Project Work

Capital budgeting
INTRODUCTION
Meaning:
Capital budgeting is the process that companies use for decision making on
capital project. The capital project lasts for longer time, usually more than one year.
As the project is usually large and has important impact on the long term success of
the business, it is crucial for the business to make the right decision.
Capital Budgeting Process:

The specific capital budgeting procedures that the manager uses depend on the
manger's level in the organization and the complexities of the organization and the
size of the projects. The typical steps in the capital budgeting process are as follows:
 Brainstorming. Investment ideas can come from anywhere, from the top or the
bottom of the organization, from any department or functional area, or from
outside the company. Generating good investment ideas to consider is the
most important step in the process .
 Project analysis. This step involves gathering the information to forecast cash
flows for each project and then evaluating the project's profitability.
 Capital budget planning. The company must organize the profitable proposals
into a coordinated whole that fits within the company's overall strategies, and
it also must consider the projects' timing. Some projects that look good when
considered in isolation may be undesirable strategically. Because of financial
and real resource issues, the scheduling and prioritizing of projects is
important.
 Performance monitoring. In a post-audit, actual results are compared to

planned or predicted results, and any differences must be explained. For
example, how do the revenues, expenses, and cash flows realized from an
investment compare to the predictions? Post-auditing capital projects is
important for several reasons. First, it helps monitor the forecasts and analysis
that underlie the capital budgeting process. Systematic errors, such as overly
optimistic forecasts, become apparent. Second, it helps improve business
operations. If sales or costs are out of line, it will focus attention on bringing
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Capital budgeting
performance closer to expectations if at all possible. Finally, monitoring and

post-auditing recent capital investments will produce concrete ideas for future
investments. Managers can decide to invest more heavily in profitable areas
and scale down or cancel investments in areas that are disappointing.
Complexity of Capital Budgeting Process

The budgeting process needs the involvement of different departments in the
business. Planning for capital investments can be very complex, often involving
many persons inside and outside of the company. Information about marketing,
science, engineering, regulation, taxation, finance, production, and behavioral issues
must be systematically gathered and evaluated.
The authority to make capital decisions depends on the size and complexity of the
project. Lower-level managers may have discretion to make decisions that involve
less than a given amount of money, or that do not exceed a given capital budget.
Larger and more complex decisions are reserved for top management, and some are
so significant that the company's board of directors ultimately has the decision-
making authority. Like everything else, capital budgeting is a cost-benefit exercise. At
the margin, the benefits from the improved decision making should exceed the costs
of the capital budgeting efforts.
Importance:
Capital budgeting also has a bearing on the competitive position of the
enterprise mainly because of the fact that they relate to fixed asset. The fixed asset
represents a true earning asset of the firm. They enable the firm to generate finished
goods that can be ultimately being sold for profits.
The Capital Expenditure decision has its effects over a long time span and inevitable
affects the company’s future cost structure.
The Capital investment decision once made are not easily reversible without much
financial loss to the firm because their may be no market for second-of –hand plant
and equipment and their conversion to other uses may most financially viable.

Capital budgeting
INDUSTRY PROFILE
Introduction:
India is the second largest producer of cement in the world. No wonder, India's
cement industry is a vital part of its economy, providing employment to more than a
million people, directly or indirectly. Ever since it was deregulated in 1982, the Indian
cement industry has attracted huge investments, both from Indian as well as foreign
investors.
India has a lot of potential for development in the infrastructure and construction
sector and the cement sector is expected to largely benefit from it. Some of the recent
major government initiatives such as development of 98 smart cities are expected to
provide a major boost to the sector.
Expecting such developments in the country and aided by suitable government
foreign policies, several foreign players such as Lafarge-Holcim, HeidelbergCement,
and Vicat have invested in the country in the recent past. A significant factor which
aids the growth of this sector is the ready availability of the raw materials for making
cement, such as limestone and coal.
Market Size:
India's cement demand is expected to reach 550-600 million tonnes per annum
(MTPA) by 2025. The housing sector is the biggest demand driver of cement,
accounting for about 67 per cent of the total consumption in India. The other major
consumers of cement include infrastructure at 13 per cent, commercial construction at
11 per cent and industrial construction at nine per cent.
To meet the rise in demand, cement companies are expected to add 56 million tonnes
(MT) capacity over the next three years. The cement capacity in India may register a
growth of eight per cent by next year end to 395 MT from the current level of 366
MT. It may increase further to 421 MT by the end of 2017. The country's per capita
consumption stands at around 190 kg.
The Indian cement industry is dominated by a few companies. The top 20 cement
companies account for almost 70 per cent of the total cement production of the
country. A total of 188 large cement plants together account for 97 per cent of the
total installed capacity in the country, with 365 small plants account for the rest. Of
these large cement plants, 77 are located in the states of Andhra Pradesh, Rajasthan
and Tamil Nadu.

Capital budgeting
Investments:
On the back of growing demand, due to increased construction and
infrastructural activities, the cement sector in India has seen many investments and
developments in recent times.
According to data released by the Department of Industrial Policy and Promotion
(DIPP), cement and gypsum products attracted foreign direct investment (FDI) worth
US$ 3,099.80 million between April 2000 and June 2015.
Some of the major investments in Indian cement industry are as follows:
 Birla Corporation Ltd, a part of the MP Birla Group, has agreed to acquire two
cement assets of Lafarge India for an enterprise value of Rs 5,000 crore (US$
750.93 million).
 Dalmia Cement (Bharat) Ltd has invested around Rs 2,000 crore (US$ 300.4
million) in expanding its business in North East over the past two years. The
company currently has three manufacturing plants in the region — one in
Meghalaya and two in Assam.
 JSW Group plans to expand its cement production capacity to 30 MTPA from
5 MTPA by setting up grinding units closer to its steel plants.
 UltraTech Cement Ltd has charted out its next phase of Greenfield expansion
after a period of aggressive acquisitions over the last two years. UltraTech has
plans to set up two Greenfield grinding units in Bihar and West Bengal.
 UltraTech Cement Ltd bought two cement plants and related power assets of
Jaiprakash Associates Ltd in Madhya Pradesh for Rs 5,400 crore (US$ 811.0
million).
 JSW Cement Ltd has planned to set up a 3 MTPA clinkerisation plant at

Chittapur in Karnataka at an estimated cost of Rs 2,500 crore (US$ 375.5
million).
 Andhra Cements Ltd has commenced the commercial production in the

company's cement plants – Durga Cement Works at Dachepalli, Guntur and
Visakha Cement Works at Visakhapatnam.

Capital budgeting
Government Initiatives:
In the 12th Five Year Plan, the Government of India plans to increase
investment in infrastructure to the tune of US$ 1 trillion and increase the industry's
capacity to 150 MT.
The Cement Corporation of India (CCI) was incorporated by the Government of India
in 1965 to achieve self-sufficiency in cement production in the country. Currently,
CCI has 10 units spread over eight states in India.
In order to help the private sector companies thrive in the industry, the government
has been approving their investment schemes. Some such initiatives by the
government in the recent past are as follows:
 The Government of Tamil Nadu has launched low priced cement branded
'Amma' Cement. The sale of the cement started in Tiruchi at Rs 190 (US$
2.85) a bag through the Tamil Nadu Civil Supplies Corporation (TNCSC).
Sales commenced in five godowns of the TNCSC and will be rolled out in
stages with the low priced cement available across the state from 470 outlets.
 The Government of Kerala has accorded sanction to Malabar Cements Ltd to

set up a bulk cement handling unit at Kochi Port at an investment of Rs 160
crore (US$ 24.0 million).
 The Andhra Pradesh State Investment Promotion Board (SIPB) has approved
proposals worth Rs 9,200 crore (US$ 1.38 billion) including three cement
plants and concessions to Hero MotoCorp project. The total capacity of these
three cement plants is likely to be about 12 MTPA and the plants are expected
to generate employment for nearly 4,000 people directly and a few thousands
more indirectly.
 India has joined hands with Switzerland to reduce energy consumption and
develop newer methods in the country for more efficient cement production,
which will help India meet its rising demand for cement in the infrastructure
sector.
 The Government of India has decided to adopt cement instead of bitumen for
the construction of all new road projects on the grounds that cement is more
durable and cheaper to maintain than bitumen in the long run.

Capital budgeting
Road Ahead:
The eastern states of India are likely to be the newer and virgin markets for
cement companies and could contribute to their bottom line in future. In the next 10
years, India could become the main exporter of clinker and gray cement to the Middle
East, Africa, and other developing nations of the world. Cement plants near the ports,
for instance the plants in Gujarat and Visakhapatnam, will have an added advantage
for exports and will logistically be well armed to face stiff competition from cement
plants in the interior of the country.
A large number of foreign players are also expected to enter the cement sector, owing
to the profit margins and steady demand. In future, domestic cement companies could
go for global listings either through the FCCB route or the GDR route.
With help from the government in terms of friendlier laws, lower taxation, and
increased infrastructure spending, the sector will grow and take India’s economy
forward along with it.
Recent trends:
The cement sector is hoping for a revival this financial year. After a gap of
four years, the industry is optimistic on demand and capacity utilization increasing.
The first half of FY15 nurtured hopes of better growth but the second half was shot by
a slowdown, especially in the quarter ending in March because of the government
cutting expenditure.
Despite the slowdown, sector insiders and analysts are hopeful of increase in
production — by at least seven to 7.5 per cent — in the current financial year.
Credit rating firm Icra said all-India cement production increased only 1.8 per cent in
the period between October, 2014 and March, 2015. In the April-September, 2014
period it grew by 9.7 per cent.
“The pre-election spending and a delayed monsoon had led to a spurt in growth of
demand for cement in the first half of FY15 but it slowed down after the elections got
over.”
In the final quarter of FY15, government spending was cut, demand from the real
estate and construction sectors was mute and income from agriculture decreased
because kharif production saw a decline in due to poor monsoon. All of this affected
demand for cement. The trend, however, is expected to reverse.

Capital budgeting
Centre for Monitoring Indian Economy Private Limited said: “This trend in cement
demand is likely to reverse during FY16 on account of higher government spending
on infrastructure as announced in the Union Budget. This is likely to boost the
demand for cement from real estate and infrastructure sectors. Therefore, we expect
the growth in cement output to accelerate to nine per cent during the year. A total of
289.4 million tonnes of cement is likely to be manufactured during the year.”
In the following year, the output is likely to grow by 8.1 per cent backed by a
sustained healthy growth in demand.
While the above factors are likely to boost cement consumption, Icra highlights the
industry has seen a slowdown in addition of new capacities due to supply glut faced in
recent times.
For instance, between FY11-FY15, the industry added 92 mt per annum (mtpa)
cement capacities as against 122 mtpa in the preceding four-year period FY07-FY11.
However, slowdown in demand (cement production grew six per cent during FY11-
FY15 as against 7.6 per cent during FY07-FY11) resulted in decline in capacity
utilization from 77 per cent in FY12 to 72 per cent in FY14 despite slowdown in fresh
capacity addition.

Capital budgeting
COMPANY PROFILE
Kesoram Industries Limited ("KIL") was incorporated as a public company

under the name Kesoram Cotton Mills Limited ("KCML") as per the provisions of the
Indian Companies Act, 1913 and received a Certificate of Incorporation dated 18
October 1919 from the Registrar of Companies, West Bengal ("ROC"). The name of
KCML was altered to Kesoram Industries and Cotton Mills Limited ("KICM")
effective 30th August, 1961. Through a Fresh Certificate of Incorporation consequent
on change of Name obtained from the ROC. The name of KICM was altered to KIL
effective 9th July, 1986.
For over 40 years, Birla Shakti has helped laid the foundations of buildings
everywhere. From schools and homes, to hospitals and skyscrapers, Birla Shakti helps
build the dreams of people. When the safety of people depends on your product, you
know that quality is of upmost importance. That is why Birla Shakti practices Total
Productivity Maintenance (TPM). Combining the key principles of plant utilization,
quality management and downtime minimization, every stakeholder’s aim is to
achieve zero product defects, zero equipment unplanned failures and zero accidents.
To support Birla Shakti’s production capabilities, a network of 491 sales engineers
and 1,544 dealers are located conveniently throughout the region, so that every
customer’s need can be met.
Birla Shakti’s quality and efficiency is certified by the International Organisation for
Standardisation for its world-class standards. Learn more about our certifications
below.
Certification for conformation with the occupational health and safety management
system in accordance with IS/ISO 18001: 2007 for Kesoram Cement Plant.
2November2014Certification for conforming with the environmental management
system in accordance with IS/ISO 14001: 2004 for Kesoram Cement Plant.
7August2013Certification for conformation with the quality management system in
accordance with IS/ISO 9001: 2008 for Kesoram Cement Plant.31 October 2014.

Capital budgeting
Under the cement division of Kesoram Industries Limited, Birla Shakti manufactures
and sells cement. We are widely recognised for our quality, strength and technology,
which has enabled us to build strong working relationships and gain the trust of our
customers and builders. As a mark of our quality management best practices, we have
been certified an ISO 9001 company.
Birla Shakti has two cement manufacturing plants located at Sedam, Karnataka (the
"Vasavadatta Cement Plant") and Basantnagar, Andhra Pradesh (the "Kesoram
Cement Plant"). Our cement business has been in operation for over 40 years, catering
to the regional demands predoimnently in Karnataka, Andhra Pradesh and
Maharashtra. Our plants are strategically located near our leased limestone deposits in
the states of Karnataka and Andhra Pradesh. Presently, we have a combined total
installed capacity of 7.25 million MT.
MISSION / VISION
MISSION:
To inspire and touch lives through our services and products.
VISION:
We Endeavour to shape tomorrow’s urban landscape and provide a better quality of

living for all mankind.

Capital budgeting
Following are some of the key events and milestones in relation to KIL:
Year Event
1919 Incorporation of the Company in the name of Kesoram Cotton Mills Limited.
1959 First rayon yarn manufacturing plant established and commissioned at Tribeni,
District Hooghly, West Bengal.
1961 First transparent paper manufacturing plant established at Tribeni, District

Hooghly, West Bengal.
1961 Name altered to Kesoram Industries & Cotton Mills Limited.
1964 Diversification into manufacturing cast iron spun pipes and pipe fittings at
Bansberia, District Hooghly, West Bengal.
1969 First cement manufacturing plant under the name of 'Kesoram Cement'
established at Basantnagar, District Karimnagar, Andhra Pradesh.
1986 Second cement manufacturing plant under the name of 'Vasavadatta Cement'
established at Sedam, District Gulbarga, Karnataka.
1986 Name altered to Kesoram Industries Limited.
1992 Automotive tyre and tube manufacturing plant established at Balasore, Odisha
with a capacity of 118 MT per day in technical collaboration with Pirelli
Limited, United Kingdom.
1999 Demerger of the Textile Business from KIL.
2009 • Commencement of at the Laksar Tyre Plant near Haridwar in the State of
Uttarakhand for production of bus/truck tyre, LCV tyre and bus/truck radial
tyre.
• Commencement of expansion work for the passenger car radial project at

Balasore.
2011 Commencement of production of two and three wheeler tyres at the Laksar
Tyre Plant.

Capital budgeting
KIL owns and operates two cement manufacturing plants, located at Sedam,
Karnataka (the "Vasavadatta Cement Plant") and Basantnagar, Andhra Pradesh (the
"Kesoram Cement Plant"). Its cement business has enjoyed an operating history of
over 40 years, catering to regional demands in Karnataka, Andhra Pradesh and
Maharashtra. The plants are strategically located near limestone deposits in the states
of Karnataka and Andhra Pradesh and have a combined total installed capacity of 7.25
million MT of Cement as of 31 March 2013. Its cement grinding units are also located
close to captive power plants. Further, KIL procures much of its fly ash from NTPC
which has power plants in close proximity to both the Vasavadatta Cement Plant and
Kesoram Cement Plant. Cement produced at the plants is marketed under the brand
names "Birla Shakti" and "Vasavadatta Cement".
All KIL Businesses maintain separate marketing and distribution networks.
KIL also manufactures viscose rayon, filament yarn and transparent paper at its plant
at Tribeni, District Hooghly, West Bengal. The rayon is marketed under the brand
name "Kesoram Rayon", while transparent paper is marketed under the brand name
"Kesophane".
The tyre, cement and rayon (including transparent paper and chemicals) business
operations contributed 59.3%, 35.2% and 5.5%, respectively, of KIL's total revenues
for the year ended 31 March 2013.
KIL has also started expansion of its existing truck and bus radial tyre manufacturing
capacity at Laksar.
KIL's Equity Shares are currently listed on the Bombay Stock Exchange, National
Stock Exchange and Calcutta Stock Exchange in India. GDRs are listed on the
Luxembourg Stock Exchange.

Capital budgeting
BOARD OF DIRECTORS(2015-16)
Chairman Basant Kumar Birla
Executive Vice Chairperson Manjushree Khaitan
Krishna Gopal Maheshwari
Pesi Kushru Choksey
Amitabha Ghosh
Prasanta Kumar Mallik
Vinay Sah
Kashi Prasad Khandelwal
Whole-time Director K. C. Jain
Cement
Certification Validity
Certification for conformation with the occupational 2 November 2014
health and safety management system in accordance
with IS/ISO 18001: 2007 for Kesoram Cement Plant.
Certification for conforming with the environmental 7 August 2013
management system in accordance with IS/ISO 14001:
2004 for Kesoram Cement Plant.
Certification for conformation with the quality 31 October 2014
management system in accordance with IS/ISO 9001:
2008 for Kesoram Cement Plant.
The Board of Directors (the "Board") of the Company has adopted the following Code
of Business Conduct and Ethics (the "Code") for directors and senior Management
personnel of the Company. Senior Management personnel mean all members of the
management one level below the Board i.e. Sr. President/President of each Division
of the Company. This code is intended to focus on the Board members including each
of the executive directors and senior management personnel on areas of ethical risk,
integrity and honesty providing guidance to help them recognize and deal with ethical
issues; mechanisms to report unethical/dishonest conducts; and help foster a culture of
honesty, integrity and accountability. The Code of Conduct as approved by the Board
and subsequent amendments thereto by the Board shall be posted on the Website of
the Company.

Capital budgeting
INTERPRETATION OF CODE
In this code wherever the word "Director" is appearing, it also means and includes
senior management personnel to the extent applicable. Any question or interpretation
under this Code of Ethics and Business Conduct will be considered and dealt with by
the Board or any committee or any person authorized by the Board in this behalf. The
Board or any designated person/committee so authorised has the authority to waive
compliance with this Code of business conduct for any director, officer or employee
of the Company. The person-seeking waiver of this Code shall make full disclosure of
the particular circumstances of the case to the Board or the designated
person/committee.
Any waiver of this Code as may be made by the Board and/or so authorised
person/committee shall be promptly posted on the Website of the company.
Each and every director and senior management personnel is expected to comply with
the letter and spirit of this Code.
I. CONFLICT OF INTEREST
Directors must avoid any conflicts of interest with the Company. Any situation that
involves, or may reasonably be expected to involve, a conflict of interest with the
Company, should be disclosed promptly to the Board. A "conflict of interest" can
occur when:
i. A director's personal interest is adverse to or may appear to be adverse to the

interests of the Company as a whole.
ii. A director, or his/her relative, receives improper personal benefits as a result

of his/her position as a director of the Company.
Explanation: Relatives here means dependant-parents, brothers, sisters, spouse,

children, daughters-in-law and sons-in-law.
As illustrations only and being not exhaustive, some of the more common instances of
conflict of interest which directors should avoid are listed below:

Capital budgeting
a. Relationship of Company with third parties
Directors shall not receive a personal benefit from a person or entity, which is seeking
to do business or to retain business with the Company. Shall not participate in any
decision making process of the Board involving another entity in which the director
has direct or indirect interest.
b. Compensation from non-Company sources
Directors shall not accept compensation (in any form) for services performed for the
Company from any source other than the Company.
c. Gifts
Directors shall not offer, give or receive gifts from persons or entities that deal with
the Company, where any such gift, is perceived as intended directly or indirectly to
influence the directors' actions as members of the Board, or where acceptance of such
gift could create the appearance of a conflict of interest.
d. Personal use of Company assets
Directors shall not use Company assets, labour or information for personal use.

Capital budgeting
REVIEW OF LITERATURE
Capital budgeting is the process of determining whether a big expenditure is in a
company's best interest. Here are the basics of capital budgeting and how it works.
Capital Budgeting Basics
A company undertakes capital budgeting in order to make the best decisions

about utilizing its limited capital. For example, if you are considering opening a
distribution center or investing in the development of a new product, capital
budgeting will be essential. It will help you decide if the proposed project or
investment is actually worth it in the long run.
Identify Potential Opportunities
The first step in the capital budgeting process is to identify the opportunities
that you have. Many times, there is more than one available path that your company
could take. You have to identify which projects you want to investigate further and
which ones do not make any sense for your company. If you overlook a viable option,
it could end up costing you quite a bit of money in the long term.
Evaluate Opportunities

Capital budgeting
Once you have identified the reasonable opportunities, you need to determine
which ones are the best. Look at them in relation to your overall business strategy and
mission. See which opportunities are actually realistic at the present time and which
ones should be put off for later.
Cash Flow
Next, you need to determine how much cash flow it would take to implement
a given project. You also need to estimate how much cash would be brought in by
such a project. This process is truly one of estimating--it takes a bit of guesswork.
You need to try to be as realistic as you can in this process. Do not use the best-case
scenario for your numbers. Most of the time, you need to use a fraction of that number
to be realistic. If the project takes off and the best-case scenario is reached, that is
great. However, the odds of that happening are not the best on new projects.
Factors Affecting Capital Budgeting:

While making capital budgeting investment decision the following factors or
aspects should be considered.
 The amount of investment
 Minimum rate of return on investment (k)
 Return expected from the investments. (R)
 Ranking of the investment proposals and
 Based on profitability the raking is evaluated I.e., expected rate of return on
investment.
Factors Influencing Capital Budgeting Decisions:

There are many factors, financial as well as non-financial, which influence
that Budget decisions. The crucial factor that influences the capital expenditure
decisions is the profitability of the proposal. There are other factors, which have to be
in considerations such as.

Capital budgeting
1. Urgency:
Sometimes an investment is to be made due to urgency for the survival of the
firm or to avoid heavy losses. In such circumstances, the proper evaluation of the
proposal cannot be made through profitability tests. The examples of such urgency are
breakdown of some plant and machinery, fire accident etc.
2. Degree of Certainty:
Profitability directly related to risk, higher the profits, Greater is the risk or
uncertainty. Sometimes, a project with some lower profitability may be selected due
to constant flow of income.
3. Intangible Factors:
some times a capital expenditure has to be made due to certain emotional and
intangible factors such as safety and welfare of workers, prestigious project, social
welfare, goodwill of the firm, etc.,
4. Legal Factors.
Any investment, which is required by the provisions of the law, is solely
influenced by this factor and although the project may not be profitable yet the
investment has to be made.
5. Availability of Funds.
As the capital expenditure generally requires large funds, the availability of
funds is an important factor that influences the capital budgeting decisions. A project,
how so ever profitable, may not be taken for want of funds and a project with a lesser
profitability may be some times preferred due to lesser pay-back period for want of
liquidity.
6. Future Earnings
A project may not be profitable as compared to another today but it may
promise better future earnings. In such cases it may be preferred to increase earnings.

Capital budgeting
7. Obsolescence.
There are certain projects, which have greater risk of obsolescence than others.
In case of projects with high rate of obsolescence, the project with a lesser payback
period may be preferred other than one this may have higher profitability but still
longer pay-back period.
8. Research and Development Projects.

It is necessary for the long-term survival of the business to invest in research
and development project though it may not look to be profitable investment.
9. Cost Consideration.
Cost of the capital project, cost of production, opportunity cost of capital, etc.
Are other considerations involved in the capital budgeting decisions?
CAPITAL BUDGETING PROCESS

Capital Budgeting is a complex process as it involves decisions relating to the
investment of the current funds for the benefit to the achieved in future and the future
always uncertain. However, the following procedure may be adopted in the process of
capital budgeting.
Capital Budgeting process:

Capital budgeting
1. Identification of Investment Proposals:

The capital budgeting process begins with the identification of
investment proposals. The proposal or idea about potential investment
opportunities may originate from the top management or may come from the rank
and file worker of any department are from any officer of the organization. The
departmental head analyses the various proposals in the light of the corporate
strategies and submits the suitable proposals to the Capital Expenditure Planning
Committee in case of large organizations or to the officers concerned with the
process of long-term investment decisions.
2.Screening the Proposals:

The expenditure Planning Committee Screens the various proposals received
from different departments. The committee views these proposals from various
angles to ensure that these are accordance with the corporate strategies or
selection criterion of the firm and also do not lead to departmental imbalances.

Capital budgeting
3. Evaluation of Various Proposals:

The next step in the capital budgeting process is to evaluate the profitability of
proposals. There are many methods that may be used for this purpose such as Pay
Back Period methods, Rate of Return method, Net Present Value method, Internal
Rate of Return method etc. All these methods of evaluating profitability of capital
investment proposals have been discussed.
4. Fixing Priorities:
After evaluating various proposals, the unprofitable or uneconomic proposals
may be rejected straight away. But it may not be possible for the firm to invest
immediately in all the acceptable proposals due to limitation of funds. Hence it is very
essential to rank the various proposals and to establish priorities after considering
urgency, risk and profitability involved therein.
5. Final Approval and Preparation of Capital Expenditure Budget:

Proposals meeting the evaluation and other criteria are finally approved to be
included in the capital expenditure budget. However, proposals involving smaller
investment may be decided at the lower levels for expeditious action. The capital
expenditure budget lays down the amount of estimated expenditure to be incurred on
fixed assets during the budget period.
6. Implementing Proposal:
Preparation of capital budgeting expenditure budgeting and incorporation of a
particular proposal in the budget does not itself authorized to go ahead with the
implementation of the project. A request for the authority to spend the amount should
further to be made to the capital expenditure committee, which may like to revive the
profitability of the project in the changed circumstances.
Further, while implementing the project, it is better to assign the responsibility

for completing the project within given time frame and cost limit so as to avoid
unnecessary delays and cost over runs. Network techniques used in the project
management such as Pert and CPM can also be applied to control and monitor the
implementation of the project.

Capital budgeting
7. Performance Review.
The last stage in the process of capital budgeting is the evaluation of the
performance of the project. The evaluation is made through post completion audit by
way of comparison of actual expenditure on the project with the budgeted one, and
also by comparing the actual return from the investment with the anticipated return.
The unfavorable variances, if any should be looked into and the causes of the same be
identified so that corrective action may be taken in future.
METHODS OF CAPITAL BUDGETING AND EVALUATION TECHNIQUES

Traditional Methods:
i) Average Rate of Return.
ii) Pay-Back Period Method
Time Adjusted Method or Discounted Method:

i) Net Present Value Method
ii) Internal Rate of Return
iii) Net Terminal Value Method
iv) Profitability Index.

Capital budgeting
RESEARCH METHODOLOGY
NEED AND IMPORTANCE:
Capital Budgeting means planning for capital assets. Capital Budgeting

decisions are vital to an organization as to include the decision as to:
 Whether or not funds should be invested in long term projects such as

settings of an industry, purchase of plant and machinery etc.,
 Analyze the proposals for expansion or creating additions capacities.
 To decide the replacement of permanent assets such as building and
equipments.
 To make financial analysis of various proposals regarding capital
investment so as to choose the best out of many alternative proposals.

Capital budgeting
SCOPE OF THE STUDY
The efficient allocation of capital is the most important financial function in

the modern times. It involves decision to commit the firm’s, since they stand the
long- term assets such decision are of considerable importance to the firm since
they send to determine its value and size by influencing its growth, probability and
growth.
The scope of the study is limited to collecting the financial data of

KESORAM CEMENTS for four years and budgeted figures of each year.

Capital budgeting
OBJECTIVES OF THE STUDY:

The study on “capital budgeting in Kesoram Limited – A case study” is based
on the following objectives.
1. To evaluate the capital budgeting practices relating to various projects of

Kesoram Limited Hyderabad
2. To Asses the long term requirements of funds and plan for application of
internal resources and debt servicing.
3. To Assess the effectiveness of long term investment decisions of Kesoram
4. To offer conclusion derived from the study and give suitable suggestions for
the efficient utilization of capital expenditure decisions.

Capital budgeting
LIMITAIONS OF THE STUDY:
1. The study is limited to Kesoram Limited only.

2. The study is limited to certain projects of Kesoram only.
3. Period of the study is restricted to five years only.
4. The present study cannot be used for inter firm comparison.
5. Limited span of time is a major limitation for this project.
6. The act and figures of the study is limited to the period of FIVE years i.e.
2011-2016.
7. The data used in reports are taken from the annual reports, published at the
end of the years.
8. The result does not reflect the day-to-day transactions.

Capital budgeting
CAPITAL BUDGETING METHODS
TRADITIONAL METHODS
1. Average Rate of Return:

The average rate of return (ARR) method of evaluating proposed capital
expenditure is also know as the accounting rate of return method. It is based upon
accounting information rather than cash flows. There is no unanimity recording the
definition of the rate of return.
ARR = Average annual profits after taxes ____ X 100

Average investment over the life of the project
The average profits after taxes are determined by adding up the after-tax profits
expected for each year of the projects life and dividing by the number of the years. In
the case of annuity, the average after tax profits is equal to any year’s profit.
The average investment is determined by dividing the net investment by two. This
averaging process assumes that the firm is suing straight line depreciation, in which
case the book value of the asset declines at a constant rate from its purchase price to
zero at the end of its depreciable life. This means that, on the average firms will have
one-half of their initial purchase prices in the books. Consequently if the machine has
salvage value, then only the depreciable cost (cost salvage value) of the machine
should be divide by two in ordered to ascertain the average net investment, as the
salvage money will be recovered only at the end of the life of the project.
Therefore an amount equivalent to the salvage value remains tied up in the

project though out its lifetime. Hence no adjustment is required to sum of salvage
value to determine the average investment. Like wise if any additional net working
capital is required in the initial year, which is likely to be released only at the end of
the projects life. The full amount of working capital should be taking determining
relevant investment for the purpose of calculating ARR. Thus,

Capital budgeting
Average investment = Net Working Capital + Salvage Value + ½ (initial cost of

machine value)
Accept – Reject Value:

With the help of ARR, the financial maker can decide whether to accept or reject the
investment proposal. As an accept – reject criterion, the actual ARR would be
compared with a predetermined or a minimum required rate of return or cut – off rate.
A project would qualify to be accepted if the actual ARR is higher than the minimum
desired ARR. Other wise, it is liable to be rejected. Alternatively the ranking method
can be used to select or reject proposals under consideration may be arranged in the
descending order of magnitude, starting with the proposals with the highest ARR and
ending with the proposal with the lowest ARR. Obviously projects having higher
ARR would be preferred with projects with lower ARR.
2. Pay Back Period:
The Pay Back method is the second traditional method of capital budgeting. It
is the simplest and, the most widely employed quantitative method for apprising
capital expenditure decisions. This method answers the question. How many years
will it for the cash benefits to pay the original cost of an investment, normally
disregarding salvage value? Cash benefits represent CFAT ignoring interest
payment. Thus the pay back method measures the number of years required for the
CFAT to pay back the original out lay required in an investment proposal.
There are two ways of calculating the pay back period. The first method can
be applied when the cash flow stream is in the nature if annuity for each year of the
projects life that is CFAT is uniform. In such a situation the initial cost of the
investment is divided by the constant annual cash flow;
Investment
Constant Annual Cash Flow
For example, an investment of Rs. 40,000 in a machine is expected to produce

CFAT of Rs 8,000 for 10 years.
Rs. 40,000
Rs. 8,000 PB = ---------------- 5 years.

Capital budgeting
The second method is used when project cash flows are not uniform (mixed stream)
but vary form year to year. In such a situation, PB is calculated by the process of
cumulating cash flows till the time when cumulative cash flow become equal to the
original investment outlay.
Accept Reject Criteria:
The pay back period can be use as a decision criterion to accept or reject investment
proposals. One application of this technique is to compare the actual pay back with a
predetermined pay back that is the pay back set up by the management in terms of the
maximum period during which the initial investment will be recovered. If the actual
pay back period less than the predetermined pay back, the project would be accepted.
If not, it would be rejected. Alternatively, the pay back can be used as a ranking
method.
When mutually exclusive projects are under consideration, then may be ranked
according length of pay back period. Thus, the project has having the shortest pay
back may be assigned rank one followed in that order so that the project with the
longest pay back would be ranked last. Obviously, projects with shorter payback
period will be selected.
DISCOUNTED CASH FLOW/ TIME ADJESTED TECHNIQUES:
1. Net Present Value Method:

The net present value is a modern method of evaluating investment proposals.
This method takes into consideration the time value of money and attempts to
calculate the return on investments by introducing the factor of time element. It
recognizes the fact that rupee earned today is worth more than the same rupee earned
tomorrow. Net present values of all inflows and outflows of cash occurring during the
life of the project is determined separately for each year by discounting these flows by
the firm’s cost of capital or a pre – determined rate. The following are the Net Present
value method of evaluating investment proposals:
1) First of all determined an appropriate rate of interest that should be selected as

minimum required rate of return called “ cut – off rate” of interest in the market and

Capital budgeting
the market- on long term loans or it should reflect the opportunity cost of capital of
the investor.
2) Compute the present value of total investment outlay, I,e., cash outflows at the
determined discount rate. If the total investment is to be made in the initial year, the
present value shall be as the cost of investment.
3) Compute the present value of total investment proceeds I,e., inflows (profit before
depreciation and after tax) at the above determined discount rate.
4) Calculate the Net present value of each project by subtracting the present value of
cash inflows from the value of cash outflows for each project.
5)If the Net present value is positive or zero, I.e., when present value of cash inflows
either exceeds or is equal to the present values of cash outflows, the proposal may be
accepted. But in case the present value of inflows is less than the present value of cash
outflows, the proposal should be rejected.
6) To select between mutually exclusive projects, projects should be ranked in order
of net present values, i.e., the first preferences to be given to the project having the
maximum net present value.
The present value of re.1 due in any number of years may be found with the
use of the following the mathematical formula:
PV= 1/(1+r) n
Where,
PV = present value
R = rate of interest/ Discount rate
N = number of years
2. Internal Rate of Return:

The second discounted cash flow or time-adjusted method of appraising capital
investment decisions is the internal rate of return method. This technique is also
known as yield on investment, marginal efficiency of capital, marginal productivity
of capital, rate of return method. This technique is also known a yield on investment,
marginal efficiency of capital, and marginal productivity of capital, rate of return,
time-adjusted rate of return and so an.

Capital budgeting
Like the present value method the IRR method also considers the time value of
money by case of the net present value method, the discount rate is the required rate
of return and being a predetermined rate, usually the cost of capital, its determinants
are external to the proposal under consideration. The IRR, on the other hand it is
based on facts, which are internal to the proposals. In other words while arriving at
the required rate of return for finding out present values the cash inflows as well as
outflows are not considered. But the IRR depends entirely on the initial outlay and
the cash proceeds of the projects, which is been evaluated of acceptance or rejection.
It is therefore appropriately referred to as internal rate of return.
The internal rate of return is usually the rate of return that a project earns.
It is defined as the discount rate ( r ) which equates the aggregate present value of
the Net cash inflows ( CFAT ) with the aggregate present value of cash outflows of
a project. In other words it is that rate which gives the project of Net present value is
zero.
The use of the IRR, as a criterion to accept capital investment decisions,
involves a comparison of the actual IRR with the required rate of return also then the
cut off rate or hurdle rate. The project would quality to be accepted if the IRR
(r) Exceeds the cut off rate.
(k). If the IRR and the required rate of return are equal the firm is different as to
whether to accept or reject the project.
3. Net Terminal Method:

The terminal value approach (TV) even mere distinctly separates the timing of the
cash inflows and outflows. The assumption behind the TV approach is that each
cash inflow is reinvested in other asset at a certain rate of return from the moment it
is received until the termination of the project.
Accept – Reject Criteria:

The decision rule is that if the present value of the sum total of the
compounded reinvested cash inflows (PVTS) is greater than the present value of the
outflows (PVO), the proposed project is accepted otherwise not.

Capital budgeting
PVTS>PVO accept
PVTS<PVO reject.
The firm would be indifferent if both the values are equal. A variation of the
terminal value method (TV) is the net terminal value (NTV). Symbolically it can be
represented as NTV = (PVTS – PVO). If the NTV is the positive accept the project, if
the negative reject the project.
4. Profitability Index:
The time adjusted capital budgeting is Profitability Index (P1) or Benefit Cost
Ratio (B / C). It is similar to the approach of NPV. The profitability index approach
measures the present value of returns per rupee invested, while the NPV is based on
the differences between the present value of future cash inflows and the present value
of cash outflows. A major shortcoming of the NPV method is that, being an absolute
measure; it is not reliable method to evaluate project inquiring different initial
investments. The PI method proves a solution to this kind of problem. It is, in other
words, a relative measure. It may be defined as the ratio, which is obtained by
dividing the present value of future cash inflows by the present value of cash inflows.
PI = Present value of cash inflows

Present value of cash outflows
This method is also known as B / C ratio because the numerator measures benefits
and the denominator costs.

Using the B / C ratio or the PI, a project will quality for acceptance if its PI exceeds
one. When PI equals 1 (one), the firm is indifferently to the project.
When PI is greater than, equal to or less than 1 (one), the Net present value is greater
than, equal to or less than zero respectively. In other words, the NPV will be positive
when the PI is greater than 1 (one); will be negative when the PI is less than 1. Thus,
the NPV and PI approach give the same results regarding the investments proposals.

Capital budgeting
Methods of Capital Budgeting
(1) Traditional methods:

 Pay back period
 Average rate return method
2.Discount cash flow method
 Net present value method
 Initial rate return method
 Profitability index method
Data collection:
Primary data: - The primary data is the data which is collected, by interviewing
directly with the organizations concerned executives. This is the direct information
gathered from the organization.
Secondary data: - The secondary data is the data which is gathered from
publications and websites.
CAPITAL BUDGETING:
A capital expenditure is an outlay of cash for a project that is expected to

produce a cash inflow over a period of time exceeding one year. Examples of projects
include investments in property, plant, and equipment, research and development
projects, large advertising campaigns, or any other project that requires a capital
expenditure and generates a future cash flow.
Because capital expenditures can be very large and have a significant impact on the
financial performance of the firm, great importance is placed on project selection.
This process is called capital budgeting.
Features of Investment Decisions:-
The following are the features of investment decisions:
 The exchange of current funds for future benefits.

Capital budgeting
 The funds are invested in long-term assets.

 The future benefits will occur to the firm over a series of year.
Importance of Investment Decisions:-
Investment decisions require special attention because of the following reasons.
 They influence the firms growth in the long run

 They affect the risk of the firm
 They involve commitment of large amount of funds
 They are irreversible, or reversible at substantial loss
 They are among the most difficult decisions to make.
Growth
The effects of investment decisions extend in to the future and have to be
endured for a long period than the consequences of the current operating expenditure.
A firm’s decision to invest in long-term assets has a decisive influence on the rate and
direction of its growth. A wrong decision can prove disastrous for the continued
survival of the firm; unwanted or unprofitable expansion of assets will result in heavy
operating costs of the firm. On the other hand, inadequate investment in assets would
make it difficult for the firm to complete successfully and maintain its market share.
Risk
A long-term commitment of funds may also change the risk complexity of the
firm. If the adoption of an investment increases average gain but causes frequent
fluctuations in its earnings, the firm will become more risky. Thus, investment
decisions shape the basic character of a firm.
Funding
Investment decisions generally involve large amount of funds, which make it
imperative for the firm to plan its investment programmers very carefully and make
an advance arrangements for procuring finances internally or externally.

Capital budgeting
Irreversibility
Most investment decisions are irreversible. It is difficult to find a market for
such capital items once they have been acquired. The firm will incur heavy losses if
such assets are scrapped.
Complexity
Investment decisions are among the firm’s most difficult decisions. They are
an assessment of future events, which are difficult to predict. It is really a complex
problem to Economic, political, social and technological forces cause the uncertainty
in cash flow estimation.
PROJECT CLASSIFICATION
Project classification entails time and effort the costs incurred in this exercise
must be justified by the benefits from it. Certain projects, given their complexity and
magnitude, may warrant a detailed analysis; others may call for a relatively simple
analysis. Hence firms normally classify projects into different categories. Each
category is then analyzed somewhat differently.
While the system of classification may vary from one firm to another, the following
categories are found in cost classification.
Mandatory investments
These are expenditures required to comply with statutory requirements.
Examples of such investments are pollution control equipment, medical dispensary,
fire fitting equipment, crèche in factory premises and so on. These are often non-
revenue producing investments. In analyzing such investments the focus is mainly on
finding the most cost-effective way of fulfilling a given statutory need.
Replacement projects
Firms routinely invest in equipments means meant to obsolete and inefficient
equipment, even though they may be a serviceable condition. The objective of such
investments is to reduce costs (of labor, raw material and power), increase yield and
improve quality. Replacement projects can be evaluated in a fairly straightforward
manner, through at times the analysis may be quite detailed.

Capital budgeting
Expansion projects
These investments are meant to increase capacity and/or widen the distribution
network. Such investments call for an expansion projects normally warrant more
careful analysis than replacement projects. Decisions relating to such projects are
taken by the top management.
Diversification projects
These investments are aimed at producing new products or services or
entering into entirely new geographical areas. Often diversification projects entail
substantial risks, involve large outlays, and require considerable managerial effort and
attention. Given their strategic importance, such projects call for a very through
evaluation, both quantitative and qualitative. Further they require a significant
involvement of the board of directors.
Research and development projects

Traditionally, R&D projects observed a very small proportion of capital
budget in most Indian companies. Things, however, are changing. Companies are now
allocating more funds to R&D projects, more so in knowledge-intensive industries.
R&D projects are characterized by numerous uncertainties and typically involve
sequential decision making.
Hence the standard DCF analysis is not applicable to them. Such projects are decided
on the basis of managerial judgment. Firms which rely more on quantitative methods
use decision tree analysis and option analysis to evaluate R&D projects.
Miscellaneous projects
This is a catch-all category that includes items like interior decoration,
recreational facilities, executive aircrafts, landscaped gardens, and so on. There is no
standard approach for evaluating these projects and decisions regarding them are
based on personal preferences of top management.

Capital budgeting
Introduction:
Until now, this web site has broken one of the cardinal rules of financial
management. This page corrects for that problem and presents now, the first part of
the subject of Capital Budgeting.
Many books and chapters and web pages purport to discuss capital budgeting when in
reality all they do is discuss CAPITAL INVESTMENT APPRAISAL. There's nothing
wrong with a discussion of the CIA methods except that authors have a duty to point
out that CIA methods are only one part of a multi stage process: the capital budgeting
process.
A discussion of CIA and nothing else means that capital budgeting decisions are
being discussed out of context. That is, by ignoring the earlier and later parts of
capital budgeting, we are never assess where capital budgeting project come from,
how alternatives are found and evaluated, how we really choose which project to
choose … and then we never review the projects and how they have been
implemented.

Capital budgeting
Definition:
Capital budgeting relates to the investment in assets or an organization that is

relatively large. That is, a new asset or project will amount in value to a significant
proportion of the total assets of the organization.
The International Federation of Accountants, IFAC, defines capital expenditures as
Investments to acquire fixed or long lived assets from which a stream of benefits is
expected. Such expenditures represent an organization's commitment to produce and
sell future products and engage in other activities. Capital expenditure decisions,
therefore, form a foundation for the future profitability of a company.
1.Projects don't just fall out of thin air: someone has to have them. The main point
here is that successful, dynamic and growing companies are constantly on the lookout
for new projects to consider. In the largest organizations there are entire departments
looking for alternatives and opportunities.
2 Look for suitable projects
Once someone has had the idea to invest, the next step is to look at suitable projects:
projects that complement current business, projects that are completely different to
current business and so on. Initially, all possibilities will be considered: along the
lines of a brainstorming exercise.
As time goes by, and as corporate objectives allow, the initial list of potential projects
will be whittled down to a more manageable number.
3 Identify and consider alternatives
Having found a few projects to consider, the organization will investigate any number
of different ways of carrying them out. After all, the first idea probably won't either be
the last or the best. Creativity is the order of the day here, as organizations attempt to
start off on the best footing.
As the diagram suggests, at each of these first three stages, we need to consider
whether what we are proposing fits in with corporate objectives. There is no point in
Capital budgeting
thinking of a project that conflicts with, say, the growth objective or the profitability
objective or even an environmental objective.
A lot of data will be generated in this stage and this data will be fed into stage four:
Capital Investment Appraisal.
4 Capital Investment Appraisals
This is the number crunching stage in which we use some or all of the following
methods
 Payback (PB)
 Accounting rate of return (ARR)
 Net present value (NPV)
 Internal rate of return (IRR)
 Profitability Index (PI)
There are other techniques of course; but the technique to be used will depend on a
range of things, including the knowledge and sophistication of the management of the
organization, the availability of computers and the size and complexity of the project
under review.
For more information here, go to my page on CIA once you have finished this page.
5 Analysis of feasibility
Stage four is the number crunching stage. This stage is where the decision is made as
to which project is to be assessed as acceptable. That is, which project is feasible?
In order to choose the project, management needs some hurdles:
 What must the payback be

 What rate of ARR is acceptable
 What is the NPV cut off
 What IRR is the least that we can accept
 What PI is the least that we can accept and so on

Capital budgeting
Some projects will be discarded as a result of this stage. For example, if the
PB cut off is, say, 2 years, and a project has a PB of 3 years, it will be rejected. The
same is true of the ARR, NPV, IRR and PI.
Capital rationing might be a problem here, too, if the organization has general cash
flow problems.
Capital Budgeting Policy Manual
Let's pause at this point to make the point that what we have just said about cut off
rates and so on come from formal procedures and documents. One such formal
document is the Capital Budgeting Policy Manual, in which formal procedures and
rules are established to assure that all proposals are reviewed fairly and consistently.
The manual helps to ensure that managers and supervisors who make proposals need
to know what the organization expects the proposals to contain, and on what basis
their proposed projects will be judged.
The managers who have the authority to approve specific projects need to exercise
that responsibility in the context of an overall organizational capital expenditure
policy.
In outline, the policy manual should include specifications for:
1. an annually updated forecast of capital expenditures

2. the appropriation steps
3. the appraisal method(s) to be used to evaluate proposals
4. the minimum acceptable rate(s) of return on projects of various risk
5. the limits of authority
6. the control of capital expenditures
7. the procedure to be followed when accepted projects will be subject to an
actual performance review after implementation
(See IFAC document The Capital Expenditure Decision October 1989 for full details
of the manual)

Capital budgeting
6 Choose the project
Once we have determined the feasible/acceptable projects, we then have to make a

decision of which to accept.
If we have capital rationing problems, we might be restricted to one project only. If

we have no cash problems, we might choose two or more.
Whatever the cash position, we would like to invest in all projects that have a positive
NPV, whose IRR is greater than our cut off rate and so on.
7 Monitor the project
As with any part of the organization, the project must be monitored as it progresses. If
the project can be kept as a separate part of the business, it might be classed as its own
department or division and it might have its own performance reports prepared for it.
If it's to be absorbed within one or more parts of the organization then it could be
difficult to monitor it separately: this is something that management has to decide as
they implement their new projects.
8 Post completion audit
The final stage: once the project has been up and running for six months or a year or
so, there must be a post completion audit or a post audit. A post audit looks at the
project from start to finish: stages 1 - 7 and looks at how it was thought of, analyzed,
chosen, implemented, and monitored and so on.
The purpose of the post audit is to test whether capital budgeting procedures have
been fully and fairly applied to the project under review.
Of course, any weaknesses that might be found during the post audit might be specific
to one project or they might relate to capital budgeting systems for the organization as
a whole. In the latter case, the auditor will report back to his superiors and to
management that systems need to be overhauled as a result of what has been found.

Capital budgeting
METHODOLOGY:
At each point of time a business firm has a number of proposals regarding various
projects in which, it can invest funds. But the funds available with the firm are always
limited and are not possible to invest trend in the entire proposal at a time. Hence it is
very essential to select from amongst the various competing proposals, those that
gives the highest benefits. The crux of capital budgeting is the allocation of available
resources to various proposals. There are many considerations, economic as well as
non-economic, which influence the capital budgeting decision in the profitability of
the prospective investment.
Yet the right involved in the proposals cannot be ignored, profitability and risk are
directly related, i.e. higher profitability the greater the risk and vice versa there are
several methods for evaluating and ranking the capital investment proposals.

Capital budgeting
DATA ANALYSIS AND INTERPRETATION
ANALYSIS OF KESORAM
Long Share
Total Total Fixed Net Capital
Years term holders’
sales assets assets Profit Employed
funds Funds
2012- - 45.45
5397.88 5299.52 1,66,719
2013 3041.39 210.21 4145.56
2013- - 45.45
5918.20 5020.35 2,14,254
2014 2126.86 379.74 2812.99
2014- - 45.45
5710.82 4985.43 2,35,458
2015 2729.15 329.23 2965.51
2015- - 109.77
5080.91 4514.67 3,66,184
2016 2306.59 515.55 2796.97
2016- - 109.77
4873.37 4581.52 4002.84
2017 1314.35 366.68 3106.28
7000
6000
5000
4000 Series1
Series2
3000
Series3
2000
1000
0
2012-2013 2013-2014 2014-2015 2015-2016 2016-2017
1. PAY BACK PERIOD METHOD:
Payback period method is a traditional method of evaluation of capital

budgeting decision. The term payback or pay out or payoff refers to the period in

Capital budgeting
which the project will generate the necessary cash and recoup the initial investment
or the cash out flows.
To calculate the pay period, the cumulative cash flows will be

calculated and by using interpolation the exact period may be calculated.
The Kesoram Cements Limited has Rs. 5639.78 crors of initial

investment and the annual cash flows for the years 2014 to 2015. Then the
payback period is calculated as follows:

Capital budgeting
CALCULATION OF PAY BACK PERIOD OF Kesoram Cements Limited
(Rs. In crorers)
SI .NO YEAR CASH INFLOW CUMULATIVE
CASH FLOWWS
1 2012-2013 7188.91 7188.91

2 2013-2014 6959.35 14148.26
3 2014-2015 6254.32 20405.98
4 2015-2016 5857.72 26263.70
5 2016-2017 5639.78 31903.48
35000
30000
25000
20000
Series1
15000 Series2
10000
5000
0
2012-2013 2013-2014 2014-2015 2015-2016 2016-2017
The above table shows that, the initial investment RS.12547.56 Cr… lies between
second year with 15203.50 Cr
Difference in cash flows

PBP = Actual (Base) year + ----------------------------------
Next year cash flows
14148.26
PBP = 1 + -------------
20405.26
= 1 + 0.69
= 1.69 year

Capital budgeting
Payback period (PBP) = 1.69 year.
ACCEPT-REJECT CRITERION:
PBP can be used as a criterion to accept or reject an investment

proposal. A proposal whose actual payback period is more than what is
pre-determined by the management.
PBP thus, is useful for the management to accept the investment decision on the
Kesoram cements limited and also to assist the management to know that the initial
investment is recovered in 1.69 years.
II. ACCOUNTING OR AVERAGE RATE OF RETURN METHOD:
It is another traditional method of capital budgeting evaluation. According to

this method the capital investment proposals are judged on the basis of their
relative profitability. The capital employed and related incomes are
determined according to the commonly accepted accounting principles and
practices over the certain life of project and the average yield is calculated.
Such a rate is called the accounting rate of return or the average return or
ARR.
It may be calculated according to any one of the following methods:
(i) Annual average net earnings

---------------------------------- X 100
Original investment
(ii) Annual average net earnings

----------------------------------- X 100
Average investment
(iii)
Increase in expected future annual net earnings
----------------------------------------------------------- X 100
Initial increase in required investment
The term average annual net earnings are the average of the earnings after
depreciation and tax. Over the whole of the economic life of the project order and
these giving on ARR above the required rate may be accepted.

Capital budgeting
The amount of average investment can be calculated according to any

of the following methods:
(a) Original investment

------------------------
2
(b) Original investment +scrap value

------------------------------------------
2
(c) Original investment +scrap value + net additional + scrap

value Working capital
---------------------------------------------------------------------------------
2
Cash flows of the Kesoram cements Limited are shown in cash flow statement.
ARR is calculated as follows:

Capital budgeting
Statement showing calculation of ARR (Rs. In Cr….)

YEARS EARNINGS AFTER TAX (EAT)
2012-2013 7188.91
2013-2014 6959.35
2014-2015 6254.32
2015-2016 5857.72
2016-2017 5639.78
TOTAL 31903.48
8000
7000
6000
5000
4000
Series1
3000
2000
1000
0
2012-2013 2013-2014 2014-2015 2015-2016 2016-2017
Average annual EAT’S

ARR = ------------------------------- x 100
Average investment
Total amount
Average Annual EAT’S = ---------------------
No of years
31903.48
= ------------------ = 6380.69
5
Average investment =3832.05
3832.05
Capital budgeting
ARR = ---------------- X 100 = 60.05 %

6380.69
Average Rate of Return = 60.05 %
ACCEPT-REJECT critters method allows Kesoram cements Limited to fix a

minimum rate of return. Any project expected to give a return below it will be straight
away rejected. The average rate of return is as good as 60.05 % of Kesoram cements
Limited depicts the prospects of management efficiency.
TIME ADJUSTED (OR) DISCOUNTED CASH FLOW METHOD:
The time adjusted or discounted cash flow methods take into accounts the profitability
time value of money. These methods are also called the modern methods of capital
budgeting.
1. NET PRESENT VALUE METHOD: (NPV)
Net present value method or NPV is one of the discounted cash flows methods. The
method is considered to be one of the best of evaluating the capital investment
proposals. Under this method cash inflows and outflows associated with each project
are first calculated.
ROLE OF DISCOUNTING FACTOR:
The cash inflows and out flows are converted to the present values using discounting
factor which is the actuary discount factor of Regulated display tool kit project of
Kesoram cements limited is 10%.
The rate of return is considered as cut off rate or required rate or rate generally
determined on the basis of cost of capital to allow for the risk element involved in the
project.
STEPS FOR CALCULATION OF NPV:
Calculation of each cash flows after taxes of three years, which is arrived at by
deducting depreciation, interest and tax from earning before tax and interest (EBIT).
This residue is profit after tax to arrive at cash flow after tax.
2) This cash flow after tax are multiplied with the values obtained from the
Table (the present value annuity table against the 8% actuary discount Rate
i.e. in the case of project.

Capital budgeting
3) NPV is derived by deducting the sum of present values from the initial
Investment.
4) Initial investments are the sum of cash flows of three years shown inCapital
expenditure table
Let us assume the discount rate be 10%:
YEARS CFAT’S PVIF @ 10% PV’S
2012-2013 7188.91 0.909

6534.71
2013-2014 6959.35 0.826
5748.42
2014-2015 6254.32 0.751
4696.99
2015-2016 5857.72 0.683
4000.82
2016-2017 5639.78 0.620
3496.66
TOTAL: 24477.62
LESS: Initial Investment: 12547.56
NPV: 11930.06

Capital budgeting
1
0.9
0.8
0.7
0.6
0.5
Series1
0.4
0.3
0.2
0.1
0
2012-2013 2013-2014 2014-2015 2015-2016 2016-2017
The accept -reject decision of NPV is very simple. If the NPV is positive then the
project should be accepted and if NPV is negative then the project should be rejected
i.e .If NPV >0 (ACCEPT)
and NPV <0 (REJECT)
Hence in the case of Kesoram cements Limited project it is visible that the positive
NPV shows the acceptance and importance of the project.
1. INTERNAL RATE OF RETURN METHOD: (IRR)
The internal rate of return method is also a modern technique of capital budgeting that
takes into account the time value of money. It is also known as “TIME
ADGUSTED RATE OF RETURN”, “DISCOUNTED CASH FLOW”,
“DISCOUNTED RATE OF RETURN”, “YIELD METHOD” and “TRAIL AND
ERROR YIELD METHOD”.
IRR is the rate the sum of discounted cash inflows equals the sum of discounted cash
outflows. It equals the present value of cash inflow to present value of cash out flows.
In this method discount rate is not known, but the cash inflows and cash out flows are
known. It is the rate of return, which equates the present value of cash inflows to out
flows or it, is the rate of return, which renders NPV TO ZERO.
STEPS INVOLVED IN THE CALCULATION OF IRR:
1) Calculation of NPV with given discount rate
2) Calculation of NPV with assumed discount rate
3) Select the higher NPV of both
Capital budgeting
4) Let R be the higher discount rate

5) Let R1 be the difference of discount rates
6) Calculation of difference of P Vs (Always higher NPV-lower NPV)
Higher NP
IRR= R + ---------------------------- XR1
Difference of P V s.
8) Decision making (Accepting- Rejecting the proposal)
FORMULATION OF STEPS:
STATEMENT OF SHOWING CALCULATION NPV @88%,89%,90% UNDER

IRR METHOD
(R s corers)
YEARS Annual Discount Discount Discount

CFA Ts Rate-88% Rate-89% Rate-90%
PVF PV PVF PV PVF PV
2012-2013 7188.91 0.531 3817.31 0.529 3802.93 0.526 3781.36
2013-2014 6959.35 0.2921 2032.82 0.2799 1947.92 0.277 1927.74
2014-2015 6254.32 0.1579 987.55 0.1481 926.26 0.145 906.87
2015-2016 5857.72 0.0858 502.59 0.0783 458.65 0.076 445.18
2016-2017 5639.78 0.0461 259.99 0.0414 233.48 0.04 225.59
7600.28 7369.26 7286.76

Capital budgeting
4500
4000
3500
3000
2500 Series1
2000 Series2
1500 Series3
1000
500
0
2012-2013 2013-2014 2014-2015 2015-2016 2016-2017
From the above calculations the following can be observed.
PV 0f net cash flows at 88% is: 7600.28cr

PV 0f net cash flows at 89% is: 7369.26 cr
DECISION:
Since the initial investment RS. 12547.56cr is lies between 88% and >80% the
company APTDC can determine the IRR as >80%
Hence IRR=>80%
IRR is the maximum rate of interest, which an organization can afford to pay on
capital, invested in, is accepted if IRR exceeds the cutoff rates and rejected if it is
below the cutoff rate.
The cutoff rate of Kesoram Limited is 10%, which is less than the IRR i.e >80%
hence the acceptance of Kesoram Limited is quiet a good investment decision taken
by management.
3. PROFITABILITY INDEX: (BCR OR PI)
Profitability index method is also known as time adjusted method of evaluating the
investment proposals. Profitability also called as benefit cost ratio (B\C) in
relationship between present value of cash inflows and the present value of cash out
flows. Thus

Capital budgeting
Present value of cash inflows

Profitability index = --------------------------------------
Present value of cash outflows.
(OR)

Profitability index = - ----------------------------------------
Initial cash outlay
CALCULATIONS OF BCR:
STEP1: Calculations of cash flows after taxes

STEP2: Calculations of Present values of cash inflows @10%.
STEP3: Application of the formula.
Statement for calculating of benefit cost ratio

YEARS CFAT’S PVIF @ 10% PV’S
7188.91 0.909
6534.71
2012-2013
6959.35 0.826
5748.42
2013-2014
6254.32 0.751
4696.99
2014-2015
5857.72 0.683
4000.82
2015-2016
5639.78 0.62
3496.66
2016-2017
TOTAL: 24477.62

Capital budgeting
7000
6000
5000
4000
Series1
3000
2000
1000
0
2012-2013 2013-2014 2014-2015 2015-2016 2016-2017

Profitability index = --------------------------------------
Initial Investment
24477.62
= ------------------ = 1.95
12547.56
Hence PI = 1.95 years.
There is a slight difference between present value index method and profitability
index method. Under profitability index method the present value of cash inflows and
cash outflows are taken as accept-reject decision.
I.e. the accept reject criterion is:
If Profitability Index > 1 (ACCEPT).
Profitability Index < 1 (REJECT).
The acceptance of by the management is evaluated through Profitability Index method

of as the PI > 1 (i.e.1.95 years)

Capital budgeting

Capital budgeting
FINDINGS
 The amount of total investment in assets as increased significantly from
4514.67 cr to Rs. 4581.52 cr.
 The amount of sales has increased from 4873.37 Cr to 5080.91 2Cr (2016-
2017) this increased sales helped the organization to improve its business
turn over in different sectors
 Pay back period for the project will be 1.69 years it indicates the project
earns good yield in future also.
 Average rate of return for the kesoram cements limited is 60.05 %.
 NPV and IRR show a good path for the organization to develop In future
markets and also the investments for the investors.
 During the same period profit before tax has decreased from Rs.-377.19 Cr
to Rs.-366.68 Cr.
 The ratio of fixed assets to long-term borrowings has not been showing
any consistent trend. It has varied from -0.51 times to 0.28 (2015-2016).
 The initial ratio’s of the investment are decreased from 10709 Cr to
11930.06 cr (2016-2017) constantly increased period of 5 years.

Capital budgeting
SUGGESTIONS
 As large sum of money is involved which influences the profitability of the firm
making capital budgeting an important task.
 Long term investment once made cannot be reversed without significance loss of
invested capital. The investment becomes sunk and mistakes, rather than being readily
rectified, must often be born until the firm can be withdrawn through depreciation
charges or liquidation. It influences the whole conduct of the business for the years to
come.
 Investment decision are the base on which the profit will be earned and probably
measured through the return on the capital. A proper mix of capital investment is
quite important to ensure adequate rate of return on investment, calling for the need of
capital budgeting.
 The implication of long term investment decisions are more extensive than those of
short run decisions because of time factor involved, capital budgeting decisions are
subject to the higher degree of risk and uncertainty than short run decision.

Capital budgeting
CONCLUSIONS
 The budgeting exercise in KESORAM also covers the long term capital
budgets, including annual planning and provides long term plan for
application of internal resources and debt servicing translated in to the
corporate plan.
 The scope of capital budgeting also includes expenditure on plant betterment,
and renovation, balancing equipment, capital additions and commissioning
expenses on trial runs generating units.
 To establish a close link between physical progress and monitory outlay and to
provide the basis for plan allocation and budgetary support by the government.
 The manual recommends the computation of NPV at a cost of capital /
discount rate specified from time to time.
 A single discount rate should not be used for all the capacity budgeting
projects.
 The analysis of relevant facts and quantifications of anticipated results and
benefits, risk factors if any, must be clearly brought out.
 Inducting at least three non -official directors the mechanism of the Search
Committee should restructure the Boards of these PSUs.
 Feasibility report of the project is prepared on the cost estimates and the cost
of generation.
 Scope of capital budgeting in KESORAM are
 * Approved and ongoing schemes
 New approved schemes
 Unapproved schemes
 Capital budgets for plant betterment’s
 Survey and investigation
 Research and development budget.

Capital budgeting
BIBLIOGRAPHY
Books:
-Financial Management - Prasanna Chandra
-Management Accounting - R.K.Sharma & Shashi K.Gupta
-Management Accounting -S.N.Maheshwary
-Financial Management -Khan and Jain
-Research Methodology -K.R.Kothari
Internet Sites:
http\\:www.google.com
http\\:www.KESORAM.co.in
http\\:www.googlefinance.com

Capital budgeting
ABBREVIATIONS
PI  Profitability index.
CB  Capital budgeting
CF’S  Cash flows.
CCF’S  Cumulative cash flows.
EAT  Earnings after tax.
EBIT  Earnings before investment and tax.
CFAT  Cash flows after tax.
PV’S  Present value of cash flows.
PVIF  Present value of inflows.
PBP  Payback period.
ARR  Average rate return.
NPV  Net present value.
IRR  Internal rate return.
B/C  Benefit cost ratio.

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Capital budgeting

Capital Budgeting Process:

 Performance monitoring. In a post-audit, actual results are compared to

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performance closer to expectations if at all possible. Finally, monitoring and

Complexity of Capital Budgeting Process

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 JSW Cement Ltd has planned to set up a 3 MTPA clinkerisation plant at

 Andhra Cements Ltd has commenced the commercial production in the

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 The Government of Kerala has accorded sanction to Malabar Cements Ltd to

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Kesoram Industries Limited ("KIL") was incorporated as a public company

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To inspire and touch lives through our services and products.

We Endeavour to shape tomorrow’s urban landscape and provide a better quality of

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1961 First transparent paper manufacturing plant established at Tribeni, District

1961 Name altered to Kesoram Industries & Cotton Mills Limited.

1986 Name altered to Kesoram Industries Limited.

1999 Demerger of the Textile Business from KIL.

• Commencement of expansion work for the passenger car radial project at

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All KIL Businesses maintain separate marketing and distribution networks.

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Executive Vice Chairperson Manjushree Khaitan

Krishna Gopal Maheshwari

Pesi Kushru Choksey

Prasanta Kumar Mallik

Kashi Prasad Khandelwal

Whole-time Director K. C. Jain

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i. A director's personal interest is adverse to or may appear to be adverse to the

ii. A director, or his/her relative, receives improper personal benefits as a result

Explanation: Relatives here means dependant-parents, brothers, sisters, spouse,

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a. Relationship of Company with third parties

b. Compensation from non-Company sources

d. Personal use of Company assets

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Capital Budgeting Basics

A company undertakes capital budgeting in order to make the best decisions

Identify Potential Opportunities

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Factors Affecting Capital Budgeting:

Factors Influencing Capital Budgeting Decisions:

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8. Research and Development Projects.

CAPITAL BUDGETING PROCESS

Capital Budgeting process:

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1. Identification of Investment Proposals:

2.Screening the Proposals:

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3. Evaluation of Various Proposals:

5. Final Approval and Preparation of Capital Expenditure Budget:

Further, while implementing the project, it is better to assign the responsibility

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METHODS OF CAPITAL BUDGETING AND EVALUATION TECHNIQUES