice.
The investment decision rules may be referred to as capital budgeting techniques
or investment criteria. A sound appraisal technique should be used to measure the
economic worth of the investment project. The essential property of a sound technique
is that it should maximize the shareholder’s wealth.
“Here, in the data analysis the financial Manager to suggest their information to
taking the initial investment from the year 2012.
A number of capital budgeting techniques are used in practice. They may be
grouped as follows:
 Payback period (PBP)
 Average rate of return (ARR)
45

 Net Present Value (NPV)
 Profitability Index(PI)
 Internal Rate of Return(IRR)
All these methods of capital budgeting techniques are explained in detail below
Initial Investment 2,00,00,000 Rs. Tax percentage 25% (such as 10%) and the
depreciation the company will be provided in the Balance Sheet. these are all the based
to calculate the Profit after Tax and cash flows.
PAY BACK PERIOD:
The payback period is one of the most popular and widely recognized
traditional methods of evaluating investment proposals. It is defined as the number of
years required in a project. If the project generates constant annual cash inflows, the
payback period can be computed by the following formulae:
Initial Investment
Pay Back period =
Annual Cash Flows
In case of unequal cash inflows, the payback period can be computed by
calculating the cumulative cash inflow and checking whether the values are recovered
to the original outlay and taking the remaining amount and apply the formulae i.e.,
Required CFAT
PBP = base year +
Next year
ACCEPTANCE RULE:
1. Many firms use the payback period as acceptance for reject criterion as
well as a method of ranking projects.
46

2. If the payback period calculated for a project is less than the maximum
or standard payback period set by management, it would be accepted, if
not, it would be rejected.
3. As a ranking method, it gives highest ranking to the project, which has
the shortest payback period and lowest ranking to the project, which has
highest payback period.
Initial Investment is Rs.2, 00, 00,000.
SHOWING THE CALCULATIONS OF PAYBACK PERIOD
(In Rupees)
Year
Profit after tax Depreciation Cash flow after
tax
Cumulative
cash flows
2012 374540 2432956 2807496 2807496
2013 3049546 2167152 5216698 8024195
2014 4380048 2437146 6817194 14841389
2015 5300374 3102096 8402470 23243860
2016 7567635 5611603 13179238 36423098
Base Year = 3rd Year; Required CFAT = 51, 58,610.07;
Next Year CFAT = 2, 32, 43,860.28
2, 00, 00,000-1, 48, 41,389.93
Payback Period = 3 +
2, 32, 43,860.28
47

= 3 + 0.2219 = 3.2219 years (0.2219 X 365 days)
= 3 years 2 months 20days.
SHOWING THE CALCULATIONS OF PAYBACK PERIOD
Inference:
From the point of Pay Back Period the project can be accepted, because to get
the initial investment of Rs. 2, 00, 00,000, it is taking a time of 3 years 2months 20
days.
48
2012 2013 2014 2015 2016

Average Rate of Return (ARR):
The Average Rate of Return (ARR) is also known as Accounting Rate of Return
using accounting information, as revealed by financial statements, to measure the
profitability of an investment. The accounting rate of return is found out by dividing
the average after tax profit by the average investment. The average investment would
be equal to half of the original investment, if it is depreciated constantly. The
Accounting rate of return can be calculated by the following formula i.e.,
Profit after Tax
A.R.R. = X 100
Book Value of the Investment
SHOWING CALCULATION OF AVERAGE RATE OF RETURN
( in Rupees)
Year
Profit before
tax
Tax25% (include
10%surcharge
Profit after tax
2012 483278 108737 374540
49

2013 3934898 885352 3049546
2014 5651675 1271626 4380048
2015 6839192 1538818 5300374
2016 9829346 2261711 7567635
Calculation of A.R.R:
Total Net Profit after Tax
Average Net Profit after Tax =
Number of years
2,06,72,143
= = 41,34,428.6
5
Initial Investment
Book Value of Investment =
2
2,00,00,000
= = 1,00,00,000
2
41,34,428.6
Average Rate of Return = X 100
1, 00, 00,000
= 41.34%
50

Inferences:
From the point of ARR method, project should be accepted, the initial
investment we can get with in less time.
Net Present Value (NPV):
The Net present value (NPV) method is the classic economic method of
evaluating the investment proposals. It is one of the discounted cash flow techniques
explicitly recognizing the time value of money. It correctly postulates that cash flows
arising at different time periods differ in value and the comparable only when their
equivalents present values are found out.
Acceptance Rule:
 Accept if NPV >0
 Reject if NPV <0
 In differences if NPV = 0
Cash flow 0 cash flow 1 cash flow n cash flow t
NPV= ---------------+ ------------- +……. + ---------------- = - C0
51
2012 2013 2014 2015 2016

SHOWING CALCULATION OF NET PRESENT VALUE
(In Rupees)
Calculations of Net Present Value:
Net Present Value = Present Value Cash Inflows - Initial Investment or cash outflows
= 3,05,33,625 - 2, 00, 00,000
= 1,05,33,625 Rs.
52
YEARS
PROFIT
AFTER
TAX DEPRICIATION
AFTER
TAX NPV @5%
PRESENT
VALUE
CASH FLOW
2012 374540.91 2432956 2807496.91 0.9523809523 2673806
2013 3049546.32 2167152 5216698.32 0.9070294784 4731699
2014 4380048.12 2437146 6817194.12 0.8638375985 5889075
2015 5300374.35 3102096 8402470.35 0.8227024747 6912768
2016 7567635 5611603 13179238 0.783526165 10326277
Total 30533625

Inferences:
As NPV is positive, the project is accepted.
Profitability Index:
It is also called as Benefit Cost Ratio. It is also a time-adjusted method of
evaluating the investing proposals. It is the relationship between present value of cash
inflows and the present value of cash outflows. Thus
Present Value of cash inflows
Profitability Index =
53
2012 2013 2014 2015 2016

Initial Investment of or cash out flows
SHOWING CALCULATION OF PROBILITTY INDEX
(In Rupees)
From the above table calculated values are
Present value of cash inflow = 3,05,33,625
Initial Investment cash outflow = 2, 00, 00,000
3,05,33,625
Profitability Index =
2, 00, 00,000
= 1.5266
Net Profitability Index = PI -1
=1.5266 – 1
54
Years
Profit after
Tax Depreciation After Tax NPV @5%
Present
Value Cash
flow
2012 374540.91 2432956 2807496.91 0.9523809523 2673806.58
2013 3049546.32 2167152 5216698.32 0.9070294784 4731699.15
2014 4380048.12 2437146 6817194.12 0.8638375985 5889075.77
2015 5300374.35 3102096 8402470.35 0.8227024747 6912768.69
2016 7567635 5611603 13179238 0.783526165 10326277
Total 30533625

=0.5266
Inferences:
As the profitability Index is >1, the project should be accepted
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
55
2012 2013 2014 2015 2016

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
SHOWING THE CALCULATIONS OF INTERNAL RATE OF RETURN
(In Rupees)
56

From the above table calculated values are:
Net Present Value of cash flow of LOWER RATE (LR) = 2,59,07,717
Net Present Value of cash flow of HIGHER RATE (HR) = 1,92,55,978
Therefore,
Present value @ L R – Initial Investment
IRR = LR+ x Rate Difference
Present value @ L R – Present value @ H R
59,07,717
= 10% + x 10
66,51,739
= 10% + 0.889 x 10
= 18.89%
57
YEARS
PROFIT
AFTER
TAX
DEPRI-
CIATION
CASH
FLOW
AFTER
TAX NPV @10%
PRESENT
VALUE
CASH
FLOW
NPV
@20%
PRESENT
VALUE
CASH
FLOW
2012 374540.91 2432956 2807496.91 0.9090909 2552269 0.83333 2339580
2013 3049546.38 2167152 5216698.32 0.8264462 4311320 0.69444 3622706
2014 4380048.64 2437146 6817194.12 0.7513447 5121858 0.57870 3945135
2015 5300374.35 3102096 8402470.35 0.6830134 5739000 0.48422 4052117
2016 7567635 5611603 13179238 0.6209213 8183270 0.40187 5296440
Total 25907717 Total 19255978

Inferences:
Therefore, IRR lies at 18.89%. It is a point where outflow = inflow
And IRR>K, Therefore it is accepted.
FINDINGS
58
2012 2013 2014 2015 2016

 The company had taken longer period i.e., payback period is 3 years 2 months
20 days to recover its initial investment.
 The average rate of return is not good i.e., ARR = 41.34% as it was just to
compensate the marginal profits.
 The net present value of ITL PVC PIPES PVT. Ltd is satisfactory as
NPV = 3,05,33,625.
 The internal rate of return i.e., IRR= 18.89% is fairly good.
 The profitability index is fairly good is it was gradually increasing in each year
as shown graphically.
 The unit cost and other expenditures are eligible to claim from the potential
buyer as approved by the Regulatory Commission
SUGGESTIONS
59

 Company should go for the improvement in the technology to improve
efficiency.
 The Company can go for different projects as it has huge reserves and surplus,
to expand its operations.
 The Company is beneficial enough to expand its business by utilizing reserves
and surplus.
 The firm has to decrease the cost of production per unit.
 For society with lower income levels or below poverty line Company should go
for subscribed rates and for industries it should increases its rate marginally to
cover the losses.
 In order to diversify its operations it has to invest in more products so that NPV
will be fairly high.
CONCLUSION
60

Under the light of inferences drawn from the analysis the company has to
concentrate on Pay Back Period and NPV for acceptance of the project. The
discounting methods are most preferable as the rate of returns is depending on the
present values. All the techniques which was used for the project resulted positively
expect on Pay Back Period. Finally it is concluded that firm can generate huge profits
by investing in more projects diversifying its operations.
BIBLOGRAPHY
61

1. M. PANDEY: Financial Management: vikas publishing house pvt ltd, 9th
edition.
2. PRASANNA CHANDRA: Financial Management: Tata McGraw-Hill, 7th
edition.
3. I.M. PANDEY: Financial Management: Tata McGraw-Hill, 4th
edition.
WEBSITES
www.google.co.in
www.integratedthermo.com
www.nandipipes.com
62

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