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C B T A: Apital Udgeting Echniques Pplication
C B T A: Apital Udgeting Echniques Pplication
CAPITAL BUDGETING
TECHNIQUES APPLICATION
ID No. Name
15-019 Mohd. Anisul Islam
15-021 Md. Habib Ullah
15-099 Md. Arman Chowdhury
15-115 Shafiul Azam
15-143 Md. Nafiz Imtiaz Khan
Reckitt Benckiser is a world leader in FMCG household, health and personal care. In
Bangladesh it has started its journey in the year of 1987 by enlisting as a pharmaceuticals
and chemical company at DSE and CSE. Its strong achievement and entrepreneurial focused
culture is renowned for giving employees unparalleled ownership of projects and decisions
and where international mobility is encouraged. RB's an organization where driven people
thrive.
Its a FTSE top 15 company and since 2000 net revenues have doubled and the market cap
has quadrupled. Today it is the global No. 1 in the majority of its fast-growing categories,
driven by an exceptional rate of innovation over a third of revenue comes from
innovations launched in the prior 3 years. It has a strong portfolio led by 19 global power
brands, such as Dettol, Finish, Airwick, Mucinex, Lysol, Vanish, Veet, Nurofen and Strepsils
which account for nearly two thirds of its net revenue. RB recently acquired SSL
International and added Durex and Scholl to its global power brands. In Bangladesh some
strong branded products of its portfolio are in market including: Dettol, Harpick, Lysol,
Vanish, and Veet etc.
Recently company has purchased a world reputed pharmaceutical company where it used
NPV analysis and discounted cash flow technique to weigh this project which is not in very
much practice in indigenous companies in Bangladesh. We can illustrate the mechanism
used in capital investment decision as follows.
Reckitt Benckiser is standout from other company significantly in terms of its capital
structure. It generally ensures equity financing to take a project. So APV, FTE, WACC are not
used in evaluation of projects. It has global reputation as a renowned corporation as why it
is easy for company to use capital market to contact equity financing. In Bangladesh it has
made their enlistment in capital market at 1987.
Project Cash Flow Determination
As previously mentioned its net revenues have doubled and the market cap has quadrupled.
The catalyst underlines this success is successful application of capital budgeting technique
application. In recent acquisition of a reputed pharmaceuticals company of India, company
used DCF (Discounted Cash Flow Analysis) to evaluate this proposal. In DCF analysis there
are some special featured to be maintained according to company policy are discussed
below:
The present value of the estimated benefits is determined by discounting the estimated
future cash flows by the companys cost of equity. As company has no debt portion in its
capital structure its cost of equity completely resembles weighted average cost of capital
(WACC).
Opportunity Cost
Capital budgeting decision of company requires proper enumeration of opportunity cost of
proposed project. As it is an existing company, various opportunity cost involved for
movement or shift of long term assets. After tax opportunity cost is recommended by
company policy for use in project evaluation.
After determining the project cash flow from above parameters decision making tools of
capital investment decision is applied.
Reckitt Benckiser is well established consumer goods company. The company is well
established and it operates its activities very smoothly by acquiring new business or
downsizing lose project. As the company is well established, the true fact is that, it rarely
takes new projects. So it does not usually have to use decision making tools like NPV, IRR,
Payback, and ARR.
Preferred approaches
When the company decides to take new projects or acquiring any existing business then the
company has its own preferences. It prefers NPV and IRR in evaluating new project. As NPV
and IRR make it easy to decide whether the project is lucrative or not, the firm uses these
approaches. Reckitt Benckiser often uses IRR approach. It is an important decision making
tool. It simplifies the decision making complexity and it is very much feasible. The company
prefers IRR to NPV. By using software program, it can easily calculate the IRR of any project.
Discount rate
Determining the appropriate discount rate is the challenge for the firm. The discount rate or
the cost of capital must be determined perfectly because the decision regarding taking the
project depends largely on it. The firm usually finds it difficult to determine the appropriate
discount rate. The more or less the company uses the prevailing interest rate on savings as
the opportunity cost. The firm takes into account the inflation that could come in the life
time of the project. This factor reflects in the discount rate as well.
Recent Application
Recently the Reckitt Benckiser acquired a new pharmaceutical in which it used NPV to
evaluate the project. It acquired Para Pharmaceutical. The initial outflow of this company
was Rs 3260 core. To find out the NPV, the company first estimated the net sales of the Para
pharmaceutical from the historical data of the pharmaceutical. Then the manager of Reckitt
Benckiser estimated the EBIT of the company. The estimated EBIT was about Rs. 108 core.
Using the above mentioned information Reckitt Benckiser used NPV approach with
appropriate discount rate. As it found the project substantially beneficial, it acquired the
pharmaceuticals.
Actually most of the firms are reluctant to use capital budgeting techniques because they
think it is time consuming and gruesome job to calculate or estimate the streams of inflows
and outflows. But a little practice is done by some renowned companies. Most of the
multinational companies use some sort of NPV or IRR to evaluate the worthiness of any
project. The Reckitt Benckiser is already an established company and it does not take much
project. So the practice of capital Budgeting technique is hardly used here. But at the time
of taking new project they take decision on the basis of NPV or IRR.
Almost all of the companies try to invest in that kind of source from where they will get a
positive return that is they want positive cash flow from their investment. Reckitt Benckiser
Bangladesh Ltd. Being a consumer goods like Cleaning products, healthcare, condiments
producing company has been doing their business fluently throughout the world. Its recent
financial condition is shown below:
Forecasting Risk
The possibility that errors in projected cash flows which lead to incorrect decision is the
forecasted risk and most of the cases if there is seriously errors in the projects Reckitt
Benkeiser focus on GIGO(Garbage In, Garbage Out) system that helps them to determine all
of the business and financial risks and takes initiative measures.
A) Systematic Risks
B) Unsystematic Risks
Scenario Analysis
The basic form of What if analysis is the Scenario Analysis. The determination of what
happens to NPV estimates when we ask what if questions. In this containing area Reckitt
Benckiser focuses on three scenarios from worst case to best case. After analyzing all the
scenarios it determine what should be projected cash flow and what should be probable
return from this kind of cash flows whether it is Worst Case, Base Case or Best Case.
Investigation of what happens to the NPV when only one variable is changed. The basic idea
with a sensitivity analysis is to freeze all of the variables except one and then change how
sensitive the estimation of the NPV to a change in that one variable. Going to do deep
analyses Reckitt Benckiser perform all the scenario analysis to determine the responsiveness
of variable change on NPV.
Simulation Analysis
Both the combination of Sensitivity and Scenario analysis can be termed as simulation
analysis and this is a major criterion of investing in any projects by Reckitt Benckiser.
It is used by Reckitt Benckiser as a very important tool for analyzing the relationship
between sales volume and probability. Most of the cases it focus on Accounting Break Even
and Financial Break Even.
From the upper factors of analysis the recent financial Condition of Reckitt Benckiser Bd.
Ltd. Is-
Inflation reduces the purchasing power of money and also reduces the value of the project
of firm. RB considers Long-term rates of return, inflation rates and discount rates that have
been assumed in calculating the pension and other employee post-retirement benefits. If
the real rates are significantly different over time to those assumed, the amounts
recognized in the income statement and in the balance sheet will be impacted.
Both real rates and nominal rates can be used for calculating the inflation effect and RB uses
real rates for calculating the effect of inflation. As we know both the process will give the
same answer. And RB has the efficiency in using these techniques. And also the company
recognizes inflation impact in determining the payment mechanisms to its employee. Thus
they can meet up with the increased rate of inflation which will help them to meet up their
optimum level of standard of living. The acquisition of Reckitt Benckiser adds two new
Power brands with good further growth potential to the Groups portfolio, taking the total
to 19. Durex, in the sexual Wellbeing category, is the global number one condom brand and
Scholl is the market leader in the foot care category in many of the markets in which it is
present. The acquisition of SSL also materially enhances the scale and critical mass of the
Groups businesses in China and Japan, two key East Asian markets.
The Group aims to mitigate market risks through active category, brand and customer
relationship management programs supported by ongoing investment into new product
development. The expiry of the Groups exclusive license for Suboxone in the United States
in 2009 and in the rest of the world in 2016 could expose the business to competition from
generic variants.
The Group has developed a new patented delivery method for this product which will
partially mitigate the risk of the expected entry of generic variants to the market. The
Groups new product pipeline may not generate consumer-relevant innovation and
improvement to fuel growth and build market shares. The Group has a well established new
product development process in place which includes the close monitoring of market trends
and identification of relevant consumer insights. Prior to the wider roll out of new products,
each undergoes a strict process of testing together with commercial trials in selected test
markets. Key management may leave, or management turnover may significantly increase.
The Group structures its employee reward program to attract and retain the best people.
The Group also has a formal succession planning process in place with plans being reviewed
and updated regularly for key management positions. Information technology systems may
be disrupted or may fail, interfering with the Groups ability to conduct its business. The
Group has disaster recovery plans in place which are tested periodically and invests in
appropriate antivirus software and other security measures to safeguard against this threat.
Conclusion
The company has expanded its business which has helped to be successful in capturing the
markets. And the company has been able to increase its revenue and profit. It is also adding
new patents in its production. It uses capital budgeting techniques in an effective way thus
it faces less risk in expanding its business. It is buying new businesses and adding new type
of business in its investment and taking many new projects. And in all the cases the
company is succeeded. The company has expanded its business to pharmaceuticals. The
company is succeeded because it has used the capital budgeting techniques efficiently.