Internship Project Report

on

Capital Budgeting

for

M/S RAJKUMAR RATHI & CO. , KISHANGARH

by

VIKRAM GAUR

B.com plus ACCA

2021-22

Submitted to

In partial fulfilment of the requirement for the award of Degree of

B.com

Submitted Through

MIT-WPU School of Commerce, Pune

1
 CERTIFICATE

This is to certify that Mr. Vikram Gaur of MIT-WPU School of Commerce

has successfully completed the project work titled INTERN and M/S RAJKU-
MAR RATHI & CO. , KISHANGARH in partial fulfilment of requirement for
the award of B.Com prescribed by the MIT World Peace University, Pune,
from 18 FEB 2022 TO 19 APRIL 2022.

This project is the record of authentic work carried out during the academic
year 2021-2022.

Project Guide Mrs. Ketki Mulay

Name and Signature ________________

2
COMPANY CERTIFICATE

3
 DECLARATION

I, Vikram Gaur hereby declare that this project is the record of authentic
work carried out by me during the academic year 2021-2022. This project is
plagiarism free and has not been submitted to any other University or Institute
towards the award of any degree.

____________

Vikram Gaur

ACKNOWLEDGEMENT

I am deeply indebted to many people for the successful completion of this

project. would like to take this opportunity and go on record to thank them for
their help and support. I am thankful to the MIT WPU for all the support pro-

4
 vided for this project. I am also thankful to CA Anish Chaparral who provided
me with this amazing internship opportunity.

I express my deep sense of gratuity and sincere feelings of obligation to my

Project Guide Mrs. Ketki Mulay who has helped me in overcoming many dif-
ficulties and who has imparted me the necessary conceptual knowledge.

I wish to thank all my teachers – for their helpful inputs – insightful comments
–steadfast love and support

Sincerely

Vikram Gaur

INDEX NO. PARTICULARS PAGE

1 INTRODUCTION 1-3
2 OBJECTIVES OF THE STUDY 4-5
3 COMPANY PROFILE 6-13
4 METHODOLOGY 14-15
5 THEORY OF CAPITAL BUGETD- 16-17
ING
6 CAPITAL BUDGETING PROCESS 18-25
7 INVESTMENT CRITERIA 26-35
8 PHASES OF CAPITAL BUDGETING 36-43

5
INDEX NO. PARTICULARS PAGE
9 KINDS OF CAPITAL BUDGETING 44-46
DECISIONS
10 DIFFICULTIES IN CAPITAL BUD- 47-48
GETING
11 DATA REQUIRED 49-52
12 ANALYSIS 53-63
13 CONCLUSION & SUGGESTIONS 64-65
14 DECISION 66-67
15 BIBLIOGRAPHY 68-69

CONTENTS

INTRODUCTION

Capital Budgeting is perhaps the most important Issue in Corporate

Finance. How a firm finance its investments that they has to make
or to define the business or businesses that it wants to be. That’s
why the process of Capital budgeting is also referred to as strategic
asset allocation.
Once the managers of a firm choose the business or businesses they
want to be in, they have to develop a plan to invest in buildings,
machineries, equipments, research and development, go downs,

6
showrooms, distribution network, information infrastructure,
brands, and other long lived assets. This is the capital budgeting
process.
Considerable managerial time, attention, and energy are devoted to
identify, evaluate, and implement investment projects. When you
look at an investment project from the financial point of view, you
should focus on the magnitude, timing, and risk ness of cash flows
associated within. In addition, consider the options embedded in
the investment project.

OBJECTIVES OF THE STUDY

• Main Objective :
The main Objective of the project is to suggest the company whether to
establish a new manufacturer Processed Equipments Pharmaceuticals at
Jaipur or not.

• Sub-Objectives :
A. To study the financial feasibility of the proposal
B. To find out the benefits that the company is going to get from the new
projects.
C. To critically evaluate the project to arrive at the right conclusion

7
D. Estimate of post scenario of the company
E. Estimating of assets & tools required for this new project

Company profile

INTRODUCTION

1. NAME OF THE FIRM : RAJKUMAR RATHI & CO.

2. STATUS: PARTNERSHIP FIRM

3. FIRM REGISTRATION NO. : 006342C
4. DATE OF ESTABLISHMENT: 24/11/1992
5. PAN NO. : AAOFR6232P
6. GST NO. : 24AAOFR6232P1ZM
7. RBI UNIQUE CODE: 898680
8. MEF NO. : MEF50821
9. RBI CATEGORY : I

8
 10. CAG EMPANELMENT NO. : WR3768

11. NO. OF PARTNERS : 7

FCA : 5
ACA : 2
12. QUALIFIED STAFF : 20

13. NO. OF BRANCHES: 05

14. HEAD OFFICE :

Office No.-C, - Center, Above Vivek Hospital, Nr. Krishna Petrol Pump,

Udhana Main Road, Surat – 394210 CA. Naresh Birla - +918000810510

15. BRANCHES:
1. Mumbai, Maharashtra
2. Bhilwara, Rajasthan
3. Kekri(Ajmer),Rajasthan
4. Kishangarh, Rajasthan
5. Ahmedabad, Gujarat

16. Partners having post degree qualification

• Cert. Course of Concurrent Audit:
· CA. NaresH Birla
· CA. Ayush Soni

• Diploma in Information System Audit:

· CA. Naresh Birla (DISA)
• Certificate Course of Forensic Audit :
· CA. Naresh Birla
Refer Annexure 1 for History.

9
Methodology of the study

The information required for successful completion of the project

has been collected through primary and secondary sources.

Primary Sources of information is through interviewing, meetings

and etc. with the various officials and employees of company
(name).

Secondary Sources of information are the balance sheets and other

financial statements of the company.

A systematic review is a means of evaluating and interpreting all available re-

search relevant to a specific research question, topic area, or phenomenon of
interest. Its aim to present an evaluation of an investigation topic by using a
trustworthy and rigorous methodology (Kitchenham, Brereton, Budgen,
Turner, Bailey, and Linkman). The systematic review of literature is defined
as by the manner in which the reviewer proceeds, stage by stage, with full

10
transparency and explicitness about what is done, typically using a protocol to
guide the
process (Young et al., 2002).
Pittaway et al. (2004) proposed a comprehensive and detailed process to arrive
at organised results from a large potential sample of articles. However, the ori-
gin of the criteria for content analysis was not explicit.
Kitchenham et al. (2009) proposed a subjective process for choosing articles in
specific journals. But, Ensslin et al. (2010) presented the Proknow-C, a de-
tailed and comprehensive process for selecting a large sample of potential
articles with the integration of criteria grounded in a worldview, which enables
a holistic view of the analysis. Proknow-C presents a structured process to
build knowledge about the researcher interest area, according to the construc-
tivist view. The methodology consists of a series of sequential procedures that
begin with the
definition of the search engine for scientific articles to be used, followed by
pre-established processes of filtering and the selection of a relevant biblio-
graphic portfolio (Ensslin et al., 2010). Proknow-C is a set of steps or guides
to filter and analyze the bibliographic information on a certain theme or sub-
ject. It is subdivided into four stages:
1. the selection of the bibliographical portfolio;
2. the bibliometrics analysis of the selected articles;
3. the systematic analysis of the selected articles; and
4. the definition of the research question and the research objective (Waiczyk
& Ensslin, 2013).
The selection of the articles is a singular process, subject to restriction re-
searchers’ limitations, according to the theme that they want to study.
The limitations of this process are as follows: the keyword definition by the
researchers; the identification of the number of citations per article through
Google Scholar; and the analysis of the article’s title, summary and
full text, according to the researchers’ preferences (Lacerda et al., 2016)

11
CAPITAL BUDGETING THEORY:

I) Meaning:
Capital budgeting is a required managerial tool. One duty of a financial man-
ager is to choose investments with satisfactory cash flows and rates of return.
Therefore, a financial manager must be able to decide whether an investment
is worth undertaking and be able to choose intelligently between two or more
alternatives. To do this, a sound procedure to evaluate, compare, and select
projects is needed. This procedure is called capital budgeting.

II) Importance:
Capital budgeting decisions are crucial to a firm's success for several reasons.
First, capital expenditures typically require large outlays of funds.

Capital budgeting process

The capital budget process is usually a multi-step process, including:

· Identification of potential investment opportunities

· Assembling of proposed investments
· Inventory of Capital Assets;

12
 · Developing a Capital Investment Plan (CIP);
· Developing a Multi-Year CIP;
· Developing the Financing Plan; and,
· Implementing the Capital Budget.

INVESTMENT CRITERIA
A wide range of criteria has been suggested to judge the worthwhile ness of
investment projects. The important investment criteria, classified into two
broad categories—non-discounting criteria and discounting criteria—are
shown in exhibit subsequent sections describe and evaluate these criteria in
some detail:

INVESTMENT CRITERIA
DISCOUNTING CRITERIA NON-DISCOUNTING CRITERIA
· Internal rate of return (IRR) · The payback period

· Modified internal rate of re- · The discounted payback pe-

turn (MIRR) riod

· Net present value (NPV)

· Profitability index (PI)

13
Table 1: Comparing Methods of Valuation under Various Sce-
narios

Indepen- Mutually
*Capital *Scale Dif-
Method dent Exclusive
Rationing ferences
Projects Projects
Not Accept- Not Ac- Not Accept-
IRR Acceptable
able ceptable able
Not Accept- Not Ac- Not Accept-
MIRR Acceptable
able ceptable able
NPV Acceptable Acceptable Acceptable Acceptable
Not Accept- Not Accept- Not Ac- Not Accept-
Payback
able able ceptable able
Dis- Not Accept- Not Accept- Not Ac- Not Accept-
counted able able ceptable able

Basic Data

Expected Net Cash Flow

Year Project L Project S

0 (100) (100)
1 10 70
2 60 50
3 80 20

The Six Criteria

14
There are six criteria that we will use:

Non-discounting criteria
· The payback period
· The discounted payback period

Discounting criteria
· Internal rate of return (IRR)
· Modified internal rate of return (MIRR)
· Net present value (NPV)
· Profitability index (PI)

Non-discounting criteria

a) The Payback Period:

The payback period measures the time that it takes to recoup the cost of the in-
vestment.

If the cash flows are an annuity, then we can simply divide the cost by the an-
nual cash flow to determine the payback period. Otherwise, as in the example,
we subtract the cash flows from the cost until the remainder is zero
The shorter the payback period, the better. Generally, firms will have some
maximum allowable payback period against which all investments are com-
pared. For our example project, we will subtract the cash flows from the initial
outlay until the entire cost is recovered.

Problems with the Payback Period

The payback period suffers from two primary problems that limit its useful-
ness in evaluating investments:

It ignores the time value of money

It ignores all cash flows beyond the payback period

15
Still, it has a couple of redeeming qualities
It is quick and easy to calculate
It gives a measure of the liquidity of the projectPayback period = Expected
number of years required to recover a project’s cost.

Project L
Expected Net Cash Flow

Year Project L Project S

0 (100) (100)
1 10 (90)
2 60 (30)
3 80 50

PaybackL = 2 + 30/80 years

= 2.4 years.
PaybackS = 1.6 years.

Weaknesses of Payback:
1.Ignores the time value of money. This weakness is eliminated with the dis-
counted payback method.
Ignores cash flows occurring after the payback period.
b) The Discounted Payback Period
The discounted payback period is exactly the same as the regular payback pe-
riod, except that we use the present values of the cash flows in the calculation.
Since our required return (WACC) is 12%, the timeline with the PVs looks
like this:
Problems with Discounted Payback
The discounted payback period solves the time value problem, but it still ig-
nores the cash flows beyond the payback period.
Therefore, you may reject projects that have large cash flows in the outlying
years that make it very profitable.
In other words, any measure of payback can lead to a focus on short-run prof-
its at the expense of larger long-term profits.

16
 Discounted Payback - is almost the same as payback, but before you figure it,
you first discount your cash flows. You reduce the future payments by your
cost of capital. Why? Because it is money you will get in the future, and will
be less valuable than money today. (See Time Value of Money if you don't un-
derstand). For this example, let's say the cost of capital is 10%.

Yea Cash Discounted Cash Running To-

r flow flow tal
0 -8000 -8000 -8000
1 3733 3397 -4607
2 3200 2645 -1962
3 1600 1202 -760
4 1066 728 -32
5 533 331 299

So we break even sometime in the 5th year. When?

Negative Balance / Cash flow from the When in the final year we
=
Break Even Year break even
-32 / 331 = .096

So using the Discounted Payback Method we break even after 4.096 years.

DISCOUNTING CRITERIA

a) The Internal Rate of Return

The internal rate of return (IRR) is the discount rate that equates the present
value of the cash flows and the cost of the investment
Usually, we cannot calculate the IRR directly; instead we must use a trial and
error process. For our example, the IRR is found by solving the following:
Problems with the IRR

17
The IRR is a popular technique primarily because it is a percentage, which is
easily compared to the WACC.
However, it suffers from a couple of flaws:
The calculation of the IRR implicitly assumes that the cash flows are rein-
vested at the IRR. This may not always be realistic.
Percentages can be misleading (would you rather earn 100% on a $100 invest-
ment, or 10% on a $10,000 investment?)

0 1 2 3
.
-100.00 10 60 80

Project L:

8.47
18.1%

43.02 18.1%

48.57
18.1%
$ 0.06 ≈ $0

IRRL = 18.1%
IRRS = 23.6%

If the projects are independent, accept both because IRR > k.

If the projects are mutually exclusive, accept Project S since IRRS > IRRL.

Note: IRR is independent of the cost of capital.

18
b) The Net Present Value

The Net Present Value (NPV) Calculator:

The calculation of net present value is useful when preparing a capital budget-
ing project. With this calculator, you can determine whether the total present
value of a project's expected future cash flows is enough to satisfy the initial
cost.
In the calculator fields below enter your required discount rate, also known as
the cost of capital or required rate of return. This is the return you require for
the project to be an attractive investment. Secondly, enter the length of the
project (in years) and the amount required to initiate the project. Finally, enter
any projected net cash flows to be received throughout the life of the project.
(If you project any cash outflows to be greater than inflows, enter a negative
number for that net cash flow.)
The net present value (NPV) is the difference between the present value of the
cash flows (the benefit) and the cost of the investment (IO):
The NPV: An Example NPV is calculated by subtracting the initial outlay
(cost) from the present value of the cash flows
Note that the discount rate is the WACC (12% in this example)

-100.00 10 60 80

0 1 2 3

Project L:

19
 9.09
49.59
60.11
NPVL = $ 18.79

NPVS = $19.98
If the projects are independent, accept both.
If the projects are mutually exclusive, accept Project S since NPVS > NPVL.
Note: NPV declines as k increases, and NPV rises as k decreases.

d) The Profitability Index

The profitability index is the same as the NPV, except that we divide the
PVCF by the initial outlay: E. PROFITABILITY INDEX (PI) The prof-
itability index, or PI, method compares the present value of future cash in-
flows with the initial investment on a relative basis. Therefore, the PI is the
ratio of the present value of cash flows (PVCF) to the initial investment of the
project.

In this method, a project with a PI greater than 1 is accepted, but a project is

rejected when its PI is less than

1. Note that the PI method is closely related to the NPV approach. In

fact, if the net present value of a project is positive, the PI will be
greater than 1. On the other hand, if the net present value is negative,
the project will have a PI of less than 1. The same conclusion is
reached, therefore, whether the net present value or the PI is used.

20
 In other words, if the present value of cash flows exceeds the initial invest-
ment, there is a positive net present value and a PI greater than 1, indicat-
ing that the project is acceptable.
PI is also known as a benefit/cash ratio.
Project L

10%
0 1 2 3

-100.00 10 60 80
PV1 9.09
PV2 49.59
PV3 60.11
118.79

Accept project if PI > 1.

Reject if PI < 1.0

Phases of capital budgeting

1. Planning:
The long term or short term capital budgeting plan represents a blue print of
what a firm proposes to do in the future typically it covers a period of three to
ten years moat commonly it spans a period of five years naturally, planning
over such an extended time horizon tends to be in fairly aggregative terms.

21
While there is considerable variation in the scope, degree of formality, and
level of sophistication in financial planning acres firms, most corporate finan-
cial plans have certain common elements.
These are:
1.Economic assumptions:
The financial plan is based on certain assumptions about the economic envi-
ronment (interest rate, inflation rate, growth rate, exchange rate, and so on).
Sales forecast:
The sales forecast is typically the starting point of the capital forecasting exer-
cise. Most capital variables are related to the sales figure.

2. Analysis:
The Three Stages of Capital Budgeting Analysis
Capital Budgeting Analysis is a process of evaluating how we invest in capital
assets; i.e. assets that provide cash flow benefits for more than one year. We
are trying to answer the following question:
Will the future benefits of this project be large enough to justify the invest-
ment given the risk involved?
It has been said that how we spend our money today determines what our
value will be tomorrow. Therefore, we will focus much of our attention on
present values so that we can understand how expenditures today influence
values in the future. A very popular approach to looking at present values of
projects is discounted cash flows or DCF. However, we will learn that this ap-
proach is too narrow for properly evaluating a project.
We will include three stages within Capital Budgeting Analysis:
Decision Analysis for Knowledge Building
Option Pricing to Establish Position
Discounted Cash Flow (DCF) for making the Investment Decision

Different basic capital budgeting analysis

Horizontal analysis: - Analysis involves the computation of amount changes
and percentage change

22
Vertical analysis: - uses percentage to show the relationship of the different
items to the total in a single statement sets a total figure equal to 100%and
compute the percentage of each components of that figure
Trend analysis: - percentage changes are calculated for several successive
years instead of between two years
Ratio analysis: - represent meaningful relationship between two numbers fi-
nancial ratios have been classified into five categories as follows
· Liquidity ratio: -
Current ratio=current assets /current liability
Quick ratio=quick assets*/current liability
*Excluding inventories
· Leverage ratio: -
Debt equity ratio=debt/equity
Interest coverage ratio=PBIT+DEP/interest on debt
DSCR=[(PAT+DEP+INT ON DEBT)/(INT ON DEBT+installment of debt
· Turnover ratio:-
Inventory turnover ratio=cost of good sold/average inventory
Fixed asset turnover ratio= net assets/average net fixed assets
Total assets turnover ratio=net sales/average total assets
· Profitability ratio:
Grass profit margin=grass profit / met sales
Net profit margin= net profit /sales
Return on total assets=profit after tax/average total assets

· Valuation ratio: -
EPS=equity earning/ number of share holders
PER=MPPS/EPS
Yield ratio=dividend+price change/initial price
3. Financial analysis
Financial analysis seeks to ascertain whether the proposed project will be fi-
nancially viable in the sense of being able to meet the burden of servicing debt
and whether the proposed project will satisfy the return expectations of those

23
the shareholders (owners of the firms). The aspects, which have to be looked
into while conducting financial appraisal in ICT projects, are:
Investment outlay analysis
Means of financing –Cost of Capital –Projected profitability- Break-even
point – Cash flows of the project Level of risk

a) Means of financing
Means by which a budget deficit is financed or a surplus is used. Means of
financing are not included in the budget totals. The primary means of fi-
nancing is borrowing from the public. In general, the cumulative amount
borrowed from the public (debt held by the public) will increase if there is
a deficit and decrease if there is a surplus, although other factors can affect
the amount that the government must borrow.
Those factors, known as other means of financing, include reductions

(or increases) in the government's cash balances, seignior age,

changes in outstanding checks, changes in accrued interest costs
included in the budget but not yet paid, and cash flows reflected
in credit financing accounts.

b) The Cost of Capital

Cost of Capital,
Discounts Rates, and
The required Rate of Return
We know how to do capital budgeting problems, but what about the discount
rate?
We also know that the discount rate will depend on the risk of the project:
Investors will require a higher required rate of return for riskier projects. In-
vestors will look at projects as portfolios and therefore the systematic risk is
the correct measure of risk. Any unsystematic risk can be diversified away,
and no compensation for this is necessary.
Required rate of return, appropriate discount rate, and cost of capital are dif-
ferent names for the same concept.

24
The cost of capital depends on the risk, and hence primarily on the use of the
funds, not the source.
Firm's overall cost of capital reflects the required rate of return on the firm's
assets as a whole. This overall cost of capital is called the weighted average
cost of capital, and reflects the costs of debt, equity, and preferred stock.

c) Investment outlay Analyses

Having the exclusive rights to a product or project is valuable, even if the
product or project is not viable today.
The value of these rights increases with the volatility of the underlying busi-
ness.
The cost of acquiring these rights (by buying them or spending money on de-
velopment - R&D, for instance) has to be weighed off against these benefits.

d)Projected profitability
Refers to the amount of profit received relative to the amount invested, often
measured by a rate of profit or rate of return on investment.
Economists and accountants measure profit in slightly different ways. What is
commonly known as profit is the difference between sales and costs by a busi-
ness enterprise? However, the term is also used more generally to refer to
value added, which only be the same when all the factors of production have
been credited their full opportunity cost.

e) Break-even point:
Definition
The price at which an option's cost is equal to the proceeds acquired by exer-
cising the option. For a call option, it is the strike price plus the premium paid.
For a put option, it is the strike price minus the premium paid Breakeven anal-
ysis a management control that approximates how much you must sell in order
to cover your costs with NO profit and NO loss. Profit comes after breakeven.
The following formula will help in the calculation of your breakeven sales vol-
ume level:

25
 Breakeven = Fixed Costs * / Contribution Margin %
**
= 250 000/15%
= 1 666 667

* Fixed Costs are those costs that are not variable as a result of the sales activ-
ity. For example, rent of the building or insurance costs may be fairly constant
no matter how sales vary, while, expenses such as advertising and usage of
shop or store supplies will vary with sales.

** Contribution Margin = Revenue - Variable Costs. In a retail

business, the gross margin % is generally recognized as the Contribution Mar-
gin %. Gross Margin equals the difference between the Sales and the Cost of
the Sales.

In this example, $1 667 are the sales that are required to cover fixed costs of
$250 000 and a margin of 15 percent, with nothing left over for profit.
If you now wanted to calculate the sales that are required to now build in a
profit factor, add the profit factor you want to allow for to the fixed costs. If in
this example, the fixed costs are $250 000 and you want a $150 000 profit, add
the two together and then apply the breakeven formula to this.

Breakeven = (Fixed Costs + Profit Margin) / Contri-

bution Margin %
= (250 000 + $150 000) / 15%
= 400 000 / 15%
= 2 666 667

If this was a small manufacturing company and you wanted to calculate how
many unit sales you need to breakeven, you could divide the breakeven sales
volume by the unit-selling price. For example, if the unit sells for 10, the
breakeven unit sales before a profit is allowed for is 166 667 units and after a

26
profit is allowed for, 266 667 units

f) Project’s Cash Flow

You have to keep the schedule of your expenditure in-line with your income
throughout the various stages of your project.

Preparing a cash flow schedule is especially important if you will be receiving

income across several stages through out your project's duration (development
grant, ticket door or art work sales, program advertising, pre-sold tickets or
workshop attendance fees, etc).

By preparing a cash flow chart you will be able to schedule your expenditure
in line with your project's income as it fluctuates from week to week

g) Level of Risk
A big question that companies have to deal with is, "What is enough secu-
rity?" This can be restated as, "What is our acceptable risk level?" These two
questions have an inverse relationship. You can't know what constitutes
enough security unless you know your necessary baseline risk level.
To set an enterprise wide acceptable risk level for a company, a few things
need to be investigated and understood. A company must understand its fed-
eral and state legal requirements, its regulatory requirements, its business driv-
ers and objectives, and it must carry out a risk and threat analysis. (I will dig
deeper into formalized risk and threat analysis processes in a later article, but
for now we will take a broad approach.) The result of these findings is then
used to define the company's acceptable risk level, which is then outlined in
security policies, standards, guidelines and procedures.
Although there are different methodologies for risk management, the core
components of any risk analysis is made up of the following:

Identify company assets

Assign a value to each asset
Identify each asset's vulnerabilities and associated threats

27
Calculate the risk for the identified assets

KINDS OF CAPITAL BUDGETING DECISIONS

There are basically three different kinds of decisions in capital budgeting they
are as follows
a) The Option to Expand/Take Other Projects
Taking a project today may allow a firm to consider and take other valuable
projects in the future.
Thus, even though a project may have a negative NPV, it may be a project
worth taking if the option it provides the firm (to take other projects in the fu-
ture) provides a more-than-compensating value.
These are the options that firms often call “strategic options” and use as a ra-
tionale for taking on “negative NPV” or even “negative return” projects.

b) Mutually Exclusive Projects

In many cases, a firm will be faced with a choice of between mutually exclu-
sive investment projects. These are cases in which the firm can undertake only
one of the potential projects. For example, a firm may be considering whether
to construct an office building or a shopping mall on a parcel of land, or decid-
ing whether to refurbish an old apartment building or turn it into a parking
garage. In this case, the NPV rule is to undertake the project with the largest
NPV, so long as it is positive.

Example 3.8
A manufacturer is considering purchasing one of two machines, A and B. The
cash flows of each of the projects are represented below on a time line. The
project’s required rate of return is 10 percent. Since these projects are mutu-
ally exclusive, which proposal (if any) should the manufacturer choose?

28
Project A

Yea
0 1 2 3 4 5
r
Cas
-
h 1,00 1,00 1,00 1,00 1,00
3,00
Flo 0 0 0 0 0
0
w

Project B

Year 0 1 2 3 4 5
Cash
-2,000 700 700 700 700 700
Flow

The NPV computations are:

Since these are mutually exclusive projects and both have NPV > 0, we take
the project with the highest NPV. Project A is thus the preferred alternative.

29
Difficulties in Capital Budgeting

a) General difficulties where we get across

Ensuring that forecasts are consistent (across departments)
Eliminating (reducing) conflicts of interest
Reducing forecast bias: the proportion of proposed projects that have a posi-
tive NPV is independent of the estimated opportunity cost of capital.

Bottom-up and top-down planning is necessary.

Control projects in progress, Post-audit afterwards
Try hard to measure incremental cash flows--when you can
Evaluate performance: actual versus projected; actual versus absolute standard
of the true cost of capital

b) Measurement problem:
While calculating the NPV, IRR, PAY BACK PPERIOD, AND PROF-
ITABILITY INDEX, we have to be vary much careful with the calculations
values throw it is a very difficult job to remember many values at a time but
we have to be care full because it will effect on the total output of project in
decision making
Risk and uncertainty:
Different capital investment proposals have different degrees of risk and un-
certainly there is a slight difference between risk and uncertainty risk involves
situations in which the probabilities of a particular event occurring are known
where as in uncertainty these probabilities are unknown.
In many cases these two terms are used inter changeably. Risk in capital in-
vestments may be due to the general economic conditions competition, tech-
nological developments, consumer preferences etc.

30
One to these reasons the revenues costs and economic life of a particular in-
vestment are not certain. While evaluating capital investment proposals a
proper adjustment should therefore be made for risk and uncertainty

Data Requirement

a) Cash flow estimates

While estimation of cash flow we have to use the four principles of cash flow
they are:-
(1) separation principle:- There are two sides of a project the invest-
ment side and the financing side and the cash flows associated with
these sides should be separated the important point to be emphasised is
that while defining the cash flows on the investment side, financing
costs should not be considered because they will be reflected in the
cost of capital figure against which the rate of return figure will be
evaluated. Operationally this means that interest on debt is ignored
while computing profits and taxes thereon. Alternatively, if interest is
deducted in the process of arriving at profit after tax an amount equal
to interest (1- tax rate) should be added to profit after tax note that
Profit before interest and tax (1 – tax rate)
= (Profit before tax + interest)(1 – tax rate)
= (Profit before tax (1 – tax rate) + interest (1 –
tax rate)
=Profit after tax + interest (1 – tax rate)
b) Incremental principle
The cash flow of a project must be measured in incremental terms. To as-
certain a projects incremental cash flows you have to look at what happens
to the cash flows of the firm with the project and without the project the
different between the two reflects the incremental cash flows attributable
to the project. That is,
Project cash flow for year t = cash flow for the firm – cash flow
for the firm

31
In estimating the incremental cash flows of the project, the following guide-
lines must be borne in mind they are consider all incidental effects ,ignore
sunk costs, include opportunity costs, question the allocation of overhead costs
,estimate working capital properly

c) Post-tax principle:
Cash flows should be measured on an after-tax basis. Some firms may ignore
tax payments and try to compensate this mistake by discounting the pre-tax
cash flows at a rate that is higher than the cost of capital of the firm. Since
there is no reliable way of adjusting the discount rate, you should always use
after-tax cash flows along with after-tax discount rate cash flows should be
measured after taxes the important issues in assessing the impact of taxes are
what tax rate should losses be treated? What is the effect of non-cash charges?

d) Consistency principle
Cash flows and the discount rates applied to these cash flows must be consis-
tent with respect to the investor group and inflation

Investor group:
Cash flows to all investors =
PBIT (1- TAX RATE) + Depreciation and non cash charges–
Capital expenditure – Change in working capital

Inflation:
Nominal cash flow t= real cash flow (1+ expected inflation rate)
t

e) Effect of indirect expenses

32
Cost Allocation is vital to understanding the costs and cost drivers of individ-
ual products, orders, customers and suppliers. Activity Based Costing is the
best method of accurately assigning indirect costs to departments, customers,
suppliers, products and orders.

However, only Resource Based costing, also known as Time Driven Costing,
accounts for variability of different transactions and orders. Other solutions as-
sign average costs, penalising the most profitable, lowest-cost, products, cus-
tomers and suppliers, while rewarding the high cost ones.

f) Effect of deprecation
If you buy agricultural property such as machinery, computers, breeding live-
stock, equipment, etc. that has a useful life of more than one year, you spread
the cost of it over several years for record keeping and tax purposes. This is
called depreciation. Property is depreciable if it meets these tests:
1. It must be used in business or held for the production of income.
2. It must have a determinable useful life longer than one year, and
3. It must be something that wears out, decays, gets used up, becomes obsolete
or loses value from natural causes.

g) Working capital effect

A company's current assets minus its current liabilities - considered a good
measure of both a company's efficiency and its financial health. A positive
working capital means that the company is able to pay off their short-term lia-
bilities. A negative working capital means that a company currently is unable
to meet their short-term liabilities with their current assets (cash, accounts re-
ceivable, inventory).

If a company's current assets do not exceed its current liabilities, then it may
run into trouble paying back creditors that want their money quickly. The
working capital ratio, which measures this ability to pay back creditors, is cal-
culated as current assets divided by current liabilities.

33
Working capital also gives investors an idea of the company's underlying op-
erational efficiency. Money that is tied up in inventory or money that cus-
tomers still owe to the company can’t be used to pay off any of its obligations.
So if a company is not operating in the most efficient manner (slow collection)
it will show up in the working capital. Comparing the working capital from
one period of time to another can see this; slow collection may illustrate an un-
derlying problem in the company’s operations.

ANALYSIS
Calculation of total sales of the project

Years Capacity Production Local Selling Total Sales

Sales Price

(in units)
1 80% 2570 1850 4132 7644200
2 90% 2892 2085 4649 9692123

34
 3 90% 2892 2085 4649 9692123
4 90% 2892 2085 4649 9692123
5 90% 2892 2085 4649 9692123
6 90% 2892 2085 4649 9692123
7 90% 2892 2085 4649 9692123
8 90% 2892 2085 4649 9692123
9 90% 2892 2085 4649 9692123
10 90% 2892 2085 4649 9692123

Calculation of variable Cost (000)

S.No. Particu- 1 2 3 4 5 6 7 8 9 10
lars

Salaries & 550 650 7500 800 820 450 620 8250 977 1268
Wages 0 0 0 0 0 0 5 0

35
 Electricity 128 145 1560 214 325 159 357 4150 422 1478
4 6 0 0 0 0 5

Repairs & 500 564 528 598 574 563 521 591 540 578
Maintenance

Administration 350 320 280 300 380 210 158 176 170 220
exp

Total
76 88 986 110 124 686 104 1316 147 1495
34 40 8 38 04 3 49 7 10 6

Calculation of Net Profit of the Project

A B C D E F

Total Variable Fixed GP=A2- TAX NET

Sales Cost Cost B2-C2 40% PROFIT

15000 7634 3500 3866 1546 2319.6

17000 8840 3500 4660 1864 2796

17300 9868 3500 3932 1573 2359.2

17500 11038 3500 2962 1185 1777.2

18000 12404 3500 2096 838.4 1257.6

36
18500 6863 3500 8137 3255 4882.2

18800 10449 3500 4851 1940 2910.6

19250 13167 3500 2583 1033 1549.8

22890 14710 3500 4680 1872 2808

Project Cost
(omit 000)

phase-I phase-II Total

Land 1495
Civil Works 1621 538
Buildings 1160 1788
Contingency 140 116

Preliminary
Expenses 341

Pre-operative
Expenses 756

Margin money for

Working capital 45

37
 Total 5558 2442 8000

So the total cost of project is of 8000000

Profitability Index or Benefit Cost

PI = [(Present value of cash in flows)/(Present value of cash out

flows)]

Cash Flow- We is going to assume that the project we are considering approv-
ing has the following cash flow. Right now, in year zero we will spend
8,000,000 rupees on the project. Then for 5 years we will get money back as
shown below.

Year Cash flow (000)

0 -8000
1 3733
2 3200
3 1600
4 1066
5 533

38
Payback –
When exactly do we get our money back, when does our project break even?
Figuring this is easy. Take your calculator.

Year Cash flow Running To-

(000) tal (000)
0 -8000 -8000
(So after the 1st year, the project
1 3733 -4267
has not yet broken even)
(So after the 2nd year, the
2 3200 -1067
project has not yet broken even)
(So the project breaks even
3 1600 533
sometime in the 3rd year)

But when, exactly? Well, at the beginning of the year we had still had a -1067
balance, right? So do this.

Negative Balance / Cash flow from the When in the final year we
=
Break Even Year break even
1607 / 1600 = .666

So we broke even 2/3 of the way through the 3rd year. So the total time re-
quired to payback the money we borrowed was 2.66 years.

39
 Discounted Payback –
Is almost the same as payback, but before you figure it, you first discount your
cash flows. You reduce the future payments by your cost of capital. Why? Be-
cause it is money you will get in the future, and will be less valuable than
money today. (See Time Value of Money if you don't understand). For this
project, the cost of capital is 10%.

Year Cash Discounted Cash flow Running Total

flow(000) (000) (000)
0 -8000 -8000 -8000
1 3733 3397 -4607
2 3200 2645 -1962
3 1600 1202 -760
4 1066 728 -32
5 533 331 299

So we break even sometime in the 5th year. When?

Negative Balance / Cash flow from the When in the final year we
=
Break Even Year break even
-32 / 331 = .096

So using the Discounted Payback Method we break even after

4.096 years.

Net Present Value (NPV) –

40
Once you understand discounted payback, NPV is so easy! NPV is the final
running total number. That's it. In the example above the NPV is 299. That's
all. You're done, baby. Basically NPV and Discounted Payback are the same
idea, with slightly different answers. Discounted Payback is a period of time,
and NPV is the final rupees amount you get by adding all the discounted cash
flows together. If the NPV is positive, then approve the project. It shows that
you are making more money on the investment than you are spending on your
cost of capital. If NPV is negative, then do not approve the project because
you are paying more in interest on the borrowed money than you are making
from the project.

PROJECTED COST=8000000
SALVAGE VALUE =5500000
COST OF CAPITAL =10% AND
TAX RATE =50%

CFBT Debt CBT Tax50% EAT CFAT 10%cap CP

6966 500 6466 3233 3233 3733 .909 3393
5900 500 5400 2700 2700 3200 .826 2643
2700 500 2200 1100 1100 1600 .751 1202
1632 500 1132 566 566 1066 .683 728
566 500 66 33 33 533 .620 331
NPV = +297

DEP= ((0PROJECTED COST- SALVAGE VALUE)/NUMBER OF

YEARS)
= ((8000-5500)/5)
= 500

NPV= (SUM OF PROFIT VOLUME – INITIAL INVESTMENT)

= (8297-8000)

41
 = (+297)

Profitability Index:

Profitability Divided Total Invest-

NPV 1
Index by ment
PI = 297 / 8,000 + 1

So in our project, the PI = 1.0375. For every borrowed and invested we get
back 1.0375, or one rupees and 3 and one-third cents. This profit is above and
beyond our cost of capital.

Internal Rate of Return –

IRR is the amount of profit you get by investing in a certain project. It is a per-
centage. An IRR of 10% means you make 10% profits per year on the money
invested in the project. To determine the IRR, you need your good buddy, the
financial calculator.

Cash flow
Year (000) 10%CAP PV 5%CAP PV
0 -8000 1 -8000 1 -8000
1 3733 .909 3393 .95 3546
2 3200 .826 2643 .90 2880
3 1600 .751 1202 .86 1376
4 1066 .683 728 .81 863
5 533 .620 331 .77 410
NPV = +297 -1075

42
IRR=LR+ (NPV@LR/PV)*R
=10+ (297/1372)*5
=11.08

Modified Internal Rate of Return - MIRR –

Is basically the same as the IRR, except it assumes that the revenue (cash
flows) from the project are reinvested back into the company, and are com-
pounded by the company's cost of capital, but are not directly invested back
into the project from which they came.
OK, MIRR assumes that the revenue is not invested back into the same
project, but is put back into the general "money fund" for the company, where
it earns interest. We don't know exactly how much interest it will earn, so we
use the company's cost of capital as a good guess.

Why use the Cost of Capital?

Because we know the company wouldn't do a project, which earned profits
below the cost of capital. That would be stupid. The company would lose
money. Hopefully the company would do projects, which earn much more
than the cost of capital, but, to play it safe, we just use the cost of capital in-
stead. (We also use this number because sometimes the cash flows in some
years might be negative, and we would need to 'borrow'. That would be done
at our cost of capital.)

How to get MIRR - OK, we've got these cash flows coming in, right? The
money is going to be invested back into the company, and we assume it will
then get at least the company's-cost-of-capital's interest on it. So we have to
figure out the future value (not the present value) of the sum of all the cash

43
flows. This, by the way is called the Terminal Value. Assume, again, that the
company's cost of capital is 10%. Here goes...

Future
Value
Cash
Times = of that Note
Flow(000)
year’s cash
flow.
Compounded for 4
3733 X (1+. 1) ^ 4 = 5465
years
Compounded for 3
3200 X (1+. 1) ^ 3 = 4260
years
Compounded for 2
1600 X (1+. 1) ^ 2 = 1936
years
Compounded for 1
1066 X (1+. 1) ^ 1 = 1173
years
Not compounded at
all because
533 X (1+. 1) ^ 0 = 533
this is the final cash
flow
This is the Terminal
TOTAL = 13367
Value

Why all those zeros? Because the calculator needs to know how many years
go by. But you don't enter the money from the sum of the cash flows until the
end, until the last year. Is MIRR kind of weird? Yep. You have to understand
that the cash flows are received from the project, and then get used by the
company, and increase because the company makes profit on them, and then,
in the end, all that money gets 'credited' back to the project. Anyhow, the final
MIRR is 10.81%.

44
CONCLUSION & SUGGESTIONS

Decision and review of project

➢ Company is getting its payback with in 2 to 3 years (approximately

2.66 years) Project can be approved such that company can get back its
profit with in a limited period.

➢ Company is getting its “ Discounted Pay Back” with in 4.06 years even
after discounting cost of capital.

➢ NPV (Net Present Value) of the company is positive “297” so project

the project can be approved.

➢ PI (Profitability Index) is good because company is making money.

Hence, the project can be approved.

➢ IRR (Internal Rate of Return) is more than the cost of capital “11.08%
so approve the project.

➢ MIRR (Modified Internal Rate of Return) is also more than the cost of
capital 10.81%

DECISION:

45
Decision Time- Do we approve the project? Well, let's review.

Decision
Result Approve? Why?
Method
2.66 Well, cause we get our money
Payback Yes
years back
Because we get our money back,
Discounted Pay- 4.096
Yes even after discounting our cost of
back years
capital.
Because NPV is positive (reject
NPV 297 Yes
the project if NPV is negative)
Profitability In-
1.0375 Yes Cause we make money
dex
Because the IRR is more than the
IRR 11.08 Yes
cost of capital
Because the MIRR is more than
MIRR 10.81% Yes
the cost of capital

Bibliography

46
Financial Management - I .M PANDEY

Financial Management - Prasanna Chandra

Financial Accounting Analysis - Jainand Narang

Financial management - M.Y.Khan and Jain

International finance – Tata Mc Graw hill

Internet – www.google.co.in, www.indiainfo.com

Last year’s annual report - 2006

Project Planning, Analysis, and selection implementation: Satyanaryana.

ANNEXES:

Annexure 1

History

47
M/s Rajkumar Rathi & Co., Chartered Accountants is a Surat based partner-
ship firm with its Head Office at Surat, Gujarat and Branch Office at Ahmed-
abad (Gujarat), Mumbai (Maharashtra), Bhilwara, Kekri. Kishangarh (Ra-
jasthan). The firm presently has seven partners contributing to the firm’s im-
mense development with wide knowledge in different areas of expertise &
nourishing it with their long years of experience.

The seeds of Rajkumar Rathi & Co. were sowed 30 years back when Mr.Ra-
jkumar Rathi started practice in 1992 with the aim of providing a comprehen-
sive range of accounting, financial and legal consulting, tax management, au-
diting - stock audit, revenue audit, concurrent audit, statutory audit, forensic
audit and due deligence exercise in banking industry , wealth management
and knowledge process outsourcing services. Our sphere of specialisation in-
cludes accounting, auditing, advisory, taxation, business consultancy and a
host of other value added financial and legal consulting.

MOTO

The motto of our firm is “Client Satisfaction is Paramount”. Our goal is 100 %
client satisfaction and to be recognized as the best in what we do. The firm is
committed to ensuring delivery of dependable, timely, high-quality work that
brings measurable value to its clients.

ValuableAssets

The most valuable assets of our firm are our employees. The growth path of
Rajkumar Rathi & Co. has been powered by its human resource that includes a
mix of article trainees and permanent employees-quailed & semi-quailed hav-
ing requisite academic qualification and experience, necessary to suit their job
profiles.

Wide Client Base

Our firm's proudest achievement has been its wide clientele operating in dif-
ferent business areas. With our relentless efforts to serve our clientele, we
have established a huge client base across industries offering them globally
consistent set of compliance, assurance and business advisory services. The

48
sphere of our service network includes corporate houses, banks and besides in-
dividuals, LLPs, HUFs and partnership firms. The clients we serve span
across various industries which include banks, stock brokers, export
houses, hospitality & health care, manufacturing and many more.

Our USP

We believe that in order to stay ahead in the vibrant changing economy, you
need the most consistent and prompt quality services. Prompt service is our
USP. The philosophy is backed by experienced and motivated professionals
with matching expertise. We intend to be a one stop-shop for all your compli-
ance and financial needs. We believe in maintaining good long-term relations
with our clients.

AREAS OF EXPERTISE:
SERVICES OFFERED

Compliance:
Compliance with the numerous government laws requires in-depth knowl-
edge of various tax laws. We at Rajkumar Rathi & Co. provide the re-
quired specialised services and formulate effective strategies which en-
able the organisation to comply with the rules of the land.
Compliance can be broadly classified as follows:
• Direct Taxes (including Income Tax & TDS)
• Indirect Taxes (including GST)
• Company Law Matters (including Company-Formation, Incorpora-
tion and Registration & DIN Allotment.

Knowledge Process Outsourcing:

Any kind of business needs to focus on core activities such as business
development, product innovation & execution. Accounting services are
the non-core activities. The non-core activities could be outsourced to ex-
perts in the field. Outsourcing leads to effective channeling of energies to-
wards the core activities of the business.

49
 Startup Services:
Any entrepreneur wanting to set-up business in India needs the help of an
expert. Most people start up in a business mainly because they have a
good proposition. However there are many inherent factors like a good
business plan, cash flow projections, financial aspects etc which can often
be quite daunting to the entrepreneur. We at Rajkumar Rathi & Co. can
help you evaluate your ideas. Further our team shall also take care of all
your compliance needs. Our services shall also give your business the
much needed cutting edge over the competitors.

Audit & Assurance Services:

Rajkumar Rathi & Co. takes care of all your audit requirements, whether
internal or external. We implement the best of industry standards in our
audit processes and assist you with tailor-made solutions to meet your
specific audit needs. Our experienced accountants will evaluate the effi-
cacy of the internal compliance mechanism of your company and ensure
that all reporting needs are complied with.
We conduct the following types of audits:
• Statutory Audit.
• Internal Audit.
• Special Investigation Audit.
• Management Audit.
We also undertake Certification work after verifying all accounts scrupu-
lously.

Business Consultancy:
Profit maximization is the objective of any business. We at Rajkumar
Rathi & Co. Chartered Accountants, provide services to help the business
owners to run their business smoothly and efficiently resulting in maxi-
mum profits. These services are structured to suit an individual
client’s needs and requirements. The services can be categorized as fol-
lows:-

50
 • Business Planning.
• Market Research & Feasibility Study.
• Profit Maximization.
• Working Capital Optimization.
• MIS & Decision Support System.

Funding/Financing:
With regard to the funding requirements of your busi-
ness, we provide the following services:-
• Determine the purpose of fund.
• Determining the quantum of finance.
• Selecting the right type of fund i.e. Debt or Equity.
• Preparing business plans, projections, cash flow forecasts and other
financial statements.
• Sounding out potential lenders.
• Introducing you to proven sources of funding.
• Liaison with Financial Institutions/Banks.

Starting Business in India:

We assist in advising on the following:
• Advising on right constitution for entry into India.
• Advising on structuring for getting funds into India based on tax effi-
ciency and repatriation of funds.
• Setting up of Accounting & Reporting system.
• Compliance with Indian Fiscal Laws.

CONTACT US
Surat Office (Head Office) Mumbai Office
rd
C, 3 Floor, Sar Corporate Center, Above 704, Building No. 31, Neptune CHS, Evershi
Vivek Hospital, Shastri Nagar, Udhana Main Millennium Paradise, Thakur Village, Kandi-
Road, Surat-394210 wali East, Mumbai – 400101
Tel: 0261-2361300 ; +91-8000810510
E-mail: carajkumarrathi@gmail.com
Web-address - www.carajkumarrathi.com

51
Ahmedabad Office Bhilwara Office
B-403 Samudra Complex, C G Road, H-83, New Bapu Nagar, Pur Road,
Ahmedabad-380009 Bhilwara (Raj.) – 311001

Kishangruh Office Kekri Office

G-15A, Ind. Area, Nr. Makrana Chouraha, C/o Rathi Building, Near Clock Tower,
Kishangarh, Ajmer – 305802 Kekri, Ajmer – 305404

52