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7/28/2019 Final Project Capital Budgeting
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Capital Budgeting
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.
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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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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