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CHAPTER-1 • INTRODUCTION • REVIEW OF LITERATURE CHAPTER-2 • OBJECTIVES OF THE STUDY • NEED OF STUDY • SCOPE OF THE STUDY CHAPTER- 3 • COMPANY PROFILE CHAPTER- 4 • RESEARCH METHODOLOGY • LIMITATION • DATA ANALYSISANDINTERPRETATION CHAPTER- 5 • FINDINGS • SUGGESTIONS • BALANCE SHEET CHAPTER- 6 • CONCLUSION • BIBILOGRAPHY
The project titled “CAPITAL BUDGETING IN DR. REDDY’S LABORATORIES LTD” aims at evaluating the capital budgeting or investment decisions to set up a facility at DR. REDDY’S LABORATORIES LTD for manufacturing NEW DRUG 30 for supplies directly from bulk units. The following capital budgeting techniques are used for evaluation assuming 9% as discounting factor:
Non-discounted techniques like PAYBACK PERIOD (PBP), AVERAGE RATE OF RETURN (ARR)
Discounted techniques like NET PRESENT VALUE (NPV), INTERNAL RATE OF RETURN (IRR) and PROFITABILITY INDEX (PI)
Capital Budgeting or investment decisions are of considerable importance to the firm. Since they tend to determine its value by influencing its growth, profitability and risk.
An efficient allocation of capital is the most important finance function in the modern times. It involves decisions to commit the firm’s funds to
the long-term assets. The investment decisions of a firm are generally known as the Capital budgeting, or Capital Expenditure Decisions. A Capital Budgeting Decision may be defined as the firm’s decision to invest its current funds most efficiently in the long-term assets in anticipation of an expected flow of benefits over a series of years. The project aims at evaluating the investment proposal for setting up a facility in Dr. Reddy’s Laboratories Ltd.
Capital Budgeting In Dr. Reddy’s
The company has separate department for all capital investments evaluation.
User department specifying the details of the project to be executed will raise an internal order request form.
The project proposal will be initially evaluated by the HOD (Head Of the Dept.).
After initial approval from the HOD the project will be evaluated by the Projects Team (Meant for evaluation of Capital investments said in point no. (1) Taking out the Technicalities of the projects and viability in the existing environment. This team will evaluate the project basically in these areas – 1 2 3 4 Guidelines from Pollution Control Board Applicability of CGMP Safety Financial viability
Once the project team evaluates the project the investment proposal will be taken to the Vice President/ President (SBU Head) based on the amount involved in the project.
After evaluation and approval from Projects team and concerned approving authority an internal order, will be created by Finance Dept, under which the total costs incurred will be traced and capitalized under the project.
REVIEWE OF LITERATURE
One of the basic questions faced by financial managers is: How should the scarce resources of the firms be allocated to get the maximum value for the firm? This refers to investment decisions, which deal with investment of firm’s resources in Long term (fixed) Assets and Short term (current) Assets or Capital Budgeting Decisions and Working Capital Management.
Capital budgeting is a decision making process for investment in assets that have long term implications, affect the future growth and profitability of the firm and basic composition and assets mix of the firm. It involves
Measuring the benefits and costs associated with each alternative option in terms of incremental cash flows,
Evaluating different proposals in the light of return expected by the investors of the firm and the return promised by the proposal, and
Applying different techniques to select an alternative with the objective of maximization of value of the firm.
Typically, Capital Budgeting decisions involve rather large cash outlays and commit the firm to a particular course of action over a relatively long period and consequently, every care should be taken care of. The future risks and uncertainties should be incorporated in the evaluation procedure so that future cash flows occur as they are intended to be. (R.P.Rustagi 2005, p367)
Definition of Capital Budgeting
The term capital budgeting refers to long-term planning for proposed capital outlays and their financing. Thus, it includes both rising of long-term funds as well as their utilization. It may this be defined as “The firm’s decision to invest its current funds most efficiently in the long-term assets in anticipation of an expected flow of benefits over a series of years”
(I.M.Pandey 2005, p141). It is the decision making process where the firm evaluate the purchase of major fixed assets. It involves the firm’s decision to invest its current funds for addition, disposition, modification and replacement of long-term or fixed asset. However, it should be noted that investment in current assets necessitated on account of investment in fixed assets, is also to be taken as a capital budgeting decision.
Features of Capital Budgeting
• • •
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 (I.M.Pandey2005,p141) Significance of Capital Budgeting
The significance of capital budgeting may be stated as follows. INVESTMENTS OF HEAVY FUNDS: Capital budgeting decisions generally, involve large investment of funds. But the funds available with the firm are always limited and the demand for fund fax exceeds the resources. Hence it is very important for a firm to plan and control its capital expenditure.
LONG-TERM IMPLICATIONS: The effect of capital budgeting decisions will be felt by the firm over a long period and therefore they have a decisive influence on the rate and direction of the growth of the firm.
IRREVERSIBLE DECISION: In most cases, capital budgeting decisions are irreversible. This is because it is very difficult to find a market for the capital asset. The only alternative will be to scrap the capital assets so
purchased or sell them at substantial loss in the event of the decision being proved wrong.
MOST DIFFICULT TO MAKE: The capital budgeting decisions require an assessment of future events, which are uncertain. It is really a difficult task to estimate the probable future events, because of economic, political, social and technological factors.
Types of Investment Decisions
INDEPENDENT INVESTMENTS: These are proposals, which do not compete with one another in a way that acceptance of one precludes the possibility of acceptance of another. In case of such proposals the firm may straightaway “accept or reject” a proposal on the basis of a minimum return on investment required. All these proposals, which give a higher, return than a certain desired rate of return are accepted and the rest are rejected.
CONTINGENT INVESTMENTS: These are proposals whose acceptance depends on the acceptance of one or more other proposals. For example a new machine has to be purchased on account of substantial expansion of plant, in this case investment in the machine is dependent upon expansion of plant. When a contingent investment proposal is made, it should also contain the proposal on which it is dependent in order to have a better perspective of the situation.
MUTUALLY EXCLUSIVE INVESTMENTS: These are proposals, which compete with each other in a way that the acceptance of one precludes
the acceptance of other or others. For example, if a company is considering investment in one of two temperature control systems, acceptance of one system will rule out the acceptance of another. Thus two or more mutually exclusive proposals cannot be accepted. Some technique has to be used for selecting the better or the best one. Once this is done other alternatives get automatically get eliminated. ( I.M.Pandey 2005,p142-143)
MAKE OR BUY DECISION: Make or buy decision is no longer a short run operating decision and it becomes a problem of capital expenditure which necessitates consideration of required rate of return, A company has to take this decision, when it has to face following choice 5 6 Buy certain part or sub-assemblies from outside suppliers; or Use available capacity to produce the item within the factory.
In this decision, the following are major considerations: 7 Costs that will be incurred under both alternatives are not
relevant to the analysis. 8 9 Potential uses of available capacity should be considered. Pertinent quantitative factors must be evaluated in the decision
process. These considerations include price stability from suppliers, reliability of delivery and quality specifications of materials or components involved.(V.K. Saxena & C.D. Vashist 2002, pT.8.15)
Factors Affecting Capital Investment Decisions
The following are the four important factors, which are generally taken into account while making a capital investment decision:
THE AMOUNT OF INVESTMENT: In case a firm has unlimited funds for investment it can accept all capital investment proposals which give a rate of return higher than the minimum acceptable or cut-off rate. However, most firms have limited funds and therefore capital rationing has to be imposed. In such an event a firm can take only such projects, which are within its means. In order to determine which project should be taken up on this basis, the projects should be arranged in an ascending order according to the amount of capital investment required. COMPUTATION OF CAPITAL INVESTMENT REQUIRED The term ‘capital investment required’ refers to the net cash outflow, which is the sum of all outflows and inflows occurring at zero time period. The net outflow is determined by taking into account the following factors. Cost of the new project Installation cost. Working capital Proceeds from sale of asset: A new asset may be purchased for
replacement of an old asset. The old asset may therefore be sold away. The cash realized on account of such sale will reduce the cost of new investment.
Tax effects: The amount of profit or loss on the sale of assets may affect the cash flows on account of tax affects. The profit/loss is ascertained by taking into account the cost of the asset, its book value and the amount realized on its sale. The tax liability will be different in each of the following case When the asset is sold at its book value. When the asset is sold at a price higher than its book value but lower than its cost. When the asset is sold at a price higher than its cost. When the asset is sold lower than its book value Investment allowance: This is allowed to encourage capital investment in Machinery and equipment. Such allowance thus reduces the cost of the initial investment of the project. MINIMUM RATE OF RETURN ON INVESTMENT: The management expects a minimum rate of return on the capital investment. The minimum rate of return is usually decided on the basis of the cost of capital. For example, if the cost of capital is 10%, the management will not like to accept A proposal, which yields a rate of return less than 10%. The project s giving a yield below the desired rate of return will therefore be rejected. CUT-OFF POINT: The cut-off point refers to the point below which a project would not be accepted. For example, if 10% is the desired rate of return, the cut-off rate is 10%. The cut-off point may also be in terms of period. For example, if the management desires that the investment in the
project should be recouped in three years, the period of three years would be taken as the cut-off period.
RETURN EXPECTED FROM THE INVESTMENT:
decisions are made in anticipation of increased return in the future. It is therefore very necessary to estimate the future return or benefits accruing from the investment proposals. There are two proposals available for quantifying benefits from capital Investment decisions. They are: ACCOUNTING PROFIT: The term accounting profit is identical with income concept used in accounting. CASH FLOWS: In this depreciation charges and other amortization charges on the fixed assets are not subtracted from gross revenue because no cash expenditure is involve.
Capital Budgeting Process
Capital Budgeting is a complex process as it involves decisions relating to the investment of current funds for the benefit to the achieved in future and the future is always uncertain, which may be divided into following phases:
• • • • •
Identification of potential investment opportunities Assembling of proposed investment Decision making Preparation of capital budget and appropriations Implementation Performance review
Identification of Potential Investment Opportunities
The Capital Budgeting process begins with the identification of investment opportunities. The planning body develops estimates of future sales, which serve as the basis for setting production targets. This information, in turn, is helpful in identifying required investment in plant and equipment. For imaginative identification of investment ideas it is helpful to
Monitor external environment regularly to scout investment opportunities. Formulating a well defined corporate strategy based on a through analysis of strengths, weakness, opportunities and threats.
Share corporate strategy and perspectives with persons who are involved in the process of Capital Budgeting.
Motivate employees to make suggestions.
Assembling Of Proposed Investments
Investment proposals identified by the production department and other departments are usually submitted in a standardized capital investment proposal form. Generally, most of the proposals, before they reach the capital budgeting team, which assembles them, are routed through several persons. The purpose of routing a proposal through several persons is primarily to ensure that the proposal is viewed from different angles. It also helps in creating a climate for bringing about co-ordination of interrelated activities. Investment proposals are usually classified into various categories for
classification is given below:
• • • •
Replacement investment. Expansion investment. New product investments/modernization. Obligatory and welfare investments.
A system of rupee gateways usually characterizes capital investment decision-making. Under this system, executives are vested with the power to okay investment proposals up to certain limits. For example in company the plant superintendent can okay investment outlays up to Rs.2000000 the works manager up to Rs 500000 and the M.D up to Rs 2000000.Investment requiring higher outlays needs the approval of the Board Of Directors.
Preparation of Capital Budget and Appropriations
Projects involving smaller outlays and which executives at lower levels can decide are often covered by a blanket appropriation for expeditious action. Project involving larger outlays is included in the capital budget after necessary approvals. Before undertaking such projects an appropriation order is usually required. The purpose of this check is mainly to ensure that the funds position of the firm is satisfactory at the time of implementation. Further, it provides an opportunity to review the project at the time of implementation.
Translating an investment proposal into a concrete project is complex; time consuming, and risk-fraught task. Delays in implementation, which are common, can lead to substantial cost over runs. For expeditious implementation at a reasonable cost, the following are helpful.
Adequate Formulation of Projects: The major reason for delay is inadequate formulation of projects. Put differently, if necessary homework in terms of preliminary studies and comprehensive and detailed formulation of the project is not done, many surprises and project cannot be over-emphasized.
Use of the Principle of Responsibility Accounting: Assigning specific responsibilities to project managers for completing the project within the defined time frame and cost limits is helpful for expeditious execution and cost control.
Use of Network Techniques: For project planning and control several network techniques likes PERT (Programming Evaluation Review Technique) and CAPM (Critical Path Method) are available. With the help of these techniques, monitoring becomes easier.
Performance review, or post-completion audit, is a feedback device. It is a means for comparing actual performance with projected performance. It may be conducted most stabilized. It is useful in several ways:
It throws light on how realistic were the assumptions underlying the project.
It provides a documented log of experience that is highly valuable for decision making.
It helps in uncovering judgmental biases. It induces a desired caution among project sponsors.(Prasanna Chandra 2006, p290-292)
Evaluation Techniques of Capital Budgeting
Evaluation Techniques of Capital Budgeting are classified into two types: 1. TRADITIONAL TECHNIQUES:
Average rate of return
2. MODERN (OR) DISCOUNTED CASH FLOW (DCF) TECHNIQUES:
• • •
Net present value (NPV) Internal rate of return (IRR) Profitability index (PI) or Benefit-cost ratio (B/C RATIO)
Traditional Techniques 1. Average Rate of Return (ARR)
The average rate of return (ARR) method of evaluating proposed capital expenditure is also known as the accounting rate of return method. It is based upon accounting information rather than cash flows. There is no unanimity
regarding the definition of the rate of return. There are a number of alternative methods for calculating the ARR. The most common usage of the average rate of return (ARR) expresses it as follows: ARR = Average annual profits (after dep & taxes) Average investment over the life of the project * 100
ACCEPT-REJECT RULE: With the help of the ARR, the financial decision maker can decide whether to accept or reject the investment proposal. As an accept-reject criterion, the actual ARR would be compared with a predetermined or a minimum required rate of return or cut-off rate. • Accept if ARR > minimum rate
• Reject if ARR < minimum rate
2. Pay Back Period (PBP)
The pay back method (PB) is the second traditional method of capital budgeting. It is the simplest and, perhaps, the most widely employed, quantitative method for appraising capital expenditure decisions. This method Net Present Value (NPV) The first DCF/PV technique is the NPV. NPV may be described as the summation of the present values of cash proceeds (CFAT) in each year
minus the summation of present value of the net cash outflows in each year. Symbolically, the NPV for projects having conventional cash flows would be:
∑ (1 + r )
- Initial investment
Wherect = cash flow at the end of year t n = life of the project r = discount rate STEPS FOR COMPUTATION OF NPV:
Firstly an appropriate rate of interest should be selected to discount cash inflows. It is generally known as cost of capital, which is equal to the minimum rate of return expected by the firm on investment proposals.
Secondly, the present value of cash inflows and cash outflows should be computed using the cost of capital as discounting rate.
Finally, the present value of cash outflows is subtracted from present value of cash inflows to get NPV.
• • • NPV>ZERO (accept) NPV<ZERO (reject) NPV=ZERO (indifferent)
Internal Rate of Return (IRR) The second discounted cash flow (DCF) or time adjusted method for appraising capital investment decisions is the internal rate of return (IRR) method. This technique is also known as yield on investment, marginal efficiency of capital, marginal productivity of capital, rate of return, and timeadjusted rate of return and so on. Like the present value method, the IRR method also considered the time value of money by discounting the cash streams. The internal rate of return is usually the rate of return the project earns. It is defined as the discount rate(r) which equates the aggregate present value of the net cash inflows (CFAT) with the aggregate present value of cash outflows of a project. In other words, it is that rate which gives the project NPV as zero. COMPUTATION OF IRR In computing IRR, future cash inflows are discounted in such a way that their total PV is just equal to the PV of total cash outflows. The time schedule of occurrence of the future cash flows is known but rate of discount is not. This discount rate is ascertained by trial and error method. This rate of discount so calculated, which equates the PV of cash inflows with PV of cash outflows is known as IRR.
∑ (1 + r )
ct = cash flow at the end of year t r = internal rate of return (IRR) n = life of the project
ACCEPT-REJECT CRITERION The use of the IRR, as a criterion to accept capital investment decisions, involves a comparison of the actual IRR with the required rate of return also known as the cut-off rate or hurdle rate. The project would qualify to be accepted if the IRR(r) exceeds the cut-off rate (k).If the IRR and the required rate of return are equal, the firm is indifferent as to whether to accept or reject the project.
• Accept if IRR > k • Reject if IRR < k • Project may be accepted if IRR = k
Profitability Index (PI) or Benefit-Cost Ratio (B/C Ratio)
Yet another time-adjusted capital budgeting technique is profitability index (PI) or benefit cost ratio (B/C RATIO) .It is similar to NPV approach. The profitability index approach measures the present value of returns per rupee invested, while the NPV is based on the difference between the present value of future cash inflows and the present value of cash outlays. A major short coming of the NPV method is that, being an absolute measure, it is not a reliable method to evaluate projects requiring different initial investments. The PI method provides a solution to this type of problem. It is, in other words, a
relative measure. It may be defined as the ratio which is obtained by dividing the present value of future cash inflows by the present value of the cash outlays. Symbolically,
Present value of cash inflows
Present value of cash outflows
This method is also called as benefit cost ratio because the numerator measures benefit and the denominator cost. More appropriate description would be present value index. ACCEPT-REJECT CRITERION Using the B/C ratio or the PI, a project will qualify for acceptance if its PI exceeds one. When PI equals 1; the firm is indifferent to the project. When PI is greater than, equal to or less than 1, the net present value is greater than, equal to or less then zero respectively. I n other words, the NPV will be positive when the PI is greater than 1; will be negative when the PI is less then one. Thus, the NPV and PI approaches give the same result regarding the investment proposals. (I.M.Pandey 2005, p143-152)
• • • PI>1 (ACCEPT) PI<1 (REJECT) PI=1 (INDIFFERENT)
OBJECTIVES OF THE STUDY
The main objectives of the study are: To study the CAPITAL BUDGETING process in Dr. Reddy’s Laboratories Ltd. To analyze and assess the financial viability of the investment proposal using the traditional and modern techniques.
NEED FOR STUDY
The study is being conducted for the purpose of a budget is an accounting plan, a forecast of activities of an enterprise in a forthcoming period. It is a formal plan of action in monetary terms. A quantitative monetary expression of future activities. It is a Management Plan what it proposes to do in the next Financial Period usually a Year. It is a Quantified Plan for future activities. Quantitative Blue Prints of Action. A Budget is effectively used for Control purposes. Control involves the Evaluation of Performance through comparison of Actual results with the plan and using the feedback either, to take corrective action or to modify the plan. A Budget sets the targets for each Functional Area and thus, provides a unique tool to Managers for effectively carrying out their control function
SCOPE OF THE STUDY
The scope of the present study includes the following:
Understanding the importance of capital budgeting in Dr. Reddy’s Laboratories Ltd
Evaluating an investment proposal of setting up facility at Dr. Reddy’s Laboratories Ltd for manufacturing NEW DRUG 30 for supplies directly from bulk units.
. The company:DR. REDDY’S LABORATORIES LTD WAS FOUNDED BY DR ANJI REDDY, AN ENTREPRENEUR-SCIENTIST, IN 1984. THE DNA OF THE COMPANY IS DRAWN FROM ITS FOUNDER AND HIS VISION TO ESTABLISH INDIA’S FIRST DISCOVERY LED GLOBAL PHARMACEUTICAL COMPANY. IN FACT, IT IS THIS SPIRIT OF ENTREPRENEURSHIP THAT HAS SHAPED THE COMPANY TO BECOME WHAT IT IS TODAY.DR ANJI REDDY, HAVING MOVED OUT OF STANDARD ORGANICS LIMITED, A COMPANY HE HAD SUCCESSFULLY COFOUNDED, STARTED DR. REDDY’S LABORATORIES LTD WITH $ 40,000 IN CASH AND $120,000 IN BANK LOAN! TODAY, THE COMPANY WITH REVENUES OF RS.2, 427 CRORE (US $546 MILLION), AS OF FISCAL YEAR 2006, IS INDIA’S SECOND LARGEST PHARMACEUTICAL COMPANY AND THE YOUNGEST AMONG ITS PEER GROUP. THE COMPANY HAS SEVERAL DISTINCTIONS TO ITS CREDIT. BEING THE FIRST PHARMACEUTICAL COMPANY FROM ASIA PACIFIC (OUTSIDE JAPAN) TO BE LISTED ON THE NEW YORK STOCK EXCHANGE (ON APRIL 11, 2001) IS ONLY ONE AMONG THEM. AND AS ALWAYS, DR. REDDY’S CHOSE TO DO IT IN THE MOST DIFFICULT OF CIRCUMSTANCES AGAINST WIDESPREAD SKEPTICISM. DR. REDDY’S CAME UP TRUMPS NOT ONLY HAVING ITS STOCK OVERSUBSCRIBED BUT ALSO BECOMING THE BEST PERFORMING IPO THAT YEAR. Dr. Anji Reddy is well known for his passion for research and drug discovery. Dr. Reddy’s started its drug discovery programme in 1993 and within three years it achieved its first breakthrough by out licensing an anti-diabetes molecule to Novo Nordisk in March 1997. With this very small but significant step, the Indian industry went through a paradigm shift in its image from being known as just ‘copycats’ to ‘innovators’! Through its success, Dr. Reddy’s pioneered drug discovery in India. There are several such inflection points in the company’s evolution from a bulk drug (API) manufacturer into a vertically integrated global pharmaceutical company today. Today, the company manufactures and markets API (Bulk Actives), Finished Dosages and Biologics in over 100 countries worldwide, in addition to having a very promising Drug Discovery Pipeline. When Dr. Reddy’s started its first
big move in 1986 from manufacturing and marketing bulk actives to the domestic (Indian) market to manufacturing and exporting difficult-tomanufacture bulk actives such as Methyldopa to highly regulated overseas markets, it had to not only overcome regulatory and legal hurdles but also battle deeply entrenched mind-set issues of Indian Pharma being seen as producers of 'cheap' and therefore ‘low quality’ pharmaceuticals. Today, the Indian pharma industry, in stark contrast, is known globally for its proven high quality-low cost advantage in delivering safe and effective pharmaceuticals. This transition, a tough and often-perilous one, was made possible thanks to the pioneering efforts of companies such as Dr. Reddy’s. Today, Dr. Reddy’s continues its journey. Leveraging on its ‘Low Cost, High Intellect’ advantage. Foraying into new markets and new businesses. Taking on new challenges and growing stronger and more capable. Each failure and each success renewing the sense of purpose and helping the company evolve. With over 950 scientists working across the globe, around the clock, the company continues its relentless march forward to discover and deliver a breakthrough medicine to address an unmet medical need and make a difference to peoples lives worldwide. And when it does that, it would only be the beginning and yet it would be the most important step. As Lao Tzu wrote a long time ago, ‘Even a 1000 mile journey starts with a single step.’
Business Dr. Reddy's is a vertically integrated, global pharmaceutical company with proven research capabilities and presence across the pharmaceutical value
chain. We manufacture Active Pharmaceutical Ingredients and Finished Dosage forms and market them globally, with a focus on United States, Europe, India and Russia. In addition, the drug discovery arm of the company conducts basic research in the areas of diabetes, cardiovascular,
inflammation and bacterial infection.
Board of Directors Dr. Reddy's has a board comprising of eminent individuals from diverse fields. The board acts with autonomy and independence in exercising strategic supervision, discharging its fiduciary responsibilities, and in ensuring that the management observes the highest standards of ethics, transparency and disclosure. Our Directors are experts in the diversified fields of medicine, chemistry and medical research, human resource development, business strategy, finance and economics. They review all information relating to significant business decisions, including strategic and regulatory matters. Every member of the board, including the non-executive directors, has full access to any information related to the company. Committees appointed by the board focus on specific areas, and take decisions within the authority delegated to them by the board. The committees also make specific recommendations to the board on various matters from time-to-time.
Corporate Governance Dr. Reddy's long-standing commitment to high standards of corporate governance and ethical business practices is a fundamental shared value of its Board of Directors, management and employees. The Company's philosophy of corporate governance stems from its belief that timely disclosures, transparent accounting policies, and a strong and independent Board go a long way in preserving shareholders trust while maximizing longterm shareholder value. Good corporate governance flows out of the commitment of the Management and the Board of Directors. When the commitment is backed by the fundamental beliefs of maximizing value for stakeholders; transparent actions in the business; values of a corporate; and mutual trust amongst all constituents of the business, the organization transforms itself into a higher plane of leadership. The forward-looking approach of Dr. Reddy's has always helped it, in achieving the desired results. This approach has transformed the company's culture to one that is relentlessly focused on the speedy translation of scientific discoveries into innovative products. Dr. Reddy's commitment towards Corporate Governance started well before law mandated such practices. The company has identified and established its core purpose, mission and core values for achieving corporate excellence. Dr. Reddy's believes in crafting an environment where the parameters of conduct and behavior of the
company and its management is constantly aligned with the business environment. The highlights of Dr. Reddy's Corporate Governance systems are an independent Board of Directors following international practices, committed management team, internal control systems and dissemination of information to various stakeholders.
Awards & Accolades The Appreciation Certificate of the District Collector for being the “Best Clean Production Industry” for the year 2006 awarded to API Unit-V.
The CII "Southern Region Leadership Excellence Award" is won by Dr. Reddy's for the year 2005. The CII "National Award for 'Excellence in Water Management" for the year 2005 is won by both API Unit-II as well as API Unit-VI. The Generics Unit of Dr. Reddy's achieves the new ISO 14001:2004 standard on 9th June, 2005. The "Greentech Environmental Excellence Silver Award" for the year 2004-05 is won by API-Global Business Unit.
4. Research Methodology
The primary data needed for the project analysis has been collected through unstructured interviews and discussions conducted with the finance department. The secondary sources of data are annual reports, brochures and web resources. A case study approach has been used for the study of capital budgeting at Dr. Reddy’s Laboratories Ltd.
The study was conducted with the data available and analysis was made accordingly.
Due to the confidential financial records, the data is not exposed so the study may not be detailed and full fledged.
Since the study is based on the financial data that are obtained from the company’s financial statements, the limitations of financial statements shall be equally applicable.
DATA ANALYSIS & INTERPRETATION
Presentation & Analysis
The proposal is to set up facility for manufacturing NEW DRUG 30 for supplies directly from bulk units. Advantages:
Facility will be constructed in available structure with suitable modifications and civil finishing’s.
• • • • •
New Drug 30 is manufactured in this unit. Building is available without sacrificing any product. Scope for expansion on service floor. Built up area available is 250 M2. QC support available with some augmentation in future.
May not possible to expand without major modifications or separateblock.
Non – flameproof equipments – area classifications may not be met with 100%.
FEASIBILITY OF THE PROPOSED NEW DRUG 30 MANUFACTURING FACILITY Process Development of Low Cost New Drug 30:
Use RM consumptions and makes of the expicients as used by contract manufacturer
Process development to offer low cost New Drug 30 formula with Fluid bed processor (FBP) technology.
Process will be developed with suitable alternative aqueous coating materials.
Low Capital Investment:
Use of low automation and low cost capital equipments, which competitors use with of course no compromise on quality of products.
• • • •
HVAC – will be 5 microns filtered air once through. Civil finishes will be suitable as per cGMP requirements. FBP technology is relatively less labor intensive compared to Auto coater. Existing Warehouses will be used. Suitable conditioned storage space will be created for final product storage.
No effluent generation practically other than equipments washings. OPERATIONAL REQUIREMENTS OF THIS PROJECT ON
The job involves key operations like manual drug coating and operation of fluid bed processor.
API operators will be require to be trained in operations, which will be done during the process of project executions. 3 – 4 weeks of training will be sufficient. Thus additional manpower is required.
For Formulations Development support can be taken from FM –II or API may have to have small setup to address smaller customizations required by the markets.
QC/QA support will be given by Unit – III with some augmentation of resources.
Quality Assurance and Regulatory affairs has given clearance for such a set up in Unit –III.
Need for any specific licenses to sell New Drug 30 need to be verified from Unit-III , however we are doing this activity from Unit-II currently.
4.2.3PROPOSED INVESTMENT: 216 Lacs
RM cost Rs./ kg Fixed Costs for New Drug 30 Per Month Labour Utilities Repairs & Maintenance Depreciation Interest
485 Rs/ month 100,833 595,620 41,667 166,667 162,000 1,066,787
4.2.4 Net Income Per Annum
(1) Operation Level (2) Sale Price Rs per Kg (3) RM Cost Rs per Kg (4) Sales Income [(1) * (2)] Variable Cost - RM Consumed [(1) (5) * (3)] (6) Contribution [(4) - (5)] Other Fixed Costs (Utilities, (7) Labour, and QC Costs) (8) Net Income [(6) - (7)] Total Net Income per annum [(8) (9) * (12 months)] (10) Investment COMPUTATION OF NET INCOME PER ANNUM (Rs in Mns) 30Tn per month 900 485 27.00 14.55 12.45 1.07 11.38 136.56 21.60 850 485 25.50 14.55 10.95 1.07 9.88 118.56 21.60 800 485 24.00 14.55 9.45 1.07 8.38 100.56 21.60 750 485 22.50 14.55 7.95 1.07 6.88 82.56 21.60 700 485 21.00 14.55 6.45 1.07 5.38 64.56 21.60
Table 1: Computation of Net Income per Annum for 30 Tons per Month
Average Rate of Return: Operation Level – 30 TNS PER MONTH
Operation Level Sale price Rs per kg (1) Avg. Income AVERAGE RATE OF RETURN (Rs in Mns) 30 Tns per month 900 850 800 750 136.56 118.56 100.56 82.56
(2) Avg. Investment ARR [(1)/(2)*100]
Table 2: Average Rate of Return for 30 Tons per Month
1400 1200 1000 ARR 800 600 400 200 0 700 750 800 Sales 850 900 Series1
Graph 1: Average Rate of Return for 30 Tons per Month
The ARR more than the pre-specified rate of return is accepted. The company requires a rate of return of 20%. Therefore, ARR of the project, which is greater than 20% as specified by management, is accepted but most viable is at a price of Rs.900 with respect to quantity of 30 Tns per month or 360 Tns per annum.
4.2.8 Payback Period: Operation Level – 30 TNS PER MONTH
Operation Level Sale price Rs per kg PAYBACK PERIOD (Rs in Mns) 30 Tns per month 900 850 800 750
(1) Investment (2) Net Income Payback Period [(1)/ (2)]
21.6 136.56 0.16
21.6 118.56 0.18
21.6 100.56 0.21
21.6 82.56 0.26
21.6 64.56 0.33
Table: Payback Period for 30 Tons per Month
0.35 0.3 0.25 PBP 0.2 0.15 0.1 0.05 0 700 750 800 Sales 850 900 Series1
Graph 2: Payback Period for 30 Tons per Month Interpretations The Payback Period calculated for a project is to be compared with some predetermined target period and Payback Period less than the target period is accepted. Therefore, target period is 3 years and project less than that is accepted but the viable is at Rs.900 with respect to the quantity of 30 Tns per month or 360 Tns per annum.
4.2.11 NPV: Operation Level – 30 TNS PER MONTH, Project Life – 5 Years
Net Present Value of the Project Investment @ discounting rate of 9% (Rs in Mns) Operation Level 30 Tns per month Sale price Rs per kg 900 850 800 750 700 (1) Project Life (2) Present Value factor @ 9% (3) Net Income Present Value Net Income for Project Life (4) [(2) * (3)] (5) Present Value of Investment 5 years 5 Years 5 Years 5years 5years 3.8 3.8 3.8 3.8 82.5 6 3. 8 64.56 245.3 3 21.6 0 223.7 3
136.56 118.56 100.56 450.5 3 21.60 428.9 3
382.1 3 313.73 21.6 0 21.60 360.5 3 292.13
Net Present Value of the project [(4) – (5)] 497.33
Table 3: Net Present Value for 30 Tons per Month, Project Life-5 Years
30 Tns for 5yrs
500 400 NPV 300 200 100 0 700 750 800 Sales 850 900
Graph 3: Net Present Value for 30 Tons per Month, Project Life-5 Years
Interpretations NPV shows present value of the project. The project is accepted if its NPV is positive and rejected if NPV is negative. Therefore, NPV of 30 Tns per month or 360 per annum for project life of 5years is showing positive and viable is at a price of Rs.900 where NPV is Rs.497.33 millions.
IRR: Operation Level – 30 TNS PER MONTH, Project Life – 5 Years
INTERNAL RATE OF RETURN FOR 5 YEARS (Rs in Mns) Operation Level 30 Tns per month Sale price Rs per kg 900 850 800 750 700 Investment -21.60 -21.6 -21.6 -21.6 -21.6 Net Income per annum for 5years 1 136.56 118.56 100.56 82.56 64.56 2 136.56 118.56 100.56 82.56 64.56 3 136.56 118.56 100.56 82.56 64.56 4 136.56 118.56 100.56 82.56 64.56 5 136.56 118.56 100.56 82.56 64.56 IRR 632% 549% 465% 382% 299% Table 4: Internal Rate of Return for 30 Tons per Month, Project Life-5 years
30 Tns for 5yrs
700% 600% 500% 400% IRR 300% 200% 100% 0% 700 750 800 Sales 850 900
Graph 4: Internal Rate of Return for 30 Tons per Month, Project Life-5 years
184.108.40.206 Interpretations The project is accepted if IRR is more than the minimum rate, which is 9% for this project. Thus, the project at a sale price of Rs.900 is getting greater than 40%, which is more than the minimum rate of return of 9% at a quantity of 30 Tns per month or 360 Tns per annum for project life of 5years.
Operation Level – 30 TNS PER MONTH, Project Life – 5 Years
PROFITABILITY INDEX FOR 5 YEARS (Rs in Mns) 30 Tns per month 900 850 800 750
Operation Level Sale price Rs per kg (1) Project Life
5 years 5 years 5 years 5 years 5 years 3.8 3.8 3.8 3.8 82.56 313.7 3 21.6 14.5 2 3.8 64.56 245. 33 21.6 11.3 6
(2) Present Value of factor @ 9% (3) Net income Present Value Net Income for (4) Project Life [(2) * (3)] (5) Present Value of Investment PI [(4)/ (5)]
136.56 118.56 100.56 518.9 3 21.6 24.0 2 450.5 3 21.6 20.8 6 382.1 3 21.6 17.6 9
Table 5: Profitability Index for 30 Tons per Month, Project Life-5 Years
30 Tns for 5yrs
25 20 15 PI 10 5 0 700 750 800 Sales 850 900 Series1
Graph 5: Profitability Index for 30 Tons per Month, Project Life-5 Years
220.127.116.11 Interpretations PI is 24.02, which is more than 1 and also NPV is positive hence the project is more viable at a sale price of Rs.900 with respect to the quantity of 30 Tns per month or 360 per annum for a project life of 5years.
The following are the findings during the study of the project:
Average Rate of Return: As per the management, the minimum rate of return expected is 20%. The project showing ARR greater than 20% is accepted with respect to operation level 30 Tons or 20 Tons or 10 Tons per month variation in sales price.
Pay Back Period: The project is accepted when Pay Back is less than 3 years which is standard payback period set by the management. The project, which gives lesser payback period among difference in sales price and quantity to be produced, is accepted and it is at price of Rs.900 whether the quantities are 30 Tons or 20 Tons or 10 Tons.
Net Present Value: The net income of the project is discounted at the minimum required rate of return – 9% and NPV is positive for different sales price and at different operational levels.
Internal Rate of Return: The capital invested is getting return of more than 40%, which is greater than 9% (cost of capital).
Profitability Index: The project showing PI more than 1 and also where NPV is positive is taken up.
As sales price rises, demand factor also needs to be taken into consideration.
Budgeting in DR. REDDY’S LABORATORITES LTD is mainly a performance based i.e., based on the performance, where as zero-based budgeting is ideal for the company like DR. LABORATORIES LTD.
There should be effective coordination between the different departments like Production sales, Purchase, Finance, Marketing etc., this will enhance the efficiency of the organization. There should be a proper budgeting control system. A thorough review of operations on frequent intervals is required. These reviews should be made with the request to changing environment. Orders received should be dispatched at proper time. Job sequencing should be pre-determined & should follow up the sequential process, until the end of the job. Thus the lead-time can be reduced.
There should be proper communication between various departments and responsibility centers.
There should be well-organized manpower planning, especially with regard to production.
Education about the importance of budgeting should be communicated to all concerned authorities, involved directly or indirectly to work according, for the growth of the company.
Balance sheet Mar ' 09 Sources of fund Loan funds Owner's fund Sources of fund Equity share capital Share application money Preference share capital Reserves & surplus Loan funds Secured loans Unsecured loans Total Uses of funds Fixed assets Gross block Less : revaluation reserve Less : accumulated depreciation Net block Capital work-in-progress Investments Net current assets Current assets, loans & advances Less : current liabilities & provisions Total net current assets Miscellaneous expenses not written Total Notes: Book value of unquoted investments Market value of quoted investments Contingent liabilities Number of equity shares outstanding (Lacks) 2,080.41 1.92 1,892.55 1681.73 966.68 1.20 1,896.92 1679.12 911.05 1.16 2,409.27 766.95 413.63 31.88 189.19 765.19 3,348.01 1,387.74 1,960.27 5,274.11 4,028.55 1,254.93 2,773.62 4,703.26 2,398.87 798.95 1,599.92 3,186.01 2,000.88 634.68 1,366.20 2,347.32 1,750.21 762.80 987.42 245.71 2,080.71 1,291.19 609.15 682.04 280.61 966.99 1,052.90 491.08 561.82 112.92 911.36 1,004.22 441.68 562.54 60.13 358.46 3.40 458.91 5,274.11 1.92 327.98 4,703.26 145.13 778.74 3,186.01 3.27 269.96 2,347.32 84.09 4,727.72 83.96 4,289.40 38.35 2,223.79 38.26 2,035.82 Mar ' 08 Mar ' 07 Mar ' 06
(Rs corers) Mar ' 04
38.26 2,008.76 35.64 22.58 2,105.24
810.95 352.85 458.10 105.25 612.05 1,343.70 413.86 929.84 2,105.24 419.48 254.94 208.33 765.19
SUMMARY & CONCLUSIONS
The Project Report is based on the Capital Budgeting DR. REDDY’S LABORATORIES LTD. The profile of the Company given briefly is collected from the official website of the DR. REDDY’S LABORATORIES LTD & brochures and the introduction, literature review on topic Capital Budgeting is text based. The Capital Budgeting procedure at DR.REDDY’S is studied and the same is applied with respect to the Pay back period, average rate of return, net present value, profitability index and internal rate of return, calculated and analyzed. Various tables and charts have been shown in order to compare the increase or decrease of profitability of the project. Capital Budgeting is an extremely important aspect of a firm's financial management. Although capital assets usually comprise a smaller percentage of a firm's total assets than do current assets, capital assets are long-term. Therefore, a firm that makes a mistake in its capital budgeting process has to live with that mistake for a long period of time.
It is concluded that the project is viable and profitable as the ARR is getting more than 20%.
The PBP indicates that investment is fully recovered in short period depending upon sales price and quantity.
NPV of the project is considered as better because of its higher Net Present Value. The IRR of the project is giving more than 40% Rate of Return whatever be the sales price and operational level.
The PI more than 1 and where project shows NPV as positive is given first preference. The company has to sell at lesser price for more quantity produced and sell at higher price for less quantity produced.
R.P. Rustagi, (2005), Financial Management Theory, Concepts and Problems (Incorporating the Emerging trends in Indian Capital Market) (Second Revised Edition), Galgotia Publishing Company, New Delhi Prasanna Chandra, (2006), Financial Management Theory and Practice (Sixth Edition), Tata McGraw-Hill, New Delhi I. M. Pandey, (2005), Financial Management (Ninth Edition), Vikas Publishing House Private Ltd, New Delhi V.K. Saxena & C.D Vashist, (2002), Cost and Management Accounting, Sultan Chand & Sons, New Delhi
7.2 Web Sites
www.drreddys.com www.wikipedia.org/wiki/capital_budgeting www.studyfinance.com www.netmba.com/finance/capital/budgeting www.eximfm.com/training/capitalbudgeting.doc www.investorwords.com
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