CHAPTER-I INTRODUCTION

INTRODUCTION

Meaning:
Capital Budgeting decisions pertaining to fixed /long term assets which by definition refer to assets which are in operation, and yield a return, over a period of time, usually exceeding one year. They, therefore involve a series of outlays of cash resources in return for anticipated flow of future benefits.

Importance:
Capital budgeting also has a bearing on the competitive position of the enterprise mainly because of the fact that they relate to fixed asset. The fixed asset represents a true earning asset of the firm. They enable the firm to generate finished goods that can be ultimately being sold for profits. The Capital Expenditure decision has its effects over a long time span and inevitable affects the companys future cost structure. The Capital investment decision once made are not easily reversible without much financial loss to the firm because there may be no market for second-of hand plant and equipment and their conversion to other uses may most financially viable. Capital investment involves cost and the majority of the firms have search capital resources. SCOPE OF THE STUDY: The efficient allocation of capital is the most important financial function in the modern times. It involves decision to commit the firms, since they stand the long- term assets such decision are of considerable importance to the firm

since they send to determine its value and size by influencing its growth, probability and growth. . NEED AND IMPORTANCE: Capital Budgeting means planning for capital assets. Capital Budgeting decisions are vital to an organization as to include the decision as to: Whether or not funds should be invested in long term projects such as settings of an industry, purchase of plant and machinery etc., Analyze the proposals for expansion or creating additions capacities. To decide the replacement of permanent assets such as building and equipments. To make financial analysis of various proposals regarding capital investment so as to choose the best out of many alternative proposals.

OBJECTIVES OF THE STUDY:

The study on capital budgeting in Ultra Tech Cements Limited A case study is based on the following objectives. 1. To evaluate the capital budgeting practices relating to various projects of Ultra Tech Cements Limited Hyderabad 2. To Asses the long term requirements of funds and plan for application of internal resources and debt servicing. 3. To Assess the effectiveness of long term investment decisions of Ultra Tech Cements Limited 4. To offer conclusion derived from the study and give suitable suggestions for the efficient utilization of capital expenditure decisions.

METHODOLOGY:
At each point of time a business firm has a number of proposals regarding various projects in which, it can invest funds. But the funds available with the firm are always limited and are not possible to invest trend in the entire proposal at a time. Hence it is very essential to select from amongst the various competing proposals, those that gives the highest benefits. The crux of capital budgeting is the allocation of available resources to various proposals. There are many considerations, economic as well as non-economic, which influence the capital budgeting decision in the profitability of the prospective investment. Yet the right involved in the proposals cannot be ignored, profitability and risk are directly related, i.e. higher profitability the greater the risk and vice versa there are several methods for evaluating and ranking the capital investment proposals. .

LIMITATIONS OF THE STUDY:

1. The study is limited to Ultra Tech Cements Limited only. 2. The study is limited to certain projects of Ultra Tech Cements Limited. 3. Period of the study is restricted to five years only. 4. The present study cannot be used for inter firm comparison. 5. Limited span of time is a major limitation for this project. 6. The act and figures of the study is limited to the period of FIVE years i.e. 2008-2012. 7. The data used in reports are taken from the annual reports, published at the end of the years. 8. The result does not reflect the day-to-day transactions. 9. It is also impossible to the study of day-to-day transactions in cash management. 10. The analysis of the capital is taken FIVE years.

CHAPTER-II INDUSTRY PROFILE & COMPANY PROFILE

INDUSTRY PROFILE

In the most general sense of the word, cement is a binder, a substance which sets and hardens independently, and can bind other materials together. The word "cement" traces to the Romans, who used the term "opus caementicium" to describe masonry which resembled concrete and was made from crushed rock with burnt lime as binder. The volcanic ash and pulverized brick additives which were added to the burnt lime to obtain a hydraulic binder were later referred to as cementum, cimentum, cment and cement. Cements used in construction are characterized as hydraulic or nonhydraulic. The most important use of cement is the production of mortar and concretethe bonding of natural or artificial aggregates to form a strong building material which is durable in the face of normal environmental effects. Concrete should not be confused with cement because the term cement refers only to the dry powder substance used to bind the aggregate materials of concrete. Upon the addition of water and/or additives the cement mixture is referred to as concrete, especially if aggregates have been added. It is uncertain where it was first discovered that a combination of hydrated nonhydraulic lime and a pozzolan produces a hydraulic mixture (see also: Pozzolanic reaction), but concrete made from such mixtures was first used on a large scale by Roman engineers.They used both natural pozzolans (trass or pumice) and artificial pozzolans (ground brick or pottery) in these concretes. Many excellent examples of structures made from these concretes are still standing, notably the huge monolithic dome of the Pantheon in Rome and the massive Baths of Caracalla. The vast system of Roman aqueducts also made extensive use of hydraulic cement. The use of structural concrete disappeared in medieval Europe, although weak pozzolanic concretes continued to be used as a core fill in stone walls and columns.

Modern cement:
Modern hydraulic cements began to be developed from the start of the Industrial Revolution (around 1800), driven by three main needs: Hydraulic renders for finishing brick buildings in wet climatesHydraulic mortars for masonry construction of harbor works etc, in contact with sea water. Development of strong concretes: In Britain particularly, good quality building stone became ever more expensive during a period of rapid growth, and it became a common practice to construct prestige buildings from the new industrial bricks, and to finish them with a stucco to imitate stone. Hydraulic limes were favored for this, but the need for a fast set time encouraged the development of new cements. Most famous was Parker's "Roman cement." This was developed by James Parker in the 1780s, and finally patented in 1796. It was, in fact, nothing like any material used by the Romans, but was a "Natural cement" made by burning septaria - nodules that are found in certain clay deposits, and that contain both clay minerals and calcium carbonate. The burnt nodules were ground to a fine powder. This product, made into a mortar with sand, set in 515 minutes. The success of "Roman Cement" led other manufacturers to develop rival products by burning artificial mixtures of clay and chalk. John Smeaton made an important contribution to the development of cements when he was planning the construction of the third Eddystone Lighthouse (1755-9) in the English Channel. He needed a hydraulic mortar that would set and develop some strength in the twelve hour period between successive high tides. He performed an exhaustive market research on the available hydraulic limes, visiting their production sites, and noted that the "hydraulicity" of the lime was directly related to the clay content of the limestone from which it was made. Smeaton was a civil engineer by profession, and took the idea no further. Apparently unaware of Smeaton's work, the same principle was identified by Louis Vicat in the first decade of the nineteenth century. Vicat went on to devise a method of combining chalk and clay into an intimate mixture, and, burning this, produced an "artificial cement" in 1817. James Frost,orking in Britain, produced what he called "British cement" in a similar manner around the same time, but did not obtain a patent until 1822. In 1824, Joseph Aspdin

patented a similar material, which he called Portland cement, because the render made from it was in color similar to the prestigious Portland stone. All the above products could not compete with lime/pozzolan concretes because of fast-setting (giving insufficient time for placement) and low early strengths (requiring a delay of many weeks before formwork could be removed). Hydraulic limes, "natural" cements and "artificial" cements all rely upon their belite content for strength development. Belite develops strength slowly. Because they were burned at temperatures below 1250 C, they contained no alite, which is responsible for early strength in modern cements. The first cement to consistently contain alite was made by Joseph Aspdin's son William in the early 1840s. This was what we call today "modern" Portland cement. Because of the air of mystery with which William Aspdin surrounded his product, others (e.g. Vicat and I C Johnson) have claimed precedence in this invention, but recent analysis of both his concrete and raw cement have shown that William Aspdin's product made at Northfleet, Kent was a true alite-based cement. However, Aspdin's methods were "rule-of-thumb": Vicat is responsible for establishing the chemical basis of these cements, and Johnson established the importance of sintering the mix in the kiln. William Aspdin's innovation was counter-intuitive for manufacturers of "artificial cements", because they required more lime in the mix (a problem for his father), because they required a much higher kiln temperature (and therefore more fuel) and because the resulting clinker was very hard and rapidly wore down the millstones which were the only available grinding technology of the time. Manufacturing costs were therefore considerably higher, but the product set reasonably slowly and developed strength quickly, thus opening up a market for use in concrete. The use of concrete in construction grew rapidly from 1850 onwards, and was soon the dominant use for cements. Thus Portland cement began its predominant role. it is made from water and sand

Types of modern cement: Portland cement:

Cement is made by heating limestone (calcium carbonate), with small quantities of other materials (such as clay) to 1450C in a kiln, in a process known as calcination, whereby a molecule of carbon dioxide is liberated from the calcium carbonate to form 8

calcium oxide, or lime, which is then blended with the other materials that have been included in the mix . The resulting hard substance, called 'clinker', is then ground with a small amount of gypsum into a powder to make 'Ordinary Portland Cement', the most commonly used type of cement (often referred to as OPC). Portland cement is a basic ingredient of concrete, mortar and most non-speciality grout. The most common use for Portland cement is in the production of concrete. Concrete is a composite material consisting of aggregate (gravel and sand), cement, and water. As a construction material, concrete can be cast in almost any shape desired, and once hardened, can become a structural (load bearing) element. Portland cement may be gray or white. Portland cement blends These are often available as inter-ground mixtures from cement manufacturers, but similar formulations are often also mixed from the ground components at the concrete mixing plant. Portland blast furnace cement contains up to 70% ground granulated blast furnace slag, with the rest Portland clinker and a little gypsum. All compositions produce high ultimate strength, but as slag content is increased, early strength is reduced, while sulfate resistance increases and heat evolution diminishes. Used as an economic alternative to Portland sulfate-resisting and low-heat cements. Portland flyash cement contains up to 30% fly ash. The fly ash is pozzolanic, so that ultimate strength is maintained. Because fly ash addition allows a lower concrete water content, early strength can also be maintained. Where good quality cheap fly ash is available, this can be an economic alternative to ordinary Portland cement. Portland pozzolan cement includes fly ash cement, since fly ash is a pozzolan, but also includes cements made from other natural or artificial pozzolans. In countries where volcanic ashes are available (e.g. Italy, Chile, Mexico, the Philippines) these cements are often the most common form in use. Portland silica fume cement. Addition of silica fume can yield exceptionally high strengths, and cements containing 5-20% silica fume are occasionally produced. However, silica fume is more usually added to Portland cement at the concrete mixer. Masonry cements are used for preparing bricklaying mortars and stuccos, and must not be used in concrete. They are usually complex proprietary formulations containing Portland clinker and a number of other ingredients that may include limestone, hydrated lime, air entrainers, retarders, waterproofers and coloring agents. They are 9

formulated to yield workable mortars that allow rapid and consistent masonry work. Subtle variations of Masonry cement in the US are Plastic Cements and Stucco Cements. These are designed to produce controlled bond with masonry blocks. Expansive cements contain, in addition to Portland clinker, expansive clinkers (usually sulfoaluminate clinkers), and are designed to offset the effects of drying shrinkage that is normally encountered with hydraulic cements. This allows large floor slabs (up to 60 m square) to be prepared without contraction joints. White blended cements may be made using white clinker and white supplementary materials such as high-purity metakaolin. Colored cements are used for decorative purposes. In some standards, the addition of pigments to produce "colored Portland cement" is allowed. In other standards (e.g. ASTM), pigments are not allowed constituents of Portland cement, and colored cements are sold as "blended hydraulic cements". Very finely ground cements are made from mixtures of cement with sand or with slag or other pozzolan type minerals which are extremely finely ground together. Such cements can have the same physical characteristics as normal cement but with 50% less cement particularly due to their increased surface area for the chemical reaction. Even with intensive grinding they can use up to 50% less energy to fabricate than ordinary Portland cements. Non-Portland hydraulic cements Pozzolan-lime cements. Mixtures of ground pozzolan and lime are the cements used by the Romans, and are to be found in Roman structures still standing (e.g. the Pantheon in Rome). They develop strength slowly, but their ultimate strength can be very high. The hydration products that produce strength are essentially the same as those produced by Portland cement. Slag-lime cements. Ground granulated blast furnace slag is not hydraulic on its own, but is "activated" by addition of alkalis, most economically using lime. They are similar to pozzolan lime cements in their properties. Only granulated slag (i.e. waterquenched, glassy slag) is effective as a cement component. Supersulfated cements. These contain about 80% ground granulated blast furnace slag, 15% gypsum or anhydrite and a little Portland clinker or lime as an activator. They produce strength by formation of ettringite, with strength growth similar to a slow Portland cement. They exhibit good resistance to aggressive agents, including sulfate. 10

Calcium aluminate cements are hydraulic cements made primarily from limestone and bauxite. The active ingredients are monocalcium aluminate CaAl2O4 (CaO Al2O3 or CA in Cement chemist notation, CCN) and mayenite Ca12Al14O33 (12 CaO 7 Al2O3 , or C12A7 in CCN). Strength forms by hydration to calcium aluminate hydrates. They are well-adapted for use in refractory (high-temperature resistant) concretes, e.g. for furnace linings. Calcium sulfoaluminate cements are made from clinkers that include ye'elimite (Ca4(AlO2)6SO4 or C4A3 in Cement chemist's notation) as a primary phase. They are

used in expansive cements, in ultra-high early strength cements, and in "low-energy" cements. Hydration produces ettringite, and specialized physical properties (such as expansion or rapid reaction) are obtained by adjustment of the availability of calcium and sulfate ions. Their use as a low-energy alternative to Portland cement has been pioneered in China, where several million tonnes per year are produced. Energy requirements are lower because of the lower kiln temperatures required for reaction, and the lower amount of limestone (which must be endothermically decarbonated) in the mix. In addition, the lower limestone content and lower fuel consumption leads to a CO2 emission around half that associated with Portland clinker. However, SO2 emissions are usually significantly higher. "Natural" Cements correspond to certain cements of the pre-Portland era, produced by burning argillaceous limestones at moderate temperatures. The level of clay components in the limestone (around 30-35%) is such that large amounts of belite (the low-early strength, high-late strength mineral in Portland cement) are formed without the formation of excessive amounts of free lime. As with any natural material, such cements have highly variable properties. Geopolymer cements are made from mixtures of water-soluble alkali metal silicates and aluminosilicate mineral powders such as fly ash and metakaolin.

11

COMPANY PROFILE

ULTRATECH CEMENT: UltraTech Cement Limited has an annual capacity of 18.2 million tonnes. It manufactures and markets Ordinary Portland Cement, Portland Blast Furnace Slag Cement and Portland Pozzalana Cement. It also manufactures ready mix concrete (RMC). UltraTech Cement Limited has five integrated plants, six grinding units and three terminals two in India and one in Sri Lanka. UltraTech Cement is the countrys largest exporter of cement clinker. The export markets span countries around the Indian Ocean, Africa, Europe and the Middle East. UltraTechs subsidiaries are Dakshin Cement Limited and UltraTech Ceylinco (P) Limited. The roots of the Aditya Birla Group date back to the 19th century in the picturesque town of Pilani, set amidst the Rajasthan desert. It was here that Seth Shiv Narayan Birla started trading in cotton, laying the foundation for the House of Birlas. Through India's arduous times of the 1850s, the Birla business expanded rapidly. In the early part of the 20th century, our Group's founding father, Ghanshyamdas Birla, set up industries in critical sectors such as textiles and fibre, aluminium, cement and chemicals. As a close confidante of Mahatma Gandhi, he played an active role in the Indian freedom struggle. He represented India at the first and second round-table conference in London, along with Gandhiji. It was at "Birla House" in Delhi that the luminaries of the Indian freedom struggle often met to plot the downfall of the British Raj. Ghanshyamdas Birla found no contradiction in pursuing business goals with the dedication of a saint, emerging as one of the foremost industrialists of pre12

independence India. The principles by which he lived were soaked up by his grandson, Aditya Vikram Birla, our Group's legendary leader. Aditya Vikram Birla: putting India on the world map

A formidable force in Indian industry, Mr. Aditya Birla dared to dream of setting up a global business empire at the age of 24. He was the first to put Indian business on the world map, as far back as 1969, long before globalisation became a buzzword in India. In the then vibrant and free market South East Asian countries, he ventured to set up world-class production bases. He had foreseen the winds of change and staked the future of his business on a competitive, free market driven economy order. He put Indian business on the globe, 22 years before economic liberalisation was formally introduced by the former Prime Minister, Mr. Narasimha Rao and the former Union Finance Minister, Dr. Manmohan Singh. He set up 19 companies outside India, in Thailand, Malaysia, Indonesia, the Philippines and Egypt. Interestingly, for Mr. Aditya Birla, globalisation meant more than just geographic reach. He believed that a business could be global even whilst being based in India. Therefore, back in his home-territory, he drove single-mindedly to put together the building blocks to make our Indian business a global force. Under his stewardship, his companies rose to be the world's largest producer of viscose staple fibre, the largest refiner of palm oil, the third largest producer of insulators and the sixth largest producer of carbon black. In India, they attained the status of the largest single producer of viscose filament yarn, apart from being a producer of cement, grey cement and rayon grade pulp. The Group is also the largest producer of aluminium in the private sector, the lowest first cost producers in the world and the only producer of linen in the textile industry in India. At the time of his untimely demise, the Group's revenues crossed Rs.8,000 crore globally, with assets of over Rs.9,000 crore, comprising of 55 benchmark quality plants, an employee strength of 75,000 and a shareholder community of 600,000. Most importantly, his companies earned respect and admiration of the people, as one of India's finest business houses, and the first Indian International Group globally. 13

Through this outstanding record of enterprise, he helped create enormous wealth for the nation, and respect for Indian entrepreneurship in South East Asia. In his time, his success was unmatched by any other industrialist in India. That India attains respectable rank among the developed nations, was a dream he forever cherished. He was proud of India and took equal pride in being an Indian. Under the leadership of our Chairman, Mr. Kumar Mangalam Birla, the Group has sustained and established a leadership position in its key businesses through continuous value-creation. Spearheaded by Grasim, Hindalco, Aditya Birla Nuvo, Indo Gulf Fertilisers and companies in Thailand, Malaysia, Indonesia, the Philippines and Egypt, the Aditya Birla Group is a leader in a swathe of products viscose staple fibre, aluminium, cement, copper, carbon black, palm oil, insulators, garments. And with successful forays into financial services, telecom, software and BPO, the Group is today one of Asia's most diversified business groups. Board of Directors :: :: :: :: :: :: :: :: :: :: :: Mr. Kumar Mangalam Birla, Chairman Mrs. Rajashree Birla Mr. R. C. Bhargava Mr. G. M. Dave Mr. N. J. Jhaveri Mr. S. B. Mathur Mr. V. T. Moorthy Mr. O. P. Puranmalka Mr. S. Rajgopal Mr. D. D. Rathi Mr. S. Misra, Managing Director

Executive President & Chief Financial Officer :: Mr. K. C. Birla Chief Manufacturing Officer :: R.K. Shah Chief Marketing Officer :: Mr. O. P. Puranmalka 14

Company Secretary :: Mr. S. K. Chatterjee Our vision "To actively contribute to the social and economic development of the communities in which we operate. In so doing, build a better, sustainable way of life for the weaker sections of society and raise the country's human development index." Mrs. Rajashree Birla, Chairperson, The Aditya Birla Centre for Community Initiatives and Rural Development

Awards won Year 2011-2012 2010-2011 2010-2011 2010 2010 2010 2009-2010 2009-2010 2009-2010 Award ASSOCHAM CSR Excellence Award for its "truly outstanding" CSR activities Subh Karan Sarawagi Environment Award Business World FICCI-SEDF CSR Award Greentech Environment Excellence Gold Award IMC Ramkrishna Bajaj National Quality Award Asian CSR Award National Award for Prevention of Pollution Rajiv Gandhi Environment Award for Clean Technology State Level Environment Award (Plant)

Making a difference Before Corporate Social Responsibility found a place in corporate lexion, it was already textured into our Group's value systems. As early as the 1940s, our founding father Shri G.D Birla espoused the trusteeship concept of management. Simply stated, this entails that the wealth that one generates and holds is to be held as in a trust for our multiple stakeholders. With regard to CSR, this means investing part of our profits beyond business, for the larger good of society.

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While carrying forward this philosophy, his grandson, Aditya Birla weaved in the concept of 'sustainable livelihood', which transcended cheque book philanthropy. In his view, it was unwise to keep on giving endlessly. Instead, he felt that channelising resources to ensure that people have the wherewithal to make both ends meet would be more productive. He would say, "Give a hungry man fish for a day, he will eat it and the next day, he would be hungry again. Instead if you taught him how to fish, he would be able to feed himself and his family for a lifetime." Taking these practices forward, our chairman Mr. Kumar Mangalam Birla institutionalised the concept of triple bottom line accountability represented by economic success, environmental responsibility and social commitment. In a holistic way thus, the interests of all the stakeholders have been textured into our Group's fabric. The footprint of our social work today straddles over 3,700 villages, reaching out to more than 7 million people annually. Our community work is a way of telling the people among whom we operate that We Care. Our strategy: Our projects are carried out under the aegis of the "Aditya Birla Centre for Community Initiatives and Rural Development", led by Mrs. Rajashree Birla. The Centre provides the strategic direction, and the thrust areas for our work ensuring performance management as well. Our focus is on the all-round development of the communities around our plants located mostly in distant rural areas and tribal belts. All our Group companies Grasim, Hindalco, Aditya Birla Nuvo, Indo Gulf and UltraTech have Rural Development Cells which are the implementation bodies. Projects are planned after a participatory need assessment of the communities around the plants. Each project has a one-year and a three-year rolling plan, with milestones and measurable targets. The objective is to phase out our presence over a period of time and hand over the reins of further development to the people. This also enables us to widen our reach. Along with internal performance assessment mechanisms, our projects are audited by reputed external agencies, who measure it on qualitative and 16

quantitative parameters, helping us gauge the effectiveness and providing excellent inputs. Our partners in development are government bodies, district authorities, village panchayats and the end beneficiaries -- the villagers. The Government has, in their 5year plans, special funds earmarked for human development and we recourse to many of these. At the same time, we network and collaborate with like-minded bilateral and unilateral agencies to share ideas, draw from each other's experiences, and ensure that efforts are not duplicated. At another level, this provides a platform for advocacy. Some of the agencies we have collaborated with are UNFPA, SIFSA, CARE India, Habitat for Humanity International, Unicef and the World Bank. Our focus areas: Our rural development activities span five key areas and our single-minded goal here is to help build model villages that can stand on their own feet. Our focus areas are healthcare, education, sustainable livelihood, infrastructure and espousing social causes. The name Aditya Birla evokes all that is positive in business and in life. It exemplifies integrity, quality, performance, perfection and above all character.

Our logo is the symbolic reflection of these traits. It is the cornerstone of our corporate identity. It helps us leverage the unique Aditya Birla brand and endows us with a distinctive visual image.

Depicted in vibrant, earthy colours, it is very arresting and shows the sun rising over two circles. An inner circle symbolising the internal universe of the Aditya Birla Group, an outer circle symbolising the external universe, and a dynamic meeting of rays converging and diverging between the two.

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Through its wide usage, we create a consistent, impact-oriented Group image. This undoubtedly enhances our profile among our internal and external stakeholders. Our corporate logo thus serves as an umbrella for our Group. It signals the common values and beliefs that guide our behaviour in all our entrepreneurial activities. It embeds a sense of pride, unity and belonging in all of our 130,000 colleagues spanning 25 countries and 30 nationalities across the globe. Our logo is our best calling card that opens the gateway to the world.

GROUP COMPANIES:

Group companies:
:: :: :: :: Grasim Industries Ltd. Hindalco Industries Ltd. Aditya Birla Nuvo Ltd. UltraTech Cement Ltd.

Indian companies:
:: :: :: :: :: :: :: Aditya Birla Minacs IT Services Ltd. Aditya Birla Minacs Worldwide Limited Essel Mining & Industries Ltd Idea Cellular Ltd. Aditya Birla Insulators Aditya Birla Retail Limited Aditya Birla Chemicals (India) Limited

International companies:
Thailand :: Thai Rayon :: Indo Thai Synthetics 18

:: :: :: ::

Thai Acrylic Fibre Thai Carbon Black Aditya Birla Chemicals (Thailand) Ltd. Thai Peroxide

Philippines :: Pan Century Surfactants Inc.

Indonesia :: PT Indo Bharat Rayon :: PT Elegant Textile Industry :: PT Sunrise Bumi Textiles :: PT Indo Liberty Textiles :: PT Indo Raya Kimia

Egypt :: Alexandria Carbon Black Company S.A.E :: Alexandria Fiber Company S.A.E China :: Liaoning Birla Carbon :: Birla Jingwei Fibres Company Limited :: Aditya Birla Grasun Chemicals (Fangchenggang) Ltd. Canada :: A.V. Group Australia :: Aditya Birla Minerals Ltd. Laos :: Birla Laos Pulp & Plantations Company Limited North and South America, Europe and Asia :: Novelis Inc. Singapore :: Swiss Singapore Overseas Enterprises Pte Ltd. (SSOE) Joint ventures :: Birla Sun Life Insurance Company :: Birla Sun Life Asset Management Company :: Aditya Birla Money Mart Limited

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UltraTech is India's largest exporter of cement clinker. The company's production facilities are spread across eleven integrated plants, one white cement plant, one clinkerisation plant in UAE, fifteen grinding units, and five terminals four in India and one in Sri Lanka. Most of the plants have ISO 9001, ISO 14001 and OHSAS 18001 certification. In addition, two plants have received ISO 27001 certification and four have received SA 8000 certification. The process is currently underway for the remaining plants. The company exports over 2.5 million tonnes per annum, which is about 30 per cent of the country's total exports. The export market comprises of countries around the Indian Ocean, Africa, Europe and the Middle East. Export is a thrust area in the company's strategy for growth. UltraTech's products include Ordinary Portland cement, Portland Pozzolana cement and Portland blast furnace slag cement.

Ordinary Portland cement Portland blast furnace slag cement Portland Pozzolana cement Cement to European and Sri Lankan norms

Ordinary Portland cement: Ordinary portland cement is the most commonly used cement for a wide range of applications. These applications cover dry-lean mixes, general-purpose ready-mixes, and even high strength pre-cast and pre-stressed concrete. Portland blast furnace slag cement: Portland blast-furnace slag cement contains up to 70 per cent of finely ground, 20

granulated blast-furnace slag, a nonmetallic product consisting essentially of silicates and alumino-silicates of calcium. Slag brings with it the advantage of the energy invested in the slag making. Grinding slag for cement replacement takes only 25 per cent of the energy needed to manufacture portland cement. Using slag cement to replace a portion of portland cement in a concrete mixture is a useful method to make concrete better and more consistent. Portland blast-furnace slag cement has a lighter colour, better concrete workability, easier finishability, higher compressive and flexural strength, lower permeability, improved resistance to aggressive chemicals and more consistent plastic and hardened consistency. Portland Pozzolana cement: Portland pozzolana cement is ordinary portland cement blended with pozzolanic materials (power-station fly ash, burnt clays, ash from burnt plant material or silicious earths), either together or separately. Portland clinker is ground with gypsum and pozzolanic materials which, though they do not have cementing properties in themselves, combine chemically with portland cement in the presence of water to form extra strong cementing material which resists wet cracking, thermal cracking and has a high degree of cohesion and workability in concrete and mortar. "As a Group we have always operated and continue to operate our businesses as Trustees with a deep rooted obligation to synergise growth with responsibility." Mr Kumar Mangalam Birla, Chairman, Aditya Birla Group The cement industry relies heavily on natural resources to fuel its operations. As these dwindle, the imperative is clear alternative sources of energy have to be sought out and the use of existing resources has to be reduced, or eliminated altogether. Only then can sustainable business be carried out, and a corporate can truly say it is contributing to the preservation of the environment. UltraTech takes its responsibility to conserve the environment very seriously, and its eco-friendly approach is evident across all spheres of its operations. Its major thrust has been to identify alternatives to achieve set objectives and thereby reduce its carbon footprint. These are done through: :: Waste management 21

:: :: :: :: ::

Energy management Water conservation Biodiversity management Afforestation Reduction in emissions

Importantly, UltraTech has set a target of 2.96 per cent reduction in CO2 emission intensity, at a rate of 0.5 per cent annually, up to 2015-16, with 2009-10 as the baseline year. This will also include CO2 emissions from the recently acquired ETA Star Cement and upcoming projects.

Ourstrategy: Our projects are carried out under the aegis of the "Aditya Birla Centre for Community Initiatives and Rural Development", led by Mrs. Rajashree Birla. The Centre provides the strategic direction, and the thrust areas for our work ensuring performance management as well.

Our focus is on the all-round development of the communities around our plants located mostly in distant rural areas and tribal belts. All our Group companies Grasim, Hindalco, Aditya Birla Nuvo and UltraTech have Rural Development Cells which are the implementation bodies. Projects are planned after a participatory need assessment of the communities around the plants. Each project has a one-year and a three-year rolling plan, with milestones and measurable targets. The objective is to phase out our presence over a period of time and hand over the reins of further development to the people. This also enables us to widen our reach. Along with internal performance assessment mechanisms, our projects are audited by reputed external agencies, who measure it on qualitative and quantitative parameters, helping us gauge the effectiveness and providing excellent inputs.

22

Our partners in development are government bodies, district authorities, village panchayats and the end beneficiaries the villagers. The Government has, in their 5year plans, special funds earmarked for human development and we recourse to many of these. At the same time, we network and collaborate with like-minded bilateral and unilateral agencies to share ideas, draw from each other's experiences, and ensure that efforts are not duplicated. At another level, this provides a platform for advocacy. Some of the agencies we have collaborated with are UNFPA, SIFSA, CARE India, Habitat for Humanity International, Unicef and the World Bank. Our vision: "To actively contribute to the social and economic development of the communities in which we operate. In so doing, build a better, sustainable way of life for the weaker sections of society and raise the country's human development index." Mrs. Rajashree Birla, Chairperson, The Aditya Birla Centre for Community Initiatives and Rural Development Making a difference: Before Corporate Social Responsibility found a place in corporate lexicon, it was already textured into our Group's value systems. As early as the 1940s, our founding father Shri G.D Birla espoused the trusteeship concept of management. Simply stated, this entails that the wealth that one generates and holds is to be held as in a trust for our multiple stakeholders. With regard to CSR, this means investing part of our profits beyond business, for the larger good of society. While carrying forward this philosophy, our legendary leader, Mr. Aditya Birla, weaved in the concept of 'sustainable livelihood', which transcended cheque book philanthropy. In his view, it was unwise to keep on giving endlessly. Instead, he felt that channelising resources to ensure that people have the wherewithal to make both ends meet would be more productive. He would say, "Give a hungry man fish for a day, he will eat it and the next day, he would be hungry again. Instead if you taught him how to fish, he would be able to feed himself and his family for a lifetime."

23

Taking these practices forward, our chairman Mr. Kumar Mangalam Birla institutionalised the concept of triple bottom line accountability represented by economic success, environmental responsibility and social commitment. In a holistic way thus, the interests of all the stakeholders have been textured into our Group's fabric. The footprint of our social work today spans 2,500 villages in India, reaching out to seven million people annually. Our community work is a way of telling the people among whom we operate that We Care.

QUALITY : Six strong benefits that make 43, 53 Grade, Super fine, Premium and Shakti the ideal cement

Higher compressive strength. Better soundness. Lesser consumption of cement for M-20 Concrete Grade and above. Faster de shuttering of formwork. Reduced construction time with a superior and wide range of cement catering to every conceivable building need, ULTRA TECH CEMENTS is a formidable player in the cement market.

Here just a few reasons why ULTRA TECH CEMENTS chosen by millions of India. Ideal raw material Low lime and magnesia content and high proportion of silicates. Greater fineness.

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CHAPTER-III LITERATURE REVIEW

25

CAPITAL BUDGETING:
A capital expenditure is an outlay of cash for a project that is expected to produce a cash inflow over a period of time exceeding one year. Examples of projects include investments in property, plant, and equipment, research and development projects, large advertising campaigns, or any other project that requires a capital expenditure and generates a future cash flow. Because capital expenditures can be very large and have a significant impact on the financial performance of the firm, great importance is placed on project selection. This process is called capital budgeting.

Factors Affecting Capital Budgeting:

While making capital budgeting investment decision the following factors or aspects should be considered. The amount of investment Minimum rate of return on investment (k) Return expected from the investments. (R) Ranking of the investment proposals and Based on profitability the raking is evaluated I.e., expected rate of return on investment.

Factors Influencing Capital Budgeting Decisions:

There are many factors, financial as well as non-financial, which influence that Budget decisions. The crucial factor that influences the capital expenditure decisions is the profitability of the proposal. There are other factors, which have to be in considerations such as. 26

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, the proper evaluation of the proposal cannot be made through profitability tests. The examples of such urgency are breakdown of some plant and machinery, fire accident etc. 2. Degree of Certainty: Profitability 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. 3. Intangible Factors: some times a capital expenditure has to be made due to certain emotional and intangible factors such as safety and welfare of workers, prestigious project, social welfare, goodwill of the firm, etc.,

4. Legal Factors. Any investment, which is required by the provisions of the law, is solely influenced by this factor and although the project may not be profitable yet the investment has to be made. 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, how so ever profitable, may not be taken for want of funds and a project with a lesser profitability may be some times 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 earnings. 27

7. Obsolescence.
There are certain projects, which have greater risk of obsolescence than others. In case of projects with high rate of obsolescence, the project with a lesser payback period may be preferred other than one this may have higher profitability but still longer pay-back period. 8. Research and Development Projects. It is necessary for the long-term survival of the business to invest in research and development project though it may not look to be profitable investment. 9. Cost Consideration. Cost of the capital project, cost of production, opportunity cost of capital, etc. Are other considerations involved in the capital budgeting decisions?

RISK AND UNCERTANITY IN CAPITAL BUDGETING:

All the techniques of capital budgeting require the estimation of future cash inflows and cash outflows. The future cash inflows are estimated based on the following factors. 1. Expected economic life of the project. 2. Salvage value of the assets at the end of economic life. 3. Capacity of the project. 4. Selling price of the product. 5. Production cost. 6. Depreciation rate. 7. Rate of Taxation 8. Future demand of product, etc. But due to the uncertainties about the future, the estimates of demand, production, sales, selling prices, etc. cannot be exact. For example, a product may become obsolete much earlier than anticipated due to unexpected technological 28

developments. All these elements of uncertainty have to be take in to account in the form of forcible risk while taking on investment decision. But some allowances for the elements of the risk have to provide. The following methods are suggested for accounting for risk in capital Budgeting. 1. Risk-Adjusted cut off rate or method of varying discount rate: The simple method of accounting for risk in capital Budgeting is to increase the cut-off rate or the discount factor by certain percentage on account of risk. The projects which are more risky and which have greater variability in expected returns should be discounted at a higher rate as compared to the projects which are less risky and are expected to have lesser variability in returns. The greatest drawback of this method is that it is not possible to determine the premium rate appropriately and more over it is the future cash flow, which is uncertain and requires adjustment and not the discount rate.

Risk Adjusted Cut off Rate

Decision Tree Analysis

Certainty Equivalent Method

Suggestions Accounting risk In Capital Budgeting

Co-Efficient of Variation Method

Sensitivity Technique

Standard Deviation Method Profitability Technique

29

2. Certainty Equivalent Method:

Another simple method of accounting for risk in capital budgeting is to reduce expected cash flows by certain amounts. It can be employed by multiplying the expected cash in flows certain cash outflows.

3. Sensitivity Technique:
Where cash inflows are very sensitive under different circumstances, more than one forecast of the future cash inflows may be made. These inflows may be regards as Optimistic, Most Likely, and Pessimistic. Further cash inflows may be discounted to find out the Net present values under these three different situations. If the net present values under the three situations differ widely it implies that there is a great risk in the project and the investors decision to accept or reject a project will depend upon his risk bearing abilities. 4. Probability Technique: A probability is the relative frequency with which an event may occur in the future. When future estimates of cash inflows have different probabilities the expected monetary values may be computed by multiplying cash inflow with the probability assigned. The monetary values of the inflows may further be discounted to find out the present vales. The project that gives higher net present vale may be accepted. 5. Standard Deviation Method: If two projects have same cost and there net present values are also the same, standard deviations of the expected cash inflows of the two projects may be calculated to judge the comparative risk of the projects. The project having a higher standard deviation is set to be more risky has compared to the other. 6. Coefficient of variation Method: Coefficient of variation is a relative measure of dispersion. If the projects have the same cost but different net present values, relative measure, I,e. coefficient of

30

variation should be computed to judge the relative position of risk involved. It can be calculated as follows. Coefficient of Variation = Standard Deviation X100 Mean

7. Decision Tree Analysis:

In modern business there are complex investment decisions which involve a sequence of decisions over time. Such sequential decisions can be handled by plotting decisions trees. A decision tree is a graphic representation of the relationship between a present decision and future events, future decisions and their consequences. The sequences of event are mapped out over time in a format resembling branches of a tree and hence the analysis is known as decision tree analysis. The various steps involved in a decision tree analysis are 1 2 3 4 5 Identification of the problem Finding out the alternatives; Exhibiting the decision tree indicating the decision points, chance events, and other relevant date; Specification of probabilities and monetary values for cash inflows; Analysis of the alternatives.

Limitations of Capital Budgeting Capital

1

Budgeting

Techniques

Suffer

From

the

Following

Limitations.
All the techniques of capital budgeting presume the various investment proposals under consideration are mutually exclusive which may not practically be true in some particular circumstances. 2. The techniques of capital budgeting require estimation of future cash inflows and outflows. The future is always uncertain and the data collected for future

31

may not be exact. Obviously the results based upon wrong data may not be good. 3. There are certain factors like morale of the employees, goodwill of the firm, etc., which cannot be correctly quantified but which otherwise substantially influence the capital decision. 4. Urgency is another limitation in the evaluation of capital investment decisions. 5. Uncertainty and risk pose the biggest limitation to the techniques of capital budgeting.

STEPS INVOLVED IN THE CAPITAL EXPENDITURE

The various steps involved in the control of capital expenditure. 1. Preparation of capital expenditure. 2. Proper authorization of capital expenditure. 3. Recording and control of expenditure. 4. Evaluation of performance of the project.

OBJECTIVES OF CONTROL OF CAPITAL EXPENDITURE

In the following all the main objectives are on control of capital expenditure: To make an estimate of capital expenditure and to see that the total cash outlay is with in the financial resources of the enterprise. 1. To ensure timely cash inflows for the projects so that non-availability of cash may not be a problem in the implementation of the project. 2. To ensure all the capital expenditure is properly sanctioned. 3. To properly co-ordinate the projects of various departments. 4. To fix priorities among various projects and ensure their follow up. 5. To compare periodically actual expenditure with the budgeted ones so as to avoid any excess expenditure. 32

6. To measure the performance of the project. 7. To ensure that sufficient amount of capital expenditure is incurred to keep pace with the rapid technological developments. 8. To prevent over expansion.

CAPITAL BUDGETING PROCESS

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

Capital Budgeting Steps:

1. Identification of Investment Proposals:

33

The capital budgeting process begins with the identification of investment proposals. The proposal or idea about potential investment opportunities may originate from the top management or may come from the rank and file worker of any department are from any officer of the organization. The departmental head analyses the various proposals in the light of the corporate strategies and submits the suitable proposals to the Capital Expenditure Planning Committee in case of large organizations or to the officers concerned with the process of long-term investment decisions. 2. Screening the Proposals: The expenditure Planning Committee Screens the various proposals received from different departments. The committee views these proposals from various angles to ensure that these are accordance with the corporate strategies or selection criterion of the firm and also do not lead to departmental imbalances.

3. Evaluation of Various Proposals: The next step in the capital budgeting process is to evaluate the profitability of proposals. There are many methods that may be used for this purpose such as Pay Back Period methods, Rate of Return method, Net Present Value method, Internal Rate of Return method etc. All these methods of evaluating profitability of capital investment proposals have been discussed. 4. Fixing Priorities: After evaluating various proposals, the unprofitable or uneconomic proposals may be rejected straight away. But it may not be possible for the firm to invest immediately in all the acceptable proposals due to limitation of funds. Hence it is very essential to rank the various proposals and to establish priorities after considering urgency, risk and profitability involved therein. 5. Final Approval and Preparation of Capital Expenditure Budget: Proposals meeting the evaluation and other criteria are finally approved to be included in the capital expenditure budget. However, proposals involving smaller investment may be decided at the lower levels for expeditious action. The capital 34

expenditure budget lays down the amount of estimated expenditure to be incurred on fixed assets during the budget period. 6. Implementing Proposal: Preparation of capital budgeting expenditure budgeting and incorporation of a particular proposal in the budget does not itself authorized to go ahead with the implementation of the project. A request for the authority to spend the amount should further to be made to the capital expenditure committee, which may like to revive the profitability of the project in the changed circumstances. Further, while implementing the project, it is better to assign the responsibility for completing the project within given time frame and cost limit so as to avoid unnecessary delays and cost over runs. Network techniques used in the project management such as Pert and CPM can also be applied to control and monitor the implementation of the project.

7. Performance Review. The last stage in the process of capital budgeting is the evaluation of the performance of the project. The evaluation is made through post completion audit by way of comparison of actual expenditure on the project with the budgeted one, and also by comparing the actual return from the investment with the anticipated return. The unfavorable variances, if any should be looked into 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.

35

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. 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 yields 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 away 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. 36

3. 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 there profitability.

METHODS OF CAPITAL BUDGETING AND EVALUATION TECHNIQUES Traditional Methods:

i) ii) Average Rate of Return. Pay-Back Period Method

Time Adjusted Method or Discounted Method:

i) ii) iii) iv) Net Present Value Method Internal Rate of Return Net Terminal Value Method Profitability Index.

37

CAPITAL BUDGETING METHODS

TRADITIONAL METHOD

DISCOUNTED CAHS FLOW METHOD

PLAY BACK PERIOD

ACCOUNTING RATE OF RETURN

INTERNAL RATE OF RETURN NET PRESENT VALUE PROFITABILITY INDEX

TRADITIONAL METHODS
1. Average Rate of Return: The average rate of return (ARR) method of evaluating proposed capital expenditure is also know as the accounting rate of return method. It is based upon accounting information rather than cash flows. There is no unanimity recording the definition of the rate of return.

38

ARR =

Average annual profits after taxes

____

X 100

Average investment over the life of the project The average profits after taxes are determined by adding up the after-tax profits expected for each year of the projects life and dividing by the number of the years. In the case of annuity, the average after tax profits is equal to any years profit. The average investment is determined by dividing the net investment by two. This averaging process assumes that the firm is suing straight line depreciation, in which case the book value of the asset declines at a constant rate from its purchase price to zero at the end of its depreciable life. This means that, on the average firms will have one-half of their initial purchase prices in the books. Consequently if the machine has salvage value, then only the depreciable cost (cost salvage value) of the machine should be divide by two in ordered to ascertain the average net investment, as the salvage money will be recovered only at the end of the life of the project. Therefore an amount equivalent to the salvage value remains tied up in the project though out its lifetime. Hence no adjustment is required to sum of salvage value to determine the average investment. Like wise if any additional net working capital is required in the initial year, which is likely to be released only at the end of the projects life. The full amount of working capital should be taking determining relevant investment for the purpose of calculating ARR. Thus, Average investment = Net Working Capital + Salvage Value + (initial cost of machine value)

Accept Reject Value:

With the help of ARR, the financial maker can decide whether to accept or reject the investment proposal. As an accept reject criterion, the actual ARR would be compared with a predetermined or a minimum required rate of return or cut off rate. A project would qualify to be accepted if the actual ARR is higher than the minimum desired ARR. Other wise, it is liable to be rejected. Alternatively the ranking method can be used to select or reject proposals under consideration may be arranged in the descending order of magnitude, starting with the proposals with the

39

highest ARR and ending with the proposal with the lowest ARR. Obviously projects having higher ARR would be preferred with projects with lower ARR. 2. Pay Back Period: The Pay Back method is the second traditional method of capital budgeting. It is the simplest and, the most widely employed quantitative method for apprising capital expenditure decisions. This method answers the question. How many years will it for the cash benefits to pay the original cost of an investment, normally disregarding salvage value? Cash benefits represent CFAT ignoring interest payment. Thus the pay back method measures the number of years required for the CFAT to pay back the original out lay required in an investment proposal. There are two ways of calculating the pay back period. The first method can be applied when the cash flow stream is in the nature if annuity for each year of the projects life that is CFAT is uniform. In such a situation the initial cost of the investment is divided by the constant annual cash flow; Investment Constant Annual Cash Flow For example, an investment of Rs. 40,000 in a machine is expected to produce CFAT of Rs 8,000 for 10 years. Rs. 40,000 Rs. 8,000 PB = ---------------- 5 years.

The second method is used when project cash flows are not uniform (mixed stream) but vary form year to year. In such a situation, PB is calculated by the process of cumulating cash flows till the time when cumulative cash flow become equal to the original investment outlay.

Accept Reject Criteria:

The pay back period can be use as a decision criterion to accept or reject investment proposals. One application of this technique is to compare the actual pay 40

back with a predetermined pay back that is the pay back set up by the management in terms of the maximum period during which the initial investment will be recovered. If the actual pay back period less than the predetermined pay back, the project would be accepted. If not, it would be rejected. Alternatively, the pay back can be used as a ranking method. When mutually exclusive projects are under consideration, then may be ranked according length of pay back period. Thus, the project has having the shortest pay back may be assigned rank one followed in that order so that the project with the longest pay back would be ranked last. Obviously, projects with shorter payback period will be selected.

DISCOUNTED CASH FLOW/ TIME ADJESTED TECHNIQUES:

1. Net Present Value Method: The net present value is a modern method of evaluating investment proposals. This method takes into consideration the time value of money and attempts to calculate the return on investments by introducing the factor of time element. It recognizes the fact that rupee earned today is worth more than the same rupee earned tomorrow. Net present values of all inflows and outflows of cash occurring during the life of the project is determined separately for each year by discounting these flows by the firms cost of capital or a pre determined rate. The following are the Net Present value method of evaluating investment proposals: 1) First of all determined an appropriate rate of interest that should be selected as minimum required rate of return called cut off rate of interest in the market and the market- on long term loans or it should reflect the opportunity cost of capital of the investor. 2) Compute the present value of total investment outlay, I,e., cash outflows at the determined discount rate. If the total investment is to be made in the initial year, the present value shall be as the cost of investment. 3) Compute the present value of total investment proceeds I,e., inflows (profit before depreciation and after tax) at the above determined discount rate. 4) Calculate the Net present value of each project by subtracting the present value of cash inflows from the value of cash outflows for each project. 41

5)If the Net present value is positive or zero, I.e., when present value of cash inflows either exceeds or is equal to the present values of cash outflows, the proposal may be accepted. But in case the present value of inflows is less than the present value of cash outflows, the proposal should be rejected. 6) To select between mutually exclusive projects, projects should be ranked in order of net present values, i.e., the first preferences to be given to the project having the maximum net present value. The present value of re.1 due in any number of years may be found with the use of the following the mathematical formula: PV= 1/(1+r) n Where, PV = present value R = rate of interest/ Discount rate N = number of years 2. Internal Rate of Return: The second discounted cash flow or time-adjusted method of appraising capital investment decisions is the internal rate of return method. This technique is also known as yield on investment, marginal efficiency of capital, marginal productivity of capital, rate of return method. This technique is also known a yield on investment, marginal efficiency of capital, and marginal productivity of capital, rate of return, time-adjusted rate of return and so an. Like the present value method the IRR method also considers the time value of money by case of the net present value method, the discount rate is the required rate of return and being a predetermined rate, usually the cost of capital, its determinants are external to the proposal under consideration. The IRR, on the other hand it is based on facts, which are internal to the proposals. In other words while arriving at the required rate of return for finding out present values the cash inflows as well as outflows are not considered. But the IRR depends entirely on the initial outlay and the cash proceeds of the projects, which is been evaluated of acceptance or rejection. It is therefore appropriately referred to as internal rate of return.

42

The internal rate of return is usually the rate of return that a project earns. It is defined as the discount rate ( r ) which equates the aggregate present value of the Net cash inflows ( CFAT ) with the aggregate present value of cash outflows of a project. In other words it is that rate which gives the project of Net present value is zero.

Accept Reject Criteria:

The use of the IRR, as a criterion to accept capital investment decisions, involves a comparison of the actual IRR with the required rate of return also then the cut off rate or hurdle rate. The project would quality to be accepted if the IRR (r) Exceeds the cut off rate. (k). If the IRR and the required rate of return are equal the firm is different as to whether to accept or reject the project. 3. Net Terminal Method: The terminal value approach (TV) even mere distinctly separates the timing of the cash inflows and outflows. The assumption behind the TV approach is that each cash inflow is reinvested in other asset at a certain rate of return from the moment it is received until the termination of the project.

Accept Reject Criteria:

The decision rule is that if the present value of the sum total of the compounded reinvested cash inflows (PVTS) is greater than the present value of the outflows (PVO), the proposed project is accepted otherwise not. PVTS>PVO accept PVTS<PVO reject. The firm would be indifferent if both the values are equal. A variation of the terminal value method (TV) is the net terminal value (NTV). Symbolically it can be represented as NTV = (PVTS PVO). If the NTV is the positive accept the project, if the negative reject the project. 43

4.

Profitability Index:
The time adjusted capital budgeting is Profitability Index (P1) or Benefit Cost

Ratio (B / C). It is similar to the approach of NPV. The profitability index approach measures the present value of returns per rupee invested, while the NPV is based on the differences between the present value of future cash inflows and the present value of cash outflows. A major shortcoming of the NPV method is that, being an absolute measure; it is not reliable method to evaluate project inquiring different initial investments. The PI method proves a solution to this kind of problem. It is, in other words, a relative measure. It may be defined as the ratio, which is obtained by dividing the present value of future cash inflows by the present value of cash inflows. PI = Present value of cash inflows Present value of cash outflows This method is also known as B / C ratio because the numerator measures benefits and the denominator costs.

Accept Reject Criteria:

Using the B / C ratio or the PI, a project will quality for acceptance if its PI exceeds one. When PI equals 1 (one), the firm is indifferently to the project. When PI is greater than, equal to or less than 1 (one), the Net present value is greater than, equal to or less than zero respectively. In other words, the NPV will be positive when the PI is greater than 1 (one); will be negative when the PI is less than 1. Thus, the NPV and PI approach give the same results regarding the investments proposals.

Methods of Capital Budgeting

(1) Traditional methods: 44

 Pay back period Average rate return method (2) Discount cash flow method Net present value method Initial rate return method Profitability index method

Data collection: Primary data: - The primary data is the data which is collected, by interviewing
directly with the organizations concerned executives. This is the direct information gathered from the organization.

Secondary data: - The secondary data is the data which is gathered

from publications and websites.

KINDS OF CB DECISIONS:
Capital Budgeting refers to the total process of generating, evaluating, selecting and following up on capital expenditure alternatives basically; the firm may be confronted with three types of capital budgeting decisions Accept reject decisions This is a fundamental decision in capital budgeting. If the project is accepted, the firm invests in it; if the proposal is rejected, the firm does not invest in it. In general, all those proposals, which yield rate of return greater than a certain required rate of return or cost of capital, are accreted and rest are rejected. By applying this criterion, all independent projects all accepted. Independent projects are the projects which do not compete with one another in such a way that the 45

acceptance of one project under the possibility of acceptance of another. Under the accept-reject decision, the entire independent project that satisfies the minimum investment criterion should be implemented.

(i)

Mutually exclusive project decision Mutually exclusive projects are projects which compete with other projects in such a way that the acceptance of one which exclude the acceptance of other projects. The alternatives are mutually exclusive and only one may be chosen.

(ii)

Capital Rationing Decision Capital rationing is a situation where a firm has more investment proposals than it can finance. It may be defined as a situation where a constraint in placed on the total size of capital investment during a particular period. In such a event the firm has to select combination of investment proposals which provides the highest net present value subject to the budget constraint for the period. Selecting or rejecting the projects for this purpose will require the taking of the following steps: 1) Ranking of projects according to profitability index (PI) or Initial rate of return (IRR). 2) Selecting of rejects depends upon the profitability subject to the budget limitations keeping in view the objectives of maximizing the value of firms.

NATURE OF INVESTMENT DECISSIONS

The investment decisions of a firm are generally known as the capital budgeting, or capital expenditure decisions. A capital budgeting decision may be defined as the firms decision to invest its current funds most efficiently in the long term assets in anticipation of an expected flow of benefits over a series of years. The 46

long term assets are those that affect the firms operations beyond the one year period. The firms investment decisions would generally include expansion, acquisition, modernization and replacement of the long-term assets. Sale of a division or business (divestment) is also as an investment decision. Decisions like the change in the methods of sales distribution, or an advertisement campaign or a research and development programme have long-term implications for the firms expenditures and benefits, and therefore, they should also be evaluated as investment decisions. It is important to note that investment in the long-term assets invariably requires large funds to be tied up in the current assets such as inventories and receivables. As such, investment in the fixed and current assets is one single activity.

Features of Investment Decisions:The following are the features of investment decisions: The exchange of current funds for future benefits. The funds are invested in long-term assets. The future benefits will occur to the firm over a series of year.

Importance of Investment Decisions:Investment decisions require special attention because of the following reasons. They influence the firms growth in the long run They affect the risk of the firm They involve commitment of large amount of funds They are irreversible, or reversible at substantial loss They are among the most difficult decisions to make.

Growth
The effects of investment decisions extend in to the future and have to be endured for a long period than the consequences of the current operating expenditure. A firms decision to invest in long-term assets has a decisive influence on the rate and direction of its growth. A wrong decision can prove disastrous for the continued survival of the firm; unwanted or unprofitable expansion of assets will result in heavy 47

operating costs of the firm. On the other hand, inadequate investment in assets would make it difficult for the firm to complete successfully and maintain its market share.

Risk
A long-term commitment of funds may also change the risk complexity of the firm. If the adoption of an investment increases average gain but causes frequent fluctuations in its earnings, the firm will become more risky. Thus, investment decisions shape the basic character of a firm.

Funding
Investment decisions generally involve large amount of funds, which make it imperative for the firm to plan its investment programmers very carefully and make an advance arrangements for procuring finances internally or externally.

Irreversibility
Most investment decisions are irreversible. It is difficult to find a market for such capital items once they have been acquired. The firm will incur heavy losses if such assets are scrapped.

Complexity
Investment decisions are among the firms most difficult decisions. They are an assessment of future events, which are difficult to predict. It is really a complex problem to Economic, political, social and technological forces cause the uncertainty in cash flow estimation.

TYPES OF INVESTEMENT DECISIONS

There are many ways to classify investments. One classification is as follows: Expansion of existing business Expansion of new business Replacement and modernization.

Expansion and Diversification

48

A company may add capacity to its existing product lines to expand existing operations. For example, the Gujarat State Fertilizer Company (GSFC) may increase its plant capacity to manufacture more urea. It is an example of related diversification. A firm may expand its activities in a new business. Expansions of a new business require investment in new products and a new kind of production activity with in the firm. If a packaging manufacturing company invests in a new plant and machinery to produce ball bearings, which the firm business or unrelated diversification. Sometimes a company acquires existing firms to expand its business. In either case, the firm makes investment in the expectation of additional revenue. Investments in existing or new products may also be called as revenue-expansion investments.

Replacement and Modernization;

The main objective of modernization and replacement is to improve operating efficiency and reduces costs. Cost savings will reflect in the increased profits, but the firms revenue may remain unchanged. Assets become outdated and obsolete with technological changes. The firm must decide to replace those assets with new assets that operate more economically. If a cement company changes from semi-automatic drying equipment to finally automatic drying equipment, it is an example of modernization and replacement. Replacement decisions help to introduce more efficient and economical assets and therefore, are also called as cost reduction investments. However, replacement decisions that involve substantial modernization and technological improvements expand revenues as well as reduce costs. Yet another useful way to classify investments is as follows: Mutually exclusive investments Independent investments Contingent investments 49

Mutually Exclusive Investments

Mutually exclusive investments serve the same purpose and compete with each other. If one investment is undertaken, others will have to be excluded. A company may, for example, either use a more labour-intensive, semiautomatic machine, or employ a more capital-intensive, highly automatic machine for production. Choosing the semi-automatic machine precludes the acceptance of the highly automatic machine.

Independent Investments
Independent investments serve different purposes and do not compete with each other. For example, a heavy engineering company may be considering expansion of its plant capacity to manufacture additional excavators and addition of new production facilities to manufacture a new product - light commercial vehicles. Depending on their profitability and availability of funds, the company can undertake both investments.

Contingent Investments
Contingent investments are dependent projects; the choice of one investment necessitates undertaking one or more other investments. For example, if a company decides to build a factory in a remote, backward area, if may have to invest in houses, roads, hospitals, schools etc. for employees to attract the work force. Thus, building of factory also requires investments in facilities for employees. The total expenditure will be treated as one single investment.

Investment Evolution Criteria:

Three steps are involved in the evaluation of an investment: Estimation of cash flows. Estimation of the required rate of return (the opportunity cost of capital) Application of a decision rule of making the choice.

50

The first two steps, discussed in the subsequent chapters, are assumed as given. Thus, our discussion in this chapter is confined to the third step. Specifically, we focus on the merits and demerits of various decision rules.

Investment decision rule

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 an investment project. The essential property of a sound technique is that it should maximize the share holders wealth. The following other characteristics should also be possessed by a sound investment evaluation criterion. It should consider all cash flows to determine the true profitability of the project. It should provide for an objective and unambiguous way of separating good projects from bad projects. It should help ranking of projects according to their true profitability. It should recognize the fact that bigger cash flows are preferable to smaller ones and early cash flows are preferable to later ones. it should be a criterion which is applicable to any conceivable investment project independent of others.

Evaluation criteria
A number of investment criteria (or capital budgeting techniques) are in use in practice. They may be grouped in the following two categories.

1. Discounted cash flow criteria Net present value(NPV) Internal rate return(IRR) Profitability index(PI)

51

2. Non discounted cash flow criteria Payback period(PB) Discounted payback period Accounting rate of return(ARR)

Net Present Value

The Net Present Value technique involves discounting net cash flows for a project, then subtracting net investment from the discounted net cash flows. The result is called the Net Present Value (NPV). If the net present value is positive, adopting the project would add to the value of the company. Whether the company chooses to do that will depend on their selection strategies. If they pick all projects that add to the value of the company they would choose all projects with positive net present values, even if that value is just $1. On the other hand, if they have limited resources, they will rank the projects and pick those with the highest NPV's. The discount rate used most frequently is the company's cost of capital. Net present value (NPV) or net present worth (NPW)[ is defined as the total present value (PV) of a time series of cash flows. It is a standard method for using the time value of money to appraise long-term projects. Used for capital budgeting, and widely throughout economics, it measures the excess or shortfall of cash flows, in present value terms, once financing charges are met. The rate used to discount future cash flows to their present values is a key variable of this process. A firm's weighted average cost of capital (after tax) is often used, but many people believe that it is appropriate to use higher discount rates to adjust for risk for riskier projects or other factors. A variable discount rate with higher rates applied to cash flows occurring further along the time span might be used to reflect the yield curve premium for long-term debt.

52

Internal Rate of Return

The internal rate of return (IRR) is a Capital budgeting metric used by firms to decide whether they should make Investments. It is also called discounted cash flow rate of return (DCFROR) or rate of return (ROR). It is an indicator of the efficiency or quality of an investment, as opposed to Net present value (NPV), which indicates value or magnitude. The IRR is the annualized effective compounded return rate which can be earned on the invested capital, i.e., the yield on the investment. Put another way, the internal rate of return for an investment is the discount rate that makes the net present value of the investment's income stream total to zero. Another definition of IRR is the interest rate received for an investment consisting of payments and income that occur at regular periods. A project is a good investment proposition if its IRR is greater than the rate of return that could be earned by alternate investments of equal risk (investing in other projects, buying bonds, even putting the money in a bank account). Thus, the IRR should be compared to any alternate costs of capital including an appropriate risk premium. In general, if the IRR is greater than the project's cost of capital, or hurdle rate, the project will add value for the company. In the context of savings and loans the IRR is also called effective interest rate. In cases where one project has a higher initial investment than a second mutually exclusive project, the first project may have a lower IRR (expected return), but a higher NPV (increase in shareholders' wealth) and should thus be accepted over the second project (assuming no capital constraints). IRR assumes reinvestment of positive cash flows during the project at the same calculated IRR. When positive cash flows cannot be reinvested back into the project, IRR overstates returns. IRR is best used for projects with singular positive cash flows at the end of the project period. 53

Profitability index
Yet another time adjusted method of evaluating the investment proposals is the benefit-cost (B/C) ratio or profitability index. Profitability index is the ratio of the present value of cash inflows at the required rate of return, to the initial cash out flow of the investment.

Evaluation of PI method
Like the NPV and IRR rules, PI is a conceptually sound method of arising investment projects. It is a variation of the NPV method and requires the same computations as the NPV method. Time value it recognizes the time value of money. Value maximization it is consistent with the share holder value maximization principle. A project with PI greater than one will have positive NPV and if accepted it will increase share holders wealth. Relative profitability in the PI method since the present value of cash in flows is divided by the initial cash out flow , it is a relative measure of projects profitability. Like NPV method PI criterion also requires calculation of cash flows and estimate of the discount rate.

Payback period:
The payback period is one of the most popular and widely recognized traditional methods of evaluating investment proposals. Payback is the number of years required to cover the original cash outlay invested in a project. If the project generates constant annual cash inflows, the payback period can be computed by dividing cash outlay by the annual cash inflow.

Evolution of payback:
54

Many firms use the payback period as an investment evaluation criterion and a method of ranking projects. They compare the projects payback with pre-determined standard pay back. The would be accepted if its payback period is less than the maximum or standard pay back period set by management as a ranking method. It gives highest ranking to the project, which has the shortest payback period and lowest ranking to the project with highest payback period. Thus if the firm has to choose between two mutually exclusive projects, the project with shorter pay back period will be selected.

Evolution of payback period;.

Pay back is a popular investment criterion in practice. It is considered to have certain virtues.

Simplicity:
The significant merit of payback is that it is simple to understand and easy to calculate. The business executives consider the simplicity of method as a virtue. This is evident from their heavy reliance on it for appraising investment proposals in practice.

Cost effective:
Payback method costs less than most of the sophisticated techniques that require a lot of the analysts time and the use of computers.

Short-term:
Effects a company can have more favorable short-run effects on earnings per share by setting up a shorter standard payback period. It should, however, be remembered that this may not be a wise long-term policy as the company may have to sacrifice its future growth for current earnings.

55

Liquidity
The emphasis in payback is on the early recovery of the investment. Thus, it gives an insight into the liquidity of the project. The funds so released can be put to other In spite of its simplicity and the so, called virtues, the payback may not be a desirable investment criterion since it suffers from a number of serious limitations.

Risk shield:
The risk of the project can be tackled by having a shorter standard payback period. As it may be in a ensured guaranty against its loss. A company has to invest in many projects where the cash inflows and life expectancies are highly uncertain. Under such circumstances, pay back may become important, not so much as a measure of profitability but, as a means of establishing an upper bound on the acceptable degree of risk.

Discounted payback period:

One of the serious objections to the payback method is that it does not discount the cash flows for calculating the payback period. We can discount cash flows and then calculate the payback. The discounted pay back period is the no. of. Periods taken in recovering the investment outlay on the present value basis. The discounted payback period still fails to consider the cash flows occurring after the payback period.

Accounting rate of return:

The accounting rate of return (ARR) also known as the return on investment (ROI) uses accounting information as revealed by financial statements, to measure the profitability of an investment. The accounting rate of return is the ratio of 56

the average after tax profit divided by the average investment. The average investment would be equal to half of the original investment if it were depreciated constantly. Alternatively, it can be found out by dividing the total if the investments book values after depreciation be the life of the project.

EVALUATION OF ARR METHOD:

The ARR method may claim some merits: Simplicity the ARR method is simple to understand and use. It does not

involve complicated computations. ACCOUNTING DATA: The ARR can be readily calculated from the accounting data, unlike in the NPV and IRR methods, no adjustments are required to arrive at cash flows of the project. ACCOUNTING PROFITABILITY: The ARR rule incorporates the entire stream of income in calculating the projects profitability. The ARR is a method commonly understood by accountants and frequently used as a performance measure. As decision criterion, how ever it has serious short comings. CASH FLOWS IGNORED: The ARR method uses accounting profits, not cash flows, in appraising the projects. Accounting profits are based on arbitrary assumptions and choices and also include non-cash items. It is, there fore in appropriate to relay on them for measuring the acceptability of the investment projects. TIME VALUE IGNORED:

57

The averaging income ignores the time value of money. In fact, this procedure gives more weight age to the distant receipts. ARBITRARY CUT-OFF : The firm employing the ARR rule uses an arbitrary cut-off yardstick. Generally, the yardstick is the firms current return on its assets (book -value). Because of this, the growth companies earning very high rates on their existing assets may project profitable projects and the less profitable companies may accepts bad projects.

PROJECT CLASSIFICATION:
Project classification entails time and effort the costs incurred in this exercise must be justified by the benefits from it. Certain projects, given their complexity and magnitude, may warrant a detailed analysis; others may call for a relatively simple analysis. Hence firms normally classify projects into different categories. Each category is then analyzed somewhat differently. While the system of classification may vary from one firm to another, the following categories are found in cost classification.

Mandatory investments:
These are expenditures required to comply with statutory requirements. Examples of such investments are pollution control equipment, medical dispensary, fire fitting equipment, crche in factory premises and so on. These are often nonrevenue producing investments. In analyzing such investments the focus is mainly on finding the most cost-effective way of fulfilling a given statutory need.

Replacement projects:
Firms routinely invest in equipments means meant to obsolete and inefficient equipment, even though they may be a serviceable condition. The objective of such investments is to reduce costs (of labor, raw material and power), increase yield and 58

improve quality. Replacement projects can be evaluated in a fairly straightforward manner, through at times the analysis may be quite detailed.

Expansion projects :
These investments are meant to increase capacity and/or widen the distribution network. Such investments call for an expansion projects normally warrant more careful analysis than replacement projects. Decisions relating to such projects are taken by the top management.

Diversification projects:
These investments are aimed at producing new products or services or entering into entirely new geographical areas. Often diversification projects entail substantial risks, involve large outlays, and require considerable managerial effort and attention. Given their strategic importance, such projects call for a very through evaluation, both quantitative and qualitative. Further they require a significant involvement of the board of directors.

Research and development projects:

Traditionally, R&D projects observed a very small proportion of capital budget in most Indian companies. Things, however, are changing. Companies are now allocating more funds to R&D projects, more so in knowledge-intensive industries. R&D projects are characterized by numerous uncertainties and typically involve sequential decision making. Hence the standard DCF analysis is not applicable to them. Such projects are decided on the basis of managerial judgment. Firms which rely more on quantitative methods use decision tree analysis and option analysis to evaluate R&D projects.

Miscellaneous projects:
This is a catch-all category that includes items like interior decoration, recreational facilities, executive aircrafts, landscaped gardens, and so on. There is no standard approach for evaluating these projects and decisions regarding them are based on personal preferences of top management.

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Capital Budgeting: eight steps:

Introduction : Until now, this web site has broken one of the cardinal rules of financial management. This page corrects for that problem and presents now, the first part of the subject of Capital Budgeting. Many books and chapters and web pages purport to discuss capital budgeting when in reality all they do is discuss CAPITAL INVESTMENT APPRAISAL. There's nothing wrong with a discussion of the CIA methods except that authors have a duty to point out that CIA methods are only one part of a multi stage process: the capital budgeting process. A discussion of CIA and nothing else means that capital budgeting decisions are being discussed out of context. That is, by ignoring the earlier and later parts of capital budgeting, we are never assess where capital budgeting project come from, how alternatives are found and evaluated, how we really choose which project to

60

choose and then we never review the projects and how they have been implemented. Definition: Capital budgeting relates to the investment in assets or an organization that is relatively large. That is, a new asset or project will amount in value to a significant proportion of the total assets of the organization. The International Federation of Accountants, IFAC, defines capital expenditures as Investments to acquire fixed or long lived assets from which a stream of benefits is expected. Such expenditures represent an organization's commitment to produce and sell future products and engage in other activities. Capital expenditure decisions, therefore, form a foundation for the future profitability of a company. Projects don't just fall out of thin air: someone has to have them. The main point here is that successful, dynamic and growing companies are constantly on the lookout for new projects to consider. In the largest organizations there are entire departments looking for alternatives and opportunities. 2 . Look for suitable projects: Once someone has had the idea to invest, the next step is to look at suitable projects: projects that complement current business, projects that are completely different to current business and so on. Initially, all possibilities will be considered: along the lines of a brainstorming exercise. As time goes by, and as corporate objectives allow, the initial list of potential projects will be whittled down to a more manageable number. 3. Identify and consider alternatives: Having found a few projects to consider, the organization will investigate any number of different ways of carrying them out. After all, the first idea probably won't either be the last or the best. Creativity is the order of the day here, as organizations attempt to start off on the best footing. 61

As the diagram suggests, at each of these first three stages, we need to consider whether what we are proposing fits in with corporate objectives. There is no point in thinking of a project that conflicts with, say, the growth objective or the profitability objective or even an environmental objective. A lot of data will be generated in this stage and this data will be fed into stage four: Capital Investment Appraisal. 4. Capital Investment Appraisal: This is the number crunching stage in which we use some or all of the following methods Payback (PB) accounting rate of return (ARR) Net present value (NPV) Internal rate of return (IRR) Profitability Index (PI) There are other techniques of course; but the technique to be used will depend on a range of things, including the knowledge and sophistication of the management of the organization, the availability of computers and the size and complexity of the project under review. For more information here, go to my page on CIA once you have finished this page. 5. Analysis of feasibility : Stage four is the number crunching stage. This stage is where the decision is made as to which project is to be assessed as acceptable. That is, which project is feasible? In order to choose the project, management needs some hurdles:

62

 What rate of ARR is acceptable What is the NPV cut off What IRR is the least that we can accept What PI is the least that we can accept and so on. Some projects will be discarded as a result of this stage. For example, if the PB cut off is, say, 2 years, and a project has a PB of 3 years, it will be rejected. The same is true of the ARR, NPV, IRR and PI. Capital rationing might be a problem here, too, if the organization has general cash flow problems. Capital Budgeting Policy Manual Let's pause at this point to make the point that what we have just said about cut off rates and so on come from formal procedures and documents. One such formal document is the Capital Budgeting Policy Manual, in which formal procedures and rules are established to assure that all proposals are reviewed fairly and consistently. The manual helps to ensure that managers and supervisors who make proposals need to know what the organization expects the proposals to contain, and on what basis their proposed projects will be judged. The managers who have the authority to approve specific projects need to exercise that responsibility in the context of an overall organizational capital expenditure policy. In outline, the policy manual should include specifications for: 1. an annually updated forecast of capital expenditures 2. the appropriation steps 3. the appraisal method(s) to be used to evaluate proposals 4. the minimum acceptable rate(s) of return on projects of various risk 5. the limits of authority 6. the control of capital expenditures 63

7. the procedure to be followed when accepted projects will be subject to an actual performance review after implementation (See IFAC document The Capital Expenditure Decision October 1989 for full details of the manual) 6. Choose the project Once we have determined the feasible/acceptable projects, we then have to make a decision of which to accept. If we have capital rationing problems, we might be restricted to one project only. If we have no cash problems, we might choose two or more. Whatever the cash position, we would like to invest in all projects that have a positive NPV, whose IRR is greater than our cut off rate and so on. 7 .Monitor the project As with any part of the organization, the project must be monitored as it progresses. If the project can be kept as a separate part of the business, it might be classed as its own department or division and it might have its own performance reports prepared for it. If it's to be absorbed within one or more parts of the organization then it could be difficult to monitor it separately: this is something that management has to decide as they implement their new projects. 8. Post completion audit The final stage: once the project has been up and running for six months or a year or so, there must be a post completion audit or a post audit. A post audit looks at the project from start to finish: stages 1 - 7 and looks at how it was thought of, analyzed, chosen, implemented, and monitored and so on. The purpose of the post audit is to test whether capital budgeting procedures have been fully and fairly applied to the project under review.

64

Of course, any weaknesses that might be found during the post audit might be specific to one project or they might relate to capital budgeting systems for the organization as a whole. In the latter case, the auditor will report back to his superiors and to management that systems need to be overhauled as a result of what has been found.

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CHAPTER-IV DATA ANALYSES AND INTERPRETATION

66

FINACIAL ANALYSIS:
ANALYSIS OF ULTRATECH CEMENTS LIMITED

Years 20072008 20082009 20092010 20102011 20112012

Total sales 5512.43 6385.50 7042.82 13205.6 4 18270.6 9

Total assets 4437.49 5743.73 6213.17 14810.6 4 16667.9 5

Fixed assets

Net Profit 1007.6

Capital Employed

Long term funds 982.66 1175.80 854.19 2789.76 2012.09

Share holders Funds 124.49 124.49 124.49 274.04 274.07

3120.00 4365.38 4716.99 10890.3 3 12166.1 3

1 977.02 1093.2 4 1404.2 3 2446.1 9

1173.21 2289.36 3232.23 4145.56 2812.99

TRADITIONAL CAPITAL BUDGETING APPRISAL METHODS RELATED TO RDTK Project 1.PAY BACK PERIOD METHOD: Payback period method is a traditional method of evaluation of capital budgeting decision. The term payback or pay out or payoff refers to the period in which the project will generate the necessary cash and recoup the initial investment or the cash out flows. To calculate the pay period, the cumulative cash flows will be calculated and by using interpolation the exact period may be calculated. The Kesoram Cements limited has Rs. 7683.708 lacks of initial investment and the annual cash flows for the years 2006 to 2010. Then the payback period is calculated as follows:

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CALCULATION OF PAY BACK PERIOD OF Heritage Foods (India) Limited SI .NO 1 2 3 4 5 YEAR (Rs. In crorers) CASH INFLOW CUMULATIVE CASH FLOWWS 1244.84 1300.02 1481.32 2169.96 3348.75 1244.84 2544.86 4026.18 6196.14 9544.89

2007-2008 2008-2009 2009-2010 2010-2011 2011-2012

The above table shows that, the initial investment RS.2687.87 Cr lies between second and third years with Rs. 2544.86 and 4026.18 Cr

Difference in cash flows PBP = Actual (Base) year + ---------------------------------Next year cash flows 1481.32 PBP = 2 + ------------6196.14 = = 2 + 0.23 2.239 year

Payback period (PBP) = 2.239 year.

ACCEPT-REJECT CRITERION: 68

PBP can be used as a criterion to accept or reject an investment proposal. A proposal whose actual payback period is more than what is predetermined by the management. PBP thus, is useful for the management to accept the investment decision on the Heritage Foods (India) Limited and also to assist the management to know that the initial investment is recovered in 1.1884years.

II. ACCOUNTING OR AVERAGE RATE OF RETURN METHOD: It is another traditional method of capital budgeting evaluation. According to this method the capital investment proposals are judged on the basis of their relative profitability. The capital employed and related incomes are determined according to the commonly accepted accounting principles and practices over the certain life of project and the average yield is calculated. Such a rate is called the accounting rate of return or the average return or ARR. It may be calculated according to any one of the following methods: (i) Annual average net earnings ---------------------------------- X 100 Original investment Annual average net earnings ----------------------------------- X 100 Average investment

(ii)

Increase in expected future annual net earnings ----------------------------------------------------------- X 100 Initial increase in required investment The term average annual net earnings are the average of the earnings after depreciation and tax. Over the whole of the economic life of the project order and these giving on ARR above the required rate may be accepted. The amount of average investment can be calculated according to any of the following methods: 69

(iii)

(a)

Original investment -----------------------2 Original investment +scrap value -----------------------------------------2

(b)

(c) Original investment +scrap value + net additional + scrap value Working capital -------------------------------------------------------------------------------2 Cash flows of the Ultratech cements Limited are shown in cash flow statement. ARR is calculated as follows:

Statement showing calculation of ARR \ (Rs. In lakes) YEARS EARNINGS AFTER TAX (EAT) 2007-2008 2008-2009 2009-2010 2010-2011 2011-2012 TOTAL 1244.84 1300.02 1481.32 2169.96 3348.75 9544.89

ARR

Average annual EATS = ------------------------------- x 100 Average investment

Total amount Average Annual EATS = --------------------No.of years 70

9544.89 = -----------------5 Average investment =1908.97 9544.89 ARR = ---------------- X 100 1908.97

= 1908.97

= 50.02 %

Average Rate of Return = 50.02 %

ACCEPT-REJECT critters method allows Ultratech cements Limited to fix a minimum rate of return. Any project expected to give a return below it will be straight away rejected. The average rate of return is as good as 50.02 % of ultratech cements Limited depicts the prospects of management efficiency.

TIME ADJUSTED (OR) DISCOUNTED CASH FLOW METHOD: The time adjusted or discounted cash flow methods take into accounts the profitability time value of money. These methods are also called the modern methods of capital budget 1.NET PRESENT VALUE METHOD: (NPV) Net present value method or NPV is one of the discounted cash flows methods. The method is considered to be one of the best of evaluating the capital investment proposals. Under this method cash inflows and outflows associated with each project are first calculated.

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ROLE OF DISCOUNTING FACTOR: The cash inflows and out flows are converted to the present values using discounting factor which is the actuary discount factor of Regulated display tool kit project of Kesoram cements limited is 10%. The rate of return is considered as cut off rate or required rate or rate generally determined on the basis of cost of capital to allow for the risk element involved in the project. STEPS FOR CALCULATION OF NPV: 1) Calculation of each cash flows after taxes of three years, which is arrived at by deducting depreciation, interest and tax from earning before tax and interest (EBIT). This residue is profit after tax to arrive at cash flow after tax. 2) This cash flow after tax are multiplied with the values obtained from the Table (the present value annuity table against the 8% actuary discount Rate i.e. in the case of project. 3) NPV is derived by deducting the sum of present values from the initial Investment. 4) Initial investments are the sum of cash flows of three years shown in Capital expenditure table

Let us assume the discount rate be 10%:

YEARS

CFATS

PVIF @ 10%

PVS

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2007-2008 2008-2009 2009-2010 2010-2011 2011-2012

0.909 1244.84 1300.02 1481.32 2169.96 3348.75 1131.55 0.826 1073.81 0.751 1112.47 0.683 1482.08 0.620 TOTAL: LESS: Initial Investment: NPV: 2076.22 6876.13 2687.87 4188.26

ACCEPT-REJECT CRITERION: The accept -reject decision of NPV is very simple. If the NPV is positive then the project should be accepted and if NPV is negative then the project should be rejected i.e .If and NPV NPV >0 <0 (ACCEPT) (REJECT)

Hence in the case of Ultratech cements Limited project it is visible that the positive NPV shows the acceptance and importance of the project.

1.INTERNAL RATE OF RETURN METHOD: (IRR)

The internal rate of return method is also a modern technique of capital budgeting that takes into account the time value of money. It is also known as TIME ADGUSTED RATE OF RETURN, DISCOUNTED CASH FLOW, DISCOUNTED RATE OF RETURN, YIELD METHOD and TRAIL AND ERROR YIELD METHOD. IRR is the rate the sum of discounted cash inflows equals the sum of discounted cash outflows. It equals the present value of cash inflow to present value of cash outflows. 73

In this method discount rate is not known, but the cash inflows and cash out flows are known. It is the rate of return, which equates the present value of cash inflows to out flows or it, is the rate of return, which renders NPV TO ZERO. STEPS INVOLVED IN THE CALCULATION OF IRR: 1) Calculation of NPV with given discount rate 2) Calculation of NPV with assumed discount rate 3) Select the higher NPV of both 4) Let R be the higher discount rate 5) Let R1 be the difference of discount rates 6) Calculation of difference of P Vs (Always higher NPV-lower NPV) Higher NP ---------------------------- XR1 Difference of P V s.

IRR= R +

8) Decision making(Accepting- Rejecting the proposal)

FORMULATION OF STEPS: STATEMENT OF SHOWING CALCULATION NPV @88%,89%,90% UNDER IRR METHOD ( Rs corers)

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YEARS

2007-2008 2008-2009 2009-2010 2010-2011 2011-2012

Annual Discount CFA Ts Rate-88% PVF PV 1244.8 0.531 661.01 4 1300.0 2 1481.3 2 2169.9 6 3348.7 5 1605.19 0.2921 0.1579 0.0858 0.0461 379.73 223.90 186.18 154.37

Discount Rate-89% PVF PV 0.529 658.52 0.2799 0.1481 0.0783 0.0414 362.87 219.38 169.90 138.63 1550.3

Discount Rate-90% PVF PV 0.526 654.78 0.277 0.145 0.076 0.04 360.10 214.79 164.91 133.95 1528.53

From the above calculations the following can be observed. PV 0f net cash flows at 88% is: 1602.19cr PV 0f net cash flows at 89% is: 1548.98 cr DECISION: Since the initial investment RS.2687.87 cr is lies between 75% and 80% the company APTDC can determine the IRR as 76.51% Hence IRR=76.51%

ACCEPT-REJECT CRITERION: IRR is the maximum rate of interest, which an organization can afford to pay on capital, invested in, is accepted if IRR exceeds the cutoff rates and rejected if it is below the cutoff rate. 75

The cutoff rate of ultratech Limited is 10%, which is less than the IRR i.e 76.51% hence the acceptance of ultratech Limited is quiet a good investment decision taken by management.

3. PROFITABILITY INDEX: (BCR OR PI) Profitability index method is also known as time adjusted method of evaluating the investment proposals. Profitability also called as benefit cost ratio (B\C) in relationship between present value of cash inflows and the present value of cash out flows. Thus Present value of cash inflows Profitability index = -------------------------------------Present value of cash outflows. (OR) Profitability index Present value of cash inflows = - ---------------------------------------Initial cash outlay

CALCULATIONS OF BCR: STEP1: Calculations of cash flows after taxes STEP2: Calculations of Present values of cash inflows @10%. STEP3: Application of the formula. Statement for calculating of benefit cost ratio 76

YEARS 2007-2008 2008-2009 2009-2010 2010-2011 2011-2012

CFATS 1244.84 1300.02 1481.32 2169.96 3348.75 TOTAL:

PVIF @ 10% 0.909 0.826 0.751 0.683 0.620

PVS 1131.55 1073.81 1112.47 1482.08 2076.22 6876.13

YEARS 2007-2008 2008-2009 2009-2010 2010-2011 2011-2012

CFATS 1244.84 1300.02 1481.32 2169.96 3348.75 TOTAL:

PVIF @ 10% 0.909 0.826 0.751 0.683 0.620

PVS 1131.55 1073.81 1112.47 1482.08 2076.22 6876.13

Profitability index

Present value of cash inflows -------------------------------------Initial Investment = 2.55

6876.13 = -----------------2687.87 Hence PI = 3

ACCEPT-REJECT CRITERION:

77

There is a slight difference between present value index method and profitability index method. Under profitability index method the present value of cash inflows and cash outflows are taken as accept-reject decision. I.e. the accept reject criterion is: If Profitability Index Profitability Index > 1 (ACCEPT). < 1 (REJECT).

The acceptance of by the management is evaluated through Profitability Index method of as the PI > 1 (i.e.3years)

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CHAPTER-V
FINDINGS SUGGESSIONS CONCLUSIONS BIBLIOGRAPHY

FINDINGS
The capital budgeting decision for Ultratech cements limited is governed by a manual issued by the planning Commission. It contains the following important provisions in the regard: (1) It suggest the use of various project 79

evaluation techniques, such as return on investment (ROD, payback period, discounted cash flow (DCF) Evaluation and Review Technique (PERT), Critical path method (CPM), and strengths, weaknesses, opportunities and Threats (SWOT) Analysis. The total assets of Ultratech cements limited recorded consistent fluctuations from 1.24 (2007-2008) to 1.87 (2011-2012). The lowest recorded as 1.14 (2009-2010). This decline is an account of lower growth rates sales in those years. The fixed assets of Ultratech cements limited showing a fluctuating trend and increased from 2.57 times (2007-2008) to 3.65 times (2011-2012). These fluctuations any be due to fixed assets investment. The fixed assets shows the fluctuating trends form 0.76 (2007-2008) to (20112012) as 1.15 and the funds were required then continuously declined. The fixed assets ratio of Ultratech cements limited as shown continuously increasing from 0.58 (2006-2007) to 0.97 (2011-2012) as. There fluctuations observed.

CONCLUSIONS

The budgeting exercise in KESORAM also covers the long term capital budgets, including annual planning and provides long term plan for

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application of internal resources and debt servicing translated in to the corporate plan. The scope of capital budgeting also includes expenditure on plant betterment, and renovation, balancing equipment, capital additions and commissioning expenses on trial runs generating units. To establish a close link between physical progress and monitory outlay and to provide the basis for plan allocation and budgetary support by the government. The manual recommends the computation of NPV at a cost of capital / discount rate specified from time to time. A single discount rate should not be used for all the capacity budgeting projects. The analysis of relevant facts and quantifications of anticipated results and benefits, risk factors if any, must be clearly brought out. Inducting at least three non -official directors the mechanism of the Search Committee should restructure the Boards of these PSUs. Feasibility report of the project is prepared on the cost estimates and the cost of generation. Scope of capital budgeting in Ultratech cements limited are * Approved and ongoing schemes New approved schemes Unapproved schemes Capital budgets for plant betterments Survey and investigation Research and development budget.

SUGGESTIONS

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 As large sum of money is involved which influences the profitability of the firm making capital budgeting an important task. Long term investment once made cannot be reversed without significance loss of invested capital. The investment becomes sunk and mistakes, rather than being readily rectified, must often be born until the firm can be withdrawn through depreciation charges or liquidation. It influences the whole conduct of the business for the years to come. Investment decision are the base on which the profit will be earned and probably measured through the return on the capital. A proper mix of capital investment is quite important to ensure adequate rate of return on investment, calling for the need of capital budgeting. The implication of long term investment decisions are more extensive than those of short run decisions because of time factor involved, capital budgeting decisions are subject to the higher degree of risk and uncertainty than short run decision.

BIBLIOGRAPHY

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Books:
-Financial Management -Management Accounting -Management Accounting -Financial Management -Research Methodology - Prasanna Chandra - R.K.Sharma & Shashi K.Gupta -S.N.Maheshwary -Khan and Jain -K.R.Kothari

Web Sites:
http\\:www.google.com http\\:www.ultratech.co.in http\\:www.googlefinance.com http://www.investopedia.com http://www.zenwealth.com http://www.cliffnotes.com http://www.capitalbudgetingtechniques.com/

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ABBREVIATIONS

PI CB CFS CCFS EAT EBIT CFAT PVS PVIF PBP ARR NPV IRR B/C

Profitability index. Capital budgeting Cash flows. Cumulative cash flows. Earnings after tax. Earnings before investment and tax. Cash flows after tax. Present value of cash flows. Present value of inflows. Payback period. Average rate return. Net present value. Internal rate return. Benefit cost ratio.

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