Final Project Capital Budgeting

7/28/2019 Final Project Capital Budgeting

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INTRODUCTION

A project is an activity sufficiently self- contained to permit financial and

commercial analysis. In most cases projects represent expenditure of capital funds bypre- existing entities which want to expand or improve their operation.

In general a project is an activity in which, we will spend money in expectation of

returns and which logically seems to lead itself to planning. Financing and

implementation as a unit, is a specific activity with a specific point and a specific ending

point intended to accomplish a specific objective.

To take up a new project, involves a capital investment decision and it is the topmanagements duty to make a situation and feasibility analysis of that particular project

and means of financing and implementing it financing is a rapidly expanding field, which

focuses not on the credit status of a company, but on cash flows that will be generated by

a specific project.

Capital budgeting has its origins in the natural resource and infrastructure sectors.

The current demand for infrastructure and capital investments is being fueled by

deregulation in the power, telecommunications, and transportation sectors, by the

globalization of product markets and the need for manufacturing scale, and by the

privatization of government owned entities in developed and developing countries.

The capital budgeting decision procedure basically involves the evaluation of the

desirability of an investment proposal. It is obvious that the firm most have a systematic

procedure for making capital budgeting decisions. The procedure for making capital

budgeting decisions.

The procedure must be consistent with the objective of wealth maximization. In

view of the significance of capital budgeting decisions, the procedure must consist of

step by step analysis.

VIMAT, Chittoor Page 1


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INDUSTRY PROFILE

Absence of a market strategy, inadequate export infrastructure and unstable

supply base are giving Indian mango growers a run for their money, more Soils,

Nutrition, and Fertilizer in the international markets where the Indian king of fruits is

still to take its place. While India produces over 11m metric tones of mangoes annually

around 63% of world produce, its export share is just 0.11%. However, APEDA has

identified UK, Germany, the Holland, France, Italy and Belgium for mango exports and

plans aggressive marketing strategies there. APEDA is making all efforts to make

available latest packaging and processing technology for our produce

India is one of the largest producers of Tropical fruits in the world and has

established the image in the international market. Due to its own advantages in climatic

conditions, India can produce wide variety of fruits and vegetables. Unfortunately, the

processing technologies and storage facilities, available are still primitive and enough

importance has not been accorded for this industry, which has tremendous growth

potential. Only recently, both the central and state governments have realized the

importance and taken steps through wide variety of measures for the growth of theindustry. Andhra Pradesh, where the plant is coming up, is known for variety of quality

fruits particularly for Mango, Papaya, Guava, etc.,

With the support of Govt. bodies, many small-scale industries (overall capacity of

upto 1000M.Tons of fruit pulp by canning process) have been established since 1970 by

leading formers and fruit traders for processing the tropical fruits. In the early 1970s

India started exporting this tropical fruit products to Gulf countries. However, could not

able to meet advanced international market requirements to enter into Europe and

American countries due to inferior product quality. Even the response in the GULF

countries has not seen the potential growth year by year due to quality related issues.

From the year 1995, Indian manufacturers realized on the technological gap in meeting

the international standards when compared with competitive producers of same products

from North America, Peru, Brazil & Egypt. Necessary steps were then initiated in



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establishing the new technologies called Aseptic Fruit Pulp to compete in international

markets. Nevertheless, today there are many small scale industries producing low quality

fruit pulps (canned pulp) and struggling to approach advanced international markets.

Though, the successful organizations like Foods & Inns, Clean foodsetc could

establish Aseptic process with latest technologies at that point of time, the plants have

not been designed completely to meet international standards.

Mango, the most important fruit of India, is grown in an area of 1.23 million ha

with an annual production of 10.99 million tonnes, which accounts for 57.18 per cent of

the total world production. This paper presents information on area and production,

cultivars, hybrids and clone, agro techniques, disorders, insect pests and diseases, harvestand postharvest management, export, problems and prospects of growing mango in India.

Top producers of Mangoes, Mango grafts,

Guavas, 2010-11

CountryProduction in

millions of tons

India ~ 13.6

People's Republic of China 4.2

Thailand 2.5

Indonesia 2.2

Mexico ~ 1.9

Pakistan ~ 1.8

Brazil ~ 1.2

World total 34.9

Key ~ 2011 data

India ranks second, next only to China, with a production of 47 million tonnes

from an area of 4.13 million ha during the year 2011 and accounting for 8.04 per cent of

the total area under fruits in the world (51.36 mill ha) and 9.34 per cent of the total world

fruit production (503.28 million tonnes). However, Banana, orange grapes and apple



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were the major fruits of the world accounting for 14.45, 13.23, 13.01, 12.36 per cent of

total world fruit production. Mango accounted for only 3.11 of the total area under the

fruits and 2.15 per cent of the total world fruit production. The total production of mango

in the word was 26.11 million tonnes out of which India alone produced 10.02 million

tonnes, accounting for 38.38 per cent and ranked first. The total area production of

mango in the world was 26.574 million tonnes from an area of 3.69 million ha out of

which India alone accounted for 40.64 per cent in terms of production and 43.36 per cent

in terms of occupied area, making it the largest producer of mangoes in the world. China,

Thailand, Mexico, Pakistan, Indonesia, Philippines and Brazil were other important

mango producers accounting for 13.48, 6.40, 5.65, 4.10, 3.79,3.64 and 3.20 per cent of

the total world mango production, respectively. Amongst the commercial producers of

mango, the highest productivity of mango was found to be in Brazil, followed by

Pakistan, Mexico and China. Highest productivity of mango was observed in Cape Verde

Is. (45.00 MT/ha), followed by Samoa (40.00 MT/ha), Guatemala (26.75 MT/ha),

Palestine (25.00 mt/ha), Peru (22.76 MT/ha) and Israel (20.00 Mt/ha). However, the

productivity was lower in the countries producing mangoes commercially. Amongst the

commercial producers of mangoes, the Brazil had highest productivity viz. 12.50 Mt/ha

followed by Pakistan (10.37 MT/ha), Mexico (8.65 Mt/ha) and China (8.56 Mt/ha). The

productivity in India was only 6.75 MT/ha, which was considerably lower vis a-vis other

countries of the world. Concerted efforts are to be made to increase the productivity of

mango to meet national standards and increase its availability for the domestic as well as

export market.

Area, Production and productivity of mango in major mango producing

countries of the world during 2011

Sl. No. Countries Area Production Productivity



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Mill. ha Prop. (%) (Mill. tons) Prop. (%) MT/ha

1 India 1.6 43.36 10.8 40.64 6.75

2 China 0.419 11.35 3.582 13.48 8.56

International Markets for Indian Mango

Asian producers find it easier to expand sales to the European Union. Europes

acceptance of different varieties is greater, because of a large demand from Asian

immigrant groups. Phytosanitary restrictions are less stringent. Transportation costs are

not as big a factor in exporting mangoes to the European Union as in exporting to the

United States market: for example, India and Pakistan are able to compete with non-

Asian suppliers to the European Union, whereas proximity gives Mexico and Haiti a

clear advantage in supplying to the United States market.

Fifty-four percent of European Union imports enter during the periods May to

July and November to December, with peak imports in June. French imports reach peak

in April and May, whereas United Kingdom imports are concentrated during the May to

July. German imports are spread more evenly throughout the year. Of the top suppliers,

Brazil provided chiefly during the period November to December, the United States

during June to October, South Africa during January to April and Venezuela during April

to July. Pakistan supplies the majority of its exports to the European Union during June

and July; Indian exports take place mainly during the month of May. Although a lions

share of Indian mango goes to the Gulf countries, efforts are being made to exploit

European, American and Asian markets. About 13,000 MT of Alphonso variety

is exported to Middle East, UK and Netherlands every year.

The different products of mango which are exported include mango chutney,

pickles, jam, squash, pulp, juice, nectar and slices. These are being exported to U.K.,

U.S.A., Kuwait and Russia. Besides these, the fresh mangoes are being exported to

Bangladesh, Bahrain, France, Kuwait, Malaysia, Nepal, Singapore and U.K.



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Hyderabad, March 31: Despite an expected low production of mangoes this

year, the total exports of mangos from Andhra Pradesh is likely to see a 100 per cent

jump over last year. Unlike last year, due to adoption of better pest management

techniques and awareness of qualitative produce, the mango growers from the state are

hoping for better price realization from other countries during this season.

"Last year, the total production of mangoes was about 32 lakh tonnes with

instances of three times of flowering during the season. This led to good production but

this year the output is expected to fall by about one-third over last years

production," according to sources. "But low volume in production will not reflect on the

exports," said APEDA officials. However, it is too early to predict on exports. Theproduction is based on the rate of flowering and climatic conditions during harvest

period, they said. The reasons...

MANGO PRODUCING STATES IN INDIA

STATE/UT'S MANGO

Area (ha) Prod.(Mt)

ANDAMAN NICOBAR 0.30 2.60



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ANDHRA PRADESH 480.40 4058.30

ASSAM 4.60 46.50

BIHAR 146.00 995.90

CHANDIGARH 0.00 0.40CHHATISHGARH 43.30 191.80

D & N HAVELI 1.20 12.50

GOA 4.60 7.60

GUJARAT 121.50 856.70

HARYANA 9.10 64.60

HIMACHAL PRADESH 38.70 24.00

JAMMU & KASHMIR 10.70 12.10

JHARKHAND 15.10 254.30

KARNATAKA 153.80 1694.00KERALA 63.80 373.20

MADHYA PRADESH 14.20 127.80

MAHARASHTRA 474.50 597.00

NAGALAND 0.30 0.40

ORRISA 177.60 577.50

PONDICHERRY 0.40 6.80

PUNJAB 6.40 93.50

RAJASTHAN 5.90 93.00

TAMIL NADU 132.70 636.30TRIPURA 4.30 13.20

UTTAR PRADESH 276.40 3588.00

UTTRANCHAL 38.40 120.80

WEST BENGAL 88.10 578.00

TOTAL 2312.30 15026.80

COMPANY PROFILE

History of Food and Inns Pvt. Ltd.

The division combines people with vast experience in agric-trading with the

FOODS AND INNS (P) Ltd Groups credibility to justify its premier standing in the

trading arena. The division was set up in 1967 and since then has handled a wide

range of products - such as Sesame Seeds, Processed Fruits, Food grains, Aqua etc.



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FOODS AND INNS (P) Ltd began its fruit processing operations in early

70s.However fruit processing operations have been given a special thrust since the last

season with an emphasis on developing strategic partnerships across the value chain

especially fruit procurement and processing. FOODS AND INNS (P) Ltd has

established it's presence as a reliable and competitive exporter to Coca Cola, USA,

Western Europe, Far East, Middle East etc.

Background of Food and Inns Pvt. Ltd

Situated at Chittoor in Andhra Pradesh, the mango belt in India, FOOD AND

INNS (P) Ltd (FIL) is a 100% Export Oriented Unit (EOU) processing Tropical Fruit

Purees, Concentrates and Fresh Fruits FOOD AND INNS Ltd was started keeping in

mind the local farming community wealth. The farming community is an integral part

and forms the backbone of the organization. In its effort to be a forerunner in the

chosen areas of business in terms of best practices in quality and technology, FIL

plans to benefit armors, the industry and the nation in a phased manner.

FOODS AND INNS Ltd believes in empowering farmers by providing

technical assistance from research institutes in the food industry to support the farmers

in achieving better quality and higher yields by developing the gardening and

harvesting techniques. Further to educating farmers with latest horticultural techniques,

FOODS AND INNS LTD is encouraging farmers to mobilize the fruits directly to the

factory, thereby minimizing the fruit handling damages and high value realizations. The

first phase has been completed, by setting up of state-of-the-art fruit processing plant to

produce natural tropical fruit puree and concentrates.

Board of Directors

S. No Name of the Director

1 Field Marshal Sam Manekshaw - M.C. Chairman

2 Mr.Utsav Dhupelia Director



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3 Mr. D.B. Engineer Solicitor

4 Mr.Raymond Simkins Foreign Director

5 Mr.C.M.Maniar Solicitor

6 Mr. D.D. Trivedi Ex. IIM Professor

7 Mr. M. B. Dalal Director

Mr. Utsav Dhupelia , a Chartered Accountant from U.K., looking after the routine

affairs of the company, is the brain and brawl for taking the companys turnover from

Rs.5Crores (USD1.1 MIO) to Rs.70Crores (USD 16 MIO) giving the status of

government recognized EXPORT HOUSE.

With the back up of technical and managerial support staff, the state of art

technology implementation, innovative R & D and Lab facilities, the doyen guidance of

Mr. Utsav coupled with the contribution of other directors, the company is poised for a

steady and continuous growth graph moving upwards in all Para meters.



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Market Presence

European Union

United States of America

Canada

Australia

Middle East including Iran & North Africa

Japan & South Korea

Share of Countries Market

Facility



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FOODS AND INNS Ltd processing facility is located in Chittoor, spread over

an area of 15 acres. This place has been earmarked to host Integrated Food Complex of

International standards. The facility currently has a tropical fruit Puree / Concentrate

processing plant and the pack house for preparing the Fresh Fruits & Vegetables.

Cutting Edge Technology

FOODS AND INNS (P) Ltd plant is equipped with state-of-the-art fruit puree

processing aseptic filling line of SIG- Mizzen, Italy to produce natural fruit pulps &

concentrates. The plant has one of the India's single largest fruit processing lines -10

TPH ripen fruit processing with Aseptic Packaging.

Initiatives Span the Following Disciplines PLC operated equipments for better control over monitoring and operations

with supervisory units.

Two stage washing of fruits to ensure HACCP quality requirement.

Two-stage sterilization to retain the natural flavor and aroma.

High speed advanced Mono block aseptic filling machine supplied by SIG

Mizzen.

Integrated Enterprise Resources Planning system is in place to automate

business processes and provide data for analysis and reporting, allowing a

closer control on quality and operations.



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Efficient Plant Layout

Minimal drop in power and steam transfer.

Straight-line process flow design to maintain the hygiene and control in

respective areas.

Special food grade self-leveling epoxy flooring to maintain optimum

hygienic conditions.

Curved corners and food grade epoxy painted walls to avoid dust

accumulation and to facilitate easy washing.

Advanced high raise insulated roofing with double layer GI Sheeting with

air extractors to maintain temperature inside the plant.

Utility lines are routed outside the plant to keep the interiors free from dust

accumulation.

Valuable Industrial Expertise

FOOD AND INNS (P) Ltd is backed with strong support and service from its

team of highly qualified technical personnel and domain experts with perceptive

knowledge and skill. Powered by priceless hands-on experience these professionals are



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upgrading themselves continuously to identify and introduce improved and innovative

product offerings that would delight customers worldwide and comply with the leading

global quality standards.

Pure & Concentrate Facility

The fruit processing aseptic line is from SIG-Mazzini of Italy. The line has a

capacity to process 10 metric tones per hour ripened fruits. The processing line is fully

integrated and controlled by PLC.

Pack House

FOODS AND INNS (P) Ltd has a set up a Fresh fruit and Vegetable processingfacility from Grief, Spain. Fresh fruits including mangoes, bananas are processed along

with tropical vegetables like Okra, Egg plant, Lemon, Bitter gourd etc. The facility also

holds ripening chambers, pre cooling chambers and cold storage to handle fresh fruits

and vegetables.

Vapor Heat Treatment

To enable Fresh Mango exports to countries like Japan and Korea, FOOD AND

INNS (P) Ltd has commissioned the VHT facility. This ensures irradiation of the fruit

flies in the fresh fruit. FOOD AND INNS (P) Ltd is the first private organization to set

up this facility in the country.

Water Management

Water is an essential & precious natural resource. It is a natures gift. Without

water there is no life on the earth. It is as important to the fruit processing industry as to

the living being. But, water is becoming scarce year by year due to increase n its

consumption in industries & agriculture sectors & indiscriminate use /wastage by human

beings, therefore, it needs a integrated& scientific approach for its management to use it

so that undesirable wastage is avoided which helps us to save water for right utilization .

Stage of Use Of Water To The Best Effect In Our Factory



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Our main source of water is bore wells. The water is potable. Water from all bore

wells is collected in a sump. From there it is pumped to over head tank to supply to

various locations of use. To manage appropriately & conserve the water, we are taking

following steps at various locations of its use:

Fruit WashingThe water is re-circulated after filtration up to it becomes dirty. This water is

chl0rinated to control the contamination by continuous dosing of chlorine in the washing

tub.

Steam Generation

Water for boiler feeding is treated in water softener to reduce the hardness. The

steam condensate of evaporator is recycled to boiler to save water & energy as

condensate will have high temperature.

The Best Effect in Our Factory

Steam condensate from other heating equipments & Vapour condensate from

pulp concentration is collected in a tank to use in crate & floor cleaning.

Floor & equipments are cleaned by compressed water jet to conserve the water.

Treated effluent is used for civil construction & gardening.

Flow meters are installed at location of major use to have control over water

utilization.

UV sterilizer is installed on main line of water, which feed to processing to

sanitize the water.

The water to be used for blending in product is treated in r o plant.

Drinking water is passed through zero-b filter.



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Waste Management

Our factory is equipped with aerobic effluent treatment plant of 250kl capacity.

Effluent from all locations of water use is collected through inter connected drains in ET

plant. It is aerated here & transferred to settlement tank for sedimentation of solid

particles. The treated effluent is sent to oxidation pond. From pond, water is used for

gardening & civil construction. The sludge is transferred to drying bed. The dried sludge

is used as manure in our garden. The main feature of our company is that no effluent

treated or untreated is released in public drains & therefore, does not pose any danger to

surrounding environment & public.

Solid Waste Management

Seeds of fruits

Stem ends & skin/peel of fruits & vegetables

Pumice-consists of fibbers & embedded pulp.

Spoiled fruits & vegetables

The seeds & peels of good fruits are passed second time through a pulped to

remove the remaining pulpy portion. The pulp extracted so & pumice are mixed & givenan enzymatic treatment & centrifuge to remove the extraneous materials so that pulp can

be used for making concentrate. This helps in improving the recovery out of fruits.

Certifications OfInternational Quality Standards

FIL's quality and business objectives are designed to challenge the organization

through continual improvement and a zeal for results. At FIL quality determines not

only the end product but processes and operations at all levels. The company's

laboratory is equipped with the latest testing facilities to perform all necessary tests.

Frequent & stringent quality checks are carried out for Physical, Chemical,

Organoleptic & Microbial parameters and immediate corrective measures are carried

out on detection of variance in parameters, assuring a high quality end product. As a

mandatory procedure, all finished products are analyzed with extreme care before

clearance by FIL's quality assurance staff.



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Our Certifications Include

HACCP (Food Safety Certification) by TUV, Germany

ISO 9001:2000 (Quality Management System) by TUV, Germany

Kosher by Star-K, USA

Sure Global Fair (SGF)

Halal Certification

Mango Pulp Industry Hopes

Mango pulp production to reach 75,000 tones by 2010

Mango is raised in 36,000 hectares in Krishnagiri district

Mango pulp processed annually is 50,000 tones

Farmers have to go to Bangalore, as there is no testing facility in Krishnagiri

Farmers are not getting fair price, even if there is a rise in prices in global

market

Customer Focus

Loyalty and a strong relationship in business are built out of years of

experience in a particular industry. FOODS AND INNS (P) Ltd expertise in the

business and its contacts with Agents\Brokers, Blender-bottlers, End User, Off-shore

logistical service providers has made the supply chain process extremely competitive.

Given our renewed emphasis on this product line we are strengthening

relationships in key markets across the buyer spectrum, understanding unique

requirements and delivering value to select global customers.



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PRODUCT PROFILE

Fruit Products

Alphonso Totapuri Guava Papaya

Products Of Vegetables

Fruit Seasons

Jan Feb Mar Apr May June July Aug Sept Oct Nov Dec

Mango

Papaya

Guava



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REVIEW OF LITERATURE

Capital Budgeting

CB is a long term investment made by the organization in different projects and it

helps the firm in evaluating the projects under taken by different techniques.

According to Weston and Brigham CB involves the entire process of planning

expenditures whose returns are expected to extend beyond one year.

The CB decisions include replacement, expansion, diversification research and

development and miscellaneous proposals.

Feature of Capital Budgeting

The important features, which distinguish capital budgeting decision in other day-

today decision, are Capital budgeting decision involves the exchange of current funds for

the benefit 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 term and significant effect on the profitability of the concern. They

involve huge funds. They are irreversible decisions. They are strategic decisionassociated with high degree of risk.

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.



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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 impose of these

assets without incurring heavy losses.

4. Long term 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

investment in capital assets but also the future growth and profitability of the firm

depends up to the investment decision taken today.

5. Difference of investment decision

The long-term investment decision are difficult to be taken because uncertainties

of future and higher degree of risk.

6. Notional Importance:

Investment decision though taken by individual concern is of national importance

because it determines employment, economic activities and economic growth.

Kinds Of Capital Budgeting

Every capital budgeting decision is a specific decision in the situation, for a given

firm and with given parameters and therefore, almost infinite number of types or forms

of capital budgeting decision may occur. Some projects affect other projects of the firm

is considering and analyzing. The project may also be classified as revenue generating or

cost reducing projects can be categorized as follows:



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(i) From the point of view of firms existence:

The capital budgeting decision may be taken by a newly incorporated firm or by

an already existing firm.

NewFirm: A newly incorporated firm may be required to take different decision such

as selection of a plant to be installed, capacity utilization at initial stages, to set up or

not simultaneously the ancillary unity etc.

Existing Firm: A firm which already exists may be required to take various decisions

from time to time meet the challenge of competition or changing environment. These

decisions may be:

Replacements and Modernization Decision

This is a common type of a capital budgeting decision. All types of plant and

machineries eventually require replacement. If the existing plant is to be replaced

because of the economic life of the plant is over, then the decisions may be known as a

replacement decision. However, if an existing plant is to be replaced because it has

become technologically outdated (though the economic life may not be over) the

decision any be known as a modernization

decision.

In case of a replacement decision,the objective is to restore the same or higher capacity, whereas in case of modernization

decision, the objectives are to increase the efficiency and/or cost reduction. In general,

the replacement decision and the modernization decision are also known as cost

reductiondecisions.

(ii) Expansion:

Sometimes, the firm may be interested in increasing the Installed production

capacity so as to increase the market share. In such a case, the finance manager is

required to evaluate the expansion program in terms of marginal costs and marginal

benefits.



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i. Diversification

Sometimes, the firm may be interested to diversify into new product lines, new

markets; production of spares parts etc. in such a case, the finance manager is required to

evaluate not only the marginal cost and benefits, but also the effect of diversification on

the existing market share and profitability. Both the expansion and diversification

decisions may be also be known as revenue increasing decisions.

The capital budgeting may also be classified from the point of view of the decision

situation as follows:

Independent Project Decision

This is a fundamental decision in Capital Budgeting. It also called as accept

/reject criterion. If the project is accepted, the firm invests in it. In general all these

proposals, which yield a rate of return greater than a certain required rate of return on

cost of capital, are accepted and the rest are rejected. By applying this criterion all

independent projects with one in such a way that the acceptance of one precludes the

possibility of acceptance of another. Under the accept-reject decision all independent

projects that satisfy the minimum investment criterion should be implemented.

(ii) Mutually Exclusive Projects Decision

Mutually Exclusive project are those, which compete with other projects in such

a way that the acceptance of one will exclude the acceptance of the other projects. The

alternatively are mutually exclusive and only one may be chosen. Suppose a company is

intending to buy a new machine. There are three competing brands, each with a different

initial investment adopting costs. The three machines represent mutually exclusive

alternatives as only one of these can be selected. It may be noted here that the mutually

exclusive projects decisions are not independent of the accept-reject decisions.

(iii) Capital Rationing Decision

In a situation where the firm has unlimited funds all independent investment

proposals yielding return greater than some pre-determined levels are accepted. However

this situation does not prevail in most of the business firms in actual practice. They have

a fixed capital budget.



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A large number of investment proposals compete for these limited funds, the firm

must therefore ration them. The firm allocates funds to projects in a manner that it

maximizes long run returns; this rationing refers to a situation in which a firm has more

acceptance investment than it can finance. It is concerned with the selection of a group of

investment proposals acceptable.

Under the accept-reject decision capital rationing employees ranking of the

acceptable investment projects. The project can be ranked on the basis of a

predetermined criterion such as the rate of return. The project is ranked in the descending

order of the rate of return.

Problems and Difficulties In Capital Budgeting

The problems in Capital budgeting decision may be as follows:

Future Uncertainty

Capital budgeting decision involves long-term commitments. However there is

lot of uncertainty in the long term. Uncertainty may be with reference to cost of the

project, future expected returns, future competition, legal provisions, political situation

etc.

Time Element

The implication of a Capital Budgeting decision are scattered over a long period.

The cost and benefit of a decision may occur at different points of time. The cost of

project is incurred immediately. However the investment is recovered over a number of

years. The future benefits have to be adjusted to make them comparable with the cost.

Longer the time period involved, greater would be the uncertainty.



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Difficulty in Quantification of Impact

The finance manager may face difficulties in measuring the cost and benefits of

projects in quantitative terms. For example, the new products proposed to be launched by

a firm may result in increase or decrease in sales of other products already being sold by

the same firm. It is very difficult to ascertain the extent of impact as the sales of other

products may also be influenced by factor other than the launch of the new products.

Assumption In Capital Budgeting

The capital budgeting decision process is a multi-faceted and analytical process.

A number of assumptions are required to be made. These assumptions constitute a

general set of condition within which the financial aspects of different proposals are to beevaluated. Some of these assumptions are:

1. Certainty With Respect To Cost and Benefits:

It is very difficult to estimate the cost and benefits of a proposal beyond 2-3 years

in future. However, for a capital budgeting decision, it is assumed that the estimate of

cost and benefits are reasonably accurate and certain.

2. Profit MotiveAnother assumption is that the capital budgeting decisions are taken with a

primary motive of increasing the profit of the firm. No other motive or goal influences

the decision of the finance manager.

3. No Capital Rationing

The capital Budgeting decisions in the present chapter assume that there is no

scarcity of capital. It assumes that a proposal will be accepted or rejected in the strength

of its merits alone. The proposal will not be considered in combination with other

proposals to the maximum utilization of available funds.

Capital Budgeting Process

Capital budgeting is complex process as it involves decision relating to the

Investment of current funds for the benefit for the benefit to be achieved in Future and



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Capital Budgeting

the future are 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 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 reviews 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

method, which may be used for this purpose such as, payback period method, rate ofreturn method, N.P.V and I.R.R etc.

Fixing Priorities

After evaluating various proposals, the unprofitable uneconomical proposal may

be rejected and it 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

project/proposals after considering urgency, risk and profitability involved in there.

Final Approval And Preparation Of Capital Expenditure Budget

Proposals meeting the evaluation and other criteria are 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.



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Capital Budgeting

Implementing proposals

Preparation of a capital expenditure budget and incorporation of a particular

Proposal in the budget doesnt itself authorize to go ahead with the implementation of the

project. A request for the 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 technique likes 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 theperformance of the project. The evaluation is made by comparing actual and budget

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.

Methods Or Techniques Of Capital Budgeting

There are many methods for the evaluating the profitability of investmentproposals the various commodity used methods are

Techniques of Capital Budgeting

Traditional Methods Time Adjusted Methods

1. Pay Back Period 1.N.P.V

2. Accounting Rate of Return 2.I.R.R

3. P.I

Traditional Methods

Payback period method (P.B.P)

Accounting Rate of Return Method (A.R.R)



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Capital Budgeting

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 decision.

It is difficult to determine the minimum acceptable payback period, which is

subjective decision.

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 in several ways, as

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

Average Investment

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



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Capital Budgeting

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.

It ignores the period in which the profit are earned as a 20% rate of return in 2

years is considered to be better than 18%rate of return in 12 years.

This method cannot be applied to a situation where investment in project is to be

made in parts.

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 thereturn on investments by introducing time element. 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 inflows 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.

Decision rule

Accept the project if the NPV of the projects 0 or positive that is present value of

cash inflows should be equal to or greater than the present value of cash outflows.

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 if the profitability of the investment

Takes in to consideration the objective of maximum profitability.

Disadvantages



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Capital Budgeting

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.

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 bedefined as that rate of discount at which the present value of cash inflows is equal to the

present value of cash outflow.

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


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Capital Budgeting

The steps are involved here are:

1. Prepare the cash flows 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 increases 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 situation 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 provide for uniform ranking of 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 my 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 .

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



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Capital Budgeting

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 outflow and uneven cash inflows.

It takes into 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

objectives of maximum profitability.

DISADVANTAGES:

More difficult to understand and operate.

It may not give good results while comparing projects with unequal investment funds.



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Capital Budgeting

NEED FOR THE STUDY

In a perfect world there would be no necessity for current assets and current

liabilities because there would be no uncertainty, no transaction costs, information search

costs, scheduling costs, or production and technology constraints. However the world in

which we live is not perfect.

So organization may be faced with an uncertainty regarding availability of

sufficient quantity of critical inputs in future at reasonable price. This may necessitate the

holding of critical inputs in future at reasonable price. This may necessitate the holding

of Inventory i.e., current assets.

To ensure that each of the current assets is efficiently managed to ensure the

overall liquidity of the unity and at the same time not keeping too high a level of any one

of them Capital Budgeting management is a must.

Capital Budgeting management ensures smooth working of the unit without any

production held ups due to the paucity of funds.

Thus as capital budgeting is the life blood and nerve center of a business. It is

managed in order to attain a smooth running of the business.



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Capital Budgeting

OBJECTIVES OF THE STUDY

To Know how the companys Capital Expenditure has planned

To study the relevance of copies of Capital budgeting in evaluating the Project.

To Study the technique of Capital budgeting for decision making.

To understand an item wise & study of the company financial performance of the

organization

To make suggestion if any for improving the financial position if the organization

To offer some useful suggestions in capital budgeting process.



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Capital Budgeting

SCOPE OF THE STUDY

The present study is undertaken with an intention that it would be helpful in

assessing the Capital Budgeting position in the organization and to make

recommendations for the improvement of the Capital Budgeting requirements of Foods

and Inns Ltd.,

The Study also highlights the present scenario of the Sugar Industry in the global

market as a whole and the contribution ofFoods and Inns Ltd., in the Indian Market &

State Market in Particular.

The Study includes various aspects regarding the future plans and

diversification activities ofFoods and Inns Ltd., in Directors Report.

Thus a good deal of ground is covered in the study, including the trends of

various components of Capital budgeting, so as to find the effect of each component on

Capital Budgeting decision.



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Capital Budgeting

RESEARCH METHODOLOGY

The study of Capital Budgeting in Foods and Inns Ltd., has been carried out of

studying the companies project reports, budget and revenue estimates. The study can

broadly divided into two phase.

1) Primary Data

2) Secondary Data

Primary Data

The data which is collected at first had for the purpose of the study is known asprimary data.

Primary data which is collected through interaction with the assistant financial

manager ofFoods and Inns Ltd.,

Secondary Data

The data which is corrected by some one previously is called by secondary Data.

It is already available in the form of internal records of the company and other

publications.

Collecting relevant Annual Reports

Analyzing the Collected data

Drafting the report

Updating the Final report

Collecting the general information about Capital Budgeting from various

standard text books

Studying the project report ofFoods and Inns Ltd.,



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Capital Budgeting

LIMITAIONS OF THE STUDY

The topic for the study is very exhaustive and covers several crucial aspects of

financial management for which the availabilities of the time is very much limited.

Under the pretext of confidentiality the organization has not disclosed the total

information.

The study is made by secondary data collection and the calculation of various

ratios depend on the information in the annual reports of the company.

Through this study of the Capital Budgeting position in Foods and Inns Ltd., thesources of funds have affected a lot due to major fluctuation in the Capital Budgeting

decision.

1) The analysis made on the basis of secondary data

2) The availability of data is only pertaining to four years is one of the

constraints.

3) As there is more dependency is secondary data realistic conclusion may not

be possible to be made.

4) Even though there are no if indicates for analyzing the financial performance

the study includes about liquidity position.

5) There may be approximations

6) The study was carried in Foods and Inns Ltd., for a period of 8 weeks.



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Capital Budgeting

DATA ANALYSIS AND INTERPRETATION

The following are details of a project of Foods and Inns Pvt Ltd., based on

the find out the capital budgeting Techniques.

Details of the Project

Investment 1135 Millions

Estimated life of the project 7 years

Estimated net cash flows

2007

2008

2009

2010

2011

Rs. In millions

405.56

393.91

325.02

321.29

824.08

Simple pay back in 3 years 11 months

Discount factor 10%



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Capital Budgeting

1. Tradition (OR) Non Discounted Cash Flow Techniques

A) Pay Back Period (P.B.P) Method

Pay back period method is one of the used popular methods in Traditional Cash

flow techniques. Here the term pay back refers The number of years

required recovering the original cash outlay invested in a project

Pay back period method can be calculated with the help of the following

Formula.

Cash out lay

Payback period = -------------------------------------------

Annual cash flows



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Capital Budgeting

COMPUTATION OF PAY BACK PERIOD

YearsCash In Flow Values

RSo In Millions

Cumulative Cash hi

Flow Values Rs. In

Millions

2007 405.56 1052.37

2008 393.91 1466.28

2009 325.02 1771.30

2010 321.29 2092.59

2011 824.08 2916.67

The recovery of the investment falls with in between the third and fifth years.

Therefore, the PB is 3 years plus a fraction of the fourth year.

Payback Period = 3 years +[(1135-1052.37) / 393.91]

-3 years + [ 2.63 s- 393.91]

= 3 years + 0.20 years

= 3.20 years.

Interpretation:

The Targeted Payback Period of the Project is 3 years 11 months. Here

the total investment completely recovered with in a period of 3 years 2 months,

which is less than the Targeted Period. So the Project is acceptable.



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Capital Budgeting

B)Accounting (OR) Average Rate Of Return (A.R.R) Method

It is an accounting method which uses the accounting information

revealed by the financial statements to measure the profitability of an investment

proposal. It can be determined by dividing the average income after taxes by

average investment that is the average book value after depreciation. According to

Solomon, according rate of return on an investment can be calculated as the ratio

of accounting net income to the initial investment.

Accounting (OR) Average rate of return method can be calculated with the help of

the following formulaAverage Income

Average Rate Of Return (A.R.R) = ---------------------------------------X 100

Average Investment

Here

Total Profit Earned By the Project in All The Year

Average Income =------------------------------------------------------------------------

Number Of Years

Initial Investment

Average Investment = ---------------------------------

2



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Capital Budgeting

Computation of Average Income

Years

Cash In Flow Values Rs.

In Millions

2007 405.56

2008 393.91

2009 325.02

2010 321.29

2011 824.08

Total Income 2916.67

Average Income 416.67

Initial Investment

Average Investment =----------------------------

2

1135 millions

= -------------------------

2

= Rs. 56.75 millions



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Capital Budgeting

Average Income

Average Rate of Return ( A.R.R) =--------------------------------- X 100

Average Investment

416.67 millions

=------------------------------------- X 100

567.65

= 0.734 millions

= 73.40%

Interpretation

The Average Rate of Return of the Project is 73.40% which is higher than the rate

specified by the Foods and Inns Pvt Ltd., So the Project is acceptable.



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Capital Budgeting

2. Modern ( OR) Discounted Cash Flow Methods

A) Net present value (N.P.V) Method

Net present value method is the wildly used and more sophisticated project is the

Evaluation techniques under discounted cash flow method. It is a superior method.

Because the value of cash inflow are taken at discounted value of one rupee . Net

present value is calculated by sub stating present value of cash inflow from present value

of Cash out flows. It recognizes the impotence of time value of money.

According to Ezra Solomon, It is a present value of future returns, discounted At

the required rate of return, minus the present value of the cost of the investment.

Net present value method can be calculated with the help of the following

formula

N.P.V = Net Present Value of Cash Inflows

Net Present Value of Cash Outflows

Computation of Net Present Value of Cash Inflow



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Capital Budgeting

Years

Cash In Flow

Values Rs. In

Millions

Discounted Value

of 1/-At 10% Cost

Of Capital

Present Value Of

cash in Flows Rs.

in Millions

2007 405.56 0.751 304.58

2008 393.91 0.683 269.04

2009 325.02 0621 201.84

2010 321.29 0.564 181.20

2011 824.08 0.513 422.75

Net Present Value of Cash in Flows 1964.47

N.P.V = Net Present Value of - Net Present Value of Cash

Cash Inflows Outflows

= 1964.47 millions-1.135 millions

Rs. 829.47 millions

Interpretation

Based on Acceptance Rule of Net Present Value method we will accept the

Project. The Present value of investment out lays and cash inflows are to be calculated

using Net present values table. The decision criteria for accepting this project because the

net present value Project is Positive value (AND) > 0. So this Project is acceptable.

B) Internal Rate of Return ( I.R.R) Method :



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Capital Budgeting

The internal rate of return is to be determined by trial and error method. The

following steps can be used for its computation.

Compute the present value of the cash flows from an investment, by using an

arbitrarily selected interest rate.

Then compare the present value so obtained with investment cost.

If the present value is higher than the cost, then the present value of inflows is to

be determined by using higher rate.

This procedure is to be continued until the present value of the flows from the

investment are approximately equal to its cost.

The interest rate that brings about this equality is the internal rate of return

Internal rate of Return method can be calculated with the help of the following formula

Excessive Value

I.R.R Lower Discount Rate =---------------------------------- X Difference in Discount Rate

Positive Value- Negative Value



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Capital Budgeting

Computation of Internal Rate of Return

Years

Cash In

FlowValues Rs.

In Millions

Discounted Value

of1/-At 27% Cost

Of Capital

Present

Value Of

Cash In

Flows Rs.

In Millions

Discounted

Value of/-

At 30%

Cost Of

Capital

Present

Value Of

Cash In

Flows Rs.

In Millions

2007 405.56 0.488 197.91 0.455 184.52

2008 393.91 0.384 151.26 0.350 137.87

2009 325.02 0.302 98.16 0.269 87.43

2010 321.29 0.249 80.00 0.207 66.50

2011 8243.08 0.198 163.67 0.159 131.02

Net Present Value of Cash Inflows 1190.58 1098.58

1190.58-1135

I.R.R= 27%+ -----------------------------------X (30-27)

1190.58-1098.58

1190.58-1135

= 27% + -------------------------------X (30-27)

1190.58-1098.58

= 27% + 0.60 (3)

=27+1.8%

=28.8%

Interpretation

Based on acceptance rule internal rate of Return method we will accept the

Project. The project is accepted the IRR is more than the 10% for this project.

A) Profitability Index (P.I) Method:



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Capital Budgeting

This method is also known as Benefit Cost Ratio According to Van Home,

the Profitability index of a project is the ratio of the present value of future net

cash flows to the Present value of initial cash outflows.

Profitability Index method can be calculated with the help of the following

formula

Present Value of Cash Inflows

Profitability Index (P.I) =-------------------------------------------------

Present Value Of cash Outflows

Computation of Profitability Index (P.I) Method



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Capital Budgeting

Years

Cash In Flow

Values Rs. In

Millions

Discounted Value

of1/- At 10% Cost

Of Capital

Present Value Of

Cash In Flows Rs.

In Millions

2007 405.56 0..751 304.58

2008 393.91 0.683 269.04

2009 325.02 0.621 201.84

2010 321.29 0.564 181.20

2011 824.08 0.513 422.75

Net Present Value of Cash in Flows 1964.47

Present value of Cash inflow

Profitability Index ( P.I) = ----------------------------------------

Present Value of Cash Outflows

= 1964.47 millions

----------------------

1135 millions

Interpretation

Based on acceptance rule Profitability index method we will accept the Project.

Because the PI of the Project is greater than 1 that 1.73, so the project is accepted.



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Capital Budgeting

FINDINGS

The Targeted Payback period of the Project is 3 years 11 months. Here the total

investment completely recovered with in a period of 3 years 2 months, which is

less than the Targeted Period. So the Project is acceptable.

Average Rate Of Return (A.R.R) of the Project is 73.40% which is higher than

the rate specified by the Foods and Inns Pvt Ltd., So the Project is

acceptable.

Net Present Value (N.P.V) Method based on Acceptance rule of Net Present

Value method we will accept the Project. The Present Value of investment out

lays and cash inflows are to be calculated using Net present value table. The

decision criteria for accepting this project because the Net present value Project is

Positive value (AND) > 0. So this Project is acceptable.

Internal Rate of Return (I.R.R) Method Based on Acceptance rule Internal

Rate of Return method we will accept the Project. The Project is accepted the

IRR is more than the 10% for this project.

Profitability Index (P.I) Method Based on Acceptance rule Profitability Index

method we will accept the Project. Because the PI of the Project is greater than 1

that 1.73, so the project is accepted.



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Capital Budgeting

SUGGESTION

As per my view I suggested like this

The Firm needs to maintain adequate capital budgeting in order to meet its daily

transactions.

It is better to decrease debt content and need to raise equity capital.

The firm needs to concentrate on debt collections to meet their business

requirements.

Firms management need to concentration on maximum utilization of all

resources including raw material and inventory to get maximum benefits.



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Capital Budgeting

CONCLUSION

Capital budgeting is a difficult process to the investment of available funds. The

benefit will attain only in the near future but, the future is uncertain.

Even though the NPV and IRR methods yield better decision-making data based

off them being sophisticated capital budgeting techniques, the payback method is not

without a purpose. The payback method is a quick and easy way to filter a project to seeif the time should be spent to further analyze whether the project should move forward.

In the example, the payback period was almost half of what the maximum payback

period was, so it was definitely a good candidate for further scrutiny. The NPV and IRR

methods both give very good accept-reject results. However, IRR is the preferred method

by most since its results are portrayed in rates of return, which most financial managers

see as representative across the board.



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Capital Budgeting

BIBLIOGRAPHY

1. S.P.Jain and K.L.Narang : Advanced Accountancy Volume II

Kalyani Publishers

2. I M Pandey : Financial Management, 9 Edition,

Vikas Publishing House Pvt.Ltd.

3. S.P.Jain & K.L.Narang : Cost and Management Accounting,

Kalyani Publishers

4. Prasanna Chandra : Fundamentals of Financial

Management

Websites:

www.google.com

www.foodsandinns.com

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