CAPITAL BUDGETING

TIMKEN INDIA LTD

Ashutosh Karan 9/7/22 FINANCIAL MANAGEMENT

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iFEEL
The Institute for Future Education, Entrepreneurship and Leadership

Financial Management

Post Graduate Diploma in Management

Assignment

On:

Capital Budgeting

Name of Student:

Ashutosh Karan

L118

Name of the Professor:

Prof. Adesh Doifode

Submitted To:

The Institute for Future Education, Entrepreneurship and Leadership

Date: - 09-07-2022
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CERTIFICATE

This is to certify that the Capital Budgeting of a company, has been prepared by Mr.
Ashutosh Karan under my direct supervision and guidance for the award of the
degree of PGDM.

His work on the subject has been checked by me from time to time. I am satisfied
regarding the authenticity of his observations, data analysis and conclusions and it
confirms to the standards of IFEEL, Lonavala.

I have great pleasure in forwarding it to IFEEL, Lonavala

Date: 09/07/2022 Prof. Adesh Doifode

Place: Lonavala Faculty & Guide FM

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ACKNOWLEDGEMENT

I would like to thank my FM Faculty Mr. Adesh Doifode who gave me a golden
opportunity to work on this project and guided me through the entire process. I
would also like to express my gratitude to my Dean, Dr Sudhir Salunkhe
wholeheartedly.
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CONTENT
Sr No Particulars Page
No
1 Introduction 5
2 Financial Ratios 6
3 Investment Criteria 7
1 Net Fixed Asset 7
2 Net Fixed Asset Turnover Ratio 8
3 Sales for the First Year 8
4 Sales Growth in Past 5 Years 8
5 Calculations Cost, Depreciation, and further Cash Flows 9
6 Cost of Equity 10
7 Cost of Debt 11
8 Weight of Equity and Weight of Debt 11
a Weight of Equity 11
b Weight of Debt 11
9 Weighted average Cost of Capital (WACC) calculation 11
10 Calculation of PV, NPV, IRR 12
a Present Value 12
b Net Present Value 12
c Internal Rate of Return 12
11 Payback Period & MIRR 13
a Payback Period 13
b MIRR 14
12 Profitability Index 14
4 Sensitivity Analysis 15
1 Analysis - Scenario 1 15
2 Analysis - Scenario 2 16
5 Analysis of the Project 17
6 Assumptions 18
7 Conclusion 19
8 Bibliography 20
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INTRODUCTION

The Timken Company is a global manufacturer of bearings and power transmission

products. Timken operates from 42 countries.

Timken is currently focused on expanding its tapered roller bearings and growing its offering
of industrial bearings and mechanical power transmission products and services. Today the
company engineers, manufactures and markets bearings, gear drives, automated lubrication
systems, belts, chain, couplings, and linear motion products, and offers a spectrum of powertrain
rebuild and repair services. Timken engineering knowledge in metallurgy, tribology and power
transmission is applied across bearings and related systems to improve the reliability and
efficiency of machinery around the world. Applications range from the Mars Rover to offshore wind
turbines.

Timken has a significant presence in India. The company's Indian subsidiary is called
Timken India, and is publicly listed on the National Stock Exchange of India and the Bombay Stock
Exchange. One of Timken India's largest customers is Indian Railways, and as of 2022, supplying
to Indian Railways accounted for approximately 17% of Timken India's revenue. In 2018, Timken
India acquired ABC Bearings, an Indian bearings manufacturing company.
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FINANCIAL RATIOS

Particulars FY21
Core EBITDA Margin (%) 21.7%
EBIT Margin (%) 15.3%
Operational Ratios
Pre-Tax Margin (%) 16.8%
PAT Margin (%) 12.4%

ROA (%) 7.58%

ROE (%) 10.66%
Performance/Efficiency
ROCE (%) 9.97%
Ratios
Fixed Asset Turnover (x) 2.52
Sales/Fixed Asset (x) 2.08

Total Debt/Equity (x) 0.02433

Financial Stability Ratios Current Ratio (x) 2.16
Quick Ratio (x) 1.32

Analysis of Ratio

• From the Operational ratios PAT margin is 12.4% which is considerably good.
• ROA is 7.58% which means company is efficiently converting the money it invests
into profit.
• ROE is 10.66% it means company is giving good returns from its Equity financing
and is more as compared to its competitors.
• Fixed Asset turnover ratio is 2.53 which is excellent to start a new project.
• Debt-Equity Ratio is 0.02433 this means the company is debt free. Inventing in any
new project Debt-Equity Ratio plays an important role hence in this case Debt-Equity
Ratio is very less hence projections will be very stable.
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INVESTMENT CRITERIA

1. Net Fixed Asset (Initial Investment)

Investment Criteria

Discounting Criteria Non-Discounting Criteria

Net Present Internal Rate Payback

Value of Return Period

We will be selecting NPV & IRR Method for Discounting Criteria and Payback Period
for Non-Discounting Criteria.

Net Block of the Company for the year ended 2021 was Rs.4605.02 million and
Capital WIP was Rs.974.73 million

Net Block of Original Company = Rs. 4,605.02 million

Capital WIP of original company = Rs. 974.73 million

Net Fixed Asset of original company = Rs. 5,579.75 million

10% of Net Fixed Asset = Rs. 557.98 million

Hence,

Initial Investment = Rs. 557.98 million

Tax Rate = 25%

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2. Net Fixed Asset Turnover Ratio

Revenue
Net Fixed Asset Turnover Ratio (NFAT) =
Net Fixed Asset

14105.2
=
5579.75

Net Fixed Asset Turnover Ratio (NFAT) = 2.53

3. Sales of the First Year

Revenue
Net Fixed Asset Turnover Ratio (NFAT) =
Net Fixed Asset

Revenue
2.53 =
557.98

Revenue (Sales for New Company) = Rs. 1410.52 million

4. Sales Growth in Past 5 Years

To calculate the increase in the sales over the period of 5 years we will use
Compound annual growth rate (CAGR) method.

4 Sales
CAGR = √Sales2021 − 1
2017

4 14105.2
CAGR = √ −1
11172.18

CAGR = 6%

Since 6% Growth is too low as compared to growth of Expenses, we will consider

8% Growth Rate for Sales.
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5. Calculations Cost, Depreciation, and further Cash Flows

Direct Cost for 1st year = Rs. 851.11 million

Indirect Cost for 1st year = Rs. 372.93 million
Total Expense = Rs. 1224.04 million

To calculate the increase in direct and indirect cost over the period of 5 years we will
use Compound annual growth rate (CAGR) method.

4 8511.07
CAGR direct = √ −1
6171

CAGR direct = 0.0837

CAGR direct = 8.37% (Converted to Percentage)

4 3729.26
CAGR indirect = √ −1
2742.36

CAGR indirect = 0.0798

CAGR indirect = 7.98% (Converted into percentage)

Depreciation Calculation

Current Year Depreciation

Depreciation =
Net Block

748.79
= ×100
5579.75

Depreciation= 13.42%
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Below is the Cash Flows for 5 years

Rs in Millions

Particulars Year 1 Year 2 Year 3 Year 4 Year 5

Net Fixed Asset 557.98 483.10 418.27 362.14 313.54
Revenue from Operations 1410.52 1523.36 1645.23 1776.85 1919.00
Less: Direct Expenses 851.11 922.34 999.54 1083.19 1173.85
Less: Indirect Expenses 372.93 402.71 434.88 469.62 507.13
Total Expenses 1224.03 1325.06 1434.42 1552.81 1680.98
EBITDA 186.49 198.31 210.81 224.04 238.01
Less: Depreciation 74.88 64.83 56.13 48.60 42.08
EBIT 111.61 133.48 154.68 175.44 195.94
Add: Other Income 23.40 23.40 23.40 23.40 23.40
Less: Interest cost 1.44 1.44 1.44 1.44 1.44
PBT 133.57 155.44 176.64 197.40 217.90
Less: Tax 33.39 38.86 44.16 49.35 54.47
Profit for the year 100.18 116.58 132.48 148.05 163.42
Add: Depreciation 74.88 64.83 56.13 48.60 42.08
Net Cash Flow 175.06 181.41 188.61 196.65 205.50

6. Cost of Equity

To Calculate Cost of Debt we will follow CAPM method

Cost of Equity = R f + β(R m − R f )

Where Rf = Risk Free Rate = 7.41%

Rm = Market Return = 21.80%

β = Reward for Risk = 0.63

Cost of Equity = 7.41 + 0.63(21.80 − 7.41)

𝐂𝐨𝐬𝐭 𝐨𝐟 𝐄𝐪𝐮𝐢𝐭𝐲 (𝐤 𝐞 ) = 𝟏𝟔. 𝟒𝟕%

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7. Cost of Debt

Interest Cost(1 − Tax)

Cost of Debt = × 100
Total Debt

1.44(1 − 0.25)
Cost of Debt = × 100
32.69

𝐂𝐨𝐬𝐭 𝐨𝐟 𝐃𝐞𝐛𝐭(𝐤 𝐝 ) = 𝟑. 𝟑𝟏%

8. Weight of Equity and Weight of Debt

a. Weight of Equity
Debt/Equity Ratio = 0.02433

1
Weight of Equity =
1 + (D/E Ratio)

1
Weight of Equity =
1 + 0.02433

Weight of Equity = 0.9762

𝐖𝐞𝐢𝐠𝐡𝐭 𝐨𝐟 𝐄𝐪𝐮𝐢𝐭𝐲 = 𝟗𝟕. 𝟔𝟐%(𝐂𝐨𝐧𝐯𝐞𝐫𝐭𝐞𝐝 𝐭𝐨 𝐏𝐞𝐫𝐜𝐞𝐧𝐭𝐚𝐠𝐞)

b. Weight of Debt

Weight of Debt = 100 − Weight of Equity

𝐖𝐞𝐢𝐠𝐡𝐭 𝐨𝐟 𝐃𝐞𝐛𝐭 = 𝟐. 𝟑𝟖 %

9. Weighted average Cost of Capital (WACC) calculation

WACC = (Weight of Equity × Cost of Equity) + (Weight of Debt × Cost of Debt)

WACC = (0.9762 × 16.47) + (0.0238 × 3.31)

𝐖𝐀𝐂𝐂 = 𝟏𝟔. 𝟏𝟔 %
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10. Calculation of PV, NPV, IRR

a. Present Value

NCF1 NCF2 NCF3 NCF4 NCF5

PV = + + + +
(1 + WACC)1 (1 + WACC)2 (1 + WACC)3 (1 + WACC)4 (1 + WACC)5

175.06 181.41 188.61 196.65 205.50

PV = + + + +
(1 + 0.1616)1 (1 + 0.1616)2 (1 + 0.1616)3 (1 + 0.1616)4 (1 + 0.1616)5

PV = 150.70 + 134.44 + 120.33 + 108 + 97.16

Present Value (𝐏𝐕) = 𝐑𝐬. 𝟔𝟏𝟎. 𝟔𝟒 𝐦𝐢𝐥𝐥𝐢𝐨𝐧

b. Net Present Value

Net Present Value = Present Value − Initial Investement
Net Present Value = 610.64 − 557.98

Net Present Value (𝐏𝐕) = 𝐑𝐬. 𝟓𝟐. 𝟔𝟔 𝐦𝐢𝐥𝐥𝐢𝐨𝐧

Since NPV is Positive and greater than zero we can proceed with the Project.

c. Internal Rate of Return

Calculation of Internal Rate of Return by Trial and Error Method

Considering WACCt = 25%

NCF1 NCF2 NCF3 NCF4 NCF5

PV = + + + +
(1 + WACCt )1 (1 + WACCt )2 (1 + WACCt )3 (1 + WACCt )4 (1 + WACCt )5

175.06 181.41 188.61 196.65 205.50

PV = + + + +
(1 + 0.25)1 (1 + 0.25)2 (1 + 0.25)3 (1 + 0.25)4 (1 + 0.25)5

PV = 140.04 + 116.10 + 96.57 + 80.55 + 67.34

PV = 500.60

NPV = Present Value – Initial Investment

NPV = 500.60 - 557.98

NPV = -57.37

As NPV is Negative, hence IRR will come between WACC and WACCt, i.e., between
16.16% and 25%
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Therefore, Calculating IRR by Interpolation method

NPVa
IRR = ra + ( × (rb − ra ))
NPVa − NPVb

ra = Lower Discount Rate(WACC) = 16.16%

rb = Higher Discount Rate(WACCt ) = 25%

NPVa = NPV at ra = 52.66

NPVb = NPV at rb = −57.37

52.66
IRR = 16.16 + ( × (25 − 16.16))
52.66 − (−57.37)

𝐈𝐑𝐑 = 𝟐𝟎. 𝟑𝟗%

11. Payback Period & MIRR

a. Payback Period

Years Year 1 Year 2 Year 3 Year 4 Year 5

Net Cash Flow 175.06 181.41 188.61 196.65 205.50
Net Cash Flow Cumulative 175.06 356.46 545.08 741.72 947.22

Cash Flow Exceeds the Initial Investment in 4th Year hence the Payback period will
be between 3 and 4 years

Unrecovered Cost
Payback Period = Years Before Full recovery +
Cash Flow during the year

(557.98 − 545.08)
Payback Period = 3 +
196.65

𝐏𝐚𝐲𝐛𝐚𝐜𝐤 𝐏𝐞𝐫𝐢𝐨𝐝 = 𝟑. 𝟎𝟕 𝐘𝐞𝐚𝐫𝐬

From the above we observe that the payback period i.e., the time period required for
the recovery of initial investment in the project is 3.07 Years. The Project can be
accepted if the payback period is less than the maximum benchmark period. Lower
the Payback period better it is for company since the initial investment will be
recovered quickly.
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b. Modified internal rate of return

PV for MIRR = NCF1 (1 + WACC)4 + NCF2 (1 + WACC)3 + NCF3 (1 + WACC)2
+ NCF4 (1 + WACC)1 + NCF5 (1 + WACC)0
PV for MIRR = 175.06(1 + 0.1616)4 + 181.41(1 + 0.1616)3
+ 188.61(1 + 0.1616)2 + 196.65(1 + 0.1616)1
+ 205.50(1 + 0.1616)0
PV for MIRR = 318.74 + 284.35 + 254.51 + 228.43 + 205.50
PV for MIRR = 1291.52
1/t
PV for MIRR
MIRR = ( ) −1
Initial Investment
1291.52 1/5
MIRR = ( ) −1
557.98
MIRR = 0.1828
𝐌𝐈𝐑𝐑 = 𝟏𝟖. 𝟐𝟖 % (𝐂𝐨𝐧𝐯𝐞𝐫𝐭𝐞𝐝 𝐭𝐨 𝐏𝐞𝐫𝐜𝐞𝐧𝐭𝐚𝐠𝐞)

12. Profitability Index

Present Value of Future Cash Flow
Profitability Index =
Initial Investment
610.64
Profitability Index =
557.98
𝐏𝐫𝐨𝐟𝐢𝐭𝐚𝐛𝐢𝐥𝐢𝐭𝐲 𝐈𝐧𝐝𝐞𝐱 = 𝟏. 𝟎𝟗
Since Profitability Index is > 1 we can continue with the Project.
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SENSITIVITY ANALYSIS

1. Analysis - Scenario 1

Increasing the Cost of Debt by 2%

Cost of Equity = 16.47 %

Cost of Debt = 5.31 %

Weight of Equity = 97.62 %

Weight of Equity = 2.38 %

WACC = (Weight of Equity × Cost of Equity) + (Weight of Debt × Cost of Debt)

WACC = (0.9762 × 16.47) + (0.0238 × 5.31)

𝐖𝐀𝐂𝐂 = 𝟏𝟔. 𝟐𝟏 %

NCF1 NCF2 NCF3 NCF4 NCF5

PV = 1
+ 2
+ 3
+ 4
+
(1 + WACC) (1 + WACC) (1 + WACC) (1 + WACC) (1 + WACC)5

175.06 181.41 188.61 196.65 205.50

PV = 1
+ 2
+ 3
+ 4
+
(1 + 0.1621) (1 + 0.1621) (1 + 0.1621) (1 + 0.1621) (1 + 0.1621)5

PV = 150.64 + 134.33 + 120.18 + 107.83 + 96.96

Present Value (𝐏𝐕) = 𝐑𝐬. 𝟔𝟎𝟗. 𝟗𝟒 𝐦𝐢𝐥𝐥𝐢𝐨𝐧

Net Present Value = Present Value − Initial Investement

Net Present Value = 609.94 − 557.98

Net Present Value (𝐏𝐕) = 𝐑𝐬. 𝟓𝟏. 𝟗𝟕 𝐦𝐢𝐥𝐥𝐢𝐨𝐧

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2. Analysis - Scenario 2

Considering debt – equity weightage of 1:1

Cost of Equity = 16.47 %

Cost of Debt = 3.31 %

Weight of Equity = 50 %

Weight of Equity = 50 %

WACC = (Weight of Equity × Cost of Equity) + (Weight of Debt × Cost of Debt)

WACC = (0.5 × 16.47) + (0.5 × 5.31)

𝐖𝐀𝐂𝐂 = 𝟗. 𝟖𝟗 %

NCF1 NCF2 NCF3 NCF4 NCF5

PV = 1
+ 2
+ 3
+ 4
+
(1 + WACC) (1 + WACC) (1 + WACC) (1 + WACC) (1 + WACC)5

175.06 181.41 188.61 196.65 205.50

PV = 1
+ 2
+ 3
+ 4
+
(1 + 0.0989) (1 + 0.0989) (1 + 0.0989) (1 + 0.0989) (1 + 0.0989)5

PV = 159.30 + 150.22 + 142.13 + 134.85 + 128.24

Present Value (𝐏𝐕) = 𝐑𝐬. 𝟕𝟏𝟒. 𝟕𝟒 𝐦𝐢𝐥𝐥𝐢𝐨𝐧

Net Present Value = Present Value − Initial Investement

Net Present Value = 714.74 − 557.98

Net Present Value (𝐏𝐕) = 𝐑𝐬. 𝟏𝟓𝟔. 𝟕𝟕 𝐦𝐢𝐥𝐥𝐢𝐨𝐧

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ANALYSIS OF THE PROJECT

1. Net Fixed Asset Turnover Ratio: Net Fixed Asset Turnover Ratio is good this
shows that the company will provide Rs. 2.53 for one rupee invested in the Project.
2. Cash Flows: Net Cash flow is increasing because Sales is assumed to increase
with the rate of 8%, although Direct and Indirect expense increased by 8.37% and
7.99% respectively, new Project is giving good Net Cash Flow.
3. Cost of Equity: Cost of Equity is on the higher side at 16.47%.
4. Cost of Debt: Cost of Debt is on the lower side at 3.31% because the company is
almost debt free with negligible short-term borrowings as compared to the Equity
but also Company will not get that much Tax shield which will impact the PAT.
5. NPV & IRR: NPV being Rs.52.66 million and IRR being 20.39% are positive for the
proposal of new project we can proceed with the project based in this.
6. Payback Period: The time period required for the recovery of initial investment in
the project is 3.07 Years
7. Modified Internal Rate of Return: The modified internal rate of return in this project
is 18.28% which is good for this project and that the project can be successfully
carried forward.
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ASSUMPTIONS
1. The increase in the sales per year is assumed to be 8%.
2. The increase in the direct expense and indirect expense is assumed to be increased
by geometric mean of the previous five years (CAGR)
3. Tax Rate is assumed to be 25%
4. The depreciation percentage to be charged is calculated by the depreciation of the
current year and the net block.
5. Depreciation is charged on WDV basis to the initial investment.
6. Other Income is assumed to be constant over the years
7. It is assumed that the loans bear a common interest rate.
8. It is assumed that the debt and the equity structure of the company remains the
same for the project also.
9. All the figures are in millions.
10. We assume that the IRR is constant for all the five years.
11. There is no salvage value in the project.
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CONCLUSION
Here we have analyzed the company’s projected cash flows for the new project.
We have also analyzed the NPV and the IRR to know about the feasibility of the project
and this project seems to be profitable from the viewpoint of the company.
We have also done two sensitivity analysis by calculating the WACC with an
increase in the cost of debt by 2%, and calculating WACC, PV & NPV by changing the
weightage of Debt and Equity to 50% equally.
By changing the Cost of debt and Weight of Equity and Debt the company is
showing Positive NPV this shows that the budgeting of New Project based on the
assumptions mentioned earlier is reliable with good returns.
Thus, we can conclude that the project should be continued
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BIBLIOGRAPHY

Websites
1. https://www.bseindia.com/stock-share-price/timken-india-
ltd/timken/522113/financials-annual-reports/
2. https://en.wikipedia.org/wiki/Timken_Company
3. https://www.timken.com/en-in/about/timken-in-india/