CAPITAL BUDGETING PROJECT:

IOCL is Indias one of the largest oil company. It produces oil and
Market leaders for carbonated soft drinks in Mexico are Coca Cola, Pepsi Cola
and Pepper Snapple. These companies accounted for a combined market share of
90%. Bedida Sol decided to start offering private label carbonated soft drinks with
similar taste, but at about half the price. Therefore they came up with a new idea of
introducing a zero calorie product line in Hola Kola.
Issues to be evaluated are:
1. A study revealed that the cost estimation of converting fixed roof to floating
roof is estimated to be INR 1.51 crores. The costs incurred in this will be
depreciated for 30 years. The method followed by IOCL is straight line
method.
2. Payback period of investment is 8.6 (Without CDM) & 8.2 (With CDM) Years.
There will be an annual saving of Rs 17.15 lakhs by converting fixed to
floating roof. Decision criteria is IRR and payback period. NPV is not
considered as decision criteria.
3. Cash flows from the project is spread over 10 year period. Cash flow is based
on the demand for the products to be produced in the plant. It also did not
take into account the reduce efficiency of the equipment as it old.
Critical evaluation:
1. While using straight line method will have equal amount of depreciation for
30 years. Newer methods of depreciation would present an accurate picture
of the project. Accelerated depreciation method like WDV method. Because
for projects which consists of equipment and machineries WDV method is
more suitable than straight line method.
2. IOCL uses payback period and IRR method as decision criteria. But if the
multiple discount rates are used IRR will not be an efficient method. Also
there will be a significant difference between NPV and IRR when calculated
over longer durations.
3. While calculating the cash flows for the new project proposal, it has not been
clearly indicated whether they have taken demand projections for the product
in the market. Cash flows may also get affected by price of crude oil and
rupee value against dollar. These factors has not been considered in
calculating the cash flows.