Capital Bugeting

CAPITAL BUDGETING
CAPITAL BUDGETING
The term Capital Budgeting refers to long term planning for proposed capital
outlay and their financing. It includes raising long-term funds and their utilization. It
may be defined as a firm’s formal process of acquisition and investment of capital.
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.
It deals exclusively with investment proposals, which an essentially long term

projects and is concerned with the allocation of firm’s scarce financial resources
among the available market opportunities.
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.
Definitions:
“Capital budgeting is long term planning for making and financing proposed
capital outlays”.
T.HORNGREEN
“Capital budgeting is concerned with allocation of the firm’s scarce financial

resources among the available market opportunities and the consideration of
investment opportunities. The consideration of investment opportunities involves the
comparison of the expected future streams of earnings from a project with immediate
and subsequent streams of expenditures for it”.
KOTTAM KARUNAKARA REDDY INSTITUTE OF TECHNOLOGY 1

CAPITAL BUDGETING
In any growing concern, capital budgeting is more or less a continuous process

and it is carried out by different functional areas of management such as production,
marketing, engineering, financial management etc. All the relevant functional
departments play a crucial role in the capital budgeting decision process of any
organization, yet for the time being, only the financial aspects of capital budgeting
decision are considered.
The role of a finance manager in the capital budgeting basically lies in the
process of critically and in-depth analysis and evaluation of various alternative
proposals and then to select one outlay of these. As already stated, the basic objectives
of financial management is to maximize the wealth of the share holders, therefore the
objectives of capital budgeting is to select those long term investment projects that are
expected to make maximum contribution to the wealth of the shareholders in the long
run.
Features of Capital
The important features, which distinguish capital budgeting decisions
in other Day-to-day decisions, are
 Capital budgeting decisions involve the exchange of current funds for

the benefits to be achieved in future.
 The futures benefits are expected and are to be realized over a series of
years.
 The funds are invested in non-flexible long-term funds.
 They have a long terms are 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.

CAPITAL BUDGETING
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.
The importance of capital budgeting arises mainly due to the following:
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 for 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.
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.

CAPITAL BUDGETING
6. Notional Importance:
Investment decision though taken by individual concern is of national
importance because it determines employment, economic activities and economic
growth.
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.
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.
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.
Evaluation of Various Proposals:

The next step in the capital budgeting process is to 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.

CAPITAL BUDGETING
Fixing 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.
FINAL APPROVAL AND PREPERATION 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.
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.
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.

CAPITAL BUDGETING
METHODS OR TECHNIQUES OF CAPITAL BUDGETING:

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

CAPITAL BUDGETING
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.
Initial Investment
Pay Back Period = ------------------------------
Annual Cash Inflows
ADVANTAGES:
 Simple to understand and easy to calculate.
 It saves in cost; it requires lesser time and labor as compared to other
methods capital budgeting.
 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.
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.

CAPITAL BUDGETING
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

CAPITAL BUDGETING
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.

CAPITAL BUDGETING
3. NET PRESENT VALUE METHOD:

The NPV method is a modern method of evaluating investment
proposals. This method takes in to consideration the time value of money and
attempts to calculate the return on investments by introducing time element. The net
present values of all inflows and outflows of cash during the entire life of the project is
determined separately for each year by discounting these flows with firms cost of
capital or predetermined rate. The steps in this method are
1. Determine an appropriate rate of interest known as cut off rate.

2. Compute the present value of cash outflows at the above-determined
discount rate.
3. Compute the present value of cash inflows at the predetermined rate.
4. Calculate the NPV of the project by subtracting the present value of cash
outflows from present value of cash inflows.
Decision rule
Accept the project if the NPV of the project is 0 or +ve that is present
value of cash inflows should be equal to or greater than the present value of cash
outflows.

CAPITAL BUDGETING
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.

CAPITAL BUDGETING
4. 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
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 + -------------------------------------------------------------
(hr-lr)
PV of cash inflows at lower rate-PV of cash inflows at
Higher rate

CAPITAL BUDGETING
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.
4. 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.

CAPITAL BUDGETING
5. 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
PV of cash inflows
Profitability index = ------------------------------
PV of cash outflows
NPV
Net profitability index = -----------------------------
Initial Outlay
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 applied 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.
DISADVANTAGES:
 More difficult to understand and operate.
 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.

CAPITAL BUDGETING
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.,
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 BUDGETING
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 an 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.
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 payback 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.

CAPITAL BUDGETING
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 fix priorities among various projects and ensure their followup.
 To compare periodically actual expenditures with the budgeted ones so
as to avoid any excess expenditure.
 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.
STEPS INVOLVED IN CONTROL OF CAPITAL EXPENDITURE:
 Preparation of capital expenditure budget

 Proper authorization of capital expenditure
 Recording and control of expenditure
 Evaluation of performance of the projects

CAPITAL BUDGETING
LONG TERM SOURCES OF FINANCE
It is natural phenomenon that the firm is always in deficit of funds.

There are two methods of raising funds.
1) Long term sources

2) Short term sources.
Capital budgeting decisions involve long term funds. The different long term
sources of finance generally followed by companies are:
1) Shares
2) Debentures
3) Term Loans.
SHARES:
Shares include ordinary or common shares and preference shares.

Ordinary or common shares are the source of permanent capital since they do not have
a maturity date. The holders of ordinary shares are share holders or stock holders are
the legal owners of the company.
Preference share is considered to be hydride security as it has many

features of both ordinary shares and debentures. Preference shares may be issued with
or without maturity date. The holders of preference shares get dividend at a fixed rate
and have preference over ordinary share holders.
DEBENTURES:
Debentures are a long term promissory note for raising loan capital.
The debenture trust deed defines the legal relationship between the issuing company
and the debenture trustee who represent the debenture holders.

CAPITAL BUDGETING
TERM LOANS:
Term loans for more than a year maturity. It is generally available for a
period of 10 years. Interest on term loans is tax deductable. They are obtained from
banks and specially created financial institutions like IFCI, ICICI IDBI etc. the
purpose of term loans is mostly to finance the company’s capital expenditure. They are
generally obtained for financing large expansion, modernization or diversification
projects. Hence, this method of financing is also called pro0ject financing. This is the
most widely used source of financing.
LEASE FINANCING:
A lease is an agreement for the use of an asset for a specified rental.
The owner of the asset is called the lease and the user the leas see. Two important
categories of lease are
1) Operating leases
2) Financial leases
Operating leases are short term cancelable leases where the risk of
obsolescence is born by the leasers.
Financial leases are long tern non-cancellable leases where any risk in
the use of asset is borne by the lessee and he enjoys the return too.
BUYING OR PROCURING:
Buying or procurement involves purchasing an asset permanently in the
form of cash or credit.
LEASING (VS) BUYING:

Leasing equipment has the tax advantage of depreciation which can
mutually benefit both the leaser and lessee. Other advantages of leasing include
convenience and flexibility as well as specialized services to the lessee. Lease proves
handy to those firms to those firms which cannot obtain loan capital from normal
sources. The pros and cons of leasing and buying are to be examined thoroughly
before deciding the method of procurement i.e., leasing or buying.

CAPITAL BUDGETING
CAPITAL BUDGETING IN OF PVC PIPES LTD
The capital Budgeting in PVC pipes Ltd is based on capital budget

manual which covers the following aspects.
I. INTRODUCTION.
The Company’s Budget for the calendar year 2010 will be prepared in
accordance with the “Budget/Accounts Consolidation Chart’ attached herewith as per
Annexure “A”
Head Office will provide the historical sales date with Fuel surcharge, without
fuel surcharge and with fuel surcharge neutralized to 25% up to September 2007 for
each area by way of a file transfer to the Regional Heads/Controllers who would in
turn disseminate the same to the concerned Branch Mangers/Area Mangers.
Each Area/Department on the consolidation Chart will have its own Budgets.
The Budgets for the service Centers reporting’s in to each area will be consolidated
with the area Budgets and similarly, the FCC and RSP Budget will be consolidated
with the Budget where they are controlled from, but would need to be computed
scientifically and reflected in the Area sales budget
All Area Budget will be consolidated first at the Branch Level , thereafter at
the Region level and finally at the company level and finally at the company level
Each Area/Department will prepare budgets as per annexure given hereto
a. Capital Budget
b. Sales Budget
c. Expenses
All budget prepared must be broken up taking into consideration the actual
number of working days at the area level in each month.

CAPITAL BUDGETING
The following information is also attached to support you in the Budget

process
1. working days region/month wise jan-dec’07, Jan-Dec’07, Jan-Dec’09

& average of these 3 years is provided in Annexure “D”
2. For the period Jan’08 to Sep’08, the actual sale % Region wise Against
each Market holiday is provided in Annexure “E”
You could refer to above-Mentioned Annexure as a guideline only:

Areas need to take into account their own market holidays
II.RESPONSIBILITY FOR PREPARATION OF BUDGETS
The Area Budget will be prepared by the Area manager supported by the Area
Accountant. The Budget will be reviewed by the Branch Manager. After review of the
Area Budget by the Branch Manager, it will be finally reviewed by the Regional head
and the Regional Controller.
The responsibility for the consolidation of the Regional Budget will be with the
regional Controllers and the responsibility for the consolidation of the Head office
Department Budget will be with the Corporation Controller All India at Head Office
and the total Company’s budget would be with V.P Corporate Accounts.

CAPITAL BUDGETING
ANNUAL PLAN EXERCISE:
The capital funds budget/annual plan is meant for making provision for
cash expenditure of capital nature including the foreign exchange component wherever
necessary.
The capital funds budget will mainly contain the following information
along with other information:
1) Revised estimates for the current year.

2) Budget estimates for the ensuring year i.e., budget year.
3) Preliminary budget estimates for the year following the budget year.
GENERAL GUIDELINES:
The capital funds budget is to be prepared under six major heads.

 Continuing schemes
 New schemes
 Modernization and rationalization
 Township
Science and technology
1. CONTINUING SCHEMES:
These schemes include all such schemes which are under implementation of
which funds provision has been made in the current year/provision is required in the
budget year.
2. NEW SCHEMES:
This scheme includes all such schemes which are proposed to be initiated in
the budget year and for which funds provision is required in the budget year.
Normally, such schemes are included in the five year plan of the company approved
by the planning commission.

CAPITAL BUDGETING
3. MODERNISATION AND RATIONALISATION(M&R):

This includes items of plant & machinery etc for which funds are required in
the budget year and the following year. All items included in M&R should
improvement/debottlenecking/replacement/productivity, improvement and welfare.
The M&R items are to be submitted in the following main characteristics accompanied
with full justification on the ageing of facilities, increased output and production,
quality requirements bottlenecks.
 Replacement/modernization
 Balancing facilities(essentially to increase production
 Operational requirements including material handing
 Quality/listing facilities
 Welfare
 Minor works
These requirements should be prioritized item wise. A separate proposal is

required for M&R items costing more than `.10, 00,000
4. TOWNSHIP:
Township budget is divided into two parts.
o Continuing township schemes

o New township schemes
Funds required against each scheme should be backed up with full data on
number on quarter/scope of work to be completed against the funds requirements
phasing of budgeted funds for current year, budget year and following year etc, should
be given similar information on number of quarter/ scope of work already completed,
expenditure incurred till last year, satisfaction level it is to be added in the above back
up information for each scheme.

CAPITAL BUDGETING
5. SCIENCE AND TECHNOLOGY:

This budget can be divided into two categories.
 Continuing schemes
 New schemes to be taken up in the budget year.
The scheme should fall in any of the above categories giving details on
physical and financial progress etc.
6. EDP SCHEMES:
All funds requirements for computer/information systems should be grouped
under EDP schemes and projected accordingly.
FUNDING MODE
As per present practice, the annual plan/capital funds budget of the company is
financed under two major heads.
 Budgetary support from the government

 Internal resources of the company
1. The budgetary support from the government is received in the form of loan and
equity in the ratio of 1:1 approximately as per the government guidelines.
2. Internal resources are the company’s own funds/reserves. The present trend
indicates gradual decline budgetary support from the government and it is
insisting on utilizing of more internal resources for capital funding. This
necessitates a rigorous and critical budget formulation exercise.
1. SCHEMES/PROJECTS:
Feasibility report for such schemes should include and analysis
of the plant initiating the report, its present status, its products and its role in the
industry. Governments view on the present future growth plants for the industry to
which the products belong and current five year plan provisions for the scheme should
also be brought out.

CAPITAL BUDGETING
NEED FOR THE PROJECT:

A brief Para on alternatives examined/results obtained should be
included in the report. This should be done taking into consideration factors like
optimum size of the plant, location, product mix, technology, demand, transportation
etc.
2. TECHNOLOGY CONSIDERATION/CHOICE:
For the product to which the scheme relates, all considerations/parameters
analyzed in making the choice should be outlined. These may be enumerated as
follows.
 Suitability of technology for the product/raw material available

 Status of technology within BLUE DART EXPRESS LTD,.
 Whether existing/new technology, if new reasons for preference and
benefits.
 Trends in the world/local markets.
 Competitiveness of the technology chosen
 Collaboration proposed
 R&D activities required
 Chances of technology had chosen getting obsolete.
2. PROJECT DESCRIPTION:
In order to help the appraisal, in analyzing evaluating the proposal, the
description should touch upon site, equipment requirement, input requirement, labor
phasing of construction, production built up, and any collaboration required, housing
needs, etc.
3. MARKETING:
The detailed market analysis in the feasibility report should answer questions
like.
 Total market potential for the product
 Expected market share
 Competitors details

CAPITAL BUDGETING
Based on the market survey the demand supply position in detail should be
given. Marketing plan for the product based on market survey and studies conducted
for the product should be mentioned in the report.
4. INDUSTRIAL LICENSE:
Feasibility report should mention the need for industrial license, if any, for the
products proposed in the investment proposal
5. CAPITAL INVESTMENT REQUIREMENTS:

It is necessary that the estimates of capital costs presented in the feasibility
report should be reasonable complete and properly estimated. For the purposes of
project appraisal, capital costs are essentially those costs which are incurred before the
commencement of commercial production. For fixed assets are costs like customs
duty, excise, insurance, transportation at the latest applicable rates should be
calculated.
6. OPERATING REQUIREMENTS:
For the purposes of project appraisal, operation costs are essentially those costs
which are incurred after the commencement of commercial production. This will help
in financial analysis.
7. FINANCIAL ANALYSIS:
The purpose of financial analysis of a project is to present some measures to
assess the financial viability of the project. The data presented in this formats should
be consistent with the production plans, operation costs, capital costs.
8. SENSITIVITY ANALYSIS:
The feasibility report should also briefly present the results of sensitivity
analysis. This is relevant whenever the key assumptions made in the feasibility report
are likely to be changed/affected.
PROJECT IMPLEMENTATION PLAN:

CAPITAL BUDGETING
The feasibility report should briefly indicate the project implementation,

organization that will be responsible for executing the scheme. This is most essential
for expansion/diversification schemes at existing plant locations.
9. ECONOMIC ANALYSIS:
Economic analysis the viability of the project is evaluated taking into account
the opportunity cost of the tradable inputs/outputs which go into the project, shadow
prices for foreign exchange, domestic resource costs of the non tradable inputs. Such
analysis may be relevant for planning commission in evaluating the projects from the
national perspective/plans.
10. PREPARATION OF DETAILED PROJECT REPORT.

For all capital investment schemes which have been approved by the
government, it is essential to prepare a detailed project report which will form the
basis of project execution. The purpose of detailed project report is not only to enable
projecting a realistic requirement of budgetary funds, but it would also improve the
planning the implementation aspects of capital projects. The detailed project report
should be submitted within 6 months from the date of financial sanction for the
scheme.

CAPITAL BUDGETING
a) REVIEW OF LITERATURE
1. 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.
2. 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.

CAPITAL BUDGETING
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 behavioral 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
Raiffa, 1982). In fact, research shows that professionals from many fields exhibit
overconfidence in their judgments, including investment bankers (Staël 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).

CAPITAL BUDGETING
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.
The Sensitivity of Investment to Cash Flow

According to classical economic theory, a firm’s investment should be driven
exclusively by the profitability of its opportunities. More specifically, the value of a
firm’s Tobin’s (1969) Q should be sufficient to explain the level of its investment.
However, as documented by Fazzari, Hubbard and Petersen (1988) and numerous
authors following them (for a review of this literature, see Hubbard, 1998), this
prediction does not seem to hold empirically. Firms that have more cash and rely less
on debt financing tend to invest more than other firms, keeping investment
opportunities fixed. The literature contains several explanations for this result,
including the effects of adverse selection and moral hazard on the cost of external
financing and Jensen’s (1986) empire-building theory (for a review, see Stein, 2003).
Another explanation is from Heaton’s (2002) model of overconfident CEOs.
Overconfident CEOs are reluctant tofinance new investments by issuing risky
securities that they perceive to be undervalued. Yet, the presence of cash or the ability
to issue (almost) riskless debt creates the financial slack these CEOs require to pursue
their aggressive investment strategies. Malmendier and Tate (2005a) perform a series
of regressions of investment on various variables known to explain the investment

CAPITAL BUDGETING
decisions of firms including Tobin’s Q and cash flows. To test the prediction that CEO
overconfidence increases the impact of cash flows on investment, they include an
interaction term between cash flows and their measure of CEO overconfidence in their
regressions. Their results confirm existing findings on investment-cash flow
sensitivity; the coefficient on cash flow is positive and significant. Their results also
show that, as predicted by Heaton (2002), the investment reaction of overconfident
CEOs to cash flows is stronger. In all their regressions, the coefficient on the
interaction term is positive and significant. To refine their test of Heaton’s (2002)
model, Malmendier and Tate (2005a) test the prediction that financially constrained
firms should be more affected by CEO overconfidence than other firms. After sorting
their sample of firms according to Kaplan and Zingales’ (1997)12 measure of a firm’s
financial constraint, they confirm that the impact of CEO overconfidence onthe
relationship between investment and cash flow is limited to firms that have difficulty
in accessing capital markets to finance their investments.
Mergers, Acquisitions, and Takeovers of the Capital Budgeting
In their review of the literature on corporate control, Jensen and Ruback (1983)
conclude, from the empirical evidence existing at that point (e.g., Dodd, 1980 Asquith,
1983, 13Eger, 1983), that mergers do not create any value for the bidding firms.
Subsequent work by Bradley, Desai, and Kim (1988) and Berkovitch and Narayanan
(1993) shows that acquisitions have a negative impact on the value of acquiring firms.
More recently, Andrade, Mitchell, and Stafford (2001) document that from 1973 to
1998 acquiring firms experienced average abnormal returns of -0.7 percent during the
three-day window surrounding the announcement of a merger. Similarly, Moeller,
Schlingemann, and Stulz (2005) report that, in over 12,000 acquisitions from 1980 to
2001, acquiring firms have lost a combined value of $220 billion at the time they
announce their plan to acquire firms for an aggregate amount of $3.4 trillion.

CAPITAL BUDGETING
Entrepreneurs, New Markets, and Novel Projects

Another capital budgeting situation that is particularly prone to the
effects of managerial Over confidence involves entrepreneurs in small, often private,
firms. Because fewer people are involved in the capital budgeting process of these
small firms, the biases of its key decision makers are less likely to be confronted by
others or by a lengthy decision process. Exacerbating this problem is the fact that these
small firms are often involved in projects and markets for which little or no data are
available, rendering any kind of statistical model powerless in curbing hasty
investment decisions. Finally, although the extreme risks involved in many
entrepreneurial decisions can be paralyzing for most individuals, they are more easily
handled and even welcome by overconfident individuals.
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.

CAPITAL BUDGETING
As Gordon and Pinches (1984) View:

Most of the literature on the subject of capital budgeting has
emphasized the selection phase, giving little coverage to the other phases. Instead, it is
usually assumed that a set of well-defined capital investment opportunities, with all of
the informational needs clearly specified suddenly appears on an executive’s desk and
all that is needed is for the manager to choose the project (s) with the highest expected
payoff. However, as most managers quickly learn, this is not the case. Further, once
projects are chosen, the evaluation of an individual project’s subsequent performance
is usually either ignored or often inappropriately handled. Our contention is that the
capital budgeting process must be viewed in its entirety, and the informational needs
to support effective decisions must be built into the firm’s decision support system

CAPITAL BUDGETING
b) NEED FOR THE STUDY
 The project study is undertaken to analyze and understand the Capital

Budgeting process in Anantha PVC pipes Pvt 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.

CAPITAL BUDGETING
c) 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 measure the present value of rupee invested.
 To understand an item wise study of the company of financial
performance of the company.
 To make suggestions if any for improving the financial positions of the

company.

CAPITAL BUDGETING
d) SCOPE OF THE STUDY
Capital budgeting is the method of calculations of inflows of the project

undertaken by the company and investment recovers position of the company. For the
evaluation of the profitability position use discounting and non-discounting techniques
like IRR, NPV and Whether or not funds should be invested in long term projects such
as setting of an industry, purchase of plant and machinery etc. analysis the proposal for
expansion or creating additional capacities. Decide the replacement of permanent asset
such as building and equipments make financial analysis of various proposals
regarding capital investment so as to choose the best out of many alternative
proposals.

CAPITAL BUDGETING
e) LIMITATIONS OF THE STUDY
 Lack of awareness of ANANTHA PVC PIPES PVT. LTD.
 Lack of time is another limiting factor the schedule period 6 weeks are
not sufficient to make the study independently regarding Capital
budgeting in ANANTHA PVC PIPES PVT LTD
 The busy schedule of the officials in the ANANTHA PVC PIPES PVT
LTD is another limiting factor. Due to the busy schedule of officials
restricted me to collect the 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.

CAPITAL BUDGETING
f) SOURCES OF DATA
To achieve a fore said objective the following methodology has been

adopted. The information for this report has been collected through the primary and
secondary sources.
Primary sources:
It is also called as first handed information 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 Anantha pvc
pipes pvt ltd.
Secondary sources:
These secondary data is existing data which is collected data which is
collected by others that is sources are financial journals, annual reports of the Anantha
pvc pipes pvt ltd.,

CAPITAL BUDGETING
INDUSTRY PROFILE
a) PLASTIC INDUSTRY
Introduction:
Plastic have become synonymous with modern living. It is undoubtedly

a product, which has penetrated extensively into the common man’s life. No wonder
the industry has achieved in terms of supply of raw material expansion and
diversification of processing capabilities and manufacturing of processing machinery
and equipment.
This versatile material with its superior qualities such as light weight,
easy process ability corrosion resistance, energy conservation, no toxicity etc. many
substitute to a large extent many conventional and costly industrial materials like
wood, metal, glass, jute, lather etc., in the future. The manifold applications of plastics
in the field of automobiles, electronics, electrical, packaging and agriculture give
enough evidence of the immense utility of plastics.
At 80 percent of total requirement for raw material and almost all types
of plastic machines required for the industry are indigenously available. The present
investment in all the three segments of the industry namely production of raw
materials, expansion and diversification of processing capacities, manufacturing of
processing machinery and ancillary equipment is `.1250 corers and it provides
employment to more than eight lake people.
On account of their inherent advantage in properties and versatility in
adoption and use, plastics have come to play a vital role in a variety of applications,
the world over. In our country, plastics are used in making essential consumer goods
of daily use for common man such as baskets, shopping bags, water bags, water
bottles, school bags, Tiffin boxes, hair combs, tooth brushes, spectacle frames and
fountain pens, they also find applications in field like packaging, automobiles, and
transportation, engineering, electronics, telecommunications, defense, medicine, and
building and construction. Plastics are growing in importance in agriculture and water
management.

CAPITAL BUDGETING
The Govt. of India recognizing the importance of plastics in agriculture

appointed on March 7th, 1981 a National Committee on the use of plastics in
agriculture under the chairmanship of Dr.G.V.K.Rao. This committee has forecast a
tremendous growth of drip irrigation through a net work of plastic pipes and tubes. In
its opinion large scale adoption of irrigation would lead to sports in demand for PVC
pipes, L.D.P.E tubes and polypropylene emitters. The committee made a number of
recommendations for promoting the use of plastics. The implementation of
recommendations would go along away in increasing the consumption of plastics,
which at present is very low. The rigid pipes, flexible pipes and sheeting, which are
being used for agricultural operations to carry out water place to place and also lining
of ponds and reservoirs to reduce seepage and most important in drip irrigation
system.
Export of plastics goods:
Plastics have excellent potentialities. Our country is equipped with all kind of
processing machinery and skilled labor and undoable, and extra to boost export,
finished plastics products will yield rich divided.
Today India exports plastic products to as many as 80 countries all over the
world. The exports, which were stagnant at around rest 60-70 cores per annum double
to 129 craters. The Plastic industry has taken up the challenge of achieving an export
target of `.17 cores.
Major export markets for plastic products and linoleum are Australia,
Bangladesh, Canada, Egypt, Hong Kong, Italy, Kuwait, Federal Republic of Germany,
Sri Lanka, Sweden, Taiwan, U.K., U.S.A., and Russia.
With view to boosting the export, the plastics and linoleum’s export promotion
council has urged the government to reduce import duty of plastic raw material, supply
indigenous raw materials at international prices, fix duty, draw backs on weighted
average basis and charge freight rate on plastic products on weights basis instead of
volume basis.

CAPITAL BUDGETING
Prospects:
The Production of various plastics a raw materials in the country is expected to

double by the end of seventh plan, the consumption of commodity plastics including
LDPE, HDPE, PP, PS AND PVC is immense scope for the use of plastics in
agriculture, electronics, automobile, telecommunications and irrigation and thus, the
plastic industry is on the threshold of an explosive growth.
Role of plastics in national economy
Plastics are not perceived as just simple colorful household products in the
mind so common person. A dominant part of the plastics of the percent and future find
their utilization in the areas.
 Agriculture, forestry and water-management.
 Automobile and transportation
 Electronics and telecommunications, buildings, construction and.
 Food processing and packaging
 Power and gas distributor.
Importance Of Pipes Industry
We shall look at the basic data about plastics and particularly those properties,
which are so, fuse in practical working with plastics. Plastics are man-made materials.
The oldest raw material for producing plastics is carbonaceous material obtained from
coal tar (benzene, phenol).
Today the majority of raw materials are obtained from petrol chemical source
and they can be economically produced in large quantities.
Plastics have changed our world and day-by-day they are becoming important.
They own their success to whole series of advantage, which they have over
conventional materials such as:

CAPITAL BUDGETING
 Lightweight
 Excellent mould ability
 Attractive colors
 Low energy requirements for convention
 Low labor and cost of manufacture
 Low maintenance & High strength weight ratio
Economic role:
Agriculture is the chief occupation in India. For the developing

countries like India modernization of the agriculture practices assumes pivotal places
in improving the economic status and the process of modernization. Includes usage of
higher productive plastics supplement to greater extent manufacturing of tools
required for new agricultural practices.
The usage of poly vinyl chloride pipes in agricultural fields, lesser

water seepage, which was predominant in earlier practices, with services of P.V.C
pipes, water can be transported efficiently with lesser from the place of higher
potential to the place of lower water potential.
Presently the revolutionary tried in water management speaks much

about drip irrigation, which is developed in Israel and is practiced by all agricultural
based nations in the world. Drip irrigation greatly P.V.C pipes as core tools of
implementation with the services of this sort, P.V.C pipes one way or the other
strengthening the hands of country’s economy.
A part with the referred P.V.C pipes supplemented with fitting is used
in houses for electrical connection and other domestic purposes. Apart from these two
applications it has got wide applications even in industrial sectors. P.V.C pipes with
much unique heart, chemical and physical characteristics serve many industrial
purposes.

CAPITAL BUDGETING
Even characteristics of weight and low price attract many more

applications. Rigid PVC pipes have been manufactured in India from the 60’s on
imported extrusion lines and there after indigenous plan were few pipes manufactures
upto 1979-83. When many extrusion lines were imported from batten field, Cincinnati,
kraaus-maffi etc. the Govt. allowed the imports of sophisticated and high output
plants, which were not available indigenously.
PVC pipes in India:
Pipes products have found wide acceptance in India and abroad. PVC is
one of the more versatile plastics. It can be extruded, moulded, calendared and
thermoformed into a multitude of furnished products. The PVC resin can be
formulated to give a wide range of properties ranging from hand, tough materials for
load bearing application lime pipes, windows and doors to flexible materials for
products a due as wire and cable insulation and shooting and flooring.
PVC products cater to both interiors and exteriors. In interiors it can be

used for flooring, profile and cable tray, wall covering modular office systems, houses
and furniture. For exteriors it is used for doors and windows, fencing partitions and
paneling, roofing and rain systems.
The other external applications are in the field of irrigation, portable

water supplies. In the field of irrigation there are several methods to irrigate the fields.
There are minor irrigation projects and major irrigation projects apart from individual
sources like wells, tube wells, bore wells. Major irrigation sector small projects will
have canals and lift irrigation schemes etc., will have canals and lift irrigation schemes
etc., will have pipelines. Cement and GI pipes were the pipes used in conventional
methods of irrigation. Now-a-days PVC pipes replaced the conventional pipes and
they constituted almost 90% in this respect.
Drip irrigation popular in the agricultural sector especially in the field

of horticulture commercial cropping and green ply houses. The drip irrigation concept
is becoming more popular with its advantages like highly yield, water conversion, less

CAPITAL BUDGETING
labor cost, less fertilizer, less past management costs, less power costs and many more
advantages. The demand for this concept is increasing at a place of 30%-40% per
annum.
Agriculture a sunrise industry in the Indian economy is mainly

dependent on the PVC pipes for the seawater sector and pumping to their aqua ponds.
They are using pipelines of four to five kilometers of 10-16 diameters pipes.
The state Govt. of A.P is using rigid PVC pipes for the irrigation water
supplies for the past few years. The state Govt. is producing PVC pipes through
APSIDC (Andhra Pradesh State Irrigation Development Corporation) for its lift
irrigation schemes. The panchayatraj department is producing pipes for public water
supply schemes. These pipes can be used for the main distributors, sub-distributors
and individual connections.

CAPITAL BUDGETING
b) ANANTHA PVC PIPES PVT LTD
Introduction:
A dynamic entrepreneur Sri S.P.Y.Reddy was established a black pipes

manufacturing company in 1977 and the name of the company is Nandi Pipes Pvt Ltd
at Nandyal, Kurnool district. Anantha PVC Pipes Pvt Ltd was incorporated in the year
2002. The factory is situated at NH-7, Hampapuram village, Raptadu mandal, and
Anantapur district and it was taken over by Nandi Group Company. The company is
managed by team of professionals under the guidance of young, experienced, and well
qualified dynamic managing director Mr.S.Sreedhar Reddy.
Origin:
Rayalaseema is economically backward area in Andhra Pradesh, was

rare field region for industries. A dynamic entrepreneur sir S.P.Y.Reddy who is
basically mechanical engineer started a unit at Nandyal, which manufactures black
pipes in 1977. The determination and hard work of Sri S.P.Y.Reddy helped him to
overcome the problems faced by the company in the initial years, and with financial
assistance from local commercial banks. The company could overcome the problems
of the merger and now it is running smoothly.
Later the company started manufacturing of PVC pipes which

terminated the manufacturing of black pipes. This resulted in the formation of a Pvt.
Ltd. company called “SUJALA PIPES PVT.LTD.” with Sri S.P.Y.Reddy as the
Managing Director.
The only major competitors to the company are Sudhakar pipes,

Maharaja Pipes. The only backdrop to it is the competition from local brands. As the
majority of the customers belong to farmers, they consider the quality. The company
has to make aware of the company’s quality standards to them.

CAPITAL BUDGETING
Board of directors:
S.P.Y.Reddy:
Sri S.P.Y.Reddy locally well known industrialist with the base at

nandyal, Kurnool district who has been successful entrepreneur, he is technically
qualified person with B.E (MEC) from R.E.C (Warangal) and with work experience at
BAARC (Bombay). He has daringly ventured and established industries in and around
nandyal from 70’s. As years went off he has established most successfully the
following nandi group of companies:
 Nandi Milk
 Maha Nandi Mineral Water
 Nandi Infosys
 Nandi Online Services
 Anantha PVC Pipes Pvt Ltd.
 Integrated Thermos Plastic Ltd.
 Nandi PVC Projects.
Promoter:
Sri.S.Sreedhar Reddy, a computer engineer and a student of IIM,

Ahemadabad has been entrusted the management of Anantha PVC Pipes Pvt Ltd.,
Hampapuram and great assistance and a great upcoming engineer and industrialist.
Branches:
 Pondicherry
 Bellary
 Sangli
 Vellore
 Goa
 Kerala

CAPITAL BUDGETING
Coverage:
At present Andhra Pradesh, parts of southern states of Karnataka,

Tamilnadu and Kerala are ambit of Sujala Pipes Pvt Ltd.
The company extended their sales in the below regions are shown
below:
1979 Nandyal Region(polyphone pipes)
1984-85 Rayalaseema Region (PVC pipes)
1985-86 Telangana Region
1986-87 Karnataka and Andhra Pradesh
1988-91 Tamil nadu and Karnataka
1991-94 Kerala
Sizes:
Various sizes ranging from ½ to 10 are offered to customers. Even
pipes with different gauges and sizes are manufactured to suit specified conditions.
Packing:
Packing plays less important role into the products like PVC pipes
because the hallow space inside can be utilized. For the purpose of cubic space
utilization in trucks while transport, organization is adopting the technique like pipes
in pipes.
Payment period:
For monarch brand the company adopts zero credit policy and goods
are not delivered unless cash remittances are made. For monarch and sagar brands
credit is entitled up to a week. The difference between these brands is due to brand
image.

CAPITAL BUDGETING
Technical details about pvc pipes:
Ingredients:
 PVC resin
 D.B.L.S
 T.B.L.S
 L.S
 C.S
 Stearic Acid
 Hydro Carbon
 Calcium Carbonate
Manufacturing process:
The main raw materials are HDPE granules and PP granules. The
manufacturing process for pipes consists of mixing various resins along with the
coloring materials in a mixture and the prepared material is fed to the extruder. In the
extruder, the material is heated to the required politicizing temperature (190deg.
centigrade to 230deg. centigrade) the extruder through the die hard to form the pipe.
The hot pipe coming out of the extruder is cooled in a water bath to retain the final
shape.
The pipe coming out of the extruder is guided through the water bath
suitable transaction system. The temperature of the water is maintained by circulating
through the cooling towards and with the help of a chilling plant.
The required length of the pipe is cut with a planetary saw. The cut
lengths are titled by titling units and get corrected in the pipe rack attached to the
titling frames. Later they are stocked separately. The company has entered into a
technical with its own processing technology.

CAPITAL BUDGETING
Channels of distribution:
Anantha PVC Pipes Pvt Ltd. has got zero level and single level channel of
distribution.
MANUFACTURER CONSUMER
MANUFACTURER DEALER CONSUMER
Anantha PVC Pipes Pvt Ltd. has an extensive network of 350 dealers in
Andhra Pradesh and who are directly serviced by company sales force and 620 dealers
in South India.
Transportation:
Transportation vehicles of Anantha PVC Pipes Pvt Ltd. outnumber the fleet of
the competitor’s vehicle. This unique strength of the organization enables the delivery
system to be efficient. This event helps the dealers to reduce inventory levels to the
minimum. The dealers are also supplemented with the benefit of the lower paid up
capital in the form of inventory.
Anantha pvc pipes pvt ltd:

Anantha PVC Pipes Pvt Ltd. was incorporated in the year Feb 2002.
The factory is situated at NH-7, Hampapuram village, Raptadu mandal, and Anantapur
district. It was taken over by Nandi group company, and it is one of the sister company
among the Nandi groups.
Its annual production capacity is 18,000 mts. And it is one of the

leading manufacturers of PVC pipes in south India. This company is equipped with
technical collaboration from Batten field of West Germany. It has made possible few
other small ventures. Pipes are sold under the brand names of MONARCH,
KOHINOOR and KRISHNA.

CAPITAL BUDGETING
Anantha PVC Pipes with their good quality, trouble free services,
durability and commercial use are a better choice than mild steel, galvanized steel, cast
iron and plastic pipes.
The company is managed by a term of professionals under the guidance

of a young, experienced and well qualified dynamic managing director Mr. Sreedhar
Reddy.
Mission Statement:
The mission statement of Anantha PVC Pipes Pvt Ltd. is as follows:
 To be preferred supply chain partner to out customer.

 To be recognised as the best in the world at we do.
 To create new values in the quality for our customers and employees.
Vision Statement:
The vision statement of Anantha PVC Pipes Pvt. Ltd. is as follows:
“Creating new values in quality by working together for you”

CAPITAL BUDGETING
Functional departments of the company
Financial department:
Through initially the company approached the external source for

financial aid, now the financial status of the company is very sound and is being run
only with self finance excepting for loans taken for hypothecation of machinery and
stock from SBI Nandyal.
The company follows cash and carry policy for monarch brand. The
product is not delivered until the cash is paid and financial department with the help of
marketing department looks after these transactions.
Marketing department:
Marketing Department is headed by the Executive Director. Marketing

Manager is in charge of all operations who reports to the Executive Director.
Marketing Manager and 35 Sales Representatives are under the control of Executive
Director. There are also 20 salesmen who have to report to the sales representatives
above them.
Personal Department:
The Personal department consists the details of the executives and

workers of the organization. The organization is formed with Sri.S.P.Y.Reddy as the
managing Director. Two Marketing managers, financial managers, public relations
officer and quality control officer who all reports to executive director. Other than
executives there are thousands workers in the organization.
Panel consisting of managing director, executive director and managers

of concerned departments makes the recruitment and selections of persons. Apart from
the attractive salaries company provides health card facilities.

CAPITAL BUDGETING
Purchasing department:
The perplexing situation i.e. conformed by the manufactures of the
PVC pipes is scarcity of resin. Though the government of India has taken various steps
to improve the supply conditions of PVC resin, the Indian manufactures could meet
only 50 percent of demand and remaining 50 percent is met from imports. The major
petrochemical company is Reliance Petrochemical Ltd.
The lead time for the acquisition of raw materials is 4 days.
The following lines highlight the human resources policies and practices:
 Effective utilization of manpower.

 To provide good working condition.
 To promote industrial development.
Application of pvc pipes:
 Agriculture and irrigation schemes.

 Rural and urban water supplies scheme.
 Tube well casing.
 Gas and oil supply lines.
 Industrial effluent disposal.
 Sewerage and drainage scheme.
 Air-condition ducting.
 Building installations.
 Industrial ducting.

CAPITAL BUDGETING
DATA ANALYSIS AND INTERPRETATIONS
INVESTMENT EVALUATION CRITERIA
Three steps are involved in the evaluation of an investment:
 Estimation of Cash Flows.

 Estimation of the required rate of return.
 Application of a decision rule for making the choice.
The investment decision rules may be referred to as capital budgeting

techniques or investment criteria. A sound appraisal technique should be used to
measure the economic worth of the investment project. The essential property of a
sound technique is that it should maximize the shareholder’s wealth.
A number of capital budgeting techniques are used in practice. They may be

grouped as follows:
 Payback period
 Average rate of return (ARR)
 Net Present Value (NPV)
 Internal rate of return (IRR)
 Profitability Index
 All these methods of capital budgeting techniques are explained in

detail below

CAPITAL BUDGETING
PAY BACK PERIOD:
The payback period is one of the most popular and widely recognized
traditional methods of evaluating investment proposals. It is defined as the number of
years required in a project. If the project generates constant annual cash inflows, the
payback period can be computed by the following formulae:
Initial Investment
Pay Back period = -----------------------------------
Annual Cash Flows
In case of unequal cash inflows, the payback period can be computed by

calculating the cumulative cash inflow and checking whether the values are recovered
to the original outlay and taking the remaining amount and apply the formulae i.e.,
Required CFAT
PBP = base year + ----------------------------
Next year CFAT
ACCEPTANCE RULE:
Many firms use the payback period as an accept or reject criterion as well
as a method of ranking projects. If the payback period calculated for a project is less
than the maximum or standard payback period set by management, it would be
accepted, if not, it would be rejected. As a ranking method, it gives highest ranking to
the project, which has the shortest payback period and lowest ranking to the project,
which has highest payback period.

CAPITAL BUDGETING
I. PAYBACK PERIOD
YEAR ROE INC TAX PAT DEP CFAT CCFAT
2006-05 59.64 5.48 0 65.12 170.40 235.52 235.52
2007-06 59.64 5.48 0 65.12 170.40 235.52 471.04
2008-07 59.64 5.48 0 65.12 170.40 235.52 706.56
2009-10 59.64 5.48 0 65.12 170.40 235.52 942.08
2010-11 59.64 5.48 0 65.12 170.40 235.52 1177.60
Base Year = 3th year Required CFAT = 93.44

Next year CFAT = 942.08 Initial investment=800crores
800 – 706.56
Payback period = 4th year + -------------------- = 4th year + 1.035yr
942.08
= 4.1035 years.

CAPITAL BUDGETING
CALCULATIONS OF PAYBACK PERIOD
CCFAT
1400
1200
1177.6
1000
942.08
800
706.56 CCFAT
600
400 471.04
200
235.52
0
2006-05 2007-06 2008-07 2009-10 2010-11
Interpretation:
As per payback period, the project is accepted because to get the initial
investment of 800 corers, it is taking a time of 4.1035 years.

CAPITAL BUDGETING
2. AVERAGE RATE OF RETURN:

The Average Rate of Return (ARR) is also known as Accounting Rate of
Return using accounting information, as revealed by financial statements, to measure
the profitability of an investment. The accounting rate of return is found out by
dividing the average after tax profit by the average investment. The average
investment would be equal to half of the original investment, if it is depreciated
constantly. The Accounting rate of return can be calculated by the following formula
i.e.,
Annual Average Profit after Tax
A.R.R. = ---------------------------------------------- X 100
Annual Average Investment
AVERAGE RATE OF RETURN
YEAR ROE INC TAX PAT

2006-07 59.64 5.48 0 65.12
2007-08 59.64 5.48 0 65.12
2008-09 59.64 5.48 0 65.12
2009-10 59.64 5.48 0 65.12
2010-11 59.64 5.48 0 65.12
CALCULATION OF ARR:
Average NPAT = 325.6/5 = 65.12
Average Investment = 325.6/2 = 162.8
65.12
ARR = ---------- X 100 = 40 %
162.8
Analysis:
From the point of ARR method, project should be accepted, as its ARR is less
than the required rate return.

CAPITAL BUDGETING
3. NET PRESENT VALUE:
The Net present value (NPV) method is the classic economic method of
evaluating the investment proposals. It is one of the discounted cash flow techniques
explicitly recognizing the time value of money. It correctly postulates that cash flows
arising at different time periods differ in value and the comparable only when their
equivalents 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.
 Appropriate discount rate should be identified to discount the
forecasted cash flow. The appropriate discount rate is the firms
opportunity cost capital, which is equal to the required rate of return,
expected by investors on investments of equivalent risk.
 Present value of cash flows should be calculated using opportunity cast
of capital as the discount rate.
 Net present value should be found out by subtracting present value of
cash outflow present value of cash inflow.
Acceptance Rule:
The project should be accepted if NPV is positive it should be clear that the
acceptance rule using NPV method is to accept the investment project if its net present
value is negative (NPV CASH OUTFLOW). The positive net present value will result
only if the project generates cash inflows at rate higher than the opportunity cost of
capital.
A project may be accepted in NPV = 0.

CAPITAL BUDGETING
Thus, the NPV acceptance rules are:
 Accept if NPV >0

 Reject if NPV <0
 Ill-defined if NPV = 0.
CALCULATION OF NET PRESENT VALUE
PV@ PV OF CASH PV OF
YR ROE INC TAX PAT DEP CFAT
12% CIF O.F COF
2006-07 59.64 5.48 0 65.12 170.4 235.52 0.893 210.32 170.4 152.17
2007-08 59.64 5.48 0 65.12 170.4 235.52 0.797 187.71 170.4 135.81
2008-09 59.64 5.48 0 65.12 170.4 235.52 0.712 167.69 170.4 121.32
2009-10 59.64 5.48 0 65.12 170.4 235.52 0.636 149.79 170.4 108.37
2010-11 59.64 5.48 0 65.12 170.4 235.52 0.567 133.54 170.4 96.62
Present value of cash inflow = 849.05
Present value of cash outflow = 614.26
Net Present Value = 849.05 – 614.26 = 234.79 crores

CAPITAL BUDGETING
GRAPHICAL REPRESENTATION OF NET PRESENT

VALUE
250
200
150
PV OF CIF
100 PV OF COF
50
0
2006-07 2007-08 2008-09 2009-10 2010-11
Analysis:
As NPV is positive, the project is accepted.

CAPITAL BUDGETING
4. PROFITABILITY INDEX:
It is also called as Benefit Cost Ratio. It is also a time-adjusted method of
evaluating the investing proposals. It is the relationship between present value of cash
inflows and the present value of cash outflows. Thus
CALCULATION OF PROFITABILITY INDEX
PV@ PV CASH PV OF
YR ROE INC TAX PAT DEP CFAT
12% CFAT O.F COF
2006 59.64 5.48 0 65.12 170.4 235.52 0.893 210.32 170.4 152.17
2007 59.64 5.48 0 65.12 170.4 235.52 0.797 187.71 170.4 135.81
2008 59.64 5.48 0 65.12 170.4 235.52 0.712 167.69 170.4 121.32
2009 59.64 5.48 0 65.12 170.4 235.52 0.636 149.79 170.4 108.37
2010 59.64 5.48 0 65.12 170.4 235.52 0.567 133.54 170.4 96.62
PV of cash inflows
Profitability Index = --------------------------
PV of cash out flows
NPV
Net Profitability Index = --------------------------
Initial cash outlay
From the above table calculated values are

Present value of cash inflow = 849.05
Present value of cash outflow = 614.26

CAPITAL BUDGETING
849.05
Profitability Index = -----------------
614.26
= 1.3822
1.3822
Net Profitability Index = ---------------
614.26
= 0.00225
GRAPHICAL REPRESENTATION OF PROFITABILITY

INDEX
250 235.52 235.52 235.52 235.52 235.52
200
152.17
150 135.81
121.32
108.37
96.62
100
50
0
2006 2007 2008 2009 2010
CFAT PV OF COF
ANALYSIS
The graph reveals that PI is high in 2006-06 and diminishes in successive
years.

CAPITAL BUDGETING
5. INTERNAL RATE OF RETURN
The internal rate of return (IRR) method is another discounted cash flow
technique, which makes account of the magnitude and timing of cash flows. Others
terms used to describe the IRR Method are yield on investment, marginal efficiency of
capital, rate of return over cost, time adjusted rate of internal return and so on. The
concept of internal rate of return is quite simple to understand in the case of one-period
projects. The IRR is calculated by interpolating the two rates with the help of the
following formula:
PV of cash inflows at lower rate - PV of cash outflows

IRR = LR+ --------------------------------------------------------------- (hr-lr)
Pv of cash inflows at lower rate-Pv of cash inflows at higher rate
Where,
Lr = Rate of interest that is lower of the two rates at which PV of Cash
inflows have been Calculated.
Hr= Rate of interest that is higher of the two rates at which PV of Cash
inflows have been Calculated.
ACCEPTANCE RULE
The accept project rule, using the IRR method, is to accept the project if
its internal rate of return is higher than the opportunity cost of capital (r>k) note that k
is also known as the required rate of return or cut-off rate. The project shall be rejected
if its internal rate of return is lower than the opportunity cost of capital. Thus the IRR
acceptance rules are:
 Accept if r>k
 Reject if r<k
 May accept if r=k

CAPITAL BUDGETING
THE CALCULATIONS OF INTERNAL RATE OF RETURN
PV @ PV OF PV @ PV OF
YR ROE INC TAX PAT DEP CFAT 12% CF 13% COF
2006-07 59.64 5.48 0 65.12 170.4 235.52 0.893 210.32 0.885 208.44
2007-08 59.64 5.48 0 65.12 170.4 235.52 0.797 187.71 0.783 184.41
2008-09 59.64 5.48 0 65.12 170.4 235.52 0.712 167.69 0.693 163.22
2009-10 59.64 5.48 0 65.12 170.4 235.52 0.636 149.79 0.613 14.37
2010-11 59.64 5.48 0 65.12 170.4 235.52 0.567 133.54 0.543 127.89
PV @ L R - C O F
Therefore, IRR = LR + ------------------------- x Rate Difference
PV @ L R - PV @ H R
849.05-828.33
= 12% + ------------------------- x 1
849.05-828.33
66.06
= 12% + --------- x 1=12% + 1%=13 %
69.43

CAPITAL BUDGETING
GRAPHICAL REPRESENTATION OF INTERNAL RATE

OF RETURN:
250
210.32208.44
200 187.71184.41
167.69163.22
149.79144.37
150 133.54127.89
100
50
0
2006-07 2007-08 2008-09 2009-10 2010-11
PV OF CF PV OF COF
Interpretation:
Therefore, IRR lies at 13%. It is a point where outflow = inflow

And IRR>K, Therefore it is accepted.

CAPITAL BUDGETING
FINDINGS
 The net present value of ANANTHA PVC PIPES LTD is satisfactory.
 The internal rate of return of the company is considerably high.
 The company will take long period to recover the initial investment.
 The profitability index is to meet company objectives.
 The average rate of return is very less because the motto is not to earn profits.
this is compensated by good benefits to the society.
 While preparing project financing ANANTHA PVC PIPES LTD considers

Social benefit of the state.
 The major portion of finance is done through secured loans.
 The unit cost and other expenditures are eligible to claim from the potential
buyer. as approved by the Regulatory Commission

CAPITAL BUDGETING
SUGGESTIONS
 Company should go for the improvement in the technology to improve

efficiency and to decrease the cost of production per unit
 For society with lower income levels or below poverty line company
should go for subscribed rates and for industries it should increase its
rate marginally to cover the losses.
 The subscribed cost in future should be reduced.
 Better technical management will reduce the auxiliary consumption.
 The company is beneficial to expand their business by using profit.

CAPITAL BUDGETING
CONCLUSION
In the study is concentrate on Pay Back, Internal Rate of Return and Net
Present Value for acceptance of the project. The discounting methods are most
preferable the rate of returns are depends on present values. The IRR is most
preferable for analyze optimum returns discounting values, under the situations, the
IRR rule can give a misleading signal for mutual exclusive project.

Capital Bugeting

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Capital Bugeting

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CAPITAL BUDGETING

Capital Budgeting May also be defined as “The decision making process by

It deals exclusively with investment proposals, which an essentially long term

“Capital budgeting is concerned with allocation of the firm’s scarce financial

KOTTAM KARUNAKARA REDDY INSTITUTE OF TECHNOLOGY 1

In any growing concern, capital budgeting is more or less a continuous process

 Capital budgeting decisions involve the exchange of current funds for

KOTTAM KARUNAKARA REDDY INSTITUTE OF TECHNOLOGY 2

IMPORTANCE OF CAPITAL BUDGETING:

2. Long term commitment of funds:

4. Long terms effect on profitability:

5. Difficulties of investment decision:

KOTTAM KARUNAKARA REDDY INSTITUTE OF TECHNOLOGY 3

CAPITAL BUDGETING PROCESS:

Capital budgeting is a complex process as it involves decisions relating

Identification of investment proposals:

Evaluation of Various Proposals:

KOTTAM KARUNAKARA REDDY INSTITUTE OF TECHNOLOGY 4

FINAL APPROVAL AND PREPERATION OF CAPITAL

Proposals meeting the evaluation and other criteria are finally

KOTTAM KARUNAKARA REDDY INSTITUTE OF TECHNOLOGY 5

METHODS OR TECHNIQUES OF CAPITAL BUDGETING:

Time adjusted or discounting techniques:

KOTTAM KARUNAKARA REDDY INSTITUTE OF TECHNOLOGY 6

1. PAY-BACK PERIOD METHOD:

KOTTAM KARUNAKARA REDDY INSTITUTE OF TECHNOLOGY 7

2. ACCOUNTING RATE OF RETURN METHOD:

Average Rate of Return Method:

Average Annual profits (after dep. & tax)

KOTTAM KARUNAKARA REDDY INSTITUTE OF TECHNOLOGY 8

 It is very simple to understand and easy to calculate.

 It ignores the time value of money.

KOTTAM KARUNAKARA REDDY INSTITUTE OF TECHNOLOGY 9

3. NET PRESENT VALUE METHOD:

1. Determine an appropriate rate of interest known as cut off rate.

KOTTAM KARUNAKARA REDDY INSTITUTE OF TECHNOLOGY 10

 It recognizes the time value of money and is suitable to apply in a

 More difficult to understand and operate.

KOTTAM KARUNAKARA REDDY INSTITUTE OF TECHNOLOGY 11

4. INTERNAL RATE OF RETURN METHOD

If IRR>K, accept project. K = cost of capital.

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

KOTTAM KARUNAKARA REDDY INSTITUTE OF TECHNOLOGY 12

1. Prepare the cash flow table using assumed discount rate to

 It is difficult to understand and operate.

KOTTAM KARUNAKARA REDDY INSTITUTE OF TECHNOLOGY 13

5. PROFITABILITY INDEX METHOD OR BENEFIT COST RATIO

KOTTAM KARUNAKARA REDDY INSTITUTE OF TECHNOLOGY 14

RISK AND UNCERTAINITY IN CAPTIAL BUDGETING:

All the techniques of Capital Budgeting require the estimation of future

 Expected economic life of the project

KOTTAM KARUNAKARA REDDY INSTITUTE OF TECHNOLOGY 15

FACTORS INFLUENCING CAPITAL EXPENDITURE DECISIONS:

2) DEGREE OF UNCERTAINITY: profitability is directly related to risk,

3) INTANGIBLE FACTORS: sometimes, a capital expenditure has to be

4) AVAILABILITY OF FUNDS: as the capital expenditure generally

5) AVAILABILITY OF FUNDS: as the capital expenditure generally

6) FUTURE EARNINGS: a project may not be profitable as compared to

KOTTAM KARUNAKARA REDDY INSTITUTE OF TECHNOLOGY 16

CAPITAL EXPENDITURE CONTROL:

Capital expenditure involves non-flexible long term commitment of

OBJECTIVES OF CONTROL OF CAPITAL EXPENDITURE:

STEPS INVOLVED IN CONTROL OF CAPITAL EXPENDITURE: