A Project report on

Investment Management
BY
P.SUPRIYA
(HT.No: 098 060 132)

Project submitted in partial fulfillment for the award of the Degree of

MASTER OF BUSINESS ADMINISTRATION
by
Osmania University, Hyderabad -500007

DECLARATION

hereby

declare

that

this

Project

Report

titled

INVESTMENT

MANAGEMENT submitted by me to the Department of Business

Management, O.U., Hyderabad, is a bonafide work undertaken by me and it is not
submitted to any other University or Institution for the award of any degree
diploma/ certificate or published any time before.

Name and Address of the Student

P.SUPRIYA
Flat no.53, Road No 4
Alkapuri,L.B.Nagar,
Hyderabad

Signature of the Student

ANNEXURE II
CERTIFICATION
This is to certify that the Project Report title Logistics Management
submitted in partial fulfillment for the award of MBA Programme of
Department of Business Management, O.U. Hyderabad, was carried out by
K.V.Ramana Reddy under my guidance. This has not been submitted to any
other

University

or

Institution

for

the

award

of

degree/diploma/certificate.

Name and address of the Guide

Head of the Department (M.B.A)

Project Guide

Signature of the Guider

Principal

any

Abstract
Logistic Management is a cross functional approach to managing the
movement of raw materials into an organisation, certain aspects of the
internal

processing

of

materials

into

finished

goods

and

then

the

movement of the finished goods out of the organisation towards the end
c o n s u m e r.

As

organisation

strive

focus

on

core

competencies

and

becoming more flexible they have reduced ownership of raw materials.

These functions are increasingly outsourced to other entitles that can
perform the activities better or lower cost effectively the effect is to
i n c r e a s e t h e n u m b e r o f o r g a n i s a t i o n s i n v o l v e d i n s a t i s f yi n g t h e c u s t o m e r
demand while reducing Supply Chain Operations. Less control and more
logistics partners led to the creation of Logistics management.
The

purpose

of

Logistics

management

is

to

improve

trust

and

collaboration among suppliers and customer i.e., among supply chain

partners of the organisation thus improving inventory visibility and
i m p r o v i n g i n v e n t o r y v e l o c i t y.
Logistics Management spans all movement and storage of raw
materials, work in progress inventory and finished goods from point of
origin to point of consumption.

ACKNOWLEDGEMENT

I a m d e e p l y i n d e b t e d t o my H e a d o f t h e d e p a r t me n t a n d g u i d e
M r.Vis w a n a t h w h o h a v e b e e n a gr e a t s o u r c e o f s t r e n g t h a n d
i n s p i r a t i o n a t e v e r y s t a g e o f pr o j e c t w o r k .
I

would

like

to

Mrs.IndiraReddy,
Director

of

acknowledge
principal

St.Pauls

P.G .

my

and

sincere

M r.

College

for

thanks

Raghava
making

to

Reddy
all

the

facilities available to me.

I a m e x t r e me l y t h a n k i n g t o M r. R a d h a K r i s h n a , D e p u t y G e n e r a l
M a n a g e r. ( H u ma n R e s o u r c e s ) a n d M r. N a res h N at a r a j a n D C
m a n a g e r, K o n d l a k o i , M r. M a h a d e v u d u o f I n v e n t o r y M a n a g e m e n t
a n d M r. S a t h i s h o f I n b o u n d o p e r a t i o n s o f R e l i a n c e R e t a i l L t d a n d
a l s o o t h e r s t a ff m e m b e r s o f R e l i a n c e R e t a i l l t d , w i t h o ut t h e i r
kind co-operation and help the project could not have been
successful.

(K.V.RAMANA REDDY)

Table of Contents

Page No.

Chapter 1: Introduction

Introduction
Objectives
Methodology
Scope

1
2
3
4

Chapter 2: Review of Literature

Introduction
Logistics Problems
Suggestions to improve
Introduction to retail industry
Organized retailing in India

6
14
15
17
24

Chapter 3: The Company

Introduction and History

Facility Locations
Products and brands
Commitments of the company
Milestones

29
31
33
37
38

Chapter 4: Data Presentation and Analysis

Introduction
Inbound Logistics

42
48

Outbound Logistic
Inventory Management

60
73

Chapter 5: Conclusions And Limitations

Conclusions
Limitations
Suggestions

Bibliography

81
82
83

84

Appendices

Organisational Structure

Store Details
Manual trip sheet
Bin categorization and stocking details

ii
vii
viii

Chapter
-1
Introduction

NEED FOR THE STUDY

The project study is undertaken to analyze and understand the Capital

Budgeting process in power sector, which gives mean exposure to practical
implication of theory knowledge.

To know about the companys operations of using various Capital budgeting

techniques.

To know how the company gets funds from various resources.

OBJECTIVES OF THE STUDY

To study the relevance of capital budgeting in evaluating the project.

To study the techniques of capital budgeting for decision-making.

To measure the present value of rupee invested.

To understand an item wise study of the company of financial

performance of the company.

To make suggestions if any for improving the financial positions of the

company.

METHODOLOGY
To achieve a fore said objective the following methodology has been adopted. The
information for this report has been collected through the primary and secondary
sources.
Primary sources:
It is also called as first handed information the data is collected through the
observation in the organization and interviews with officials. By asking questions
with the accounts and other persons in the financial department. A part from these
some information is collected through the seminars, which were held by
APGENCO.
Secondary sources:
These secondary data is existing data which is collected data which is collected by
others that is sources are financial journals, annual reports of the APGENCO Ltd.,
APGENCO website, and other publications of APGENCO.

LIMITATIONS OF THE STUDY

Lack of awareness of power generation sector of APGENCO Ltd.

Lack of time is another limiting factor the schedule period 6 weeks are
not sufficient to make the study independently regarding Capital budgeting
in APGENCO Ltd.

The busy schedule of the officials in the APGENCO Ltd is another

limiting factor. Due to the busy schedule of officials restricted me to collect
the complete information about organization.

Non-availability of confidential financial data.

The study is conducted in a short period, which was not detailed in all
aspects.

PLAN OF THE STUDY

INTRODUCTION
Need for the study
Objectives of the study
Methodology of the study
Limitations
COMPANY PROFILE
History of APGENCO
Landmarks and Achievements
Performance of APGENCO
CONCEPTUAL AND THEORETICAL FRAMEWORK
Introduction to Capital Budgeting
Importance of Capital Budgeting
Capital Budgeting process
Methods of Capital Budgeting techniques
DATA ANALYSIS
Analysis of various Capital Budgeting techniques
FINDINGS
SUGGESTIONS

HISTORY OF APGENCO:
When APSEB came in to existence in 1959, APSEB started functioning with the
objectives of maintaining the power sector efficiently and economically
simultaneously ensuring demand meets the supply. During the last decade
inadequate capacity addition and low system frequency operation of less than
48.5 Hz for more then half a decade considerably reduced the power supply
reliability. The imbalance of the revenues against the cost of production, no
significant reduction in technical losses and energy thefts, high costs
purchases from IPPs other SEBs gradually worsened the financial position
of APSEB.

HIGH LEVEL COMMITTEE AND ITS RECOMMENDATIONS:

Government of Andhra Pradesh realizing the declining tendency of the financial
position of APSEB and considering the Government of Indias Liberalized
policy fir attracting private investment into power sector, set up a high level
committee in January 1995 to look into present working of the APSEB and
suggest remedies for improvement.
The committee after detailed deliberations with all the concerned and critical
analysis submitted the report in which it suggested some recommendations.
Government of Andhra Pradesh considering the recommendations made by
committee had embarked upon the AP ELECTRICITY REFORMS ACT in
1998. As a sequel the APSEB was unbundled into Andhra Pradesh Power
Generation Corporation (APGENCO) and Transmission Corporation of Andhra
Pradesh Limited (APTRANSCO) on 01.02.99. APTRANSCO was further
unbundled W.e.f 01.04.2000 into Transmission Corporation and four
Distribution Companies (discoms).
Thus APGENCO was incorporated as a company under the provisions of
Companies Act, on 29.12.1998. According to the Andhra Pradesh Electricity
Reforms Act, 1998, APGENCO commenced its business operations effective
from 1.2.1999 and according to the memorandum of APGENCO has to
acquire, establish, construct and operate Power-generating stations.

ABOUT APGENCO:
Andhra Pradesh Power Generation Corporation Limited is one of the Pivotal
organizations of Andhra Pradesh, engaged in the business of power generation.
Apart from operation and maintenance of the of the power plants it has undertaken
the execution of the ongoing and new power projects scheduled under capacity
addition programme and is taking up renovation and modernization works of the
old power stations.
APGENCO came into existence on 28.12.1998 and commenced operations from
01.02.1999. This was a sequel to Governments reforms in power sectors to
unbundle the activities relating to Generation, transmission and Distribution of
power. All the generating stations owned by erstwhile APSEB were transferred to
the control of APGENCO.
The installed capacity of APGENCO AS ON 31.12.2005 IS 6550.9 MW
comprising 2962.50 MW Thermal, 3586.4 MW Hydro and 2MW Wind power
stations, and contributed about half the total Energy Requirement of Andhra
Pradesh. APGENCO is the third largest power generating utility in the country next
to NTPC and Maharastra; its installed Hydro Capacity of 3586.4 MW is the highest
among the country.

APGENCO has an equity base of Rs.2107 crores with 10273 dedicated employees
as on 30.09.2003. The company has an asset base of approximately Rs.12000
crores.

OUR VISION:
To be the best power utility in the country and one of the best in the world.
OUR MISSION:
To generate adequate and reliable power most economically, efficiently
and Eco-friendly.
To spearhead accelerated power development by planning and
implementing new power projects.
To implement Renovation and Modernization of all existing units and
enhance their performance.
CORE VALUES:
To proactively manage change to the liberalized environment and global
trends.
To build leadership through professional excellence and quality.
To build a team based organization by sharing knowledge and
empowering employees.
To treat everyone with personal attention, openness, honesty and respect
they deserve.
To break down all departmental barriers for working together.
To have concern for ecology and environment.

19

LANDMARKS AND ACHIEVEMENTS:

APGENCO is the third Largest Power utility in the country in terms of

Installed Capacity-6580.9MW.

Our Hydro Installed Capacity 3586.4 MW is the highest in the country.

Thermal plants are consistently winning the Gold and Silver medals for
Meritorious Productivity Award.

Availability of thermal plants has been (over a decade) well above the
national average.

Recently Srisailam Left Bank Power House, a unique complete under

ground powerhouse is successfully commissioned and being operated. This
is the first such one in southern region.

AMRP LIFT IRRIGATION Scheme is taken upon and completed well

below the stipulated time and budget .In that the pumping station
commissioned (18MW) is first such one in India where water is lifted to an
height of 100Mts.

Srisailam complex is the largest hydro power station with installed

capacity 1670 MW in the country.

Nagarjuna Sagar Left canal powerhouse is the first hydro station in the
country to use SCDCA for operation of the units from control room besides
enhancing the Excitation and Governor system with microprocessor controls.

Pochampadu Hydro electric scheme is the first hydro power station to

use microprocessor controls in the powerhouse.

Thermal generation during 2004-05 23360 MU is highest ever

achieved by APGENCO.

The average PLF of 89.7 % during 2004-05 is the highest ever achieved
and highest in the country when compared with the utilities having
comparable installed capacity and vintage.

20

Since 1994-95 VTPS and RTPP are occupying top two positions in terms
of PLF rankings, except in the year 1999-00 in which RTPP stood second.
VTPS stood FIRST in the country during 1994-95,1995-96,1996-97,199798and 2001-02 and RTPP stood first in the country during 1998-99,200001,2002-03 and 2003-04.

RTPP has been receiving meritorious productivity Award for last six
consecutive years and bagged Gold Medal five years in a row since 1998-99.

VTPS has been receiving Meritorious Productivity Award for last twenty
consecutive years and bagged Gold Medal 9 times in a row since 1994-95.

KTPS V Stage has been receiving Meritorious Productivity Award for last
four consecutive years and bagged gold medal four times in a row since
1999-00.

About VTPS STAGE-IV (1x500MW)

Orders were placed on M/s BHEL manufactured items and zero date
commenced on 5-08-2005.
Consultancy contract is awarded on 20-09-2005.
For Balance of plant and civil works, Pre-bid meeting with pre-qualified
bidders was conducted on 27-01-2006 and 28-01-2006 Receipt of
technical and financial bids are due on 28-02-2006.
Unit will be commissioned by May 2008.

21

INSTALLED CAPACITY-THERMAL
NAME OF THERMAL POWER
STATION
VTPS (210MW)
RTPP (210MW)
KTPS -ABC (4x60MW&4x120MW)
KTPS-V (250MW)
RAMAGUNDAM THERMAL

NO.OF
UNITS
6
2
8
2
1

STATION
TOTAL THERMAL CAPACITY

19

INSTALLED
CAPACITY
1260MW
420MW
720MW
500MW
62MW
2962MW

APGENCO IS THE 3RD LARGEST THERMAL GENERATION UTILITY

IN THE COUNTRY.
Name of the

Capacity
stat
ion

NTPC
MAHAGENCO
APGENCO

23,345MW
10,331MW
6,551MW

APGENCO IS THE HIGHEST HYDRO GENERATION UTILITY IN

THE COUNTRY.
NAME OF THE STATION
APGENCO
KPCL-KARNATAKA
NHPC

CAPACITY
3586.4 MW
3135.4 MW
2773.0 MW

22

OPERATIONAL PERFOMANCE
OVERALL PERFOMANCE OF APGENCO
YEAR
2004-

GENARATION
(MU)

ALL
APGENCO AVERAGE

INDIA RANKING
I

05
2003-

23360

04
2002-

22455.2

03
2001-

23032

02
2000-

22245

01
1999-

21934

00
1998-

21499

99
1997-

19834

98
1996-

19019

97
1995-

16720

96
1994-

15103

95

10842

89.7

74.8
III

56

72.7
II

88.9

72.1
I

86.3

70.0
I

85.1

68.7
II

83.2

67.5
III

77.6

64.6
I

82.3

64.9
I

78.1

64.5
I

78.2

63.1
II

70.1

60.1

PLANT WISE PERFORMANCE

GENERATION (MU)
STATION 2003- 2004- 2005-06
(APR04
05
NOV)
VTPS
10164 9851.1 7054

PLF %
2005-06
2003- 2004(APR04
05
NOV)
91.84 89.2
84.8
23

RTTP
KTPS
KTPS-V
RTS-B
NTS

3401.6
4225.9
4038.3
471.28
153.94

3353.8
5364.1
4140.2
496.2
154.4

1511
3362.9
2508.2
282
7.42

92.2
68.7
91.95
85.8
58.4

91.2
87.5
94.5
90.6
58.8

54.5
72.8
76
68.4
16.9

COMPARISONS OF PLANT LOAD FACTOR

PLANT WISE COMPARISONS
PLF
NAME OF THE STATION CAPACITY(MW) %
KOTHAGUDAM V stg
500
94.5
DADRI (NTPC)
840
92.9
KORBA (NTPC)
2100
92.7
SIMHADRI (NTPC)
1000
92.7
UNANCHAR (NTPC)
840
92.2
RIHAND (NTPC)
1500
91.2
RAYALSEEMA (APGENCO) 420
91.2
METTUR (TNEB)
840
90.8
RAMAGUNDAM
B
(APGENCO)
62.5
90.6
RAMAGUNDAM
(APGFENCO)
2600
90.3
SINGRAULI (NTPC)
2000
90.2

STATE WISE COMPARISONS

NAME OF THE UTILITY
APGENCO

THERMAL
CAPACITY(MW)
2972.5

PLF %
89.7
24

GUJARAT SECL
NTPC
ORISSA PGC
RAJASTHAN RVUNL
KARNATAKA PCL
PUNJAB SEB
TAMILNADU SEB
NEYVELI
LIGNITE
CORPORATION
MAHARASTRA SEB
CHATTISGARH SEB
MADHYA PRADESH GPCL
SOUTHERN REGION
ALL INDIA

420.0
20185.0
420.0
2295.0
1470.0
2120.0
2970.0

87.5
87.3
86.0
85.1
83.2
77.5
76.9

2490.0
6396.0
1240.0
2272.5
13892.5
67165.9

76.8
76.6
72.9
72.1
84.1
74.8

PERFORMANCE HIGHLIGHTS OF APGENCO:

25

 APGENCO Achieved Top Position Among Power Utilities in All India

PLF Rankings.
Highest PLF of 89.7 % achieved by APGENCO since inception.
Highest thermal generation is 23360 MU achieved by APGENCO since
inception 1965).
Highest daily Thermal generation 72.03 MU achieved on 18-112004
since inception.
APGENCO has achieved Top Position among power utilization in PLF
Rankings.
Total Installed Capacity of 6580.9 MW is 3rd largest in the country after
NTPC in Maharastra.
VTPS achieved all time high daily generation 5364 MU and highest PLF
of 102.5% on 31-03-2005 since inception (1979).
Highest daily APGENCO total generation 109.64 MU achieved on 27-082004 since inception (1955).

26

ENVIRONMENTAL CONCERNS
Environmental policy (unwritten)
Comply with relevant environmental legislations and regulatory
requirements for establishment and operation of the power stations.
Commitment

to

continual

improvement

in

the

environmental

performance to ensure protection or environment, preservation or

ecology, conservation or natural resources and sustainable development.
Provide adequate facilities, framework to achieve environmental
objectives and targets.

EIA AND DEVELOPMENT OF EMP

Keeping in view the environmental policy, Environmental Impact
Assessments are carried out for individual stations and Environmental
Management Plans are developed for implementation during construction
and operation phases.

POLLUTION CONTROL SYSTEMS

High efficiency Electro-static Precipitators (ESPs) is installed to control
Suspended Particulate matter (SPM) in flue gas. All new plants are
designed for SPM level of 100mg/Nm3.Old units are upgraded or under
up gradation for50/115mg/Nm3 against APPCB limit of 115mg/Nm3.
Latest micro processor based EPIC-II controllers are installed for
improvement

of

collection efficiency

and reduction of

power

27

consumption online flue gas dust monitoring systems are installed at

VTPS, RTPP and KTPS Stage-V
Coal Plant and other plant effluent are treated in the Setting Tanks. Plant
and colony Sewage is treated in the septic tanks. Oxidation pond is
provided at RTPP for better treatment of sewage. At other stations like
VTPS Activated sludge treatment with diffused Aeration is under
contemplation. Effective De-cantation systems are provided in the ash
ponds to control suspend solids. Suspended solids in the ash pond outlet
effluent are below 50ppm against standard of 100 ppm.
Re-circulation and Re-use system is provided at RTPP and at other
stations such systems are under contemplation.

AFFORESTATION
Green belt is provided with different species to act as sink for absorbing
pollutants, sound barrier and to maintain Bio-diversity. About4lakh plants
are available at all stations.

SAFETY AND HEALTH MEASURES

APGENCO developed Safety and Health standards based on Factories
Act 1947,Workmen compensation Act and Health and Safety Acts of UK
and USA and safety measures are being implemented.

ASH UTILISATION
The annual generation of fly ash from Thermal Power Plants of APGENCO is
presently around 6.8 million tons/annum. APGENCO has been implementing
following measures.
28

 Dry fly ash and pond ash are issued free of cost to all consumers.
Brick plants are set up at VTPS, RTPP and KTPS.
Research and field tests are underway through Acharya NG Ranga
Agricultural University (ANGRAU) and Department of Agriculture,
GOAP to establish benefits with fly ash use for agriculture for all crops in
the different agro-climate zones of Andhra Pradesh.
Feasibility of ash stowing to mines is under study. Ash utilization has
witnessed improvement year by year as shown in the bar chart.

IS0 14001 CERTIFICATION

APGENCO is in the process of being certified for ISO 14001 Environmental
Management Systems in a phased manner at tits thermal power stations such as
Vijay Wada Thermal Power Station, Rayalaseema Thermal Power Project,
Kothagudem Thermal Power Station Stage-V and Kothagudem Thermal power
Station(old). ISO 14001 Certification process has started at Rayalseema
Thermal Power Project during June2003 and is expected to be completed by
September 2004. at other thermal power stations certification process will be
taken up in phased manner.

GOALS ARE TO BE ACHIEVED

To achieve emission standards at all thermal power stations by
undertaking suitable up gradation/modifications in the system.

29

 To achieve effluents standards at all thermal power stations by adopting

suitable treatment systems.
To ensure zero discharge of effluents from the plants by installing recycling are re-use systems at major power plants i.e., VTPS and KTPS.
To develop ISO 14001 Environmental Management Systems for major
thermal power stations of APGENCO.
To achieve ash utilizations as per action plans submitted to the MOE&F
notification dated 14.09.1999.
To develop greenbelt in the wider area by adding considerable number of
trees every year at power stations.
To strengthen the Environmental Management cells, its performance in
monitoring and auditing, providing training on the relevant aspects.

30

Organizational Chart
Sri A.K.Goyal (I.A.S)
Chairman
Sri Ajay Jain (I.A.S)
Managing Director

Sri G.Vijay Kumar

Director (Thermal)

Sri U.G.Krishna Murthy

Director (Technical)

Sri. G.Adisheshu
Director (Hydel)

Sri V.Veerabhadra Rao

Director (Commercial)

Sri D.Prabhakar Rao

Director (Finance)

31

32

CAPITAL BUDGETING

Introduction:
The term Capital Budgeting refers to long term planning for proposed capital
outlay and their financing. It includes raising long-term funds and their
utilization. It may be defined as a firms formal process of acquisition and
investment of capital.
Capital Budgeting May also be defined as The decision making process by
which a firm evaluates the purchase of major fixed assets. It involves firms
decision to invest its current funds for addition, disposition, modification and
replacement of fixed assets.
It deals exclusively with investment proposals, which an essentially long term
projects and is concerned with the allocation of firms scarce financial resources
among the available market opportunities.
Some of the examples of Capital Expenditure are
(i) Cost of acquisition of permanent assets as land and buildings.
(ii) Cost of addition, expansion, improvement or alteration in the fixed
assets.
(iii) R&D project cost, etc.,
Definitions:
Capital budgeting is long term planning for making and financing proposed
capital outlays.
T.HORNGREEN

33

Capital budgeting is concerned with allocation of the firms scarce financial

resources among the available market opportunities. The consideration of
investment opportunities. The consideration of investment opportunities
involves the comparison of the expected future streams of earnings from a
project with immediate and subsequent streams of expenditures for it.
In any growing concern, capital budgeting is more or less a continuous process
and it is carried out by different functional areas of management such as
production, marketing, engineering, financial management etc. All the relevant
functional departments play a crucial role in the capital budgeting decision
process of any organization, yet for the time being, only the financial aspects of
capital budgeting decision are considered.
The role of a finance manager in the capital budgeting basically lies in the
process of critically and in-depth analysis and evaluation of various alternative
proposals and then to select one out of these. As already stated, the basic
objectives of financial management is to maximize the wealth of the share
holders, therefore the objectives of capital budgeting is to select those long term
investment projects that are expected to make maximum contribution to the
wealth of the shareholders in the long run.

Features of Capital Budgeting:

The important features, which distinguish capital budgeting decisions in other
Day-to-day decisions, are
Capital budgeting decisions involve the exchange of current funds for the
benefits to be achieved in future.
The futures benefits are expected and are to be realized over a series of
years.
The funds are invested in non-flexible long-term funds.

34

 They have a long terms are significant effect on the profitability of the
concern.
They involve huge funds.
They are irreversible decisions. They are strategic decisions associated
with high degree of risk.
IMPORTANCE OF CAPITAL BUDGETING:
The importance of capital budgeting can be understood from the fact that an
unsound investment decision may prove to be fatal to the very existence of the
organization.
The importance of capital budgeting arises mainly due to the following:
1.Large investment:
Capital budgeting decision, generally involves large investment of funds. But
the funds available with the firm are scarce and the demand for funds for
exceeds resources. Hence, it is very important for a firm to plan and control its
capital expenditure.

2. Long term commitment of funds:

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

3. Irreversible nature:
The Capital expenditure decisions are of irreversible nature. Once, the decision
for acquiring a permanent asset is taken, it becomes very difficult to dispose of
these assets without incurring heavy losses.

35

4. Long terms effect on profitability:

Capital budgeting decision has a long term and significant effect on the
profitability of a concern. Not only the present earnings of the firm are affected
by the investments in capital assets but also the future growth and profitability
of the firm depends up to the investment decision taken today. Capital
budgeting decision has utmost importance to avoid over or under investment in
fixed assets.

5. Difficulties of investment decision:

The long terms investment decisions are difficult to be taken because
uncertainties of future and higher degree of risk.

6. Notional Importance:
Investment decision though taken by individual concern is of national
importance because it determines employment, economic activities and
economic growth.

KINDS OF CAPITAL BUDGETING:

Every capital budgeting decision is a specific decision in the given situation, for
a given firm and with given parameters and therefore, an almost infinite number
of types or forms of capital budgeting decisions may occur. Even if the same
decision being considered by the same firm at two different points of time, the
decision considerations may change as a result of change in any of the variables.
However, the different types of capital budgeting decisions undertaken from
time to time by different firms can be classified on a number of dimensions.
Some projects affect other projects the firm is considering and analyzing. At the
other extreme, some proposals are pre-requisite for other projects. The projects
may also be classified as revenue generating projects or cost reducing projects.

36

In general, the projects can be categorized as follows:

1.

From the point of view of firm's existence: The capital budgeting decisions
may be taken by a newly incorporated firm or by an already existing firm.
a) New Firm: A newly incorporated firm may be required to take
different decisions such as selection of a plant to be installed, capacity
utilization at initial stages, to set up or not simultaneously the ancillary
unit etc.
b) Existing: Firm: A firm which is already existing may also be required
to take various decisions from time to time to meet the challenges of
competition or changing environment. These decision may be :
(i)

Replacement and Modernization Decision: This is a common type of

a capital budgeting decision. All types of plant and machineries
eventually require replacement. If the existing plant is to be replaced
because the economic life of the plant is over, then the decisions may
be known as a replacement decision. However, if an existing plant is
to be replaced because it has become technologically outdated (though
the economic life may not be over), the decision may be known as a
modernization decision. In case of a replacement decision, the
objective is to restore the same or higher capacity, whereas in case of
modernization decision, the objective is to increase the efficiency
and/or cost reduction. In general, the replacement decision and the
modernization decisions are also known as cost reduction decisions.

(ii) Expansion: Some times, the firm may be interested in increasing the
installed production capacity so as to increase the market share. In such a case,
the finance manager is required to evaluate the expansion program in terms of
marginal costs and marginal benefits.

37

(ii)

Diversification: Some times, the firm may be interested to diversify

into new product lines, new markets, production of spare parts etc. In
such a case, the finance manager is required to evaluate not only the
marginal cost and benefits, but also the effect of diversification on the
existing market share and profitability. Both the expansion and
diversification decisions may also be known as revenue increasing
decisions.

From the point of view of decision situation: The capital budgeting

decisions may also be classified from the point of view of the decision
situation as follows:

(i) Independent Project Decision:This is a fundamental decision in Capital Budgeting. It is also called as acceptreject criterion. If the project is accepted the firm does not invest in it. In
general all these proposals, which yield a rate of return greater, than ascertain
required rate of return on cost of capital, are accepted and the rest are rejected.
By applying this criterion all independent project with one another in such a
way that the acceptance of one precludes the possibility of acceptance of
another. Under the accept-reject decision all independent projects that satisfy
the minimum investment criterion should be implemented.
(ii) Mutually Exclusive Projects Decision:Mutually Exclusive projects are those, which compete with other projects in
such a way that the acceptance of one will exclude the acceptance of the other
projects. The alternatives are mutually exclusive and only one may be chosen.
Suppose a company is intending to buy a new machine. There are three
competing brands, each with a different initial investment adopting costs. The
three machines represent mutually exclusive alternatives as only one of these
38

can be selected. It may be noted that the mutually exclusive alternatives, as only
one of these can be selected. It may be noted here that the mutually exclusive
projects decisions are not independent of the accept reject decisions.
(iii) Capital Rationing Decisions: In a situation where the firm has unlimited funds all independent investment
proposals yielding return greater than some pre-determined levels are
accepted. However this situation does not prevail in most of the business
firms in actual practice. They have a fixed capital budget. A large number
of investment proposals compete for these limited funds the firm must
therefore ration them. The firm allocates funds to projects in a manner
that it maximizes long run returns this, capital rationing refers to a
situation in which a firm has more acceptance investment than it can
finance. It is concerned with the selection of a group of investment
proposals acceptable. Under the accept-reject decision capital rationing
employees ranking of the acceptable investments projects. The projects
can be ranked on the basis of a predetermined criterion such as the rate of
return. The projects are ranked in the descending order of the rate of
return.
PROBLEMS AND DIFFICULTIES IN CAPITAL BUDGETNG:
The problems in capital budgeting decisions may be as follows:
a) Future uncertainty: Capital budgeting decisions involve long term
commitments. However there is lot of uncertainty in the long term. The
uncertainty may be with reference to cost of the project, future expected
returns, future competition, legal provisions, political situation etc.
b) Time Element: The implications of a Capital Budgeting decision are
scattered over a long period. The cost and benefits of a decision may
occur at different points of time. The cost and benefits of a decision may
occur at different points of time. The cost of a project is incurred

39

immediately. However, the investment is recovered over a number of

years. The future benefits have to be adjusted to make them comparable
with the cost. Longer the time period involved, greater would be the
uncertainty.
c) Difficulty in Quantification of impact. The finance manager may face
difficulties in measuring the cost and benefits of projects in quantitative
terms. For example, the new products proposed to be launched by a firm
may result in increase or decrease in sales of other product proposed to be
launched by a firm may result in increase or decrease in sales of other
products already being sold by the same firm. It is very difficult to
ascertain the extent of impact as the sales of other products may also be
influenced by factors other than the launch of the new products.
ASSUMPTIONS IN CAPITAL BUDGETING:
The capital budgeting decision process is a multi-faceted and analytical process.
A number of assumptions are required to be made. These assumptions constitute
a general set of conditions within which the financial aspects of different
proposals are to be evaluated. Some of these assumptions are:
1. Certainty with respect to cost and benefits: It is very difficult to estimate the
cost and benefits of a proposal beyond 2-3 years in future. However, for a
capital budgeting decision,
It is assumed that the estimates of cost and benefits are reasonably accurate and
certain.
2. Profit motive: Another assumption is that the capital budgeting decisions are
taken with a primary motive of increasing the profit of the firm. No other
motive or goal influences the decision of the finance manager.
3. No Capital Rationing: The Capital Budgeting decisions in the present chapter
assume that there is no scarcity of capital. It assumes that a proposal will be
40

accepted or rejected on the strength of its merits alone. The proposal will not be
considered in combination with other proposals to consider the maximum
utilization of available funds.

41

CAPITAL BUDGETING PROCESS:

Capital budgeting is a complex process as it involves decisions relating to the
investment of current funds for the benefit to be achieved in future and the
future is always uncertain. However, the following procedure may be adopted
in the process of Capital Budgeting.
Identification of investment proposals:
The capital budgeting process begins with the identification of investment
proposals. The proposal about potential investment opportunities may originate
either from top management or from any officer of the organization. The
departmental head analysis the various proposals in the light of the corporate
strategies and submits the suitable proposals to the capital expenditure planning.
Screening Proposals:
The expenditure planning committee screens the various proposals received
from different departments. The committee views these proposals from various
angles to ensure that these are in accordance with the corporate strategies, or
selection criterion of the firm and also do not lead departmental imbalances.
Evaluation of Various Proposals:
The next step in the capital budgeting process is to various proposals. The
methods, which may be used for this purpose such as, pay back period method,
Rate of return method, N.P.V and I.R.R etc.
Fixing Priorities:
After evaluating various proposals, the unprofitable uneconomical proposal may
be rejected but may not be possible for the firm to invest immediately in all the
42

acceptable proposals due to limitation of funds. Therefore, it essential to rank

the projects/proposals after considering urgency, risk and profitability involved
there in.

FINAL APPROVAL AND PREPERATION OF CAPITAL

EXPENDITURE BUDGET:
Proposals meeting the evaluation and other criteria are finally approved to be
included in the capital expenditure budget. The expenditure budget lays down
the amount of estimated expenditure to be incurred on fixed assets during the
budget period.
Implementing Proposals:
Preparation of a capital expenditure budget and incorporation of a particular
proposal in the budget doesnt itself authorize to go ahead with the
implementation of the project. A request for authority to spend the amount
should be made to the capital expenditure committee, which reviews the
profitability of the project in the changed circumstances. Responsibilities should
be assigned while implementing the project in order to avoid unnecessary
delays and cost overruns. Network techniques like PERT and CPM can be
applied to control and monitor the implementation of the projects.

Performance Review:
The last stage in the process of capital budgeting is the evaluation of the
performance of the project. The evaluation is made by comparing actual and
budgeted expenditures and also by comparing actual anticipated returns. The
unfavorable variances, if any should be looked in to and the causes of the same
be identified so that corrective action may be taken in future.
43

METHODS OR TECHNIQUES OF CAPITAL BUDGETING:

There are many methods for evaluating the profitability of investment
proposals. The various commonly used methods are
TECHNIQUES OF CAPITAL BUDGETING

Traditional Methods
1. Pay back
2. Accounting rate of return

Time adjusted methods

1.N.P.V
2.I.R.R
3.P.I

Traditional methods:
(I) Payback period method (P.B.P)
(II) Accounting Rate of return method (A.R.R)
Time adjusted or discounting techniques:
(I) Net Present value method (N.P.V)
(II) Internal rate of return method (I.R.R)
(III) Profitability index method (P.I)

44

1. PAY-BACK PERIOD METHOD:

The pay back some times called as payout or pay off period method represents
the period in which total investment in permanent assets pay back itself. This
method is based on the principle that every capital expenditure pays itself back
with in a certain period out of the additional earnings generated from the capital
assets.
Decision rule:
A project is accepted if its payback period is less than the period specific
decision rule.
A project is accepted if its payback period is less than the period specified by
the management and vice-versa.
Pay Back Period

Initial Cash Outflow

= -----------------------------Annual Cash Inflows

ADVANTAGES:
Simple to understand and easy to calculate.
It saves in cost; it requires lesser time and labour as compared to other
methods capital budgeting.
In this method, as a project with a shorter pay back period is preferred
to the one having a longer pay back period, it reduces the loss through
obsolescence.
Due to its short-term approach, this method is particularly suited to a
firm which has shortage of cash or whose liquidity position is not
good.
DISADVANTAGES:

45

 It does not take into account the cash inflows earned after the pay back
period and hence the true profitability of the project cannot be
correctly assessed.
This method ignores the time value of the money and does not
consider the magnitude and timing of cash inflows.
It does not take into account the cost of capital, which is very
important in making sound investment decisions.
It is difficult to determine the minimum acceptable pay back period,
which is subjective decision.
It treats each asset individually in isolation with other assets, which is
not feasible in real practice.

2.ACCOUNTING RATE OF RETURN METHOD:

This method takes into account the earnings from the investment over the whole
life. It is known as average rate of return method because under this method the
concept of accounting profit (NP after tax and depreciation) is used rather than
cash inflows. According to this method, various projects are ranked in order of
the rate of earnings or rate of return.
Decision rule:
The project with higher rate of return is selected and vice versa.
The return on investment method can be used in several ways, as
Average Rate of Return Method:

46

Under this method average profit after tax and depreciation is calculated and
then it is divided by the total capital out lay.

Average rate of return

Average Annual profits (after dep. & tax)

---------------------------------------------------x 100
Net Investment

ADVANTAGES:
It is very simple to understand and easy to calculate.
It uses the entire earnings of a project in calculating rate of return and
hence gives a true view of profitability.
As this method is based upon accounting profit, it can be readily
calculated from the financial data.
DISADVANTAGES:
It ignores the time value of money.
It does not take in to account the cash flows, which are more important
than the accounting profits.
It ignores the period in which the profits are earned as a 20% rate of
return in
2 years is considered to be better than 18% rate if return in 12 years.
This method cannot be applied to a situation where investment in
project is to be made in parts.
3. NET PRESENT VALUE METHOD:
The NPV method is a modern method of evaluating investment proposals. This
method takes in to consideration the time value of money and attempts to
calculate the return on investments by introducing time element.

The net

47

present values of all inflows and outflows of cash during the entire life of the
project is determined separately for each year by discounting these flows with
firms cost of capital or predetermined rate. The steps in this method are
1. Determine an appropriate rate of interest known as cut off rate.
2.
Compute the present value of cash outflows at the above-determined
discount rate.
3. Compute the present value of cash inflows at the predetermined rate.
4. Calculate the NPV of the project by subtracting the present value of cash
outflows
From present value of cash inflows.
Decision rule
Accept the project if the NPV of the project is 0 or +ve that is present value of
cash inflows should be equal to or greater than the present value of cash
outflows.

ADVANTAGES:
It recognizes the time value of money and is suitable to apply in a
situation with

uniform cash outflows and uneven cash inflows.

It takes in to account the earnings over the entire life of the project and
gives the true view of the profitability of the investment
Takes in to consideration the objective of maximum profitability.
DISADVANTAGES:
More difficult to understand and operate.

48

 It may not give good results while comparing projects with unequal
investment of funds.
It is not easy to determine an appropriate discount rate.

4. INTERNAL RATE OF RETURN METHOD

The internal rate of return method is also a modern technique of capital
budgeting that takes in to account the time value of money. It is also known as
time-adjusted rate of return or trial and error yield method. Under this method
the cash flows of a project are discounted at a suitable rate by hit and trial
method, which equates the net present value so calculated to the amount of the
investment. The internal rate of return can be defined as that rate of discount at
which the present value of cash inflows is equal to the present value of cash
outflows.
Decision Rule:
Accept the proposal having the higher rate of return and vice versa.
If IRR>K, accept project.
If IRR<K, reject project.

K = cost of capital.

DETERMINANTION OF IRR
a) When annual cash flows are equal over the life of the asset.
Initial Outlay
FACTOR = --------------------------- x 100
Annual Cash Inflow
b) When the annual cash flows are unequal over the life of the asset:
Pv of cash inflows at lower rate - Pv of cash outflows
IRR = LR + ------------------------------------------------------------------------- (hr-lr)

49

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

The steps are involved here are
1. Prepare the cash flow table using assumed discount rate to discount the
net cash
Flows to the present value.
2. Find out the NPV, & if the NPV is positive, apply higher rate of discount.
3. If the higher discount rate still gives a positive NPV, increase the discount
rate further. Until the NPV becomes zero.
4. If the NPV is negative, at a higher rate, NPV lies between these two rates.
ADVANTAGES:
It takes into account, the time value of money and can be applied in
situations with even and even cash flows.
It considers the profitability of the projects for its entire economic life.
The determination of cost of capital is not a pre-requisite for the use of
this method.
It provides for uniform ranking of various proposals due to the percentage
rate of return.
This method is also compatible with the objective of maximum
profitability.
DISADVANTAGES:
It is difficult to understand and operate.
The results of NPV and IRR methods may differ when the projects under
evaluation differ in their size, life and timings of cash flows.
This method is based on the assumption that the earnings are reinvested
at the IRR for the remaining life of the project, which is not a justified
assumption.
50

PROFITABILITY INDEX METHOD OR BENEFIT COST RATIO

METHOD:It is also a time-adjusted method of evaluating the investment proposals. PI also
called benefit cost ratio or desirability factor is the relationship between present
value of cash inflows and the present values of cash outflows. Thus
PV of cash inflows
Profitability index = -----------------------------PV of cash outflows
NPV
Net profitability index = ----------------------------Initial Outlay

ADVANTAGES:
Unlike net present value, the profitability index method is used to rank
the projects even when the costs of the projects differ significantly.
It recognizes the time value of money and is suitable to applied in a
situation with uniform cash outflows and uneven cash inflows.
It takes into an account the earnings over the entire life of the project and
gives the true view of the profitability of the investment.
Takes into consideration the objective of maximum profitability.
DISADVANTAGES:
More difficult to understand and operate.

51

 It may not give good results while comparing projects with Unequal
investment funds.
It is not easy to determine and appropriate discount rate.
It may not give good results while comparing projects with unequal lives
as the project having higher NPV but have a longer life span may not be
as desirable as a project having some what lesser NPV achieved in a
much shorter span of life of the asset

52

53

DATA ANALYSIS

INVESTMENT EVALUATION CRITERIA

Three steps are involved in the evaluation of an investment:

Estimation of Cash Flows.

Estimation of the required rate of return.

Application of a decision rule for making the choice.

The investment decision rules may be referred to as capital budgeting

techniques or investment criteria. A sound appraisal technique should be used
to measure the economic worth of the investment project.

The essential

property of a sound technique is that it should maximize the shareholders

wealth.
A number of capital budgeting techniques are used in practice. They may be
grouped as follows:

Pay back period

Average rate of return (ARR)

Net Present Value (NPV)

Internal rate of return (IRR)

Profitability Index

All these methods of capital budgeting techniques are explained in detail below:

54

PAY BACK PERIOD:

The pay back period is one of the most popular and widely recognized
traditional methods of evaluating investment proposals. It is defined as the
number of years required in a project. If the project generates constant annual
cash inflows, the payback period can be computed by the following formulae:
Initial Investment
Pay Back period = ----------------------------------Annual Cash Flows

In case of unequal cash inflows, the pay back period can be computed by
calculating the cumulative cash inflow and checking weather the values are
recovered to the original outlay and taking the remaining amount and apply the
formulae i.e.,
Required CFAT
PBP = base year + ---------------------------Next year CFAT
ACCEPTANCE RULE:
Many firms use the payback period as an accept for reject criterion as well as a
method of ranking projects. If the payback period calculated for a project is less
than the maximum or standard pay back period set by management, it would be
accepted, if not, it would be rejected. As a ranking method, it gives highest

55

ranking to the project, which has the shortest payback period and lowest ranking
to the project, which has highest payback period.

56

STATEMENT SHOWING CALCULALTION OF PAY BACK PERIOD

YEAR ROE

INC

TAX

PAT

DEP

58.8
58.8

10.95
10.95

69.75
69.75

237.75

58.8

10.95

58.8

10.95

58.8

10.95

58.8

10.95

58.8

10.95

58.8

10.95

58.8

10.95

58.8

10.95

168.00 237.75
237.75
168.00
237.75
168.00
237.75
168.00
237.75
168.00
237.75
168.00
237.75
168.00
237.75
168.00
237.75
168.00
237.75
168.00

2433.28

2
3
4
5
6
7
8
9
10
11
12
13
14
15
16
17
18
19
20
21
22
23
24
25

58.8
58.8
58.8
58.8
58.8
58.8
58.8
58.8
58.8
58.8
58.8
58.8
58.8
58.8
58.8

5.48
5.48
5.48
5.48
5.48
5.48
5.48
5.48
5.48
5.48
5.48
5.48
5.48
5.48
5.48

Base Year = 8h year

0
0
0
0
0
0
0
0
0

69.75
69.75
69.75
69.75
69.75
69.75
69.75
69.75

CFAT CCFAT

22.5
22.5

41.78
41.78

14.00
14.00

55.78
55.78

22.5

41.78

14.00

55.78

22.5

41.78

14.00

55.78

22.5

41.78

14.00

55.78

22.5

41.78

14.00

55.78

22.5

41.78

14.00

55.78

22.5

41.78

14.00

55.78

22.5

41.78

14.00

55.78

22.5

41.78

14.00

55.78

22.5

41.78

14.00

55.78

22.5

41.78

14.00

55.78

22.5

41.78

14.00

55.78

14.00

55.78

14.00

55.78

22.5
22.5

41.78
41.78

475.00
713.25
951.00
1188.75
1426.50
1664.25
1902.00
2139.75
2377.50
2489.06
2544.84
2600.62
2656.40
2712.18
2767.96
2823.74
2879.52
2935.30
2991.08
3046.86
3102.64
3158.42
3214.20

Required CFAT = 198

57

Next year CFAT = 237.75

2100 1902
Pay back period = 9 year + --------------------------237.75
th

= 8th year + 0 .83yr

= 8.83 years.

Interpretation:
As per pay back period, the project is accepted because to get the initial
investment of 2100 crores, it is taking a time of 8.83 years. So the project can be
accepted.

2.AVERAGE RATE OF RETURN:

The Average Rate of Return (ARR) is also known as Accounting Rate of Return
using accounting information, as revealed by financial statements, to measure
the profitability of an investment. The accounting rate of return is found out by
dividing the average after tax profit by the average investment. The average
investment would be equal to half of the original investment, if it is depreciated
constantly. The Accounting rate of return can be calculated by the following
formula i.e.,
Annual Average Profit after Tax
A.R.R. = ---------------------------------------------- X 100
Annual Average Investment

58

STATEMENT SHOWING CALCULATION OF AVERAGE RATE OF

RETURN
YEAR
1
2
3
4
5
6
7
8
9
10
11
12
13
14
15
16
17
18
19
20
21
22
23
24
25
Total

ROE
58.8
58.8
58.8
58.8
58.8
58.8
58.8
58.8
58.8
58.8
58.8
58.8
58.8
58.8
58.8
58.8
58.8
58.8
58.8
58.8
58.8
58.8
58.8
58.8
58.8

INC
10.95
10.95
10.95
10.95
10.95
10.95
10.95
10.95
10.95
10.95
5.48
5.48
5.48
5.48
5.48
5.48
5.48
5.48
5.48
5.48
5.48
5.48
5.48
5.48
5.48

TAX
0
0
0
0
0
0
0
0
0
0
22.5
22.5
22.5
22.5
22.5
22.5
22.5
22.5
22.5
22.5
22.5
22.5
22.5
22.5
22.5

PAT
69.75
69.75
69.75
69.75
69.75
69.75
69.75
69.75
69.75
69.75
41.78
41.78
41.78
41.78
41.78
41.78
41.78
41.78
41.78
41.78
41.78
41.78
41.78
41.78
41.78
1324.20

CALCULATION OF ARR:
59

Average NPAT

= 1324.2/25

Average Investment
ARR

52.968
= ---------- X 100
1050

= 2100/2

52.968.
=

1050

= 5.04%

Interpretation:
From the point of ARR method, project should be accepted, as its ARR is less
than the required rate return (5.04% < 12%).

60

NET PRESENT VALUE:

The Net present value (NPV) method is the classic economic method of
evaluating the investment proposals. It is one of the discounted cash flow
techniques explicitly recognizing the time value of money.

It correctly

postulates that cash flows arising at different time periods differ in value and the
comparable only when their equivalents present values are found out.
The following steps are involved in the calculation of NPV.

Cash flows of the investment project should be forecasted based on

realistic assumptions.

Appropriate discount rate should be identified to discount the

forecasted cash flow.

The appropriate discount rate is the firms

opportunity cost capital, which is equal to the required rate of return,

expected by investors on investments of equivalent risk.

Present value of cash flows should be calculated using opportunity cast

of capital as the discount rate.

Net present value should be found out by subtracting present value of

cash outflow present value of cash inflow.

61

Acceptance Rule:
The project should be accepted if NPV is positive it should be clear that the
acceptance rule using NPV method is to accept the investment project if its net
present value is negative (NPV CASH OUTFLOW). The positive net present
value will result only if the project generates cash inflows at rate higher than the
opportunity cost of capital.
A project may be accepted in NPV = 0.

Thus, the NPV acceptance rules are:

Accept if NPV >0
Reject if NPV <0
Ill-defined if NPV = 0.

62

63

STATEMENT SHOWING CALCULATION OF NET PRESENT VALUE

YR ROE
0
1
2
3
4
5
6
7
8
9
10
11
12
13
14
15
16
17
18
19
20
21
22
23
24
25

58.8
58.8
58.8
58.8
58.8
58.8
58.8
58.8
58.8
58.8
58.8
58.8
58.8
58.8
58.8
58.8
58.8
58.8
58.8
58.8
58.8
58.8
58.8
58.8
58.8

INC

TAX

PAT

DEP

CFAT

10.95
10.95
10.95
10.95
10.95
10.95
10.95
10.95
10.95
10.95

0
0
0
0
0
0
0
0
0
0
22.5
22.5
22.5
22.5
22.5
22.5
22.5
22.5
22.5
22.5
22.5
22.5
22.5
22.5
22.5

69.75
69.75
69.75
69.75
69.75
69.75
69.75
69.75
69.75
69.75

168.00
168.00
168.00
168.00
168.00
168.00
168.00
168.00
168.00
168.00

237.75
237.75
237.75
237.75
237.75
237.75
237.75
237.75
237.75
237.75

41.78
41.78
41.78
41.78
41.78
41.78
41.78
41.78
41.78
41.78
41.78
41.78
41.78

14.00
14.00
14.00
14.00
14.00
14.00
14.00
14.00
14.00
14.00
14.00
14.00
14.00
14.00
14.00

55.78
55.78
55.78
55.78
55.78
55.78
55.78
55.78
55.78
55.78
55.78
55.78
55.78
55.78
55.78

5.48
5.48
5.48
5.48
5.48
5.48
5.48
5.48
5.48
5.48
5.48
5.48
5.48
5.48
5.48

41.78
41.78

PV@
12%
1.000
0.893
0.797
0.712
0.636
0.567
0.507
0.452
0.404
0.361
0.322
0.287
0.257
0.229
0.205
0.183
0.163
0.146
0.130
0.116
0.104
0.093
0.083
0.074
0.066
0.059

PV
CFAT
212.31
189.49
169.28
151.21
134.80
120.54
107.46
96.05
85.83
76.56
16..01
14.34
12.77
11.43
10.21
9.09
8.14
7.25
6.47
5.80
5.18
4.63
4.13
3.68
3.29
1465.97

CASH
O.F
420.00
168.00
168.00
168.00
168.00
168.00
168.00
168.00
168.00
168.00
168.00
0
0
0
0
0
0
0
0
0
0
0
0
0
0
0

PV OF
COF
420.00
150.02
133.90
119.62
106.85
95.26
85.18
75.94
67.87
60.65
54.10
0
0
0
0
0
0
0
0
0
0
0
0
0
0
0
1369.39

64

Present value of cash inflow = 1465.97

Present value of cash outflow = 1369.39
Net Present Value = 1465.97- 1369.39 = 96.58 crores
Interpretation:
As NPV is positive, the project is accepted.

65

PROFITABILITY INDEX:
It is also called as Benefit Cost Ratio. It is also a time-adjusted method of
evaluating the investing proposals. It is the relationship between present value
of cash inflows and the present value of cash outflows. Thus

STATEMENT SHOWING CALCULATION OF PROFITABILITY INDEX

YR ROE
0
1
2
3
4
5
6
7
8
9
10
11
12
13
14
15
16
17
18
19
20
21
22
23
24
25

58.8
58.8
58.8
58.8
58.8
58.8
58.8
58.8
58.8
58.8
58.8
58.8
58.8
58.8
58.8
58.8
58.8
58.8
58.8
58.8
58.8
58.8
58.8
58.8
58.8

INC

TAX

PAT

DEP

CFAT

10.95
10.95
10.95
10.95
10.95
10.95
10.95
10.95
10.95
10.95

0
0
0
0
0
0
0
0
0
0
22.5
22.5
22.5
22.5
22.5
22.5
22.5
22.5
22.5
22.5
22.5
22.5
22.5
22.5
22.5

69.75
69.75
69.75
69.75
69.75
69.75
69.75
69.75
69.75
69.75
41.78
41.78
41.78
41.78
41.78
41.78
41.78
41.78
41.78
41.78
41.78
41.78
41.78
41.78
41.78

168.00
168.00
168.00
168.00
168.00
168.00
168.00
168.00
168.00
168.00

237.75
237.75
237.75
237.75
237.75
237.75
237.75
237.75
237.75
237.75

14.00
14.00
14.00
14.00
14.00
14.00
14.00
14.00
14.00
14.00
14.00
14.00
14.00
14.00
14.00

55.78
55.78
55.78
55.78
55.78
55.78
55.78
55.78
55.78
55.78
55.78
55.78
55.78
55.78
55.78

5.48
5.48
5.48
5.48
5.48
5.48
5.48
5.48
5.48
5.48
5.48
5.48
5.48
5.48
5.48

PV@
12%
1.000
0.893
0.797
0.712
0.636
0.567
0.507
0.452
0.404
0.361
0.322
0.287
0.257
0.229
0.205
0.183
0.163
0.146
0.130
0.116
0.104
0.093
0.083
0.074
0.066
0.059

PV OF
CFAT
212.31
189.49
169.28
151.21
134.80
120.54
107.46
96.05
85.83
76.56
16..01
14.34
12.77
11.43
10.21
9.09
8.14
7.25
6.47
5.80
5.18
4.63
4.13
3.68
3.29
1465.97

CASH
O.F
420.00
168.00
168.00
168.00
168.00
168.00
168.00
168.00
168.00
168.00
168.00
0
0
0
0
0
0
0
0
0
0
0
0
0
0
0

PV OF
COF
420.00
150.02
133.90
119.62
106.85
95.26
85.18
75.94
67.87
60.65
54.10
0
0
0
0
0
0
0
0
0
0
0
0
0
0
0
1369.39

66

PV of cash inflows
Profitability Index = -------------------------PV of cash out flows
NPV
Net Profitability Index = -------------------------Initial cash outlay
From the above table calculated values are
Present value of cash inflow = 1465.97
Present value of cash outflow = 1369.39

Profitability Index

Net Profitability Index

1465.97
= ------------------1369.39
=

1.071

96.58
--------------1369.39

0.071

67

INTERNAL RATE OF RETURN

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

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

IRR = LR+ ------------------------------------------------------------------------ (hr-lr)
Pv of cash inflows at lower rate-Pv of cash inflows at higher rate
WHERE,
Lr = Rate of interest that is lower of the two rates at which PV of Cash inflows
have been
Calculated.
Hr= Rate of interest that is higher of the two rates at which PV of Cash
inflows have been Calculated.

68

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

69

STATEMENT SHOWING THE CALCULATIONS OF INTERNAL RATE

OF RETURN

YR
1
2
3
4
5
6
7
8
9
10
11
12
13
14
15
16
17
18
19
20
21
22
23
24
25

ROE
58.8
58.8
58.8
58.8
58.8
58.8
58.8
58.8
58.8
58.8
58.8
58.8
58.8
58.8
58.8
58.8
58.8
58.8
58.8
58.8
58.8
58.8
58.8
58.8
58.8

INC
10.95
10.95
10.95
10.95
10.95
10.95
10.95
10.95
10.95
10.95
5.48
5.48
5.48
5.48
5.48
5.48
5.48
5.48
5.48
5.48
5.48
5.48
5.48
5.48
5.48

TAX
0
0
0
0
0
0
0
0
0
0
22.5
22.5
22.5
22.5
22.5
22.5
22.5
22.5
22.5
22.5
22.5
22.5
22.5
22.5
22.5

PAT
69.75
69.75
69.75
69.75
69.75
69.75
69.75
69.75
69.75
69.75

DEP
168.00
168.00
168.00
168.00
168.00
168.00
168.00
168.00
168.00
168.00

CFAT
237.75
237.75
237.75
237.75
237.75
237.75
237.75
237.75
237.75
237.75

41.78
41.78
41.78
41.78
41.78
41.78
41.78
41.78
41.78
41.78
41.78
41.78
41.78
41.78
41.78

14.00
14.00
14.00
14.00
14.00
14.00
14.00
14.00
14.00
14.00
14.00
14.00
14.00
14.00
14.00

55.78
55.78
55.78
55.78
55.78
55.78
55.78
55.78
55.78
55.78
55.78
55.78
55.78
55.78
55.78

PV @
12%
0.893
0.797
0.712
0.636
0.567
0.507
0.452
0.404
0.361
0.322
0.287
0.257
0.229
0.205
0.183
0.163
0.146
0.130
0.116
0.104
0.093
0.083
0.074
0.066
0.059

PV OF
PV @
CFAT@12% 13%
212.31
0.885
189.49
0.783
169.28
0.693
151.21
0.613
134.80
0.543
120.54
0.480
107.46
0.425
96.05
0.376
85.83
0.333
76.56
0.295
16..01
0.261
14.34
0.231
12.77
0.204
11.43
0.181
10.21
0.160
9.09
0.141
8.14
0.125
7.25
0.111
6.47
0.098
5.80
0.087
5.18
0.077
4.63
0.068
4.13
0.060
3.68
0.053
3.29
0.047

PV OF
CFAT@13%
210.41
186.16
164.76
145.74
129.10
114.12
101.04
89.39
79.17
70.14
14.56
12.89
11.38
10.10
8.92
7.86
6.97
6.19
5.47
4.85
4.30
3.79
3.35
3.00
2.62

1465.97

1396.26

70

Therefore, IRR

PV @ L R - C O F
LR + --------------------------------- x Rate Difference
PV @ L R - PV @ H R

1465.97 1369.39
12% + ------------------------- x 1
1465.97 1396.26

96.58
12% + --------- x 1=12% + 1.39%=13.39%
69.71

Interpretation:
Therefore, IRR lies at 13.39%. It is a point where outflow = inflow.
And IRR>K, Therefore it is accepted.

WORKINGS
71

ROE

420 x 14% =

58.8

Incentive
Pisa

Difference of Standard capacity - Actual capacity x 0.25

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

Standard capacity = ------------------------------------------------------------x plf
1000
500 MW x 24 x 365
For the first 10 y = --------------------------- X 90 %
1000

= 3942

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

= 3723

For the years

(11 25y)

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

Actual capacity = ------------------------------------------------------------ x plf %
1000
500 MW x 24 x 365
= --------------------------1000

X 80 %

= 3504

Therefore, Incentive
For the first 10 y = (3942 3504) x 0.25

109.5 = 10.95
10

for the years =

(11 25y)

54.75 = 5.48
10

(3723 3504) x 0.25

72

Depreciation

80% of CC = 2100 x 80% = 1680

Which is paid in 10 equal installments = 1680 / 10 = 168

And balance 10% = 210 which is paid in 15 equal installments = 210 / 15 = 14
Tax

35 % of ( ROE + incentive) = 22.5

Note: For the first 10 years tax holiday

73

74

FINDINGS:
The power sector is a service sector which falls in basic infrastructure sector the
motto of investment is to serve the society rather than profit making hence the
social cost benefit analysis method to be followed.

The net present value of VTPS-IV is satisfactory.

The internal rate of return of VTPS-IV is considerably high.

The VTPS-IV will take long period to recover the initial investment.

The profitability index is to meet company objectives.

The average rate of return is very less because the motto is not to earn
profits. This is compensated by good benefits to the society.

As discussed in earlier chapter APGENCO follows, systems and

procedures as per the Andhra Pradesh State Electricity Act, accordingly
project initiative is taken up.

While preparing project financing APGENCO considers Social benefit of

the state.

APGENCO generates the power based on requirement of APTRANSCO.

The projects life is expected to be 25 years; due to this the gestation

period is very high.

The entire project is financed by the power financial institutions like

(PFC, REC).

The major portion of finance is done through secured loans.

The unit cost and other expenditures are eligible to claim from the
potential buyer as approved by the Regulatory Commission.

75

76

SUGGESTIONS

Company should go for the improvement in the technology to improve

efficiency and to decrease the cost of production per unit

For society with lower income levels or below poverty line company
should go for subscribed rates and for industries it should increase its rate
marginally to cover the losses.

The subscribed cost in future should be reduced.

The risk is associated with the project, since the generation period is high.

Government of AP should provide notional debt equity.

Better technical management will reduce the auxiliary consumption.

77