A

Dissertation report
On
“A STUDY ON ANALYSIS OF CAPITAL BUDGETING AND ITS
DECISIONS”

Submitted By
MISS. RUTUJA ARVIND MOHALKAR
(MBA-FINANCE)

Under the Guidance of

PROF. ROHIT ALANDIKAR

Submitted To
SAVITRIBAI PHULE PUNE UNIVERSITY

In the partial fulfilment of the requirements for the award of MASTER IN

BUSINESS ADMINISTRATION (MBA)

Through

Progressive Education Society’s

Modern Institute Business Management
1186 Shivajinagar, Pune 411005
BATCH 2018-20
DECLARATION

I Rutuja Arvind Mohalkar of MBA-2: Seat no hereby declare that the dissertation work titled “A
STUDY ON ANALYSIS OF CAPITAL BUDGETING AND ITS DECISIONS” which has been
submitted to University of Pune is an original work of the undersigned and has not been reproduced from
any other source. All the references have been duly acknowledged

Date: ___________ Signature of Student

Place: Pune Name: Rutuja Arvind Mohalkar

Seat No.:
ACKNOWLEDGEMENT

I would like to express my deepest appreciation to all those who provided me the possibility to complete this
report.

A special gratitude I give to my project guide Prof. Rohit Alandikar, whose contribution in stimulating
suggestions and encouragement, helped me to coordinate my project especially in writing this report.

I express my gratitude towards Prof .Dr. Vijayalaxmi Shrinivas (Director of MIBM) and Prof. Dr. Nivedita
Ekbote (Co-ordinator of MIBM) Pune, for providing me all the facility that was required

This report is prepared by utmost care and deep routed interest .All that I have done is only due to such
supervision and assistance and I would not forget to thank them.
SR NO TITLE PAGE NO.

1 INTRODUCTION 1

2 LITERATURE REVIEW AND 4

THEORETICAL BACKGROUND

3 RESEARCH METHODOLOGY 15

4 DATA ANALYSIS 16

5 FINDINGS 26

6 CONCLUSIONS 27

7 RECOMMENDATIONS AND 28
SUGGESTIONS

8 LIMITATIONS OF THE STUDY 29

9 BIBLOGRAPHY 30
ABSTRACT-

This project report is entitled to “A study on analysis of Capital Budgeting and its Decisions.” The main
objective of the project is to assess various sources of finance and to analyse the capital budgeting decision
of the selected case. It helps in taking fair and better decision about the proposals.

Here for the analysis a Case of BALAJI CHIPS CO. was prepared and studied in which two proposals were
made on capital budgeting techniques. That decisions helped in evaluating best proposal those were- NPV,
ARR, PAYBACK, PI

The details regarding the study were done on secondary data analysis. The case discussed came to the
Conclusion of selecting a proposal that showed various benefits of why the proposal is best for long term
purpose. Thus the study recommends to evaluate various decisions and techniques, to get favourable result
for the long term perspective.
CHAPTER 1-

INTRODUCTION-

Capital budgeting is a process of evaluating investments and where decision is made of selecting a best
proposal with some huge expenses in order to obtain the best returns on investment.

Organizations are often faced with the situations of selecting between two projects/investments or the
buy vs replace decision. Ideally, an organization would like to invest in all profitable proposals but due to the
limitation on the availability of capital an organization has to select between different projects/investments.

Capital budgeting, in other terms is called as investment appraisal, is the planning method used to identify
whether an organization’s long term investments, major capital, or expenditures are worth pursuing.

Major technique’s for capital budgeting decisions include Net present value, Internal rate of return, Payback
period, Profitability index, Equivalent annuity and Real options analysis.

The IRR method will result in the same way as the NPV method for non- mutually exclusive projects in an
unrestrained environment; But, for mutually exclusive projects, the decision rule of taking the project with
the highest IRR may select a project with a lower NPV.

The purpose of budgeting stands to provide a forecast of revenues and expenditures. That is, to build a
model of how a business might perform financially if certain approaches , events, and plans are carried out.
It allows the actual financial process of the business to be measured against the projection, and it establishes
the cost control for a project, platform, or operation.

Budgeting helps to assist the planning of actual operations by driving managers to study how the conditions
might change, and what steps should be taken in such an event. This encourages managers to consider
problems before they arise. It also helps in co-ordinating the activities of an organization by convincing
managers to scrutinize relationships between their own operation and those of other departments.

1
Other essential features of a budget include:

 To control resources
 To communicate plans to several responsibility centre managers
 To inspire managers to strive to achieve budget goals
 To estimate the performance of managers
 To deliver visibility into the company’s performance

Capital Budgeting , mostly focusses on the part of budgeting, more specifically on long-term investment,
major investment and capital expenditures. The main objective of capital budgeting involve:

Ranking Project:

The actual value of capital budgeting is ranking of projects. Utmost organizations have various projects that
could potentially be financially worthwhile. Once it is determined that a specific project has surpassed its
hurdle, then it should be ranked in contradiction of peer projects (e.g. – highest Profitability index to lowest
Profitability index). The highest ranking projects should be executed until the budgeted capital has been
used.

Raising funds:

When an Organisation regulates its capital budget, it must obtain funds. Three methods are normally
available to publicly-traded corporations: corporate bonds, preferred stock, and common stock. The ultimate
mix of those funding sources is determined by the financial managers of the firm and is linked to the amount
of financial risk that the business is willing to undertake. Preferred stock have no financial risk but
dividends, including all in arrears, must be paid to the preferred stockholders before any cash expenditures
can be made to common stockholders; they generally have interest rates higher than those of corporate bonds
Capital budgeting is an essential task as large sums of money are involved, which influences the profitability
of the firm. Also, a long-term investment, once made, cannot be reversed without significant loss of invested
capital. The inferences of long-term investment decisions are more extensive than those of short-term
decisions because of the time factor involved.

2
OBJECTIVE AND SCOPE-

 To access the various sources of finance for Capital expenditure

 To find out the profitable Capital expenditure through selected Case of Balaji Wafers Co.

SCOPE OF THE STUDY-

 To Analyse the effects of Capital Budgeting Decisions

 To understand the practical usage of Capital Budgeting in evaluating the project

3
CHAPTER 2-

LITERATURE REVIEW-
Book Name- Capital Budgeting: Nature & Scope

Authors: Sandeep Goel

Published by: Business Expert Press (2015)

Revised date: 27-Apr-2016

Abstract-This section is excerpted from ‘Capital Budgeting'. Capital budgeting is an essential part of the
financial management of a business organization. It is a process that business houses use to assess an
investment project. The decision of whether to accept or reject an outlay project is capital budgeting
decision. Capital budgeting is important as it determines the long-term financial and monetary profitability
of any investment project. It places down the future success of a business. The present book objects to
develop not only an understanding of the concepts of capital budgeting but also to provide its practical
presentation to help the students learn both theory and practice of capital budgeting to be used in the
financial supervision of a business organization.

Capital Budgeting practices in Indian Companies-

Author- Roopali Batra

Published by- Department of Management, I.K. Punjab Technical University, Kapurthala, Punjab, India

RBI chair , Centre for Research in Rural and Industrial Development (CRRID), Chandigarh, India

Abstract-The instability of the global economy, moving business practices, and academic expansions have
created a need to reconsider Indian corporate capital budgeting practices. Our research is based on a sample
of 77 Indian firms listed on the Bombay Stock Exchange. Results tells that commercial practitioners largely
follow the capital budgeting practices anticipated by academic theory. Discounted cash flow techniques of
net present value and internal rate of return and risk adjusted rate of return analysis are most widespread.

4
Capital Intensive Industries of India-

(Issue- 5th May 2019)

Author- Abhishek Jha, Sunil Arora-

Abstract-

The above literature review dealt with a analysis of past studies conducted on capital budgeting and its
associated aspects. Both the foreign and Indian studies on capital budgeting were included as part of the
study. The assessment tried to critically analyse each and every aspect of every individual study from
practice to statistical tools being applied and findings. An effort was made to find the significant gaps in
prior studies. It was identified by the review that non-sophisticated approaches of capital budgeting and risk
valuation are still being used, and this needs to be considered. Additionally, risk assessment methods were
revealed to be not refined, which can become part of a upcoming study. This also included a method to
effectively incorporate risk information in the capital budgeting technique.

5
THEORETICAL BACKGROUND-

Capital budgeting contains choosing projects that add value to a company. The capital budgeting method can
involve practically anything including obtaining land or purchasing fixed assets like a new truck or
machinery. Companies are typically required, or at least recommended, to commence those projects which
will increase profitability and thus improve shareholders' capital.

However, what rate of return is estimated acceptable or unacceptable is influenced by other factors that are
specific to the business as well as the project. For example, a social or charitable project is often not
permitted based on the rate of return, but more on the desire of a business to raise goodwill and contribute
back to its community. Capital budgeting is the process by which investors decide the value of a possible
investment project.

The three utmost common methods to project selection are payback period (PB), internal rate of return (IRR)
net present value (NPV).

The payback period decides how long it would take a company to see for cash flows to recover the original
investment.

The internal rate of return is the expected return on a project. If the rate is higher than the cost of capital, it's
a good proposal.

The net present value shows how profitable a proposal will be versus alternatives, and is possibly the most
effective of the three method .

6
Capital budgeting is vital because it creates accountability and measurability. Any business that seeks to
finance its resources in a project, without understanding the risks and returns involved, would be held as
responsible by its proprietors or shareholders. Moreover, if a business has no mode of measuring the
efficiency of its investment decisions, chances are that the corporate will have little chance of surviving in
the competitive marketplace.

Companies (aside from non-profits) exist to earn profits. The capital budgeting process is a measurable way
for businesses to regulate the long-term economic and financial profitability of any investment project.

How Capital Budgeting works -

When a firm is offered with a capital budgeting decision, one of its first tasks is to determine whether the
project will prove to be profitable or not. The payback period (PB), internal rate of return (IRR) and net
present value (NPV) techniques are the most shared approaches to project selection. Though an ideal capital
budgeting solution is such that all three metrics will indicate the same decision, these methods will often
produce contrary results. Depending on management's preferences and selection criteria, more importance
will be given on one approach over another. However, there are common advantages and disadvantage
associated with these extensively used valuation methods.

Different companies will use different valuation approaches to either accept or reject capital budgeting
projects. Although the NPV method is considered the favourable one among analysts, the IRR and PB
methods are frequently used as well as under certain circumstances. Managers can have the most assurance
in their study when all three methods indicate the same course of action.

7
Types of Investment and stages of Capital Budgeting

Classification of Investment project-

The decision making process of capital budgeting varies depending on whether the project is independent,
mutually exclusive or is a provisional project. Independent projects are those where the acceptance or
rejection of one does not directly exclude other projects from concern or affect the likelihood of their
selection.

Mutually Exclusive projects can be defined as two or more projects that cannot be tracked simultaneously–
the acceptance of one inhibits the acceptance of the alternative proposal.

Besides this, Contingent project is the one in which the acceptance or rejection of which is reliant on on the
decision to accept or reject one or more other projects. Capital Budgeting Decision making method may also
vary depending on the nature of the investment project, i.e. whether it is an expansion or a diversification or
a replacement and modernisation project.

Expansion projects are those which invest in other assets to expand existing product or service line or
increase the capacity to provide the growing demand. Diversification projects on the other hand are those in
which investment is directed at producing new products or services or arriving into new production activity
or new business. It can also be defined as expansion of new industry.

Replacement and Modernisation Investment is meant to replace outdated and old-fashioned equipment or
assets with new efficient and economical assets so as to diminish operating costs, increase the yield and
expand the operating efficiency.

8
Stages of Capital Budgeting Process

Capital budgeting method can be divided into four major phases: identification, development, selection and
post-audit. In the first phase, ideas and suggestions for probable investment opportunities of enterprise assets
are identified. In the second phase, ideas and suggestions with greatest income potential are established into
complete and detailed investment plans. In the third phase, investment plans are compared, and those that
seem to be in the best interest of the enterprise are selected. In the final phase, investment performance is
observed for any significant variants from expectations to determine if goals are being met. Several tasks are
required to be executed at different phases which are briefly explained below.

1) Strategic Planning -

Strategic planning can be defined as an organization's practise of defining its strategy by setting its
guidelines, directions, priorities and specifying the structural, strategic and tactical areas of business
development that would enable achievement of the corporate goal.

2) Identification of Investment Opportunities -

This means developing a mechanism wherein the investment ideas coming from inside of the firm, such as
from its employees, or from outside the firm, such as from a firm’s consultants are ‘listened and paid
attention to’ by the organization.

3) Preliminary Screening of the Projects -

This step is undertaken to avoid excessive wastage of resources like time, money and effort, these identified
investment opportunities are endangered to a preliminary screening process by organisation i.e. to isolate the
marginal and unsound proposals.

4) Financial appraisal of Project -

Financial appraisal of projects contains the application of cash flow forecasting techniques, project
evaluation or capital budgeting methods, risk analysis techniques and even mathematical programming
techniques so as to determine whether the planned investment project would add value to the Organisation or
not.

9
5) Qualitative factors in project estimation -

Along with quantitative analysis, qualitative factors are also considered which involves many like societal
impact on employment, environmental impact of the plan and safety issues involved, government’s political
attitude towards the venture.

6) Accept/reject decision-

To decide whether to accept/reject a project, all material, coming from the financial appraisal and qualitative
results, is collected for making decisions. Executives with experience and knowledge also consider other
relevant facts using their routine information sources, expertise, ‘gut feeling’ and, also, judgements.

7) Project implementation and monitoring-

Once an investment project is accepted, the implementation phase for an business project, includes the
setting up of manufacturing facilities, project and engineering designs, negotiations and contracting,
building, and training and plant commissioning. Also effective methods are vital to monitor and control the
capital budgeting process as the project may face some practical problems, such as human relationship,
political manoeuvring and so on.

8) Post implementation or Audit/project review -

This is the last phase which includes the examination of the project’s progress in its implementation phase,
an in-depth analysis of the actual costs and profits to date, the likely future prospects of the project and a
comparison of these projections to the initial expectations. Post-implementation audit can offer useful
feedback to project appraisal or strategy formulation by analysing the past ‘rights’ and ‘wrongs’.

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Capital Budgeting techniques and its consideration

Capital Budgeting Techniques -

Firms use capital budgeting techniques to decide whether or not a particular project is economically viable
and adds to the value or capital of the firm. In case of more than one project, these aid the management in
recognising the projects that maximise the firm’s objective function of shareholders’ wealth maximization.
While some businesses prefer traditional non-discounted fewer sophisticated techniques like Pay Back
Period Method, Accounting Rate of Return etc., others have stirred towards more sophisticated Discounted
Cash Flow (DCF) techniques like Net Present Value (NPV) and Internal Rate of Return (IRR). The two
broadly categorised methods of capital budgeting are discussed below.

Traditional Capital Budgeting Techniques-

The traditional techniques of capital budgeting, also called as Non-Discounted Cash Flow Techniques
(NDCF), do not contemplate the time value of money and give equal weight to money earned in different
time phases.

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1) Payback period method-

The Payback period for a proposal that generates constant cash flows is intended by dividing the initial
outlay of the project with the annual cash inflow and in case annual cash inflows are unequal, the payback
period can be initiated by adding up the cash inflows until the total is equal to the original cost of
investment. If there are a number of investment proposals, than the one with a shorter payback period is
chosen .In case of a single project, if the payback period calculated for a proposal is less than the maximum
payback period set up by the organisation, it would be accepted otherwise it would be rejected. Moreover
being simple to understand and easy to calculate, the Payback period process has the advantage that it
requires less time and effort element of a business.

2) Accounting rate of return (ARR)-

ARR is calculated by dividing the average annual net profits after taxes by the average investment which
means, average return on average investment = (average annual profit / average investment) x 100. If the
ARR of the venture is more than the cut off rate decided by the organization, then the investment project is
accepted else it is rejected. ARR has certain returns like it is simple and easy to understand as it directly uses
the accounting profits without the difficulty of estimating the cash flows of a project.

Secondly, it incorporates the complete stream of income of an investment proposal. However it’s certain
serious errors are that it considers accounting profits and not cash flows, ignores the time value of money
and is not valid where investment is done in parts. In the present researches these traditional techniques have
been found to be applied as a additional method in combination with the mostly used Discounted Cash Flow
techniques.

12
Discounted cash flow Capital Budgeting techniques-

These techniques give due weightage to the time value of money by using an suitable discount rate to
estimate the present value of cash flows.

1) Net Present Value (NPV) Method

Net Present Value here denotes to present value of net cash inflows generated by a project less the initial
investment on the project. Before calculating NPV, a target rate of return is set (generally the firm’s proper
cost of capital) which is used to discount the net cash inflows from a project. According to Porterfield
(1966), the NPV of a venture is the present value of cash inflows minus the present value of the cash
outflows.

If NPV is positive (NPV > 0), i.e. the present value of cash inflow surpasses the present value of cash
outflows, then the investment offer is accepted, but if NPV is negative (NPV < 0) then the investment
proposal is rejected. This method has the benefit that it is consistent with the objective of shareholders’
capital maximization as it considers the entire stream of earnings of a project. Also it obviously recognizes
the time value of money and gives due importance on timing and magnitude of cash inflow

However, this method has certain computational complications like difficulty in cash flow estimation,
difficulty in measuring discount rate and indefinite results in case of mutually exclusive projects with
unequal life or unconventional cash flow arrangements.

2) Internal rate of return method-

This technique is also known as time-adjusted rate of return; yield method, trial and error yield method etc.
The Internal Rate of Return can be known as that rate of discount, which equates the present value of cash
inflows with the cash outlflow.

If the Internal Rate of Return(r) is higher or equal to the minimum required rate of return i.e. cost of capital
or cut off rate then the investment proposal is accepted and it is rejected if the Internal rate of return is less
than the cost of capital or cut off rate. In case of a number of proposals, highest rank is given to the offer,
which has the highest Rate of Return.

13
3) Modified internal rate of return (MIRR)

MIRR is a modification and an development over the traditional Internal Rate of Return (IRR). The MIRR
can be calculated by the following steps: - Firstly ,Calculate the present value of the cash outflow (PVC)
associated with the project using cost of capital (r) as the discount rate.

MIRR is better than IRR in two ways.

Firstly, it assumes that project’s cash flow are reinvested at the cost of capital which is further realistic than
at the same rate of return as that made by the project itself in case of IRR. Secondly, it generally gives only
one rate, therefore avoids the problem of multiple rate of returns.

4) Discounted payback period-

A major limitation of the conventional payback period is that it does not take into account the time value of
money. To overcome this restraint, the discounted payback period has been suggested. In this method cash
flows are initially converted into their present values by applying a appropriate discount rate and then these
are added to find the time period to recuperate the initial outlay of the project. The time period at which the
cumulated present value of cash inflows becomes equal to present value of cash outflows is identified as
discounted payback period. As per this technique a project with a shorter payback period is ideal to the one
which has a longer payback period.

5) Profitability Index (PI)/Benefit Cost Ratio

The profitability index relates the present value of future cash inflows with the initial investment on a
relative basis. Thus, the Profitability Index (PI) is the ratio of the present value of cash flows (PVCF) to the
initial investment of the project. The approval rule under this method is that, a proposal with a PI greater
than one is accepted, but a project with PI less than one is rejected and the proposal may or may not be
accepted if the PI is equal to one. The PI method is closely connected and very similar to the NPV approach.
It has the same advantages as NPV like it considers time value of money and maximises shareholders
wealth.

14
CHAPTER 3-

RESEARCH METHODOLOGY-

A research method is a organised plan for conducting research. Sociologists draw on a variety of both
qualitative and quantitative research methods, with experiments, survey research, participant observation,
and secondary data. Quantitative methods purpose is to classify features, count them, and create statistical
models to test hypotheses and clarify observations.

Research methodology is the route through which researchers need to conduct their research. It shows the
path through which these researchers communicate their problem and objective and present their outcome
from the data obtained during the study period. This research design and methodology chapter also shows
how the research result at the end will be obtained in line with meeting the objective of the project . This
chapter hence discusses the research methods that were used during the research procedure

Sources of data-

 Primary data
 Secondary data -

This information is collected through secondary sources-

Desk review has been conducted to collect data from several secondary sources. Secondary data sources
have been attained from literatures and the remaining data were from the companies’ manuals, reports, and
some organisation documents which were included under the desk review. Reputable journals, books,
articles, periodicals, proceedings, magazines, newsletters, newspapers, websites, and other sources were
measured on the capital budgeting decisions .The data is also obtained from the existing working
documents, manuals, procedures, reports, statistical data, policies, regulations, and the standards were taken
into consideration for the review.

15
CHAPTER 4-

DATA ANALYSIS-

A firm is Successful only if it invests wisely by taking informed decisions and earn profits .Capital
Budgeting Decisions are usually long term decisions so a firm needs to be much more cautious while taking
the final decision on whether to go for a project or not, Here we are going to take a case of a hypothetical
company in which we get to learn different aspects of capital budgeting decisions.

Case Study of Balaji Wafers Company-

Balaji Wafers Co. wants to bring about healthier and better chips to be launched as there is great demand and
opportunity in the market.

With a view for expansion ,extensive research was conducted and they came up with an effective idea of
bringing two business proposals , The first proposals here after referred as Project A in house production by
setting up own manufacturing plant which will involve huge capital investment . The other proposal,
hereafter referred as Project B that proposes outsourcing of production to a reputed manufacturing firm, thus
saving capital investments but affecting profit margins

This analysis was carried out so as to evaluate the proposals and get better results for decisions.

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RELEVANT DATA-

 Project A-

A) The proposal of setting up company’s own manufacturing plant involves initial investment as:
 Buying a newly built factory building of Rs 20 Cr
 Purchase of machinery Rs 130 Cr
Total starting Investment Rs 150 Cr

B) The newly set up factory will take some time in reaching its full production capacity. The market
production forecasted the production volume as follows-

Year 1 2 3 4 5

Expected sales Revenue 50 100 150 200 250

(Rs Cr)

C) Cash flows: The company is likely to bear fixed operation and maintenance expenses of 5 Cr, where
variable cost increases each year by Rs 10 Cr the company is subjected to 30% tax on earnings and
Straight line method of depreciation.

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 In Crores

PARTICULARS YEAR 1 YEAR 2 YEAR 3 YEAR 4 YEAR 5

Sales 50 100 150 200 250
(-) variable cost 10 20 30 40 50
contribution 40 80 120 160 200
(-) fixed cost 5 5 5 5 5
(-) depreciation 25 25 25 25 25
EBIT 10 50 90 130 170
Tax @30% 30.0% 30.0% 30.0% 30.0% 30.0%
3 15 27 39 51
EAT 7 35 63 91 119
(+) Depreciation 25 25 25 25 25
CFAT 32 60 88 116 144

 Total investment= Initial Investment+ Operating expenses=

150 +150+25=325 Cr

 Total Cash flows after tax= 32+60+88+116+144=440 Cr

 Total Earning after tax= 7+35+63+91+119= 315 Cr

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2) Project B:

A) The proposal of outsourcing the production to another firm involved an initial investment for tenders,
legal expenses and advance payments of 5 Crores

B) The market analyst forecasted the demand volumes for Chips as follows-

Year 1 2 3 4 5
Expected sales revenue(Rs 100 120 140 160 180
Cr)

C)Cash flows- The Company is likely to bear agreement cost and other operating cost which will variably
increase below are mentioned the costs for 5 years and the company is subjected to 30% tax on earnings.

In Crores

particulars Year 1 Year 2 Year 3 Year 4 Year 5

Sales revenue 100 160 220 280 340

Agreement cost 30 45 60 65 70
other operating cost 5 8 10 12 15

EBIT 65 107 150 203 255

(-) Taxes 30% 30% 30% 30% 30% 30%

19.5 32.1 45 60.9 76.5
EAT/CFAT 45.5 74.9 105 142.1 178.5

 Total Investment =Initial Investment+ Charges=5+270+50=325 Cr

 Total Cash flow after tax/Earning after tax=546 Cr

19
Financial Analysis- Decisions

For assessing the two proposals, some popular methods are used and compared with the two projects.

1) Average Rate of Return Method-

Project A:

Average EAT= (Total EAT/Period) =Rs 315/5 Cr =63Cr

Average Investment= Total Investment/2 =Rs325/2 Cr =162.5 Cr

ARR=(Average EAT/ Average Investment)*100% =

= (63 /162.5)*100% = 38.76 %

Project B:

Average EAT=(Total EAT/Period) =Rs 546/5 Cr =102 Cr

Average Investment= Total Investment/2 =Rs325/2 Cr =162.5 Cr

ARR=(Average EAT/ Average Investment)*100% =

= (102/162.5)*100% = 62.76%

INTERPRETATION- Both the projects have good value of return and Project B has better ARR. But ARR
does not consider the time value of money , which means the returns taken in during later years may be
worth less than those taken in now ,and does not consider cash flows , which can be a integral part of
maintaining business .Thus the project solely cannot be depended on ARR as the method for selecting the
project.

Finally accounting rate of return does not consider the increased risk of long term projects and the
increased variability of long periods of time.

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2) Payback Period-

Year Annual CFAT Cumulative CFAT

Project A Project B Project A Project B
1 32 45.5 35 45.5
2 60 74.9 95 120.4
3 88 105 183 225.4
4 116 142.1 299 367.5
5 144 178.5 443 546

We need to recover the investment of Rs 325 Cr, thus payback period for each project is

Project A-

CFAT at the end of year 4=299, CFAT at the end of year 5= 443

Therefore by interpolation=4+299/443=4.67 years

Project B-

CFAT at the end of the year 3= 225.4, CFAT at the end of year 4=367.5

Therefore by interpolation =3+225.4/367.5=3.61 years

INTERPRETATION-

On evaluating basis of payback period project B recovers the investment early than project A , but to rely on
just two decisions was not enough.

Therefore the decision was made of doing more research on capital budgeting analysis through other
techniques .

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3) Net Present Value Method( NPV)-

The discount rate element of the NPV formula is a way to account for this .Companies may have different
ways of identifying the discount rate. Here we assume discount rate as 10% which is close to expected rate
of returns

Year CFAT of CFAT of PV factor PV of CFAT of PV of CFAT of

Project A Project B @10% Project A Project B
1 32 45.5 0.91 29.12 41.405
2 60 74.9 0.83 49.8 62.167
3 88 105 0.75 66 78.75
4 116 142.5 0.68 78.88 96.9
5 144 178.5 0.62 89.28 110.67
313.08 389.892

Total PV of Cash outflow of Project A= Rs 150 cr

Net present value of Project A = PV of cash inflow-PV of Cash outflow

=313.08- 150

=163 Cr

Net present Value of Project B= PV of cash inflow-PV of cash outflow

=389.892-5

=384.892 Cr

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INTERPRETATION-

PV (Discount factor) is calculated with the given formula-

=1/ (1+r )n

Analysis of NPV gave us results, where both the projects have NPV positive and so both projects are good to
invest in. But project B had significantly higher NPV than Project A, implying that Project B is more
profitable and it is a factor of calculating time value of money that can give us positive output from selecting
a profitable proposal.

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4) Profitability Index- (PI)

It is a method used by firms for determining a relationship between costs and benefit for doing proposed
project.

Profitability Index- (Net present value + Initial Investment) /Initial Investment

Project A = 163+150/150= 2.08

Project B = 384.892+5/5 =77.97 i.e 78

INTERPRETATION-

As per the analysis of PI, both the projects are greater than 1 , which means the venture should be profitable
for both the projects and looking at the data ,PI of Project B is greater than that of Project A. In other words
project B is a good investment to be made i.e a higher number means a more attractive investment.

24
OVERALL ANALYSIS-

We have seen different methods for Capital budgeting proposals

 ARR (Average rate of return)

 PAYBACK PERIOD
 NPV ( Net present value)
 PI ( Profitability index)

That tells us about the analysis made where we come to the conclusion that project B is better in all the
above technique of capital budgeting proposal and it also suggests us on choosing which particular proposal.

The proposal of outsourcing the production to another firm can be considered as wise decision because it
leads us to more profitable solutions.

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FINDINGS-

Our Analysis was of selecting a better decision for the project.

1. It was found that ARR for project A is 38.76% and ARR of Project B is 62.76%,that shows the return
is more for project B and has good value of return.

2. The Payback period of the project A is 4.67 years and of project B is 3.61 years and so it shows that
the total investment can be recovered within a short period of time for project B and can be an ideal
one to choose.

3. NPV of project A is 163 Cr and that of project B is 384.892 Cr, where you can judge on the decision
that the net present value with higher value gives higher profitability.

4. PI of project A is 2.08, whereas for project B is 78, so project B is a good investment to be made.

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CONCLUSIONS-

As Conclusion capital budgeting is a procedure of company used to determine whether available projects are
worth for pursuing in a long term project such as new machinery, new plant, and new goods for its business .

Capital Budgeting method are used to determine long term objectives , new investment opportunities and
maintaining also estimating future and current cash flows .

With any capital budgeting methods measuring risks uncertainty and the cost of capital and projected project
performance determine as whether to accept the project or reject it.

When using estimation techniques .It is best to use more than one perception so as not to be biased about the
outcome.

Most of the businesses consider NPV for decision making but it is important to consider certain other actions
of Capital budgeting as each one provides different piece of relevant data to the decision maker.

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CHAPTER 5-

RECOMMENDATIONS AND SUGGESTIONS –

There should be proper analysis of capital budgeting method on what is to be taken for the purpose of
making decision as the proposal for the company is to be considered for long term perspective

It is recommended that, every company shall carry measures to study more than one approach as there can
be chances of error for a single decision.

If the results are different for each of the proposals than the most common study is to rely on NPV analysis.

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CHAPTER 6-

LIMITATIONS OF THE STUDY

The methods of capital budgeting require estimation of future cash inflows and outflows. The future is

always indefinite and the data collected for future may not be exact. Obliviously the results based upon
incorrect data may not be good.

There are numerous factors like morale of the employees, goodwill of the firm, etc., which cannot be
correctly enumerated but which otherwise substantially influence the capital decision.

Determination is another limitation in the evaluation of capital investment decisions.

Uncertainty and risk pose the biggest restriction to the techniques of capital budgeting.

All the techniques of capital budgeting presume that several investment proposals under consideration are
mutually exclusive which may not be basically true in some particular Conditions.

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REFERENCES AND BIBLIOGRAPHY-

 https://cleartax.in/s/capital-budgeting

 https://www.investopedia.com/articles/financial-theory/11/corporate-project-valuation-methods.asp

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