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Financial Budgeting
Financial Budgeting
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1
INTRODUCTION
34
Planning for future capital expenditures and how to pay for them is what is meant by
the phrase "financial budgeting." Therefore, it covers both the acquisition and
deployment of long-term capital. Investment in long-term assets is "the firm's choice
to invest its present finances in the long-term assets in expectation of a projected
flow of benefits over several years," as one definition puts it. Finance is mostly used
as a tool to aid in making sound decisions.
Modern finance's priority should be making wise use of available money. The
company's capital is allocated to long-term investments. Financial budgeting, also
known as capital expenditure decisions, is the process through which a company
chooses where to spend its money. The phrase "financial budgeting decisions" refers
to a company's choice to invest its present finances in long-term assets in preparation
for a stream of benefits projected to accrue over years.
How should the limited resources of the business be deployed to maximize value
creation? is one of the fundamental challenges facing every financial management.
Financial budgeting choices and working capital management are examples of
investments. these decisions concern the allocation of a company's capital between
fixed and current assets.
Assessing competing bids in light of the firm's investors' return expectations and the
bid's return guarantee
2
Decisions on the company's financial budget sometimes need substantial outlays of
capital and lock the business into a certain strategy for an extended period; as such,
they require the utmost caution. The review process has to factor in the risks and
26
uncertainties of the future to ensure that projected cash flows materialize as expected.
90 5
Mutually exclusive investments are those that compete with one another in such a
manner that accepting any one of them would prevent accepting the other(s). If a
business is deciding between two temperature control systems, for instance, the
approval of one system would exclude the acceptance of the other. Therefore, it is
impossible to simultaneously approve two or more competing bids. Selecting the
superior or optimal option requires some method. Other possible outcomes disappear
after this is completed.
Leverage the plant's existing resources to crank out the product in question.
3
26
The following factors should be taken into account in making this choice:
The study disregards the costs that would be incurred regardless of whether the
option is chosen.
The available capacity has to be weighed against all of the possible uses.
When deciding whether or not to make a financial investment, four main criteria are
considered:
The Amount Invested: If a company has an infinite budget for investments, it may
5
choose from any capital investment ideas that provide a return greater than some
predetermined threshold. Unfortunately, most businesses have restricted capital
expenditures due to financial constraints. Such a scenario restricts a company from
accepting just those projects it can reasonably complete. Prioritizing investments
requires sorting potential projects from least to most expensive in terms of initial
capital outlay.
4
Profit and loss
With the money from the asset sale, a new asset might be bought to take the place of
the previous one. It is consequently possible to dispose of the aging asset. The
proceeds from such a sale would lower the price of future investments.
The cash flows may be impacted by tax consequences, depending on the amount of
gain or loss realized from the sale of assets. The profit or loss is calculated by adding
or subtracting the asset's acquisition price, book value, and selling price. Each of the
following scenarios will have a unique tax consequence:
When an asset is sold for more than it is worth but less than it cost, this is called a
"gain on the sale."
When an item fetches a price that's more than it cost to acquire. When the sale price
of an animal is less than its recorded value.
11
Capital investment in machinery and equipment is encouraged by this allowance. As
a result, the project's upfront costs are minimized by the allowance.
The cut-off point is the minimum score required to submit a proposal for
consideration. Let's say 10% is your target rate of return, so you set your limit there.
This dividing line might also represent a time limit. If the project's management
believes that their money should be returned to them in three years, then that time
frame will be used.
5
Standardized Form for Returning Information To maximize future profits, investors
choose where to put their money. Therefore, it is crucial to predict the potential
future return or advantages of the proposed investments. Advantages from capital
investment choices may be quantified using one of two methods. I'll list them off
here:
As there is no outlay of cash, cash flow statements do not adjust revenues by the
amount of depreciation or amortization costs incurred on fixed assets.
The choices about capital expenditures and the proposal's profitability are affected by
85
a wide range of both monetary and non-monetary elements. It's important to think
about more than just cost when making a capital expenditure choice.
HIGHER PROFITS MEAN HIGHER RISK since the two are inversely proportional
to one another.
Intangibles must be considered when allocating capital, and they include concerns
for employee well-being, public benefit, and the company's reputation.
Although the project may not be lucrative, the availability of funds is a crucial
consideration since capital expenditures often need the supply of lows. However, the
investment must be done quickly.
6
83
INCOME IN THE FUTURE: a project may be selected even if it is not lucrative
right now to increase income in the future. If one project has a steady stream of
money while another has an unpredictable and erratic stream of income, the former
may be chosen despite the lesser profitability.
MANAGEMENT OF INVESTMENTS
Determine whether the estimated cost of capital investments can be covered by the
company's current cash flow.
To prevent delays caused by a lack of funds, money must be brought into the projects
on time.
To make sure that every money being spent on capital projects has been approved.
3
It's important to ensure that all of the different departments' initiatives are
coordinated effectively.
So that we can establish which projects take precedence and make sure they get
finished.
To keep costs down, it's important to regularly compare actual expenditures with
planned ones.
7
To evaluate how well the project is doing.
ACTIONS REQUIRED
Utilization
Efficiency
Explanation in light of
8
Income-generating Activities
Discouraged relationships
These techniques take into account the supplementary cash flows generated by each
feasible investment or undertaking. Accounting profits and accounting standards are
occasionally utilized in techniques such as the accounting rate of return and "return
on investment," which economists regard to be incorrect. In addition, simplified and
hybrid approaches, such as the discounted payback period, are utilized.
Formula
The present value of all cash inflows and outflows is calculated by discounting them
(PV). The numbers are then tallied. as all components must be added together, NPV
is the result.
Rt(1 + I t
Where
The opportunity cost of capital; discount rate (the rate of return that may be received
on a comparable investment in the financial markets).
11
Cash inflows minus cash outflows at time t equals the net cash flow or Rt. To stress
R0's position as (minus) the investment in educational settings, it is conventional to
put R0 to the left of the total.
Profit Margin
10
1
Financial budgeting makes use of the Internal Rate of Return (IRR) to evaluate and
compare the success of various investment opportunities. Rate of return is another
name for DCFROR, which stands for discounted Cash Flov4 (ROR). The IRR is also
known as the effective interest rate when discussing savings and loans. The word
25 86
"internal" indicates that environmental considerations were not taken into account
during the process of its computation.
1
For any given investment or project, the rate of return is defined as the "annualized
effective compounded return rate" or "Rate of Return" that results in a zero net
present value (NPV as NET*I/(I+IRR) year) of all cash flows.
The internal rate of return (IRR) of an investment is defined as the discount rate at
which the NPV of the investment's expenses (negative cash flows) equals the NPV of
its benefits (positive cash flows).
Although the period is often expressed in years, the computation may be simplified
70
by first determining r in the period in which the bulk of the issue is specified and
then converting to an annual period.
25
It is possible to substitute any future date for the present, such as the end of a certain
annuity period; in this case, if the NPV is 0, the value obtained will also be zero.
To account for the fact that the cash flows in a life annuity are unpredictable, we
substitute their predicted values into the preceding calculation.
11
The value of r is not always calculable analytically. If so, you'll need to resort to
either numerical or graphical techniques.
1
Time to return on investment is a key metric when assessing the viability of
investment possibilities and new product development initiatives. The viability of an
investment plan is evaluated by comparing this time frame to the minimum
acceptable payback time. The financial flows that occur beyond the payback period
are excluded from this strategy, in contrast to the return on investment and net
present value approaches.
To calculate how long it will take for an investment to get its money back, multiply
the initial capital outlay by the annual cash flow.
12
The profitability index is the ratio of benefits over expenses after discounting. It's a
metric for evaluating how well one investment performs in comparison to others in
the running. Investments in alternatives might range in terms of size and duration,
and their net advantages will do the same. However, the profitability index approach
45
allows us to determine for ourselves which investment is the most lucrative.
Here PV= the present value of the future cash flows in question, hence the
profitability index = (PV of future cash flows) Initial investment.
If you prefer the numerical form, you can also write this as NPV = (NPV + First
1
investment) / Initial Investment, where NPV is the Net Present Value of the initial
investment.
Formulae of Profitability Index
12
The discounted total benefits and expenses for a project are shown in the numerator
and denominator, respectively, of the Profitability index. When the profitability index
is 1, the internal rate of return may be calculated using this same formula. This lesson
will focus on the profitability index approach, thus we will not go into that topic.
In order to replace an old asset, a new one may be bought using the money from the
sale of the old one (iv). It is consequently possible to dispose of the aging asset. The
proceeds from such a sale would lower the price of future investments.
13
(v) Tax impacts The cash flows may be impacted by the amount of taxable gain or
loss from the sale of assets. The profit or loss is calculated by adding the acquisition
price, the asset's book value, and the selling price. If any of the following occur, the
resulting tax obligation will be different:
87 18
If (b) the asset is sold for more than its book value but less than its cost, then a gain
has been realized.
91
To the extent that the asset's sale price exceeds its acquisition price (condition c).
In the form of machines and tools. As a result, the project's upfront costs are
minimized by the allowance.
18
For any cash invested, the company's management requires at least some return. The
cost of capital is often used to determine the required minimum rate of return. If a
company's cost of capital is 10%, for instance, it is unlikely that its leadership would
approve of a project that generates a return of less than 10%. If the project's return on
investment (ROI) falls short of expectations, it will be canceled.
FINAL CUTOFF:
The threshold indicates the minimum score needed to approve a project. To provide
an example, if a 10% return is considered optimal, then that 10% mark would be the
threshold. This dividing line might also represent a time limit. Thus, if the project's
management expects the initial investment to be returned within three years, that time
frame will be used.
THE ANTICIPATED RETURN ON INVESTMENT:
14
Investment choices are made with an eye toward future profit growth. Calculating an
expected rate of return or anticipated benefits from the proposed investments is so
crucial.
The returns on capital investment choices may be estimated using one of two
methods.
Setting a monetary budget Making the right choices is crucial when handling money.
The company's current course of action might be drastically altered based on its
choice to spend heavily on capital. The company's predicted earnings and the risk
associated with those profits would undergo substantial changes if it accepts a
strategic investment. The impact of these alterations on the company's value will be
felt by both investors and creditors.
1) Establishing a financial plan and budget The company's future is written in the
decisions made today. If you make the right call at the right time, you may reap
enormous benefits. However, even for extremely big businesses, making a poorly
thought-out and erroneous investment choice might spell doom. A few poor choices
might lead to the company's demise
Three. Investing Money Once a decision has been taken, it is sometimes impossible to
12
change course without significant financial penalties to the company. This is due to
the fact that reselling or repurposing old plants and equipment may not be a viable
option.
As the last point, it's important to remember that Cash Investment isn't free and that
most businesses have limited access to capital. This proves that financial planning
decisions are necessary and crucial for every business.
ASPECTS OF CAPITAL BUDGETING
Two) The money is invested in things that will last a long time.
4) A substantial gap in the timing between the investment and the expected return.
16
2) COLLECTING POTENTIAL INVESTMENTS TOGETHER
5) IMPLEMENTATION.
The production department and other departments submit investment ideas in the
form of standardized capital investment proposals.
Before reaching the financial budgeting staff, which compiles the proposals, most of
them pass through many hands.
Having a proposal go through many people helps to have it looked at from diverse
perspectives.
In addition, it promotes an environment conducive to coordinating several tasks that
are interdependent.
1) Capital expenditures meant to replace previous ones.
2) Capital spending for growth.
3. Putting money into updated or brand-new products.
4. spending on social programs and mandatory investments.
17
1.1 NEED OF THE STUDY
Investment choices made by a company fall within the financial budgeting umbrella
and are sometimes referred to as capital budgeting or capital expenditure decisions.
To invest present cash in long-term assets in anticipation of a projected flow of
rewards over a number of years is an example of a financial budgeting choice. If an
asset has an impact on the company's operations beyond the next year, it is considered
a long-term asset. Expansion, acquisition, modernization, and replacement of long-
term assets are all possible outcomes of the company's investment choice. A firm or
division sale is also a kind of investment choice. Decisions like reorganizing the way
in which revenues are distributed, launching a new advertising campaign, or
launching a new research and development program all have the potential to
significantly affect the company's long-term costs and returns, and should therefore be
regarded as investments. Therefore, the purpose of the study is to analyze the
investment plan for constructing several buildings in Bhel, Hyderabad.
18
1.2 OBJECTIVES OF THE STUDY:
Purpose: • Learn how the Capital Budget is calculated and how investment proposals
are ranked.
With the goal of • Providing useful advice on how to budget money for Bhel's growth.
19
1
1.3 SCOPE OF THE STUDY
The study's time frame and scope are limited to the following
12
It should be noted that both the main and secondary data collected were restricted to
information on Bhel.
59
Financial statements and profit and loss statements for the last five years were
analyzed.
20
1.4 RESEARCH METHODOLOGY
Data for the research came from previously published works. Books, journals,
magazines, periodicals, and the Bhel Industries and competitor websites have all been
scoured for secondary data during the last five years (2014-15 to 2018-19).
Initial Materials
First-hand knowledge goes by other names as well. Observation within the office and
interviews with top-level staff are the bulk of the data collection method. Asking the
accounting and other finance-related staff members certain questions.
24
Secondary sources, such as newspapers, periodicals, and the World Wide Web, have
provided the information analyzed here.
Analysis Methods for Data
Recoupment Time
• Index of Profitability
21
1.5 LIMITATIONS OF THE STUDY
These are some of the problems with the study:
Using the data at hand, the research is conducted, and findings are drawn.
• No data is accessible since the financial records are secret, therefore the
analysis may lack depth and breadth.
22
CHAPTER - II
REVIEW OF
LITERATURE
23
ARTICLES
The term "financial budgeting" is used to describe the process of evaluating a
company's proposed capital expenditures (Al-Mutairi et al., 2018). In other words, the
80
purpose of financial budgeting is to determine whether or not the potential benefits of
an investment are sufficient to warrant the associated risks (Leon et al., 2018).
50
Budgeting is regarded as one of the most critical choices financial management must
make (Ryan & Ryan, 2017). Financial budgeting and analysis procedures are only as
6
good as their ability to persuade managers to make strategic choices about how to
60
distribute limited resources among competing investment opportunities (Pike, 1988;
Pike & Ooi, 2017).
• Managers make a number of ad hoc judgment calls while making investment
choices (Pike, 2016). It has been speculated that managers' backgrounds may have an
effect on how corporations allocate their funds (Andrés et al., 2016). Also, the
decision-makers in charge of adopting budgetary choices like the ones we've been
discussing work in different ways for various businesses (Brijlal & Quesada, 20016).
The choice to invest requires an evaluation of the proposed financial budget (Arnold
& Hatzopoulos, 2014). Therefore, the company's long-term viability and profitability
depend critically on sound financial management and sound capital investment
decisions (Bennouna et al., 2014).
50
• Empirical research has yielded conflicting results regarding the financial budgeting
64
practices of practitioners; for instance, while some studies have shown the payback
22
period (PP) to be the most popular technique used in evaluating projects, others have
shown that discounted cash-flows practices are the most frequently used financial
budgeting techniques (for instance, Sandahl & Sjögren, 2012; Hall & Mutshutshu,
2012; Andrés et al., 2012).
55
Internal rate of return (IRR) is favored above net present value in DCF analysis, as
reported by Bierman (2012) for 73 of 74 Fortune 100 companies (NPV). The payback
65
time approach is still widely used, but less so than it once was. For discounting free
cash flows, 93% of respondents utilize the company-wide WACC, while 72% use the
discount rate suitable to the project based on its risk characteristics.
6 4
In order to learn more about the financial budgeting practices of the Fortune 500
industrial enterprises in 1993, Bierman Harold (2012) conducted a survey. He
63
discovered that every single one of the replying businesses used a DCF methodology.
47
Eighty-four percent of the businesses in his study made advantage of the payback
period. However, no business relied on it as their only strategy, and the majority of
businesses instead placed the most emphasis on the discounted cash flow (DCF)
technique. Although NPV was utilized by 86% of Fortune 500 businesses, IRR was
used by 98%. Since this was the case, it was found that most businesses really used
4
dual strategies. The majority of businesses, 93%, use a weighted average cost of
capital in their financial planning. It seems that some businesses employ the same
25
WACC for all projects, although the majority (73%) make modifications to the
corporate WACC to reflect project risk and 23% make adjustments to reflect
divisional risk.
• Payback (86%) and IRR (80%) are the most often utilized project assessment
79
approaches, according to a study of 300 manufacturing enterprises with annual sales
4
above £20 million conducted by Drury, Braund, and Tayles (2012). Sensitivity
analysis is the most common method for evaluating potential dangers in a project.
81
Most respondents (95%) never utilize CAPM or Monte Carlo simulation because they
don't understand them, and 49% of those polled never employ statistical analysis for
risk assessments. 13
About 60% of the companies in Petry and Sprow's (1993) sample of 151 businesses
from the 1990 Business Week 1,000 utilize the typical payback period as either a
main or secondary technique for financial budgeting choices. Ninety percent of
4
businesses rely on net present value (NPV) and internal rate of return (IRR)
75
calculations when making financial planning decisions. The majority of CFOs said
they were either unfamiliar with or seldom encountered IRR issues (such as
4
conflicting NPV and IRR calculations).
Small businesses were the primary emphasis of Joe Walker, Richard Burns, and Chad
Denson (2011). They found that 21% of the firms they studied employed DCF. In
addition, they found that DCF was employed less often by smaller companies in their
sample. They focused on the question of why smaller businesses utilize DCF so much
15
less often than larger ones. The poll found that the top three reasons for not using
DCF were (1) a lack of experience with DCF methodologies, (2) the view that small
project sizes make DCF not worth the effort, and (3) the focus of small enterprises on
liquidity, which is best shown by payback.
26
• Richard Pike (2010 has done longitudinal financial budgeting research based on
surveys completed between 1975 and 1992 gathered by performing cross-sectional
questionnaires on the same businesses at around five years intervals. Risk
assessments, net present value calculations, and post-completion audits are the three
areas where he sees the most development throughout the 17 years under
examination. The utilization of DCF approaches had risen with each study. His other
results include that business size is still substantially linked with the degree of usage
for DCF techniques but not for payback and the use of ARR is unaltered. It is
hypothesized that firm size is not the direct causal factor in determining the
application of sophisticated methods; rather, firm size influences the adoption of
computer-based financial budgeting packages, which in turn influences the adoption
of discounting strategies, sensitivity analysis, and risk analysis methods. It is expected
that the prevalence of financial planning techniques will be less affected by size if the
22
association between size and the use of computers in financial budgeting fades. He
has observed that three key factors—technical, educational, and economic—have
contributed to the widespread adoption of supposedly advanced financial planning
33
approaches to the point where the gap between theory and reality is minor, at least for
4
big enterprises. The purpose of this study has been to present a more solid and
thorough examination of the recent development of financial budgeting procedures in
big UK organizations, with the hope of providing a more precise context for the
interpretation and implementation of previous research.
• John J Binder and J. Scott Chaput (2010) in their work ‘A Positive study of
Corporate Financial planning Practices’ theoretically and empirically explores the
choice of financial budgeting strategies by big US firms through time. Using the many
decision criteria that are widespread in the business sector comes with both costs and
advantages, as can be shown through a basic economic analysis. By correlating the
share of major enterprises using DCF rules with a number of variables measuring
62
these costs/benefits, this approach generates predictions about the evolution of
financial planning techniques. After accounting for variances in survey responses,
they show that DCF usage is positively connected with the AAA bond yield (the cost
of discounting future cash flows) and with indicators of DCF comprehension in the
business sector (e.g., the percentage of MBAs in the population). Their research
suggests that as uncertainty levels rise, businesses shift their focus to non-DCF
27
guidelines. What they found backs up the idea that businesses weigh the costs and
benefits of several financial planning rules before settling on one. These guidelines
may assist in shifting the focus of academic research away from the critique of widely
93
used financial budgeting techniques and toward the exploration of the reasons for the
46
widespread use of these techniques in actual practice. Their theories provide fresh
suggestions for research into corporate financial planning procedures. That is, it
would be fascinating to go further into the question of which techniques are employed
for specific projects and why, beyond just asking businesses to identify the methods
they use. They suggest that further polls like this one might shed light on why
companies choose certain financial planning strategies.
• DCF approaches such as NPV/IRR are the most essential techniques for project
assessment, according to a poll conducted by Kester and Chang (2009) among 226
74
CEOs from Australia, Hong Kong, Indonesia, Malaysia, the Philippines, and
72
Singapore. Worldwide, sensitivity analysis and scenario analysis are regarded as the
best methods for evaluating potential dangers in projects. Seventy-two percent of
Aussie respondents rely on CAPM when estimating the price of a stock. Both
57
Indonesia (53.4% of the population) and the Philippines (58.6%) choose the risk
premium approach (cost of loan + risk premium). In Hong Kong, 53.8% of people use
the dividend yield plus growth rate strategy.
Many competing uses demand a share of a limited pool of resources that businesses
must distribute. Firms may use the structure provided by financial management to
make informed choices.
33
The investment choices include not only those that boost earnings and profits but also
those that cut expenses. Consequently, the company's investment choices and asset
composition choices.
28
29
Expenditures that are recorded as assets on the balance sheet are considered capital
expenditures from an accounting perspective. Unless it is a non-depreciable asset like
land, this asset will be written off gradually over time. Conventions in accounting,
legal requirements, and the intention of management to inflate or deflate reported
earnings all play a role in determining whether an expense should be recorded as a
capital or revenue item. It is common practice for accountants to classify expenditures
on research and development, mass media advertising campaigns, and plant and
67
machinery refurbishment as operating expenses rather than capital expenditures,
94
despite the fact that these investments are expected to yield a steady flow of future
benefits.
FEATURES
17
Positive outcomes are anticipated down the road, although it may take many years.
They will have a major impact on the company's bottom line in the long run.
Planning for one's financial future requires careful budgeting. Company profits are
impacted by financial budgeting choices. Their impact on the company's ability to
compete in the market is equally significant. The budgeting choice is crucial to the
company's future.
Investments that are made at the right time may bring in huge profits, while those
made at the wrong time can put even the largest companies out of business.
29
Any choice to invest in fixed assets will have far-reaching consequences for the future
of the business, including how much it will have to spend on operations.
Investment in the capital is expensive, and most businesses have limited access to
financial resources.
88 6
Choosing where to put one's capital has a significant impact on the number of people
working in the economy, the kinds of businesses that can open, and the rate of
economic growth.
Organizations place a high value on budgetary choices, particularly those that pertain
to the allocation of resources toward long-term goals, such as the establishment of
industry standards. funding the acquisition of equipment and machinery etc. For the
purpose of evaluating the proposed growth or new capacity building Replacement
choices for fixed assets like infrastructure. The purpose of doing a financial analysis
of potential capital investment projects is to choose the best one available.
Value of Alternatives
30
Project Selection
IMPLEMENTATION
28
It's a crucial choice in the context of capital budgeting. The company will put money
77
into the venture if it is approved. Applying this criterion means that all standalone
initiatives are approved since the company will not invest in those that aren't
49
approved. To be considered independent, a project must not be in direct competition
with another.
Two options, each with drawbacks, must be chosen for a given project.
These are initiatives that are in direct competition with one another, wherein only one
14
may be accepted. Investments that are incompatible with one another are permitted
under the accept-reject criteria.
31
ANALYSIS OF THE INVESTMENT PLAN
Businesses, at all times, are presented with a wide variety of investment ideas.
However, companies only have so much money, so they can't afford to put money
into every idea they hear about.
The following two guiding ideas should be considered while making your criteria
choice.
52
The idea of larger being better than smaller holds that, all else being equal, larger
items are to be favored over smaller ones.
In other words, the bird in hand principle states that early advantages are preferable
37
when all other factors are equal.
In order to make sound choices, it is necessary to use both of the above guidelines.
INVESTMENT CRITERIA
32
DISCOUNTED CASH FLOW METHODS
The distinguishing characteristics of discounted cash flow financial budgeting
28
techniques are that they taking into consideration the time value of money while
68
evaluating the cost and benefits of the projects. They also take into consideration the
7
benefits and costs occurring during the entire life of the project
NET PRESENT VALUE METHOD
Formula
Rt(1 + i) tWhere
89
There are two main ways to evaluate plans for large-scale investments:
95
Methods for Discounting Cash Flows
Discounted cash flow financial planning strategies are distinct in that they factor in
the value of money over time when calculating project costs and returns. They think
about the project's lifetime and all of its expenses and advantages.
In finance, the NPV or NPW of a stream of future cash inflows and outflows is equal
48
to the sum of the PVs of those cash flows. When there are no outgoing cash flows
(such as the principal and interest on a bond) and only future cash inflows (coupon
2
payments and the eventual redemption value), the NPV equals the present value of
future cash flows minus the purchase price (which is its own PV). The net present
value (NPV) approach is often used to evaluate long-term projects by factoring in the
time worth of money. It's a common metric in capital budgeting and other areas of
economics, finance, and accounting since it reflects the surplus or deficit of cash
flows in present value terms after financing costs are deducted
The present value of all cash inflows and outflows is calculated by discounting them
(PV). The numbers are then tallied. hence, NPV equals the total of all terms,
33
tRt(1 + I
The opportunity cost of capital; discount rate (the rate of return that may be received
on a comparable investment in the financial markets).
Cash inflows minus cash outflows at time t equals the net cash flow or Rt. To stress
R0's position as (minus) the investment in educational settings, it is conventional to
43
put R0 to the left of the total.
Figure out what rate of interest you should choose as your minimum acceptable rate
2
of return. In other words, this is the rate of return below which the investor will no
longer consider the investment worthwhile.
Using the above-estimated discount rate, compute the present value of the entire
investment proceeds, i.e., each flow.
7
Subtract the present value of cash outflow from the total cost of any project to get its
NPV.
69
Using the following formula, you can calculate the present value of a rupee due in any
specified number of years.
PV = 1/ (I+r)t
Value at Present = PV
r=interest rate
34
The Acceptance Criteria
For initiatives that can't coexist, the different proposals would be rated from least to
most desirable. This should be approved since it has a larger NPV than the other two.
MERITS:
44
This approach of evaluation is valid since it takes into account the proposal's long-
term effects.
Changing the denominator of the NPV calculation allows for the discount rate to be
included in the computation. The longer the time frame, the lower the value of money
and the greater the discount rate, hence this rate is dynamic.
DEMERITS:
16
There are significant issues with the present value approach due to the need to
calculate the appropriate rate of return for discounting cash flows.
84 48
In the case of projects with varying effective lifespans, this approach may not provide
desirable outcomes.
35
2
ANNUALIZED RETURN ON INVESTMENT (IRR)
Financial budgeting makes use of the Internal Rate of Return (IRR) to evaluate and
compare the success of various investment opportunities. This metric is known by a
few other names, including the DCF Rate of Return and the rate of return (ROR). E11
The IRR is also known as the effective interest rate when discussing savings and
35 40
loans. The word "internal" indicates that environmental considerations were not taken
into account during the process of its computation (e.g., the interest rate or inflation).
An investment's IRR is defined as the rate of return that, when applied annually,
2
results in a net present value (NPV as Cr NET*1/(1+IRR)year) of zero for all cash
flows, positive and negative, from that investment.
The internal rate of return (IRR) of an investment is defined as the discount rate at
which the NPV of the investment's expenses (negative cash flows) equals the NPV of
its benefits (positive cash flows).
In principle, a business (or an individual) should take on any and all initiatives or
investments that provide an internal rate of return (IRR) higher than the cost of
capital. The firm's ability to invest may be constrained by its limited resources and/or
its inability to effectively manage a large number of initiatives.
Formulae
82
The internal rate of return is derived from the net present value as a function of the
2
rate of return, given a set of pairs (time, cash flow) associated with a project. An
internal rate of return is a rate of return whereby this function equals zero.
36
14
The internal rate of return (r) is defined as the product of the total number of periods
N, the net present value (NPV), and the number of (period, cash flow) pairings (n, Cn)
where n is a positive integer.
Although the period is often expressed in years, the computation may be simplified by
first determining r in the period in which the bulk of the issue is specified (for
28
example, in months if most of the cash flows occur at monthly intervals) and then
converting to an annual period.
35
It is possible to substitute any future date for the present, such as the end of a certain
annuity period; in this case, if the NPV is 0, the value obtained will also be zero.
To account for the fact that the cash flows in a life annuity are unpredictable, we
substitute their predicted values into the preceding calculation.
The value of r is not always calculable analytically. If so, you'll need to resort to
either numerical or graphical techniques.
MERITS
2
The potential return or risk of a project is determined by factoring in all cash flows
expected to occur over the course of its lifetime.
DEMERITS
When the NPV of a project does not fall with discount rates, the calculations might be
deceptive and provide contradictory outcomes. It also doesn't always point to the best
option when choosing between competing endeavors.
37
METHOD OF THE PROFITABILITY INDEX (PI):
MERITS:
Project profitability may be measured relatively by dividing the current value of cash
inflows by the starting cash outflows.
DEMERITS:
Frustratingly complex.
38
MODE OF REPAYMENT DURING PERIOD OF l)
The payback period of an investment proposal is the time it takes for the cash flow
after taxes to equal the initial expenditure. Pre-tax cash flow is essential. The scrap
value is ignored when calculating the payback term. The PBP may be determined in
two different methods.
Estimated yearly cost-cutting due to the projected investment is reflected in the cash
flows.
In other words, the project is approved if and only if the computed PBP is lower than
the standard.
14
Cash flow fluctuations from one year to the next need the second option. The
repayment schedule is determined.
The PBP method's inability to account for inflation led to this situation. A better
solution is to add up the current values of all inflows in reverse chronological order.
7
Discounted PBP refers to the horizon at which the present value of cash inflows is
equal to the present value of cash outflows. The project gets approved since its
reduced payback duration is shorter than expected.
The PBP is often utilized for financial analysis despite its major flaw.
39
Given a very lengthy project life and a consistent yearly cash flow, the PBP may be
thought of as basically equivalent to the IRR.
Similar to the breakeven point is the PBP. As a general guideline, it speeds up the
time spent on creating and assessing data.
For making a final decision on an investment proposal, the payback time approach
may be employed as a deciding factor. Given the possibility of a single investment.
The project will be approved if its yearly payback time is less than the target payback
period.
MERITS
DEMERITS
If the cash inflows and outflows don't balance out right away, you may calculate the
payback time by adding them up until the total is equal to the project's upfront cash
investment.
40
Rate of Return in Accounting (2) (ARR)
The term "accounting rate of return technique" refers to the average rate of return
used in financial statements. It's based on financial data (profit) rather than actual cash
inflows. We may decide whether or not to invest in a project based on the information
provided by the ARR approach.
The actual ARR would be compared to the minimum needed rate of return or cut-off
rate established by using ARR as an accept/reject criterion. For a project to be
approved, its actual ARR must be greater than the target ARR.
Budgetary Means
The Typical Capital Outlay = New Working Capital plus Salvage Value plus
Percentage
10
The Typical Annual Net Profit After Taxes + Net Cash Flow After Taxes
To do this, we compare the average real rate of return to some floor or needed
minimum rate of return. If the projected rate of return is greater than the target rate of
return, the project would be approved.
41
With several options on the table, it might be helpful to rank them according to their
typical rates of return. Prioritization may be accomplished by placing proposals with
increasing average rates of return at the front of the list.
MERITS
To determine the typical rate of return, we must consider all of the money received.
together with the flow of money. This projection of cash flows is predicated on the
following considerations.
Input expenses
Ratio of Decay
Taxation Rate
42
What the product's future demand will be like, etc.
43
CHAPTER-III
INDUSTRY AND COMPANY
PROFILE
44
3.1 INDUSTRY PROFILE
The Government of India's Department of Commerce, Ministry of Commerce, and
Industry founded the India Brand Equity Foundation (IBEF). IBEF's major mission is
to increase the visibility of Indian goods and services abroad by promoting the Made
in India badge in foreign markets. To accomplish this goal, IBEF collaborates
extensively with public and private sector actors.
India is already widely recognized as a reliable business partner, top investment
destination, expanding market, and source of high-quality services and manufactured
goods, and it is poised to see explosive expansion in the years to come.
Talent, Markets, Growth, and Opportunity are the engines that propel Brand India.
When it comes to current, accurate, and complete data on the Indian economy, states,
and sectors, www.ibef.org is the go-to resource for international investors,
international policymakers, and international media.
To spread awareness of Brand India, IBEF collaborates with a wide range of local and
international organizations.
78
There are two main categories in India's electrical equipment market: 1
Transformers, cables, transmission lines, and other T&D and ancillary equipment
An estimated 8% of manufacturing's value and 1.5% of GDP come from this area. 2
45
21
When it comes to mobile phone manufacturing, India is second only to China (from
just 2 mobile phone factories in 2014).
The value of mobile phone exports is expected to reach $1.7 billion by the end of the
forecast period (2021-22). (April 21-September 21).
About 27% of India's overall exports are in the category of engineering goods. The
Zero tariff Export Promotion Capital Goods (EPCG) plan has been a major
contributor to the recent development in exports of Engineering Goods.
13
The goal of the Indian Electrical Equipment Industry Mission Plan (2012-22) is to
establish India as a leader in the global manufacturing of electrical machinery. In
addition, it seeks to attain an output of USD 100 Bn by reducing the industry's trade
imbalance. 3
The demand for the electrical gear is expected to rise as a result of government
incentives to boost power-producing capacity. 4
Increases in both infrastructure spending and industrial output will drive expansion.
In order to weld ferrous tubes more quickly and with less energy usage than is
possible with traditional fusion welding or solid-state techniques, scientists have
devised smart IoT-based equipment.
46
Recent Proclamations
39
On June 29th, 2022, an agreement was signed between the Ministry of Heavy
Industries (MHI) and the Ministry of Skill Development and Entrepreneurship
(MSDE) to promote education and apprenticeships in the engineering trades for the
benefit of the capital goods industry.
27
On May 18th, 2022, MHI and the National Research Development Corporation
54
signed a memorandum of understanding to cooperate on a number of initiatives aimed
at ensuring the successful rollout of the Scheme for Enhancement of Competitiveness
in the Indian Capital Goods Sector.
58
On January 19th, 2021, Meity said that they were considering budgeting INR 7,500 cr
for IT hardware manufacturing under the PLI Scheme.
Statistics
The Indian Institute of Technology in Kharagpur, West Bengal, has received INR
37.692 crore as part of the Scheme for Enhancement of competitiveness in the Indian
Capital Goods Sector to establish a "Centre of Excellence."
The United States (14.7% of the total), China (5.7%), the United Arab Emirates
(5.1%), Italy (4.0%), and Germany (3.4%) are the top five destinations for India's
exports of Engineering Goods.
Engineering goods exports in August 2022 are estimated to be worth USD 8,253.47
mn, or 25.01% of the total exports for the month.
A total of USD 111632.94 million was earned from the export of engineering goods
between Apr. 21 and Mar. 22. This is an increase of 45.51 percent compared to the
same period in the previous year.
47
During the time period of April 21–March 22, engineering items accounted for 26.72
percent of the country's overall exports.
Machine and equipment production has increased by 10.8 percent, bringing the
average index of industrial production to 102.5 in the fiscal year 2021-22.
April 2022 saw a 7.8 percent rise from April 2021 when the index was rated at 94.4 to
a current value of 101.8 for Industrial Production of Manufacture of machinery and
equipment n.e.c. (weight: 4.76 percent).
Progress Motivators
27
To ensure the swift and effective rollout of the Scheme for Enhancement of
Competitiveness in the Indian Capital Goods Sector, MHI and the National Research
Development Corporation have signed a Memorandum of Understanding.
30
The capital goods industry is expected to benefit from an MoU signed by the
Ministries of Heavy Industries (MHI) and Skill Development and Entrepreneurship
(MSDE).
For the purpose of developing and commercializing Advanced Chemistry Cell (ACC)
Battery Storage, three companies have signed a Program Agreement under the PLI
Scheme.
48
In the electrical equipment industry, 100% FDI is permitted via the automated route,
provided that all necessary norms and legislation are followed.
From April 2000 to June 2022, the Electrical Equipment sector received a total of
USD 11,085.62 million in FDI equity investment. This accounts for 1.83% of the
overall FDI inflow across all industries.*
From April 2000 to June 2022, the Miscellaneous Mechanical & Engineering
Industries received a total of USD 4,138.24 million in FDI equity inflow.*
From April 2000 to June 2022, the Industrial Machinery industry attracted a total of
USD 6,229.09 million in foreign direct investment (FDI) equity inflow or 1.03% of
the total FDI inflow across all sectors*.
Machine Tools received a total of USD 1,034.71 million in FDI equity investments
between April 2000 and June 2022.*
Costs incurred-
INR 40,000 cr
49
INR 7,325 cr
76
See This Link for Information on Private Insurance Coverage Options
Industrial Strategy
REVOKING LICENSE *
13
With the goal of elevating India to the top of the list of countries producing electrical
machinery. By reducing the trade imbalance, it also hopes to increase output to $100
billion.
41
Phase Two of the Scheme to Improve Competitiveness in the Indian Capital Goods
Sector *
To further the progress made in Phase I of the Capital Goods scheme and to generate
even more enthusiasm for the development of a robust and internationally competitive
capital goods sector, the Scheme provides support to Common Technology
Development and Services Infrastructure with a total budget of INR 1207 crores,
including support from the Government's General Fund of INR 975 crore and
contributions from private industry totaling INR 232 crore.
The Scheme for Increasing Competitiveness in the Indian Capital Goods Sector has
approved two Centres of Excellence (CoEs) as part of its second phase.
73
Besides these federal and state programs, every Indian state has its own set of
incentives designed to attract businesses to the country. Subsidized land costs,
reduced stamp duties, exemptions from land sales and leases, patent subsidies,
electricity tariff incentives, a concessional interest rate on loans, investment
subsidies/tax incentives, subsidies for economically depressed regions, special
incentive packages for megaprojects, etc.
PROMOTION OF Exports *
51
Each of these schemes—Export Promotion Capital Goods Scheme, Duty Remission
scheme, Focus Product Scheme, Special Focus Product scheme, and Focus Market
scheme—offers its participants a different set of benefits.
ADVANCEMENT OF SKILLS *
FACILITIES INCENTIVES *
The government has designated fifteen special economic zones (SEZs) for the
manufacturing of engineering-related goods, including electrical equipment. In
addition, the engineering industry stands to benefit greatly from the expansion of the
Delhi-Mumbai industrial area.
An important part of India's public sector, Bharat Heavy Electricals Limited (BHEL)
is a major company in its industry. BHEL was founded to serve the demands of
India's power industry. Power, industry, transportation, and other vital economic
pillars all rely on my illustrious sector to convert, transmit, use, and save energy.
With over 160 project locations throughout INDIA and the rest of the world, and 10
separate production divisions, 8 service centers, and 4 power sectors, BHEL is well-
equipped to meet the needs of its clients quickly and efficiently.
52
Established in 1965, BHEL's Heavy Power Equipment Plant in Hyderabad is able to
produce Steam Turbines and Auxiliaries, Gas Turbines, Turbo Generators,
Compressors, Oilrigs, Pumps, and Heat Exchangers, among other products. Power
and Industrial Bowl Mills and Circuit Breakers.
31
The Ramachandra Puram Unit of Bharat Heavy Electricals Limited, Hyderabad, is
located about 30 kilometers from the city center on the outskirts of the old city of the
Qutub Shahi Kings. With the motto "Bringing Power To The People," BHEL,
Hyderabad had its start in 1965.
B.H.E.L., Ramachandra Puram owes its achievements to the fact that it strives to
contribute significantly to India's economic development. Putting up great effort to
contribute to India's development into a prosperous and independent nation.
B.H.E.L's first products were steam turbines, generators, and auxiliaries with
capacities of 12 MW, 60 MW, and 110 MW, all of which were developed in
conjunction with Skoda of Czechoslovakia and sold to the power and industrial
sectors.
After recognizing the need of diversifying its offerings, BHEL Hyderabad expanded
into new fields, using cutting-edge technology developed by global leaders.
B.H.E.L.'S STRATEGIES
VISION:
53
MISSION:
To dominate the Indian market for engineering goods, systems, and services in the
areas of power and transportation; manufacturing; utilities; and related infrastructure.
VALUES:
OBJECTIVES:
AIM: To increase BHEL's competitiveness across all of its business lines and into
emerging markets and internal processes, so ensure stable growth.
CUSTOMER FOCUS: To earn the trust and loyalty of our customers by exceeding
53
their expectations for value and service in every aspect—from the quality of our
products to the speed with which they are delivered.
EMPLOYEE ORIENTATION: Investing consistently in HR and being alert to the
51
requirements of employees so that they may realize their full potential, enhance their
skills, understand their roles and duties, and contribute to the company's success.
19
One of the company's top focuses is improving its technical prowess so that it can
better serve its customers and get an edge in the market.
To live up to the high standards set by our investors, customers, workers, and the
government that owns BHEL and the nation as a whole.expansion of an organization
54
By producing a wide range of products and offering complete services (from idea to
commissioning), BHEL, Hyderabad has become a Premier Engineering Institution
capable of fulfilling the expanding needs of core industries.
71
The development of the Hyderabad Unit may be broken down into six distinct stages,
with the first being the actual execution of the project. Every time BHEL, Hyderabad
expanded, it set a new standard for excellence by incorporating cutting-edge
technology and broadening its offerings to meet the shifting needs of its clientele.
ISO 9001 (1994) and ISO 9002 (1994) certifications were granted to BHEL
Hyderabad for all of its products by BVQI. As before, success has been achieved and
is still being maintained.
ADDITIONAL LICENSURES
Our Heat Exchangers and Pressure Vessels have been granted permission to bear the
56
prestigious "U" Symbol of the American Society of Mechanical Engineers (ASME),
USA.
55
56 BOARD OF DIRECTORS Atul Sobti Chairman Managing Director
57
58
HR AND Admin Section Intro: The General Manager of BHEL, Hyderabad's Human
Resources and Administration Department (P & A). The P&A Division is broken up
into sub-sections in order to conform to the organizational structure, and they are as
follows:
1) Workforce Development
2) Local Government
Hindi Section 6
f) Transportation Department.
Society for the Cooperation of Workers Under Contract with BHEL (BLCCS)
b) Establishment Section The Establishment Section is divided into two parts: the
Executive Establishment Section (EE), led by a Senior Manager, and the Non-
Executive Establishment Section (NEES), which is divided into seven personnel cells
led by personnel executives of varying ranks. All executives' documentation is kept in
one central location: the executive establishment section (EE).
The seven Personnel Cells serve the administrative requirements of the factory as a
whole, handling paperwork for workers in their respective departments and keeping
track of their personal information.
60
CHAPTER – IV
DATA ANALYSIS
&
INTERPRETATIONS
61
62
63
64
65
66
67
68
69
70
71
72
73
74
75
76
77
CHAPTER - VI
FINDINGS
SUGGESTIONS
CONCLUSION
78
FINDINGS & SUGGESTIONS
20
In this research project focusing on BHEL's budgeting practices, we've collected, evaluated,
and interpreted the available data. A highly dedicated, talented, efficient, and knowledgeable
team is BHEL's greatest asset, and the company prides itself on providing its employees with
a pleasant and productive work environment.
The data analysis resulted in the following conclusions.
It would cost an initial outlay of Rs 5,125,000,000 to complete the first project, whose
generation is the disparity in cash flows over a period of 10 years.
The plan has a positive NPV and IRP. If so, you need a return of 17.7 percent.
1.22 times >1 is a profitable profitability index.
There was a return of 43.8% on capital.
Generation 2 is the uneven cash flows over a 10-year period. A sum of Rs. 10,250,000,000
will be spent at the outset.
With a reduced PBP of 3.1 years, the investment will provide a profit in 3 years and 1 month.
If the project's Net Present Value (NPV) and Internal Rate of Return (IRR) are both positive,
the minimum acceptable rate of return (28% p
A profitability index of 1.74 indicates a profitable business.
A 62.9% ROI is achieved.
Uneven cash flow over a ten-year period is the focus of our third project, generation.
Initiation capital is 4125 million rupees.
The cash inflow has not fully fulfilled the investment. Since no repayment time is involved
(PBP).
The project has a negative NPV and IRR since the total discounted cash inflow is less than the
total cost of investment.
Having a profitability index of 0.58 is not ideal.
Investment yields a 19.8 percent rate of return.
A disparity in cash flow is generated over a ten-year period in the fourth project. Total initial
outlay is Rs. 8,125,000,000.
A 5.7-year PBP is the discounted target. In 5 years and 7 months, the capital outlay will be
recouped.
Considering the proposal's negative NPV and IRR, the minimum acceptable rate of return is
10.4%.
There is cause for concern given that the profitability index is just 0.9.
An ROI of 32% is achieved.
Inequitable financial flow during a 10-year period is the fifth generational project. The initial
outlay is Rs. 1920,000,000.
79
The cash inflow has not fully fulfilled the investment. There is thus no time for repayment
(PBP).
The project has a negative NPV and IRR since the total discounted cash inflow is less than the
total cost of investment.
With a profitability index of 0.44, things are looking bleak.
The ROI comes in at 14.78%.
80
RECOMMENDATIONS AND SUGGESTIONS
A universally applicable first-ever undertaking Because the project has a positive PBP of 4.2
years and a positive NPV, IRR, ROI, and PI, it will be implemented.
The NPV, IRR, ROI, and PI for the second project add up to positive numbers, making it a
go.
For the proposal's third project, both NPV and IRR are negative since the total pre-discounted
cash inflow is less than the cost of investment. Cash flow has not fully fulfilled the
investment, hence there is no PBP. ROI is 20%, which indicates values, thus the project is
needed even if P>I is just 0.58.
The project's net present value (NPV) is negative, its IRR is 10.4%, its project payback period
(PBP) is 5.7 months, and its return on investment (ROI) is 32%.
If the total of the project's pre-discounted cash inflows is less than the investment's cost, then
the project's net present value (NPV) and internal rate of return (IRR) will be negative. There
is no PBP since the cash inflow has not yet realized the full investment. Despite the low P>I
ratio (0.44), the project is needed since the ROI is 15%
81
BIBILIOGRAPHY
82
BIBILIOGRAPHY
1. Books
Budgeting and Management by I.M. Panday
Managing Your Business: M.Y. Khan & P.K. Jain
Management of Finances by Prasanna Chandra
Sudhendra Bhatt on Financial Management
To Count the Costs, by V. K. Saxena and C. D. Vashist
Strategic Money Management by S. N. Maheshwari
2. NEWSPAPERS .
The NEWSPAPERS are the second source.
1) Convention in Business
2) The current economic climate
(3) Type of Organization
3. JOURNALS .
Journal of Financial Economics, 2011, Chen, N. "Some Empirical Tests of Arbitrage Pricing."
Quote from "Finance" magazine in December 1983.
Cite: "Economic Forces and the Stock Market," by N. Chen, R. Roll, and S. Ross.
July 1986 issue of the Journal of Business, "Market,".
Market and Industry Factors in Stock Price Behavior. King, B.
January 1966 issue of the Journal of Business.
In "A Critique of the Tests of the Asset Pricing Theory: Part I: On
testing history and future of the theory." Financial Journal
From "Economics" magazine, March 1977.
See Sharpe, W. "A Simplified Model of Portfolio Analysis," Management Accounting
Review, vol.
January 1963 issue of "Government Science."
"A Finite Algorithm to Maximize Certain Functions," by B. Von Holhenbalken.
An Example of a Pseudo Concave Function
83