capital budgeting of opgc ltd

A Project ReportOn

“CAPITAL BUDGETING”

Of

Odisha Power Generation Corporation Ltd.

(Submitted for the Partial Fulfillment of the Requirements of Master of Business Administration

Programme under Utkal University)

Submitted By:Ashish Kumar Sahoo

Roll No- 13-MBA-004(13209V132014)

Faculty Guide: Corporate Guide:

Dr. (Mr) Dasarathi Sahu Mr. Gyanendra Mishra

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ACKNOWLEDGEMENT

Words are indeed inadequate to convey my deep sense of gratitude to all those who have

helped me in completing this summer project to the best of my ability. Being a part of this

project has certainly been a unique and a very productive experience on my part.

I would like to express my sincere gratitude to Sri B.B. Mishra (HOD, Department of

Business Administration, Utkal University) for helping me complete the project in a

successful manner.

I am really thankful to Sri Basant Kumar (Training & Placement Officer, Department

of Business Administration, Utkal University) for giving me the opportunity to work in

my preferred choice of esteemed organization, and assisting me in this project and sharing

his valuable suggestions and experience for the completion of the same.

I would also like to thank my guide Dr. (Mr) Dasarathi Sahu (Lecturer, Department of

Business Administration, Utkal University) for making all kinds of arrangements to carry

out the project successfully and for providing her constant guidance and help to solve all

kinds of queries regarding the project work. His systematic way of working and

incomparable guidance has inspired the pace of the project to a great extent.

Last, but not the least, I would like to thank all the Teachers & Staff Members of MBA

Department, Utkal University for their moral support and help in all respects for the

completion of my work.

Above all in my heart I am quite thankful to my parents, friends, etc whose support directly

or indirectly went into the successful completion of the project.

Ashish Kumar Sahoo

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DECLARATION

I, Ashish Kumar Sahoo, student of Department of Business Administration, Utkal University hereby declare that the project entitled “CAPITAL BUDGETING” is the record of authentic work carried out by me, during the academic year 2013- 2014 and has not been submitted to any other university or institutes towards the award of any other degree.

An attempt has been made by me to provide all relevant and important details regarding the topic to support the theoretical edifice with concrete research evidence. This will be helpful to clean the fog surrounding the various aspects of the topic.

I hope that this project will be beneficial for the organization.

Bhubaneswar Name: Ashish Kumar Sahoo

Roll No.: 13MBA004 (13209V132014)

Department of Business Administration

Utkal University, Vani Vihar

Bhubaneswar

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C E R T I F I C A T E

This is to certify that the report of the project submitted is an outcome of the Summer

Internship Training entitled “Capital Budgeting” carried out by Ashish Kumar Sahoo,

bearing Roll No.: 13MBA004 (13209V132014) under my guidance and supervision for

the partial fulfillment of MBA under Department of Business Administration, Utkal

University, Vani Vihar, Bhubaneswar (Odisha), India.

To the best of my knowledge the report,

1. Embodies the work of the candidate himself.

2. Has duly been completed.

3. Fulfils the requirement of the Ordinance relating to the MBA degree of the

University and,

4. Is up to the desired standard for the purpose of which is submitted.

Name: Dr. (Mr) Dasarathi Sahu

Designation: Lecturer

Utkal University

Vani Vihar

Bhubaneswar (Odisha)

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TO WHOMSOEVER IT MAY CONCERN

This is to certify that Mr Ashish Kumar Sahoo has successfully completed the project

work titled “Capital Budgeting” in partial fulfilment of the requirement for the summer

training of Master of Business Administration in Department of Business

Administration Utkal University, Vani Vihar, Bhubaneswar (Odisha) under my

supervision from 2nd May, 2014 to 30th June, 2014

Signature of the Mentor

(Mr. Gyanendra Mishra)

Date:

Place: OPGC LTD.,

Zone-A, 7th Floor,

Fortune Tower,

BBSR-751004

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INDEX

S. No: CONTENTS PAGE NO.

CHAPTER-1 6 - 14

Introduction

Objectives of the study

Need of the study

Scope of the study

Importance of the study

Limitations of the study

Methodology

CHAPTER-2 15 - 35

Review of Literature

CHAPTER-3 36 - 43

Company profile

CHAPTER-4 44 - 56

Data Analysis and Interpretation

CHAPTER-5 57 - 71

Findings

Suggestions

Conclusion

Bibliography

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CHAPTER-1

INTRODUCTION

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INTRODUCTION

Capital budgeting is an essential part of every company’s financial management. Capital

budgeting is a required managerial tool. One duty of financial manager is to choose

investment with satisfactory cash flows with high returns. Therefore a financial manager

must be able to decide whether an investment is worth undertaking and able to decide

and be able to choose intelligently between two or more alternatives.

Capital budgeting involves the planning and control of capital expenditure. It is the process

of deciding whether or not to commit resources to a particular long term project whose

benefits are to be realized over a period of time.

A capital budgeting decision is defined as the firms decision to invest its current funds

efficiently in the long-term assets in anticipation of an expected flow of benefits over a

series of years. The firm’s investment decisions would generally include expansion,

acquisition, modernization, and replacement of the long-term assets. They are the

assessment of future events, which are difficult to predict. It is really complex problem to

estimate the future cash flow of an investment.

The investment decision of a firm is generally know as Capital Budgeting or Capital

Expenditure Decision. Capital budgeting is also known as “Investment Decision Making”,

“Capital Expenditure Decisions”, “Planning Capital Expenditure” and “Analysis of Capital

Expenditure.

“Capital budgeting is finance terminology for the process of deciding whether or not to

undertake an investment project.”

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A logical prerequisite to the analysis of investment opportunities is the creation of

investment opportunities. Unlike the field of investments, where the analyst more or less

takes the investment opportunity set as a given, the field of capital budgeting relies on the

work of people in the areas of industrial engineering, research and development, and

management information systems (among others) for the creation of investment

opportunities. As such, it is important to suggest that students keep in mind the

importance of creativity in this area, as well as the importance of analytical techniques.

Budgeting requires the company to look ahead and formalize future goals. It is the

planning process used to determine whether an organization’s long term investments such

as new machinery, replacement machinery, new plants, new products, and research

development projects are worth pursuing. It is budget for major capital, or investment,

expenditures.

Capital budgeting techniques based on accounting earnings and accounting rules are

sometimes used - though economists consider this to be improper - such as the accounting

rate of return, and “return on investment.”

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OBJECTIVES OF THE STUDY

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

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

To analyze the present value of rupee invested.

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

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

finance.

To understand the practical usage of capital budgeting techniques.

To understand the nature of risk and uncertainty.

To analyze the strengths and weakness of existing Techniques in capital

budgeting.

To measure the profitability of the project by considering all cash flows.

To make recommendations and to improve further process of capital budgeting.

To evaluate capital projects using traditional methods of investment appraisal and

discounted cash flows methods.

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NEED FOR THE STUDY

The project study is undertaken to analyze and understand the Capital Budgeting

process in ODISHA POWER GENERATION CORPORATION LTD, which gives mean

exposure to practical implication of theory knowledge.

To know about the company’s operations of using various Capital budgeting

techniques.

To know how the company gets funds from various resources.

The financial department can implement and can get positive results by

maintaining proper financial reports.

To analyze the proposal for expansion or creating additional capacities.

To make financial analysis of various proposals regarding capital investment so as

to choose the best out of many alternatives proposals.

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SCOPE OF THE STUDY

“Preparation of capital budgeting is an important tool for

efficient

and effective managerial decisions.”

So in every organization they have to examine the capital budgeting process, therefore the

financial manager must be able to decide whether an investment is worth undertaking and

able to decide and be able to choose intelligently between two or more alternatives.

The process by which company’s appraise investment decision, in particular by

which capital resources are allocated to specific projects.

Capital budgeting requires firms to account for the time value of money and project

risk, using a variety of more or less formal techniques.

Capital budgeting decisions affect the profitability in terms of interest of the firm.

They also have a bearing on the competitive position of the enterprise. It’s a

diversification burden.

Capital investment involves cost and the majority of the firms have scarce capital

resources.

Capital budgeting is a complex process as it involves decisions relating to the

investment of huge resources for the benefit of achievement in future as it is

always uncertain.

Understanding the importance of the capital budgeting in Odisha Power Generation

Corporation Ltd.

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IMPORTANCE OF THE STUDY

Capital budgeting is of paramount important in financial decision making:

Decisions affect the probability of the firm, as they also have a bearing on the

competitive positions of the enterprises.

A capital expenditure decision has its effect over a long time and inevitable affect’s

the company future cost structure.

The capital investments firm acquires the long-lived assets that generate the firm’s

future cash flows and determine its level of profitability.

Proper capital budgeting analysis is critical to a firm’s successful performance

because capital investments decisions can improve cash flows.

Capital investment involves cost of majority of the firms have scarce capital

resources.

Capital decisions are not easily reversible, without much financial loss to the firm.

To make financial analysis of various proposals regarding capital investment so as

to choose the best out of many alternatives proposals.

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LIMITATION OF THE STUDY :

Lack of time is the major limiting factor, i.e., the schedule period of 6 weeks are not

sufficient to make the study independently regarding Capital Budgeting in OPGC

Ltd.

The busy schedule of the officials in the OPGC Ltd. is another limiting factor. Due to

the busy schedule time taken to collect 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.

All the techniques of capital budgeting are not used in OPGC. Therefore it was

possible to explain only few methods of capital budgeting.

The formula has been used according to the availability of the data.

Since the procedures and policies of the company does not allow disclosing of all

financial information and has to be completed with the available data collected

with the maximum effort.

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RESEARCH METHODOLOGY

SOURCES OF DATA:

The following research methodology has been adopted to achieve the aforesaid objective. The information for this report has been collected through the primary and secondary sources.

Primary sources:

Primary sources is also called as first handed information as 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 Odisha Power Generation Corporation Ltd.

Secondary sources:

These secondary data is existing data which is collected by others that is sources are financial journals, annual reports of the OPGC LTD.

Research Design:

Research design - Analytical.

Analytical tool - Capital Budgeting, analyzing the capital budgeting.

Techniques- Traditional and Modern methods.

Data Sources - Secondary data has been collected from Company records, annual

reports.

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CHAPTER – 2

REVIEW OF LITERATURE

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CAPITAL BUDGEING:

INTRODUCTION

An efficient allocation of capital is the most important finance function in modern times. It involves decisions to commit firm’s funds to long-term assets. Such decisions are tend to determine the value of company/firm by influencing its growth, profitability & risk.

Investment decisions are generally known as capital budgeting or capital expenditure decisions. It is clever decisions to invest current in long term assets expecting long-term benefits. Firm’s investment decisions would generally include expansion, acquisition, modernization and replacement of long-term assets.

Such decisions can be investment decisions, financing decisions or operating decisions. Investment decisions deal with investment of organization’s resources in Long term (fixed) Assets and / or Short term (Current) Assets. Decisions pertaining to investment in Short term Assets fall under “Working Capital Management”. Decisions pertaining to investment in Long term Assets are classified as “Capital Budgeting” decisions.

Capital budgeting decisions are related to allocation of investible funds to different long-term assets. They have long-term implications and affect the future growth and profitability of the firm.

In evaluating such investment proposals, it is important to carefully consider the expected benefits of investment against the expenses associated with it. Organizations are frequently faced with Capital Budgeting decisions. Any decision that requires the use of resources is a capital budgeting decisions. Capital budgeting is more or less a continuous process in any growing concern.

For Example: Purchase of Land is an example of Capital Budgeting decision. Similarly replacement of outdated equipment with modern machines, purchase of a brand or business, computerization and networking the organization, investment in research and development of a product launch of a major promotional campaign etc are all example of Capital Budgeting decisions.

However, in all cases, the decisions have a long-term impact on the performance of the organization. Even a single wrong decision may in danger the existence of the firm as a profitable entity.

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.,

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REVIEW OF LITERATURE

Introduction

One of the three major decisions made by managers is the decision to invest in fixed assets. Investments in fixed assets involve large capital outlays and the consequences of these investments decisions impact a firm’s operations for a very long time. Therefore a variety of quantitative and analytical techniques are applied by managers in project selection to enable them to make good decisions in this area.

Literature

It is widely accepted that discounted cash flow methods are the best way to evaluate capital budgeting proposals. While several decades ago discounted cash flow methods may not have been widely used (Istvan, 1961) more recent studies (Kim, Crick and Kim, 1986) suggest that increasingly firms are adopting discounted cash flow analysis. Much of the empirical research on capital budgeting practices adopted by corporate managers is based on US data (See for example Mukherjee and Hingorani, 1999.) A few studies such as those by Payne, Heath, and Gale (1999), Jog and Srivastava (1995) and Keste et. al (1999), examine capital budgeting practices followed by firms in different countries such as Canada, Australia, Hong Kong, Indonesia, Malaysia, Philippines and Singapore. This study examines managerial behavior and preferences with respect to the capital budgeting decision using a sample of German firms. Our unique sample and the results of our analysis help to fill a gap in finance literature and provide useful information to managers contemplating German collaborations.

Capital budgeting is the process by which firms determine how to invest their capital. Included in this process are the decisions to invest in new projects, reassess the amount of capital already invested in existing projects, allocate and ration capital across divisions, and acquire other firms. In essence, the capital budgeting process defines the set and size of a firm’s real assets, which in turn generate the cash flows that ultimately determine its profitability, value, and viability.

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In principle, a firm’s decision to invest in a new project should be made according to whether the project increases the wealth of the firm’s shareholders. For example, the Net Present value (NPV) rule specifies an objective process by which firms can assess the value that new capital investments are expected to create. As Graham and Harvey (2001) document, this rule has steadily gained in popularity since Dean (1951) formally introduced it, but its widespread use has not eliminated the human element in capital budgeting. Because the estimation of a project’s future cash flows and the rate at which they should be discounted is still a relatively subjective process, the behavioural traits of managers still affect this process.

Studies of the calibration of subjective probabilities find that individuals are overconfident in that they tend to overestimate the precision of their knowledge and information (Fischhoff, Slovic, and Lichtenstein, 1977; Alpert and Raffia, 1982). In fact, research shows that professionals from many fields exhibit overconfidence in their judgements, including investment bankers (Stael von Holstein, 1972), engineers (Kidd, 1970), entrepreneurs (Cooper, Woo, and Dunkelberg, 1988), lawyers (Wagenaar and Keren, 1986), negotiators (Neale and Bazerman,1990), and managers (Russo and Schoemaker, 1992).

Several factors may explain why managers may also be expected to be overconfident, especially in a capital budgeting context. First, capital budgeting decisions can be complex. They often require projecting cash flows for a wide range of uncertain outcomes.

Second, capital budgeting decisions are not well suited for learning. As Kahneman and Lovallo (1993, p. 18) note, learning occurs “when closely similar problems are frequently encountered, especially if the outcomes of decisions are quickly known and provide unequivocal feedback.” In most firms, managers infrequently encounter major investment policy decisions, experience long delays before learning the outcomes of projects, and usually receive noisy feedback.

Furthermore, managers often have difficulty rejecting the notion that every situation is new in important ways, allowing them to ignore feedback from past decisions altogether. Learning from experience is highly unlikely under these circumstances (Einhorn and Hogarth,1978; Brehmer, 1980).

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Third, unsuccessful managers are less likely to retain their jobs and be promoted. Those who succeed may become overconfident because of a self-attribution bias. Most people overestimate the degree to which they are responsible for their own success (Miller and Ross, 1975; Langer and Roth, 1975; Nisbett and Ross, 1980). This self-attribution bias causes successful managers to become overconfident (Daniel, Hirshleifer, and Subrahmanyam, 1998; Gervais and Odean, 2001).

Fourth, managers may be more overconfident than the general population because of a selection bias. Those who are overconfident and optimistic about their prospects as managers are more likely to apply for these jobs. Moreover, as Goel and Takor (2008) show, firms may endogenously select and promote on the basis of overconfidence, as overconfident individuals are more likely to have generated extremely good outcomes in the past. Finally, as Gervais, Heaton, and Odean (2009) argue, overconfident managers may simply be easier to motivate than their rational counterparts and so hiring them is more appealing to firms.

Reviews and Appeals of Capital Budgeting

In the corporate finance capital budgeting survey literature the capital budgeting process has been described in terms of four stages: (1) identification, (2) development, (3) selection, and (4) control. The identification stage comprises the overall process of project idea generation including sources and submission procedures and the incentives/reward system, if any. The development stage involves the initial screening process relying primarily upon cash flow estimation and early screening criteria. The selection stage includes the detailed project analysis that results in acceptance or rejection of the project for funding. Finally, the control stage involves the evaluation of project performance for both control purposes and continuous improvement for future decisions.

All four stages have common areas of interest including personnel, procedures, and methods involved, along with the rationale for each. All four stages are critical to the overall process, but the selection stage is arguably the most involved since it includes the choices of analytical methods/techniques used, how the cost of capital is determined, how adjustments for projects risks are assessed and reflected, and how, if relevant, capital rationing affects project choice. The selection stage has also been the most investigated by survey researchers, particularly in the area of selection techniques, resulting in a relative neglect of the other stages. This in turn has led to appeals to future researchers to consider the other stages in their survey research efforts.

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THEOROTICAL FRAME WORK

Introduction

Capital Budgeting may also be defined as “The decision making process by which a firm evaluates the purchase of major fixed assets. It involves firm’s decision to invest its current funds for addition, disposition, modification and replacement of fixed assets.

Features of Capital Budgeting:

The important features, which distinguish capital budgeting decisions from other day-to-day decisions, are

Capital budgeting decisions involve the exchange of current funds for the benefits to be achieved in future.

They have a long terms 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. The funds are invested in long-term assets. The future benefits will occur to the firm over a series of years.

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.

There are several factors that make capital budgeting decisions among the critical decisions to be taken by the management. The importance of capital budgeting can be understood from the following aspects of capital budgeting decisions:

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 far 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 a permanent basis. The long-term commitment of funds increases the financial risk involved in the investment decision.

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3. Irreversible nature:

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

4. Long terms effect on profitability:

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

5. Difficulties of investment decision:

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

6. National Importance:

Investment decision though taken by individual concern is of national importance because it determines employment, economic activities and economic growth of any region/country.

7. After the Capacity and Strength to Compete:

Capital budgeting decisions affect the capacity and strength of a firm to face competition. A firm may loose competitiveness if the decision to modernize is delayed.

FACTORS INFLUENCING CAPITAL EXPENDITURE DECISIONS:

There are many, factors financial as well as non financial which influence the capital expenditure decisions and the profitability of the proposal yet, there are many other factors which have to be taken into consideration while taking a capital expenditure decision. They are:

1. URGENCY:

Sometimes, an investment is to be made due to urgency for the survival of the firm or to avoid heavy losses. In such circumstances, proper evaluation cannot be made through profitability tests. Examples of such urgency are breakdown of some plant and machinery, fire accidents etc.

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2 .DEGREE OF UNCERTAINITY:

Profitability is directly related to risk, higher the profits, greater is the risk or uncertainty Sometimes, a project with some lower profitability may be selected due to constant flow of income as compared to another project with an irregular and uncertain inflow of income.

3. INTANGIBLE FACTORS:

Sometimes, a capital expenditure has to be made due to certain emotional and intangible factors such as safety and welfare of the workers, prestigious project, social welfare, goodwill of the firm etc.

4. AVAILABILITY OF FUNDS:

As the capital expenditure generally requires the provisions of law is solely influenced by this factor and although the project may not be profitable, yet the investment has to be made.

5. AVAILABILITY OF FUNDS:

As the capital expenditure generally requires large funds the availability of funds is an important factor that influences the capital budgeting decisions. A project howsoever profitable may not be taken for want of funds and a project with lesser profitability may sometimes be preferred due to lesser pay back period for want of liquidity.

6. FUTURE EARNINGS:

A project may not be profitable as compared to another today, but it may promise better future earnings. In such cases, it may be preferred to increase future earnings.

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.

1. Certainty with respect to cost & Benefits: It is very difficult to estimate the cost and benefits of a proposal beyond 2-3 years in future.

2. Profit Motive: Another assumption is that the capital budgeting decisions are taken with a primary motive of increasing the profit of the firm.

The activities can be listed as follows:

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Dis-investments i.e., sale of division or business. Change in methods of sales distribution. Undertakings an advertisement campaign. Research & Development programs. Launching new projects. Diversification. Cost reduction.

PROBLEMS & DIFFICULTIES IN CAPITAL BUDGETING:

1. Future uncertainty: Capital Budgeting decisions involve long-term commitments. 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.

2. 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 point of time. The cost of a project is incurred immediately. However, the investment is recovered over a number of years. The future benefits have to be adjusted to make them comparable with the cost. Longer the time period involved, greater would be the uncertainty.

3. Difficulty in Quantification of Impact: The finance manger may face difficulties in measuring the cost and benefits of projects in quantitative terms. Example: The new 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 product.

RISK AND UNCERTAINITY IN CAPTIAL BUDGETING:

All the techniques of Capital Budgeting require the estimation of future cash inflow and cash outflow. The cash flows are estimated, based on the following factors.

Expected economic life of the project Salvage value of the asset at the end of the economic life Capacity of the project Selling price of the product Production cost Depreciation rate Rate of taxation Future demand of the product, etc.,

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But, due to uncertainties about the future, the estimates of demand, production, sales, costs, selling price, etc cannot be exact. For example a product may become obsolete much earlier than anticipated due to unexpected technological developments.

All these elements of uncertainties have to be taken into account in the form of forcible risk while taking a decision on investment proposals. It is perhaps the most difficult task while making an investment decision. But some allowances for the element of risk have to be provided.

CAPITAL EXPENDITURE CONTROL:

Capital expenditure involves non-flexible long term commitment of funds. The success of an enterprise in the long run depends upon the effectiveness with which the management makes capital expenditure decisions. Capital expenditure decisions are very important as their impact is more or less permanent on the well being and economic health of the enterprise. Because, of its large scale mechanization and automation and importance of capital expenditure for increase in the profitability of a concern. It has become essential to maintain an effective system of capital expenditure control.

OBJECTIVES OF CONTROL OF CAPITAL EXPENDITURE:

To make an estimate of capital expenditure and to see that the total cash outlay is within the financial resources of the enterprise.

To ensure timely cash inflows for the projects so that non availability of cash may not be a problem in the implementation of the problem.

To ensure that all capital expenditure is properly sanctioned. To properly co-ordinate the projects of various departments. To measure the performance of the project. To ensure that sufficient amount of capital expenditure is incurred to keep pace

with the rapid technological development. To prevent over expansion.

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KINDS OF CAPITAL BUDGETING DECISIONS

The overall objectives of capital budgeting are to maximize the profitability of a firm or the return on investment. These objectives can be achieved either by increasing revenues or by reducing costs. This, capital budgeting decisions can be broadly classified into two categories:

1. Increase revenue,

2. Reduce costs

The first category of capital budgeting decisions is expected to increase revenue of the firm through expansion of the production capacity or size of the firm by reducing a new product line.

The second category increases the earning of the firm by reducing costs and includes decisions relating to replacement of obsolete, outmoded or worn out assets. In such cases, a firm has to decide whether to continue the same asset or replace it. The firm takes such a decision by evaluating the benefit from replacement of the asset in the form or reduction in operating costs and the cost\ cash needed for replacement of the asset.

Both categories of above decision involve investments in fixed assets but the basic difference between the two decisions are in the fact that increasing revenue investment decisions are subject to more uncertainty as compared to cost reducing investments decisions.

Further, in view of the investment proposal under consideration, capital budgeting decisions may be classified as:

1. Accept-Reject Decision:

Accept reject decisions relate independent projects do not compute with one another. Such decisions are generally taken on the basis of minimum return on investment. All those proposals which yield a rate of return higher than the minimum required rate of return of capital are accepted and the rest rejected. If the proposal is accepted the firm makes investment in it, and if it is rejected the firm does not invest in the same.

2. Mutually Exclusive Project Decision:

Such decisions relate to proposals which compete with one another in such a way that acceptance of one automatically excludes the acceptance of the other. Thus one of the proposals is selected at the cost of the other.

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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.

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 their profitability.

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 years.

IMPORTANT OF INVESTMENT DECISIONS:

They influence the firm’s growth in 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.

TYPE OF INVESTMENT DECISIONS:

Expansion of existing business. Expansion of new business. Replacement & Modernization.

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CAPITAL BUDGETING PROCESS:

Capital budgeting is a complex process as it involves decisions relating to the investment of

current funds for the benefit to be achieved in future and the future is always uncertain.

However, the following procedure may be adopted in the process of Capital Budgeting.

1. 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.

2. 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.

3. Evaluation of Various Proposals:

The next step in the capital budgeting process is to evaluate various proposals. The

methods, which may be used for this purpose such as, payback period method, Rate of

return method, N.P.V and I.R.R etc.

4. Priorities:

After evaluating various proposals, the unprofitable uneconomical proposal may be

rejected but may not be possible for the firm to invest immediately in all the acceptable

proposals due to limitation of funds. Therefore, it essential to rank the projects/proposals

after considering urgency, risk and profitability involved there in.

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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. The expenditure budget lays down the amount of

estimated expenditure to be incurred on fixed assets during the budget period.

6. Implementing Proposals:

Preparation of a capital expenditure budget and incorporation of a particular proposal in

the budget doesn’t itself authorize to go ahead with the implementation of the project. A

request for authority to spend the amount should be made to the capital expenditure

committee, which reviews the profitability of the project in the changed circumstances.

Responsibilities should be assigned while implementing the project in order to avoid

unnecessary delays and cost overruns. Network techniques like PERT and CPM can be

applied to control and monitor the implementation of the projects.

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 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.

28

METHODS OR TECHNIQUES OF CAPITAL BUDGETING PROCESS

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

Techniques of Capital Budgeting Decisions

Traditional/Non- Discounting Cash flow Methods

Discounted Cash Flow/Time Adjusted Methods

Payback Period

Method

Accounting Rate of Return

Net Present Value

Internal Rate of Return

Profitability Index

Traditional methods/ Non- Discounting Cash flow 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)

29

1. PAY-BACK PERIOD METHOD:

The pay back sometimes called as payout or pay off period method represents the period in which total investment in permanent assets pay back itself.

This method is based on the principle that every capital expenditure pays itself back within a certain period out of the additional earnings generated from the capital assets.

Decision rule:

A project is accepted if its payback period is less than the period specific decision rule. A project is accepted if its payback period is less than the period specified by the management and vice-versa.

Pay Back Period= Initial Cash Outflow / Annual Cash Outflow

ADVANTAGES:

Simple to understand and easy to calculate. In this method, as a project with a shorter payback period is preferred to the one

having a longer pay back period, it reduces the loss through obsolescence. Due to its short-term approach, this method is particularly suited to a firm which

has shortage of cash or whose liquidity position is not good.

DISADVANTAGES:

It does not take into account the cash inflows earned after the payback period and hence the true profitability of the project cannot be correctly assessed.

This method ignores the time value of the money and does not consider the magnitude and timing of cash inflows.

It does not take into account the cost of capital, which is very important in making sound investment decisions.

30

2. ACCOUNTING RATE OF RETURN METHOD:

This method takes into account the earnings from the investment over the whole life. It is known as average rate of return method because under this method the concept of accounting profit (NP after tax and depreciation) is used rather than cash inflows.

According to this method, various projects are ranked in order of the rate of earnings or rate of return.

Decision rule:

The project with higher rate of return is selected and vice – versa.

The return on investment method can be used in several ways, as

Average Rate of Return Method:

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

Average Annual profits (after dep. & tax)Average rate of return= ---------------------------------------------------------- x 100 Net investment

ADVANTAGES:

It is very simple to understand and easy to calculate. It uses the entire earnings of a project in calculating rate of return and hence gives

a true view of profitability. As this method is based upon accounting profit, it can be readily calculated from

the financial data.

DISADVANTAGES:

It ignores the time value of money. It does not take in to account the cash flows, which are more important than the

accounting profits. This method cannot be applied to a situation where investment in project is to be

made in parts.

31

3. NET PRESENT VALUE :

The Net Present value method is a classic economic method of evaluating the investment proposals. It is one of the methods of discounted cash flow. It recognizes the importance of time value of money”.

It correctly postulates that cash flows arising of different time period, differ in value and are comparable only when their equivalent i.e., 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.

An appropriate rate of interest should be selected to discount the cash flows, generally this will be the “Cost of capital rate” of the company.

The present value of inflows and out flows of an investment proposal, has to be computed by discounting them with an appropriate cost of capital rate.

The Net Present value is the difference between the “Present Value of Cash inflows” and the present value of cash outflows.

Net present value should be found out by subtracting present value of cash outflows from present value of cash inflows. The project should be accepted if NPV is positive.

NPV = Present Value of Cash inflow – Present value of the cash outflow

Cost often is CF0 and is negative.

Decision Rule:

Accept if NPV > 0

Reject if NPV < 0

May accept if NPV = 0

32

NPV=∑ ¿

t=0

n

CFt(1+k )t

. ¿

NPV=∑ ¿

t=1

n

CFt(1+k )t

−CF0 . ¿

ADVANTAGES:

It recognizes the time value of money and is suitable to apply in a situation with uniform cash outflows and uneven cash inflows.

It takes in to account the earnings over the entire life of the project and gives the true view of the profitability of the investment.

Takes in to consideration the objective of maximum profitability.

DISADVANTAGES:

More difficult to understand and operate. It may not give good results while comparing projects with unequal investment of

funds. It is not easy to determine an appropriate discount rate.

4. 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

Profitability index = PV of cash inflows / Initial Investment or cash outflows

Net profitability index = Profitability index - 1

ADVANTAGES:

Unlike net present value, the profitability index method is used to rank the projects even when the costs of the projects differ significantly.

It recognizes the time value of money and is suitable to apply 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.

33

PI=∑t=1

n CF t(1+k )t

CF0

DISADVANTAGES:

It may not give good results while comparing projects with Unequal investment funds.

It is not easy to determine and appropriate discount rate. It may not give good results while comparing projects with unequal lives as the

project having higher NPV but have a longer life span may not be as desirable as a project having some what lesser NPV achieved in a much shorter span of life of the asset.

5. INTERNAL RATE OF RETURN METHOD

The internal rate of return method is also a modern technique of capital budgeting that takes in to account the time value of money.

It is also known as time-adjusted rate of return or trial and error yield method. Under this method the cash flows of a project are discounted at a suitable rate by

hit and trial method, which equates the net present value so calculated to the amount of the investment.

The internal rate of return can be defined as “that rate of discount at which the present value of cash inflows is equal to the present value of cash outflows”.

Decision Rule:

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

If IRR>K, accept project.

K = cost of capital.

If IRR<K, reject project.

DETERMINANTION OF IRR

a) When annual cash flows are equal over the life of the asset.

Initial Outlay

FACTOR = --------------------------- x 100

Annual Cash Inflow

34

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

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

IRR = LR + --------------------------------------------------------------------------------------- x (Hr-Lr)

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

The steps are involved here are

1. Prepare the cash flow table using assumed discount rate to discount the net cash Flows to the present value.

2. Find out the NPV, & if the NPV is positive, apply higher rate of discount.

3. If the higher discount rate still gives a positive NPV, increase the discount rate further. Until, the NPV becomes zero.

If the NPV is negative, at a higher rate, NPV lies between these two rates.

ADVANTAGES:

It takes into account, the time value of money and can be applied in situations with even and even cash flows.

It considers the profitability of the projects for its entire economic life. The determination of cost of capital is not a pre-requisite for the use of this

method. It provides for uniform ranking of various proposals due to the percentage rate of

return. This method is also compatible with the objective of maximum profitability.

DISADVANTAGES:

It is difficult to understand and operate. The results of NPV and IRR methods may differ when the projects under evaluation

differ in their size, life and timings of cash flows. This method is based on the assumption that the earnings are reinvested at the IRR

for the remaining life of the project, which is not a justified assumption.

35

CHAPTER – 3

COMPANY PROFILE

36

COMPANY PROFILE

Odisha Power Generation Corporation (OPGC) was incorporated on 14th November, 1984.

OPGC started as a wholly owned Govt. company of the state of Odisha with objective of

establishing, operating and maintaining thermal power generation stations. It is a maiden

venture, the company has set up two thermal power plants with a capacity of 210 MW

each in the IB Valley are of Jharsuguda District in the State of Odisha (Ib Thermal Power

Station) at a cost of Rs.11350 million. The locational advantage of the power plant lies in its

close proximity to the coal mines as well as to the Hirakud reservoir. This gives the

company the distinct advantage of low cost of Raw Material leading to low cost

generation.

THE PARTNERSHIP:

As a part of reforms in the energy sector of the state 49% of the equity was divested in

favour of a private investor i.e. AES Corporation, USA in early 1999. AES is one of the

largest global power company. It generates and distributes electric power to millions of

people in 26 countries. It has 123 countries power generation facilities. It generates over

44000MW of electricity. It has 14 distribution companies. Odisha Power Generation

Corporation is seen making progress with its Ib Valley power plant expansion project in

Jharsuguda district.

THE PRESENT BUSINESS:

Today OPGC has firmly established its credentials as a successful power generating

company both technically & commercially by providing clean, safe & reliable power. With

the available resources and fuel security in terms of allocation of captive mine, the

Company has rightfully capitalised on its credentials and experience to further expand its

capacity by adding 2X660 MW units.

Shareholder Percentage No. of Shares Amount (In Rs.)Govt. of Odisha 51 25,00,109 25,00,109,000AES India Pvt. Ltd. 16.25 7,96,178 7,96,178,000AES OPGC Holding (incorporated in Mauritius)

32.75 16,05,887 16,05,887,000

Total 100 49,02,174 49,02,174,000

37

MISSION AND VISION

VISION

A world-class power utility committed to generate clean, safe and reliable power,

enhancing value for all stake holders and contributing to national growth.

MISSION

To attain global best practices by adopting, innovating and deploying cutting edge

solutions.

To achieve excellence in reliability, safety and quality of power by creating a culture

of empowerment and high performance.

To be a responsible corporate citizen having concern for environment, society,

employees and people at large.

CORE VALUES

Put safety first.

Honour of commitments.

Act with integrity.

Strive for Excellence.

Have Organizational Pride.

Foster Teamwork.

38

STRENGTH OF OPGC

This is a Pithead Power plant with coal field located nearby & a Merry go round

system for Coal transportation.

There is adequate water availability from the nearby Hirakud Reservoir with an

Intake Channel connected to Reservoir.

Long term PPA with the State Power Transmission utility i.e. GRIDCO for 100% off-

take.

Payment security mechanism comprising Escrow Account and revolving Letter of

Credit with GRIDCO.

Infrastructure like land and common facilities are already available for expansion of

two more units.

A Dedicated workforce of Young Engineers & support staff.

39

AWARDS AND RECOGNITIONS

OPGC received the CII award (1st) in Best Practices on SHE on 20th Nov, evening

from Honorable Chief Minister, Odisha with his message "Well done OPGC &

Congratulation".

OPGC received reorganization from AES Board of Directors for achieving 5 Years

without a lost time incident on February 3, 2009"

OPGC Received the Greentech Safety Award - 2008 Gold for outstanding

achievement in Safety Management.

OPGC received First Prize in Lowest weighted frequency rate of Accident by

Directorate of Factories and Boilers, Odisha, Bhubaneswar. The award was

presented by the Honorable Minister of State Ind. Labor and Employment,

Government of Odisha in the august presence of commissioner cum secretary.

OPGC received GREENTECH Safety GOLD Award-2007 on 22nd Feb 2007 at Mumbai

from Greentech Foundation. OPGC received this Award for last 3 consecutive years.

OPGC received GREENTECH Safety GOLD Award 2006 in Coal based Power sector

for outstanding achievement in safety management from Greentech foundation.

OPGC received Safety Award from Directorate of Factories & Boilers, Odisha for "1st

Prize in Longest Accident Free Period category for the yr.2004 ".

OPGC (ITPS) received "CII-Odisha Award for Best Practices in Environment, Safety &

Health (ESH)-Runner".

OPGC (ITPS) has been selected for the prestigious "Greentech Environment

Excellence Gold Award in Thermal Power Sector for them year 2004-2005".

IBTPS has received OHSAS 18000 certification from BVQI from 05th May 2005.

OPGC received "Greentech Safety Gold Award in Power Sector" for the year 2004-

05 in recognition to outstanding achievement in Safety Management at IBTPS.

IBTPS has received State Safety Award for "Best Environment Management" Year

2002-03 from Director of Factories Director of Factories & Boilers, Odisha on 27th

Nov'2004.

40

OPGC has received prestigious Greentech Environment Excellence Gold Award in

thermal power sector for the year 2003-04 in recognition to Best Environment

Management.

Environment Management System (EMS) established & implemented at ITPS was

recommended for ISO 14001 certification by BVQI in Oct'2004 after final audit

conducted from 11-14th Oct2004 & received the Certificate from 14th October

2004.

State Pollution & control Excellency Award 2003 for Implementation of

Environmental Pollution control measures & Constant effort for protection of

environment.

Pollution control appreciation award –2002 Promoted by Odisha Pollution Control

Board.

Meritorious Productivity Awards (promoted by CEA) for the year 1999-2000 –Cash

Award of Rs.8.31Lakhs, Silver shield & a Gold medal.

Safety award from Chief inspector, Factories and Boiler Odisha for the year 1999 for

zero accident in industry.

Meritorious performance of Thermal Power Station from Ministry of Power, Govt.

of India (promoted by CEA) for the year 1998-99 -Cash Award of Rs.4.09Lac and a

Silver shield.

Incentive award from Ministry of Power, Govt. of India ( promoted by CEA )for

better performance of thermal power station for the year 1997-1998 –Cash Award

of Rs.3.40 Lac.

Incentive award from Ministry of Power, Govt. of India (promoted by CEA) for

reducing specific fuel oil consumption during the year 1997-Cash Award of Rs.5.31

Lac.

Incentive award from Ministry of Power, Govt. of India (promoted by CEA) for

reducing specific fuel oil consumption during the year 1996 -Cash Award of Rs.7.53

Lac.

41

Corporate Social Responsibility (CSR)

OPGC's vision of sustainable growth drives both business decisions as well as Corporate

Social Responsibility (CSR) initiatives. Seeking to herald an inclusive business paradigm,

OPGC has CSR interventions that are based on social, environmental and economic

considerations and are well-integrated into the decision-making structures and processes

of the organization.

OPGC works in the core sectors of Education, Community Health, sustainable Livelihood

development and rural infrastructure development and its CSR efforts are primarily

focused on protection of environment, providing infrastructure support in our operational

areas, water management, protection and preservation of our heritage, arts and culture,

promotion of sports, entrepreneurship building and sponsorship of seminars, conferences,

workshops etc.

The following CSR activities were undertaken by OPGC in the peripheral villages of ITPS and

Manoharpur coal block area.

ITPS Periphery

Organised Shishu Mela & Shishu Mohatsav on the occasion of 15th August and 26th

January respectively in 36 periphery schools.

Supply of furniture to 6 periphery schools.

Financial support to 5 periphery schools.

Supply of drinking water to 25 periphery villages.

Day to day maintenance of periphery pipelines for supply of drinking water to 17

villages.

Installation of additional water tank at village Rengali.

Construction of boundary wall of Samali Temple at village Bhutia.

Earth work and strengthening the bund of Jamtudia Kanta (Pond) of village

Dhubadera.

Upgradation of periphery road from ITPS boundary towards Adhapada.

42

Painting and distempering of boundary wall of Vattarika Temple at Kumarbandh.

Construction of 2 nos. of bathing ghats at village Kantatikra.

Upgradation of internal road of village Sardhapali.

Repairing of Upper Primary School at village Banharpalli.

Renovation of leading channel of Baragad MIP.

Di-siltation of Hatipada Pond at village Adhapada.

Distribution of Mosquito net at village Bhaludole.

Dengue awareness campaign in the periphery villages.

Free Health Camps to 3 periphery Ashram Schools.

Anti-mosquito fogging spray in periphery villages.

Free Tailoring training to 130 women and adolescent girls of periphery villages in

two batches.

Supply of Sports Kits to 6 periphery villages.

Mines periphery

Socio economic survey report for MGR was finalized and submitted to respective

Collectors.

Cleaning of roads and construction of fair weather roads were completed.

Draft R&R Plan was prepared by Project Team and Architect for design of R&R

colony has been appointed.

As per directions of DTET, temporary ITC facilities likes; repairs & modification of

buildings, electricity supply & laboratory equipments were provided.

In addition a number of activities for promotion of sports and culture were under taken in

the form of organising sports tournament, competition and sponsoring local cultural

events.

This has helped maintaining healthy relationship with the people around the plant area.

43

CHAPTER - 4

DATA ANALYSIS ANDINTERPRETAT ION

44

INTRODUCTION:

In OPGC Ltd. a number of new projects are going on. 3 examplary

projects are selected for the study. Some of the essential aspects of the

projects are Depreciation Rate, Corporate Income Tax Rate and The

Discounting Factor. The Depreciation rate considered is 4.75%, the

Corporate Income Tax Rate is 34% (approximately) and the Discounting

Factor is 15% which is normally followed by the corporate houses. The

following table gives the abstract for these projects of the company.

SL. NO.

PROJECT NAME BUDGET ESTIMATES

DEPRECIATION TAX PV FACTOR

01. Project A 60 crores 4.75% 34% 15%

02. Project B 25 crores 4.75% 34% 15%

03. Project C 20 crores 4.75% 34% 15%

45

1. Project A (Estimated Budget Rs 60 crores )

Calculation of Cash Flow after Tax (CFAT)

Year 1 2 3 4 5 Total

PBDT 35.00 38.20 40.00 42.50 42.50 198.20

Less: Dep@ 4.75%

2.85 2.85 2.85 2.85 2.85 14.25

PBT 32.15 35.35 37.15 39.65 39.65 183.95Less: Tax@ 34%

10.93 12.02 12.63 13.48 13.48 62.54

PAT 21.22 23.33 24.52 26.17 26.17 121.41Add: Dep 2.85 2.85 2.85 2.85 2.85 14.25

CFAT 24.07 26.18 27.37 29.02 29.02 135.66CCFAT 24.07 50.25 77.62 106.64 135.66

A. Calculation of pay back period:

The pay back period lies between 2 and 3 years. Therefore the exact pay back period will be as follows:

Pay back period = Base year + required CFAT/Next year CFAT

Exact pay back period = 2 + 60 – 50.25/27.37= 2 + 0.35= 2.35PBP = 2.35

B. Calculation of ARR:

ARR = AVERAGE ANNUAL PAT/ AVERAGE INVESTMENT × 100

ARR= 24.282/30 × 100 = 80.94%ARR = 80.94%

46

C. Calculation of NPV:

Year Cash Flows PV @ 15% PV of CashFlows

0 (60.00) 1.00 (60.00)

1 24.07 0.870 20.94

2 26.18 0.756 19.79

3 27.37 0.658 18.01

4 29.02 0.572 16.59

5 29.02 0.497 14.42

Total Cash Flow 89.75

NPV 29.75

NPV = PV OF CASH INFLOW – PV OF CASH OUTFLOW

PV of cash flow @ 15% = 89.75Cash Out Flow = 60.00

Therefore to decrease the cash flow we increase the rate. Let the new rate be 18%


0 (60.00) 1.00 (60.00)

1 24.07 0.847 20.38

2 26.18 0.718 18.79

3 27.37 0.609 16.66

4 29.02 0.516 14.97

5 29.02 0.437 12.68


47

NPV 23.48

D. Calculation of IRR & IR:The IRR is usually the rate of return that a project earns. PI measures the present value of returns per rupee invested.

IRR = Ri + PV of CF at Ri - PV of COF × (Rh – Ri) PV of CF at Ri – PV of CF at Rh

IRR = 15 + 89.75 – 60 × (18 – 15) 89.75 – 83.48 = 29.2IRR = 29.2%

E. Calculation of Profitability Index:

PROFITABILITY INDEX (PI) = PV OF CASH INFLOWS/INTITAL CASH OUTLAY

PI= 89.75/60 = 1.49Profitability Index (PI) = 1.49 times

2. Project B(Estimated Budget Rs 25 crores)

Calculation of Cash Flow after Tax (CFAT)

Year 1 2 3 4 5 Total

PBDT 10.25 15.84 20.50 20.50 20.50 87.59

Less: Dep@ 4.75%

1.1875 1.1875 1.1875 1.1875 1.1875 5.9375

PBT 9.0625 14.6525 19.3125 19.3125 19.3125 81.6525

Less: Tax@ 34%

3.08125 4.98185 6.56625 6.56625 6.56625 27.75385

PAT 5.98125 9.67065 12.74625 12.74625 12.74625 53.89065

Add: Dep 1.1875 1.1875 1.1875 1.1875 1.1875 5.9375

48

CFAT 7.16875 10.85815 13.93375 13.93375 13.93375 59.8281

CCFAT 7.16875 18.0269 31.9606 45.89435 59.8281

A. Calculation of pay back period:The pay back period lies between 2 and 3 years. Therefore the exact pay back period willbe as follows:


Exact pay back period = 2 + 25.00 – 18.0269/13.93375 = 2 + 0.5 = 2.5PBP = 2.5


ARR = AVERAGE ANNUAL PAT/ AVERAGE INVESTMENT × 100ARR = 10.77813/12.5 × 100 = 86.2%ARR = 86.2%


Year Cash Flows PV @ 15% PV of Cash Flows0 (25.00) 1.00 (25.00)1 10.25 0.870 8.91752 15.84 0.756 11.97503 20.50 0.658 13.4894 20.50 0.572 11.7265 20.50 0.497 10.1885

Total Cash Flow 56.29604NPV 31.29604

NPV = PV OF CASH IN FLOW – PV OF CASH OUTFLOW


Therefore to decrease the cash flow we increase the rate. Let the new rate be 18%

Year Cash Flows PV @ 18% PV of Cash Flows0 (25.00) 1.00 (25.00)1 10.25 0.847 8.68175

49

2 15.84 0.718 11.373123 20.50 0.609 12.48454 20.50 0.516 10.5785 20.50 0.437 8.9585

Total Cash Flow 52.07587NPV 27.07587

D. Calculation of IRR & IR:

The IRR is usually the rate of return that a project earns. PI measures the present value of returns per rupee invested.


IRR = 15 + 56.29604 – 25.00 × (18 – 15) 56.29604 – 52.07587 = 37.23IRR = 37.23%

E. Calculation of Profitability Index


PI= 56.29604/25Profitability Index (PI) = 2.25 times

3. Project C(Estimated Budget Rs 20 crores)

Calculation of Cash Flow after Tax (CFAT)Year 1 2 3 4 5 Total

PBDT 7.83 13.42 19.00 20.03 20.03 80.31

Less: Dep@ 4.75%

0.95 0.95 0.95 0.95 0.95 4.75

PBT 6.88 12.47 18.05 19.08 19.08 75.56

Less: Tax@ 34%

2.3392 4.2398 6.137 6.4872 6.4872 25.6904

PAT 4.5408 8.2302 11.913 12.5928 12.5928 49.8696

Add: Dep 0.95 0.95 0.95 0.95 0.95 4.75

50

CFAT 5.4908 9.1802 12.863 13.5428 13.5428 54.6196

CCFAT 5.4908 14.671 27.534 41.0768 54.6196

A. Calculation of pay back period:

The pay back period lies between 2 and 3 years. Therefore the exact pay back period will be as follows:


Exact pay back period = 2 + 20 – 14.671/12.863 = 2 + 0.4 = 2.04PBP = 2.04


ARR = AVERAGE ANNUAL PAT/ AVERAGE INVESTMENT × 100

ARR = 9.97392/10 × 100 = 99.73%ARR = 99.



0 (20.00) 1.00 (20.00)

1 7.83 0.870 6.8121

2 13.42 0.756 10.14552

3 19.00 0.658 12.502

4 20.03 0.572 11.45716

5 20.03 0.497 9.95491


51

NPV 30.87169

NPV = PV OF CASH INFLOW – PV OF CASH OUTFLOW


Therefore to decrease the cash flow we increase the rate. Let the new rate be 18

Year Cash Flows PV @ 18% PV of Cash Flows

0 (20.00) 1.00 (20.00)

1 7.83 0.847 6.63201

2 13.42 0.718 9.63556

3 19.00 0.609 11.571

4 20.03 0.516 10.33548

5 20.03 0.437 8.75311


NPV 26.92716

D. Calculation of IRR & IR:The IRR is usually the rate of return that a project earns. PI measures the present value of returns per rupee invested.


IRR = 15 + 50.87169 – 20.00 × (18 – 15) 50.87169 – 46.92716 = 38.47IRR = 38.47%

E. Calculation of Profitability Index


52

PI = 50.87169/20Profitability Index (PI) = 2.5

Comparative Analysis of all the 3 projects

Project Names

DiscountedPBP

(years)

ARR(%)

NPV(Rs in

crores)

PI(times)

IRR(%)

A 2.35 80.94 29.75 1.49 29.2

B 2.5 86.2 31.29604 2.25 37.23

C 2.04 99.73 30.87169 2.5 38.47

53

PROJECT A PROJECT B PROJECT C0

0.5

1

1.5

2

2.5

3

2.35 2.52.04

PAY BACK PERIOD (YEARS)

PAY BACK PERIOD (YEARS)

INTERPRETATION:

3 projects are showing the positive values, therefore the projects are accepted. In project 3 we can recover the investment within a short period of time i.e., 2.04

years, when compare with the other projects.


20

40

60

80

100

120

80.94 86.299.73

ARR (%)

ARR (%)

54

INTERPRETATION:

When compare to all the projects of ARR, in the 3 project i.e., Project C the ARR % is 99.73%, so in this project the average rate of return is more.

PROJECT A PROJECT B PROJECT C28.5

29

29.5

30

30.5

31

31.5

29.75

31.2960430.87169

PROJECTS NPV (Rs. In Crores)

PROJECTS NPV (Rs. In Crores)

INTERPRETATION :

The NPV should be greater than the cash outflow then only the project should be accepted. All projects are showing the positive values only. When compare to all the projects the NPV value is more in 2nd project.

55


5

10

15

20

25

30

35

40

45

29.2

37.23 38.47

PROJECT IRR (%)

PROJECT IRR (%)

INTERPRETATION:

When compare to all the projects the IRR percentage is more in 3rd project i.e., 38.47, better we can choose the 3rd project.


0.5

1

1.5

2

2.5

3

1.49

2.252.5

PROFITABILITY INDEX (%)

PROFITABILITY INDEX (%)

INTERPRETATION:

When compare to all the projects the Profitability Index is more in 3rd project i.e., 2.5 times. But we can choose the project 1, because we can recover over investment with short period in this project i.e., 1.49 times.

56

CHAPTER – 5

FINDINGS, SUGGESTIONS &CONCLUSION

57

FINDINGS

The followings points were observed from the capital budgeting is as follows:

The first project i.e., Project A is generating unequal cash flows for 5 years. The

initial investment is Rs. 60 crores.

The ARR is 80.94% which is greater than the company’s rate of return.

The discounted pay back period is 2.35 years.

NPV and IRR are positive for the proposal.

The Profitability Index (PI) is 1.49 > 1.

Project B is experiencing the unequal cash flows and the initial investment is Rs. 25

crores.

The ARR is 86.2% more than required rate of return. Therefore, accept on

ARR basis (traditional method).

NPV is positive for the project and the IRR > ARR.

The discounted pay back period is 2.5 years.

The Profitability of the project on every one rupee of its investment is 2.25

times.

The 3rd project is Project C is also generating unequal cash flows for 5 years. The

initial investment is Rs. 20 crores.

The ARR is 99.73% which is greater than the required rate of return.

The discounted pay back period is 2.04years.

NPV and IRR are positive for the proposal.

The Profitability Index (PI) is 2.5 times which is higher among all projects. As its

returns are high, the project is also risky.

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SUGGESTIONS AND RECOMMENDATIONS

Few of my suggestions are based on the results observed in three of the projects which

were as follows:

In 1st project i.e., Project A is having a high Accounting Profit (ARR) no 80.94%,

NPV, IRR and PI are also positive. This is risky project as its returns are also high.

Therefore, the project is accepted.

Project B is profitable in all contexts.PBP, ARR, NPV, IRR and PI are positive. As it

returns are positive, accept the project.

The 3rd project is Project C is having a high Accounting Profit (ARR) no 99.73% and

remaining all techniques are positive, but this is a risky project as its returns are

high. Therefore, the project is accepted.

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CONCLUSION

When an organization is setting up a capital budgeting for the business, they are

planning for the outcome of the month. How involved the project budgeting is

individual will be depends on their investment decisions in a business.

When making the capital budgeting decision, the financial manager effectively

analyzed the long term investment programmes, so that it will improve the

business over all.

Many businesses ignore or forget the other half of the budgeting. Capital budgeting

are too often proposed, discussed and accepted. It can be used to influence

managerial action for long-term implications and affect the future growth and

profitability of the firm. Good management looks at what that difference means to

the business.

Remember to keep the records that have been created. The company should have

capital budgeting records of the projects always on file, so that it gives the future

course of action for the investment proposal for long-term period.

Organizations must make sure that, more attention should be paid upon the

investment proposal or course of action whose benefits are likely to be available in

future over the lifetime of the project, as the demand on resources is almost always

higher than the availability of resources.

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BIBLIOGRAPHY

1. M. PANDEY: Financial Management: Vikas publishing house pvt. ltd, 9th edition.

2. PRASANNA CHANDRA: Financial Management: Tata McGraw-Hill, 7th edition.

3. I.M. PANDEY: Financial Management: Tata McGraw-Hill, 4th edition.

4. Annual report of OPGC Ltd.

Websites:

www.google.com

www.opgc.co.in

www.studyfinance.com

www.wikipedia.org/wiki/capital_budgeting

www.eximfm.com/training/capital budgeting.doc

www.yahoofinance.com

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capital budgeting of opgc ltd

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