2 Contents 1. Introduction 2. Acknowledgements PART I: Identifying 3. Project Proposal 4. Strategy & Capital Allocation 5. Screening of Project Ideas PART II: ANALYSIS 6. Market Analysis & Demand Analysis 7. Technical Analysis 8. Financial Estimates & Projections PART III: Selection 9. Investment Criteria PART IV: Risk Analysis 10. Project Risk 11. Firm Risk 12. Market Risk PART V: Financing 13. Notes & References 1 7


This section is HEADED Introduction rather than Preface in the hope of decoying habitual skippers into reading for their own comfort. Before getting into detail discussion of the Capital budgeting & other section a brief introduction about telecommunications sector. Normally any Financial Research report first contains the Company Profile & then the Industry Profile to facilitate the reader. I have changed the order because it is hard to define Tejas Networks without knowing the Industry.

“Communication has joined food, clothing, housing & transportation as a basic human right.”
Telecommunication is the transmission of signals over a distance for the purpose of communication. Based on the above definition & as per my understanding of the above definition I have classified the telecom sector into the following categories:




Telecom Products

Telecom Service Providers/Operators

Telecom Equipments (1)

Telecom Cables (2)

Telecom/Netwo rking Infrastructure (3)

Basic Services BSNL & MTNL

Cellular Mobile Hutch,Airtel

ISP Dishn etDSL

Intl. Long Distances RIL, VSNL


National Long Distances Railtel

PMRTS Arya Offshore

Unified Access Service Shyam, TTML

VSAT Services Bharati televentu res


Telephone Instruments Canara Communicati on Systems

Mobile handset Manufactures Ericsson India

Telecom Accessories Gupta Telecom

Twisted Pair Cable Co-Axial Cable Fiber Optic Sudarshan Telecom



Broadband Infrastructure CMTS, Digital Loop Carrier, DSL, CPE, DSLAMs, IMS, IP Services Platform, IPTV (AlcatelLucent, Cisco)

Carrier Infrastructure Carrier Core Switch/Routing , Carrier Edge Switch/Routing , Carrier Ethernet, Carrier Ethernet Access & Aggregation Routers, IMS, Mobile Backhaul for Radio Access Networks. (Cisco, ECI, Force 10, Tejas)

Carrier IP Telephony Application Servers, Hosted Multimedia Application Servers, Switching & Signalling, Class5 Alternatives, IMS, Transport & End-Points, Media Gateways, Session Border Controllers. (NokiaSiemens)

Optical Infrastructure Metro Access Systems, Metro Core ROADM, Metro Edge-SDH, Metro EdgeSONET, Mobile Backhaul for Radio Access Networks, Optical Switching Systems, PON systems, WAN DWDM systems. (Huawei, Nortel, ECI, Tejas)

Wireless Infrastructure CDMA 2000 Network, GSM/UTS Network, IMS, Metroscale, Wi-Fi Infrastructure, Imax Infrastructure. (Cisco, Huawei, Juniper Networks, Nortel)

After going through the above classification of Telecom Sector, I give a try to understand Tejas Network. Basically Tejas is Telecom Infrastructure1 Company whose domain is Optical Infrastructure. Tejas develops state-of-the-art products that bring the power of intelligent optical networking to optical access. Before getting into detail discussion of Capital Budgeting, a few words on this Project. The aim of this Project is to “improve my own understanding” on the subject of CAPITAL BUDGETING. This Project should be seen as an “academic project “not as a Professional report. Capital budgeting also referred to as Capital Investment or Capital project or just project or project valuation. Organization of the Project

DEFINITION: Organizations, personnel, procedures, facilities and networks employed to transmit and receive information by electrical or electronic means

6 Organized in terms of the broad phases of capital budgeting, this project is divided into five parts: Part 1: Identifying consists of Topic 3 to 5; Part 1 covers the planning phase of capital budgeting. Topic3 consists of project proposal. Topic 4 discusses the key concepts, models & considerations that are helpful in articulating the capital allocation strategy for this project. Topic 5 looks at the ways of screening the project proposal. Part 2: Analysis topic 6 to 8. Topic 6 basically focuses on gathering & analyzing the basic information about the project. It discusses the key steps involved in market & demand analysis. Topic 7 dwells on the various facets of Technical analysis. Topic 8 explains how financial estimates & projections relating to a project are developed. Part 3: Selection focuses extensively the various investment criteria. Part 4: Risk analysis expounds the techniques for measuring & evaluating the risk of the project. Topic 10 deals with project risk. Topic 11 deals with firm risk & Topic 12 on market risk. Part 5: Financing discusses how projects may be financed. I look forward to receiving suggestions from the readers for further improving my knowledge.

A brief introduction on Capital budgeting:

7 Capital budgeting is the process of Identifying, analysis & selecting investment projects whose return are expected beyond one year. Capital budgeting is important to the management due to the following reasons:  Their long-term consequences, significantly impact the company’s future activities  Capital expenditure decisions often involve substantial cash outlays  Decisions once taken become difficult to reverse Capital budgeting process The entire capital budgeting process can be divided into the following steps: 1. Identification The process of capital budgeting begins with identifying potential investment opportunities. 2. Analysis The focus of this process of capital budgeting is on gathering, preparing, & summarizing relevant information about various project proposal which are begin considered for inclusion in the capital budget. 3. Selection The focus of this process is judge the worthwhile ness of a project. They are divided into two broad categories viz. non-discounting criteria & the discounting criteria. The details of this process will be discussed later. Since the selection process considers the worthwhile ness of the project we are supposed to consider the risk factors that are associated with the project. The details of the risk analysis are considered in the later sections.




Nobody can really guarantee the future. The best we can do is to size up the chances, calculate the risks involved, estimate our ability to deal with them and make our plans with confidence. – HENRY FORD II


Project Proposal Needs of Customers through ISP2 are:  High Speed Internet access.  A combination of application delivering Voice, Video and data through Internet.  High Bandwidth at low cost.  Flexibility for future services & availability regardless of location. Solution: Ethernet3 over SDH/SONET. Advantages of Using Ethernet:  It’s flexible, easy to manage & operate.  It is capable of handling up to 10Gbs4 with excellent reach via Optical networks.  It’s is the lowest cost network technology on the Market.  It provides efficient Ethernet transport with excellent OAM (Operations, Administration & Maintenance) features.  It uses Bandwidth in an efficient manner.

ISP means Internet Service Provider. Ethernet is a packet based transmission protocol that is primarily used in LANs. Ethernet is the common name for the IEEE 802.3 industry specification and it is often characterized by its data transmission rate and type of transmission medium (e.g., twisted pair is T and fiber is F). 4 Gigabits per second.
2 3


Strategy & Capital Allocation. If you look at any organization, which are successful, or failure today is mainly the result of capital allocation decisions made in the past. Capital is scarce and must be allocated across competing claims very judiciously. Capital Budgeting may be viewed as a two-stage process. In the first stage, promising growth opportunities are identified through the use of strategic planning techniques and in the second stage; individual investment proposals are analyzed and evaluated in detail to determine there worth. This topic discusses strategic planning techniques & approaches aimed at promising growth opportunities. Caution: The strategy discussed here are about the project proposal mentioned in the Topic 1 & it should not be confused or compared with the Company’s strategy. A strategy is a long term plan of action designed to achieve a particular goal, most often "winning". To formulate any effective strategy, it's essential to understand two basic questions: What are we doing and what are your competitors doing? Before answering the second question, let’s discuss about the first question. Strategy involves matching a firm’s ‘Strengths’ and ‘Weakness’ (InternalAnalysis)-its distinctive competencies- with the ‘opportunities’ and ‘threats’ present in the external environment. Fig 1 shows schematically how strategies are formulated based on the concept.


Fig 1. Formulation of Strategy External Environmental Analysis 1. Customers: They can bargain for price cut, ask for superior quality & better service. A classic example is BSNL; it wants prices lower than China, quality of Japan & the most up-to-date technology with the broadest functionality of U.S.A 2. Competitors: They inflate cost, push prices down & reduce profits. 3. Suppliers: They can rise prices, lower quality & curtail the range of free offers they provide. 4. Regulation: TRAI rules & regulations &IEEE standards. 5. Infrastructure: Has the state of art R&D labs. 6. Political Environment: As far as Political environment is conducive in doing the business. Internal Environmental Analysis 1. Technical Know-How: A team of highly motivated individuals equipped with latest technology developments. 2. Marketing & Distribution Capacity: A team of highly motivated individuals. 3. Logistics: No Issues 4. Financial Resource: Always spends 10% of Sales revenue on R&D projects. 5. Resource: Highly skilled employees.

Based on the above analysis of Internal & External environment, we will use SWOT Analysis & TOWS matrix. SWOT is an acronym for Strength, Weakness, Opportunities & Threats. SWOT Analysis is a powerful technique for understanding our Strengths and Weaknesses, and for looking at the Opportunities and Threats we face. TOWS Analysis is a variant of the classic business tool, SWOT Analysis. TOWS and SWOT are acronyms for different arrangements of the words Strengths, Weaknesses, Opportunities and Threats. By analyzing the external environment (threats and opportunities), and your internal environment (weaknesses and strengths), you can use these techniques to think about the strategy of your whole organization, a department or a team.


At a practical level, the only difference between TOWS and SWOT is that TOWS emphasizes the external environment whilst SWOT emphasizes the internal environment. Note: The word “Weakness” has been changed to “Areas of Improvement”

External Environment

External Opportunities (O) 1.Demand Variability 2. Political Environment. 3. Entry barriers.

External Threat (T) 1.Customers 2. Compitetors. 3. Suppliers. 4. Regulation. 5.Price 6.Substitutes

Internal Environment

Internal Strength (S) 1.Technical KnowHow 2. Financial Resource. 3. Resources. 4. Marketing & Sales Distribution. 5.Infrastrucure Areas of Improvement (I) 1.

SO “Maxi-Maxi” Strategy 1. Product Differentiation & low cost. 2. Create & capture new demand. 3. Enter into new developing markets. IO “Mini-Maxi” strategy

ST”Maxi-Mini” Strategy 1. Long-term relationship with suppliers. 2. Difficult for competitors to imitate. 3. Building a product image. IT “Mini-Mini” strategy

Portfolio Strategy


The business portfolio is the collection of businesses and products that make up the company. The best business portfolio is one that fits the company's strengths and helps exploit the most attractive opportunities. The aim of a portfolio is: 1. Analyze its current business portfolio & decide which SBU’s should receive more or less investment, and 2. Develop growth strategies for adding new products & business to the portfolio. 3. Decide which businesses or product should no longer be retained. Mc Kinsey Matrix McKinsey Matrix has two dimensions, viz, competitive position & industry attractiveness. The criteria or factors used for judging industry attractiveness and competitive position along with suggested weights for them are as follows: Industry Attractiveness Criteria
Industry Size Industry Growth Industry Profitability Capital Intensity Technological Stability Competitive Intensity Cyclicality

0.10 0.30 0.20 0.05 0.10 0.20 0.05

Competitive position Key Success Factors Weight
Market share Technological Know-How Product Quality After-Sales Service Price Competitveness Low Operating Costs Productivity 0.15 0.25 0.15 0.20 0.05 0.10 0.10

Applying the above McKinsey Matrix criteria to Tejas Networks:
Industry Attractiveness Criteria Industry Size Industry Growth Industry Profitability Capital Intensity Technological Stability Competitive Intensity Cyclicality Weight 0.10 0.30 0.20 0.05 0.10 0.20 0.05 Rating 4 4 4 4 3 3 3 Weighted Score 0.40 1.20 0.80 0.20 0.30 0.60 0.15 3.65

14 Competitive Position Key Success Factors Market Share Technological Know-How Product Quality After-Sales Service Price Competitiveness Low Operating costs Productivity Weight 0.15 0.25 0.15 0.20 0.05 0.10 0.10 Rating 3 5 4 3 4 4 5 Weight Score 0.45 1.25 0.60 0.60 0.20 0.40 0.50 4.00

Strategic Planning & Capital Budgeting Capital expenditures particularly the major ones are supposed to sub serve the strategy of the Firm. Hence relationship between strategic planning & capital budgeting should be properly recognized. Exhibit 1 presents a way of defining this relationship. As emphasized in this exhibit Capital budgeting should be squarely related to corporate strategy.



Environmental Assessment

Managerial vision, Values

Corporate Appraisal

Strategy Plan

Capital Budgeting

Product Strategy Market Strategy Production Strategy And so on

This part of the concept is drawn from the book Strategic Management-A Methodological Approach by A.J.Rowe STRATEGIC POSITION AND ACTION EVALUATION (SPACE) SPACE is an approach to hammer out an appropriate strategic posture for a firm and its individual businesses. An extension of the two-dimensional portfolio analysis, SPACE involves a consideration of four dimensions:  Company’s competitive advantage  Company’s financial strength  Industry strength  Environmental stability

Strategic Postures


The basic strategic postures associated with the SPACE approach are as follows: Aggressive Posture This is appropriate for a company which  Enjoys a competitive advantage and considerable financial strength and  Belongs to an attractive industry that operates in a stable environment. Competitive Posture This is suitable for a company which  Enjoys a competitive advantage but has limited financial strength, and  Belongs to an attractive industry operating in a relatively unstable Environment. Conservative Posture This is appropriate for a company which  Enjoys financial strength but has limited competitive advantage, and  Belongs to a not-so-attractive industry operating in a relatively stable environment. Defensive Posture This is suitable for a company which  Lacks competitive advantage as well as financial strength, and  Belongs to not-so-attractive industry operating in an unstable environment. Applying the SPACE concept to Tejas Networks Tejas Networks falls under Competitive posture. The key planks of the competitive posture are as follows:  Maintain and enhance competitive advantage by product improvement and differentiation  Widen the product line  Improve marketing effectiveness and  Augment financial resources. There is a commonality between competitive posture described here and the generic strategy of product differentiation suggested by Michael Porter. The generic strategy of Porter and the key options associated with SPACE are shown below for Competitive posture.

Financial Strength


Competitive Strength


Industry Strength

Environmental Strength


Screening of Project Ideas
The search for promising projects ideas is the first step towards establishing a successful venture. As the tradition adage goes the key to success lies in “getting into right business at the right time”. While this advice is simple, its accomplishment is difficult because good business opportunities tend to be elusive. Identification of such opportunities requires imagination, sensitivity to the environmental changes and realistic assessment of what the firm can do. Identification is often the outcome of a triggering process rather than an analytical exercise. While the notion of identification is simple, it is difficult to develop methods or procedures for accomplishing it, as there is no well-defined theory to guide this task. And as Gordon & Pinches observed:” These difficulties more severe as one move up the hierarchy of organizational decision-making levels because of the relative uniqueness of higher level decision as compared to low-level decision.” With this note of caution, this topic discusses certain broad considerations & guidelines helpful in screening of project ideas. The objective is to identify investment opportunities, which are prima facie feasible & promising & which merit further examination and appraisal. The discussion is divided into six sections as follows:       Monitoring the environment Corporate appraisal Profit potential of industries: Porter Model Preliminary screening Project rating index Sources of positive net present value.

3.1 MONITORING THE ENVIRONMENT Basically a promising investment idea enables the firm to exploit opportunities in the environment by drawing on its competitive strengths. Hence the firm must systematically monitor the environment & assess its competitive abilities.


3.2 CORPORATE APPRAISAL A realistic appraisal of corporate strengths & weaknesses is essential for identifying investment opportunities, which can be profitably exploited. The broad areas of corporate appraisal & the important aspects to be considered under them as follows:      Marketing & distribution Productions & operations Research & developments Corporate resources & personnel Finance & accounting

3.3 TOOLS FOR IDENTIFY PROMISING INVESTMENTS There are several useful tools or frameworks that are helpful in identifying promising investment opportunities. The most popular ones are the Porter Model, Life Cycle approach & Experience Curve. In this project we will be discussing only Porter Model. The model of the Five Competitive Forces was developed by Michael E. Porter in his book “Competitive Strategy: Techniques for Analyzing Industries and Competitors” in 1980. Since that time it has become an important tool for analyzing an organizations industry structure in strategic processes. Porter’s model is based on the insight that a corporate strategy should meet the opportunities and threats in the organizations external environment. Especially, competitive strategy should base on and understanding of industry structures and the way they change. Porter has identified five competitive forces that shape every industry and every market. These forces determine the intensity of competition and hence the profitability and attractiveness of an industry. The objective of corporate strategy should be to modify these competitive forces in a way that improves the position of the organization. Porter’s model supports analysis of the driving forces in an industry. Based on the information derived from the Five Forces Analysis, management can decide how to influence or to exploit particular characteristics of their industry. The five basic competitive forces are: 1. Threat of new Entrants 2. Rivalry among the existing firms

20 3. Pressure from the substitute products. 4. Bargaining power of buyers 5. Bargaining power of sellers. Fig 2 diagrammatically shows the forces that drive competition & determine the industry profit potential.

Potential Entrants Threat of New entrants


Bargaining Powers Of Suppliers

THE INDUSTRY Rivalry between existing firms

Bargaining Power of Buyers


Threat of Substitute Products Substitutes

Threat of New Entrants: New entrants add capacity, inflate costs, push prices down and reduce profitability. Rivalry between existing firms: If the rivalries between the firms are strong, competitive moves & countermoves dampen the average profitability of the industry. Pressure from the Substitute: Substitute products may limit the profit potential of the industry by imposing a ceiling on the prices that can charge by the firms in the industry.


Bargaining Power of Buyers: They can bargain for price cut, ask for superior quality & better service and induce rivalry among competitors. If they are powerful, they can depress the profitability of the supplier industry. Bargaining Power of Suppliers: Suppliers like buyers can exert a competitive force in an industry as they can raise prices, lower quality & curtail the range of free services that they provide.

Applying the above Porter’s Model to Tejas Networks

Threat of New Entrants

Suppliers Flextronics, Jabil

Tejas Networks Rivalry (Competitive) companies are Cisco, ZTE, Force10, Nortel, Orion Networks

Buyers BSNL, ITI, Airtel

Threat of Substitutes

An overview to overcome the Porter’s Five Forces is: 1. Reducing the Competitive Rivalry between Existing Players
  

Avoid price competition Differentiate your product Focus on different segments

2. Reducing the Treat of New Entrants

Create a marketing / brand image

   

Patents Tie up with suppliers Tie up with distributors Customer Loyalty

3. Reducing the Bargaining Power of Suppliers
 

Partnering Increase dependency

4. Reducing the Bargaining Power of Customers
 

Increase loyalty Value added services

5. Reducing the Threat of Substitutes5
 

Legal actions Switch costs

3.4PRELIMINARY SCREENING Preliminary screening is required to eliminate ideas, which prima facie are not promising. For this purpose the following aspects may be looked into: • • • • • • Compatibility with the promoter Consistency with governmental priorities Availability of inputs Adequacy of markets Reasonableness of cost Acceptability of risk level

3.5PROJECT RATING INDEX A preliminary evaluation may be translated into a project-rating index. The steps involved in determining the project-rating index are as follows: • Identify factors relevant for project rating. • Assign weights to these factors. • Rate the project proposal on various factors, using a suitable rating scale. • For each factor, multiply the factor rating with the factor weight to get the factor score. • Add all the factor scores to get the overall project-rating index.

Threat of substitutes in Telecom Infrastructure Company is very rare.


Applying the project-rating index to Ethernet over SDH/SONET. Factor Factor Weight VG 5 Input Availability Technical Know-How Reasonableness of Cost Adequacy of market Complementary relation -ship with other product Stability Dependence on firm’s Strength Consistency with govern -Mental priorities 0.25 0.10 0.05 0.15 0.05 0.10 0.20 0.10 * * Rating Index * * * * * G 4 * Rating A 3 P 2 VP 1 1.00 0.50 0.20 0.75 0.20 0.40 1.00 0.40 4.45 Factor Score

3.6 SOURCES OF POSITIVE NET PRESENT VALUE There are six main entry barriers that result in positive NPV projects. They are as follows: • Economies of scale • Product differentiation • Cost advantage • Marketing reach • Technological edge • Government policy


PART 2 ANALYSIS 4.Market and Demand Analysis 5.Technical Analysis 6.Financial Estimates and Projections Statistics may be defined as "a body of methods for making wise decisions in the face of uncertainty." W.A. Wallis

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