Disinvestment & payback period

Presented by

SAI KIRAN.B

(12NA1E0036)

Introduction

Investment and disinvestment are two sides of the same coin. Investment refers to conversion of money or cash into securities, debentures, bonds or any other claims on money. At the same time, disinvestment invloves the conversion of money claims or securities into money or cash.

Disinvestment DEFINITION

“The action of an organisation orgovernment selling or liquidatingan asset or subsidiary”

Objectives of Disinvestment

To reduce the financial burden on government

To improve public finances

To introduce, competition and market discipline

To increase growth of the firm

To encourage wider share of ownership

Reasons for Disinvestment

• To meet fiscal deficit

• Expansion or diversification of the firm

• To repayment of government debts

• Implementation of government plan

• PSU's give negative rate of return on capital

The Indian economy had virtually embracedbankruptcy during the period of 1980-92.

In 1991, there was 236 operating public sectorundertakings, of which only 123 were profit making.

The top 20 profit making PSU’s were responsible for80 percent of profits.

The return on public sector investment for the year1990-91 was just over 2 percent.

Background of Disinvestment

Criteria for Disinvestment

The decision regarding disinvestment or liquidation viewed in the light of following criteria:

Whether the objectives of the company are achieved

Whether there is decrease in number of beneficiaries

Whether serving the national interest will be affected because of disinvestment

Whether private sector can efficiently operate and manage the undertaking.

Whether the original rate of return targeted could not be possible to achieve.

Whether socio-economic objectives lots its purpose

The govt. in July 1991 initiated the disinvestment process inIndia, while launching the New Economic Policy (NEP).

The govt. had appointed the Krishnamurthy committee in1991 and Rangarajan committee in 1992 to look after thedisinvestment process.

Both the committees have recommended disinvestments tofulfill objectives of modernization of the PSE’s through:

(a) Strengthening R &D

(b) Initiating diversification/expansion programme.

(c) Retaining and reemployment of employees.

(d) Funding genuine needs of expansion.

(e) Mitigating fiscal deficit of the government.

Process of Disinvestment

Contd..

These committees also distinguished between theshort term and long term goals of the disinvestmentand advised the govt. not to sacrifice the long termgoals for the sake of fulfilling the short termobjectives.

The govt. has announced in its NEP that mitigating thefiscal deficits is the only objective of disinvestment.

The crucial shift in govt. policy for disinvestment ofPSU’s was mainly attributed to poor performance ofthese enterprises and burden of financing theirrequirements through budget allocation.

Contd..

Process of Disinvestment

Privatization implies a change in ownership, resulting in achange in management.

The privatization of public sector enterprises will occur onlywhen govt. sells more than 51% of its ownership to privateentrepreneurs.

Disinvestment on the other hand, has a much widerconnotation as it could either involve dilution of govt. stake toa level that result in a transfer of management or could alsobe limited to such a level as would permit govt. to retaincontrol over the organization.

Disinvestment beyond 50% involves transfer of management,where as disinvestment below 50% would result in the govt.

continuing to have a major say in the undertaking.

Privatization and Disinvestment

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PAYBACK PERIOD: Definition

Is the time required for a firm

to recover its original

investment.

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FORMULA: Payback Period

Payback period tells how long it will take a

project to break even.

Payback period

= Original investment ÷Annual cash flows

= $1,000,000 / $500,000

= 2 years

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PAYBACK PERIOD: Uses

• Sets maximum payback period for all projects; rejects any that exceed payback period

• Measures risk

– Riskier firms use shorter payback period

– In liquidity problems, use shorter payback period

• Avoids obsolescence

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PAYBACK PERIOD: Summary

Payback period provides information that can be used to help

– Control risks of uncertain future cash flows

– Minimize impact of investment on liquidity problems

– Control risk of obsolescence

– Control effects of investment on performance measures