Capital budgeting

CHAPTER – I
INTRODUCTION TO THE CAPITAL BUDGETING
Capital budgeting and investment appraisal are the planning processes used in
corporate finance to assess whether long-term investments made by an organization—
such as new or replacement machinery, plants, products, or R&D projects—are
financially worthwhile to fund with cash from the firm's capitalization structures
(debt, equity, or retained earnings). It is the procedure of distributing funds for
significant investments or capital costs. A fundamental objective that falls within the
purview of corporate finance is raising the company's value for the benefit of its
shareholders.
Capital budgeting is the process a business employs to evaluate potential
significant projects or investments. Examples of initiatives that would need to be
approved or denied prior to approval include building a new factory or making a
sizable investment in an outside business.
A business may evaluate a possible project's lifetime cash inflows and
outflows as part of capital planning to see if the projected returns will satisfy a
suitable target benchmark. The process of capital budgeting is sometimes referred to
as "investment assessment."
In an ideal world, companies would take advantage of any and all chances and
projects that increase profit and value for shareholders. However, management uses
capital budgeting tools to identify which initiatives would generate the best return
over an applicable length of time, given that any business's capital or money available
for new projects is limited.
Many formal methods are used in capital budgeting, including the techniques such as
 Accounting rate of return
 Payback period
 Net present value
 Profitability index
 Internal rate of return
Importance of Capital Budgeting
Capital budgeting is the formal process of allocating funds for significant
purchases or investments. It involves the crucial decision made by the business over
how to use its current resources for the expansion of the company, including the
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 Capital budgeting

purchase, sale, modification, or replacement of fixed assets. Because of the enormous

amount of money invested and the risk involved, capital planning becomes essential.
Importance of capital budgeting –
1. Time's Impact on Profitability
2. Huge Investments
3. Reversing a decision is not possible.
4. Spending manage
5. in rank Flow
6. Helps in Investment Decision
7. Wealth Maximization
8. Risk and Uncertainty
9. The Difficulties of Choosing Investments
10. National Importance

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 Capital budgeting

CHAPTER-II
CONCEPTUAL FRAME WORK & REVIEW OF LITERATURE
The long-term financial planning for proposed capital outlays is referred to as capital
budgeting. It involves obtaining long-term funding and making use of it. It can be
characterized as the official procedure used by a company to invest and acquire
capital.
"The decision making process by which a firm evaluates the purchase of major
fixed assets" is another definition of capital budgeting. It entails the firm's choice to
allocate its present money for the addition, modification, and replacement of fixed
assets.
It deals exclusively with investment proposals, which are essentially long term
projects and are concerned with the allocation of firms scarce financial resources
among the available market opportunities.
Some of the examples of capital expenditure are
1. Cost of acquisition of permanent assets as land and buildings.
2. Cost of additions expansion, improvement as alteration in the fixed
assets.
3. R & D projects cost etc.,
Definition:
It is defined as "the process of investing a company's current funds in long-
term assets as profitably as possible over a number of years."
“Capital Budgeting is long term planning for financing proposed capital
outlays”.
T. Horngren
Meaning and Definition of Capital Budgeting:
The long-term financial planning for proposed capital outlays is referred to as
capital budgeting. It involves obtaining long-term funding and making use of it. It can
be characterized as the official procedure used by a company to acquire and invest
funds.
"The decision-making process by which a firm evaluates the purchase of
major fixed assets" is another definition of capital budgeting.It involves the choice
made by the company to use its current assets to add, replace, and modify fixed assets.

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 Capital budgeting

Its deals exclusively with investment proposals, which are essentially long
term projects and are concerned with the allocation of firms scarce financial resources
among the available market opportunities.
Some of the examples of capital expenditure are.
I. The price of purchasing long-term assets like real estate, buildings, equipment,
and goodwill, etc.
II. Cost of addition, expansion, improvement as alteration in the fixed assets.
III. Research and development project cost, etc.,
The distribution of a company's limited financial resources among the open
market opportunities is the focus of capital budgeting. When evaluating investment
options, one must weigh the projected future revenue streams from a project against
the upfront and ongoing costs associated with it.
Capital budgeting is essentially a continuous process in any grouping concern.
It is handled by various functional areas of management, including production,
marketing, engineering, financial management, etc. All relevant functional
departments are taken into consideration when making capital budgeting decisions.
The primary responsibility of a finance management in capital budgeting is to
thoroughly and critically analyze and assess the many possible ideas, after which they
must choose one. As previously mentioned, the primary goal of financial management
is to maximize shareholder wealth. Consequently, the goal of capital budgeting is to
identify long-term investment projects that are anticipated to have the greatest
potential to increase shareholder wealth over time.
FEATURES OF CAPITAL BUDGETING
The important features, which distinguish capital budgeting decision in other
day to day decisions, are.
 Making decisions on capital budgeting entails exchanging current resources
for future advantages.
 It is anticipated that the benefits would materialize over a number of years.
 The funds are invested in non-flexible and long term funds.
 They have a substantial and long-term impact on the company's profitability.
 They are irreversible decisions.
 They are ‘strategic’ investment decisions, involving large sums of money,
major departure from the past practices of the firm, significant change of the

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 Capital budgeting

firm’s expected earnings associated with high degree of risk, as compared to

‘tactical’ investment decisions which involve a relatively small amount of
funds that do not result in a major departure from the past practices of the
firm.
Need for Capital Budgeting:
The need for capital budgeting arises on account of the following reasons:
1) Maintaining Firm’s Competitive Position:
Only when the plants undergo periodic modernization will the company be
able to compete in the market. Plants that become obsolete must be replaced quickly.
This calls for capital expenditure, thus careful preparation is necessary.
2) Planning for future needs of the firm:
Capital budgets provide a plan of action which enables management to
forecast the quantity and timing of the production factors required to yield the desired
result.
3) Coordinating:
The requirement of various departments are budgets unified and harmonized
efforts can be ensured during the process. It results in greater efficiency and
productivity.
4) Cost Control:
Because the actual and budgeted expenses are regularly compared, control
over spending is made easier. Every time there are performances that go over budget,
corrective action can be done. Accountabilities can be set and responsibilities can be
allocated. Decentralized authority along with the necessary mechanism components
allows for the practice of efficient cost control.
5) Organizational Effectiveness:
Optimizing capital budgets maximizes the effectiveness of the organization.
The establishment of a framework that enables management to accomplish its goals is
aided by the proper allocation of the planned expenditure to the relevant cost and
profit centers.

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 Capital budgeting

Components of Capital Budgeting:

The following are the basic components of capital budgeting analysis:
1) Cash Outflows:
It is important to properly assess the money that will be invested at the
beginning of the project and any additional funds that will be needed later on. Other
expenses, such as those associated with shipping, installation, and working capital
requirements, are just as significant as the asset's cost.
2) Cash Inflows:
The next step is to estimate the projected financial returns on the investment.
Exercise must be performed as carefully as possible in terms of quantity and time. For
the duration of the project, the benefits will be the difference between the projected
revenues to be produced and the estimated costs to be incurred during a future time.
3) Cut-Off Rate:
The minimum rate of return which the firm would expect to have for accepting
a particular proposal should be predetermined. Generally, it is the firm’s marginal cost
of capital.
4) Ranking the Proposals:
There could be several appealing and accessible investing options. In this
situation, there may be multiple opportunities to take advantage of. Prioritizing and
ranking various investment proposals will assist management in making the right
choices, especially in situations where funds are limited.
5) Risk and Uncertainty:
The future is never guaranteed. Its blood runs with risk. Therefore, a company
can only be considered healthy if the risk and uncertainty components are
appropriately evaluated and appropriate measures are implemented to evaluate
profitability based on the evaluation of inherent risk and uncertainty. It is possible to
assign probability to the different predicted net revenues for this reason. Since it is
impossible to predict the future due to a wide range of elements including the general
state of the economy, specific factors related to the investment, competition, technical
advancements, consumer preferences, labor circumstances, etc., it is difficult to
determine the probability. Even yet, research into the components' effects should
continue, and appropriate modifications should be made when assessing investment
proposals.

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 Capital budgeting

6) Non-Monetary Aspects:
The monetary evaluation of investment proposals may lead to wrong
conclusions at times. Non- monetary considerations should also be weighted. For
example, image of the company is very important to be considered.
IMPORTANCE OF CAPITAL BUDGETING
The importance of capital budgeting can be understood from the facts that an
unsound investment decision may prove to be fatal to the very existence of the
organization.
The importance of capital budgeting arises mainly due to the following.
1. Large investment:
Making decisions about capital budgeting typically requires significant
financial outlays. However, the firms' available finances are limited, and the demand
for capital outpaces supply. Therefore, it is critical for a business to plan and manage
its capital expenditures.
2. Long term commitment of funds:
Capital expenditure involves not only large amount of funds but also funds for
long term or a permanent basis. The long term commitment of funds increase the
financial risk involved in the investment decision.
3. Irreversible nature:
The capital expenditure decisions are of irreversible nature. Once, the decision
for difficult to impose of these asset without incurring heavy losses.
4. Long term effect on profitability:
A company's long-term and substantial impact on its profitability is the result
of its capital budgeting decisions. The firm's current earnings are impacted by its
capital asset investment, but so are its future growth and the decisions made today
regarding investments. Making decisions on capital budgeting is nearly essential to
preventing excessive or insufficient investment in fixed assets.
5. Difference of investment decision:
The long term investment decision is difficult to be taken because
uncertainties of future and higher degree of risk.
KINDS OF CAPITAL BUDGETING:

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 Capital budgeting

Each capital budgeting decision is unique, and given the limitations and their
implications, there are countless possible kinds or variations of capital budgeting
decisions. Even if the same decision is being examined by the same company at two
distinct times, any change in one of the variables could affect the decision's
considerations. Nonetheless, there are other dimensions that may be used to
categorize the various forms of capital budgeting that various businesses occasionally
do. Certain efforts influence other initiatives that the firms are thinking about and
evaluating. On the other hand, some ideas are necessary in order to proceed with other
initiatives. The projects can also be characterized as cost-reduction or revenue-
generating initiatives, which fall into the following categories:
I. From the point of view of the firm’s existence:
The capital budgeting decision may be taken by a newly incorporated firm or
by an already existing firm.
New firm:
a) A recently formed business could have to make different decisions about what
plant to install, how to use capacity initially, whether to put up an ancillary
unit concurrently or not, etc.
b) Existing firm:
A firm which already exists may be required to take various decisions from time
to time meet the challenge of competition or changing Environment. These decisions
may be

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 Capital budgeting

i) Replacement and Modernization decision:

This kind of machinery is frequently needed to be replaced over time. The
choice will be made if the current plant has to be replaced since its useful life is
coming to an end. On the other hand, a decision may be considered a replacement
decision if an existing plant needs to be replaced since its economic life has come to
an end. Nonetheless, the decision to replace an existing plant because it is
technologically outdated (even though the plant's useful life may not be over) may be
referred to as a modernization decision. In case of a replacement decision, the
objective is to restore the same as higher capacity where as in case of modernization
decision, the objectives are to increase the efficiency and/or cost reductions. In
general, the replacement decision and the modernization decision are also known as
cost reduction decisions.
ii) Expansion
iii) In order to gain a larger market share, companies may occasionally be
interested in expanding their installed manufacturing capacity. The
finance manager must assess the growth program in terms of marginal
costs and benefits in such a scenario.
iv) Diversification
Sometimes, the firm may be interested to diversity into new product lines, new
markets production of spares part etc. in such a case, the finance manager is required
to evaluate the only the marginal cost and benefits, but also the effect of
diversification on the existing market share and profitability. Both the expansion and
diversification decisions may be also known as revenue increasing decisions.
II. From the point of view of Decision situation
The capital budgeting may also be classified from the point of view of the
decision situation as follows:
i) Dependent project decision
This is a fundamental decision in capital budgeting. It is also called as accept
reject criterion. If the project is accepted, the firm invests in it. In general, all these
proposals, which field at rate of return greater than certain required rate of return on
cost of capital are accepted and the rest are rejected. By applying this criterion all
independent projects with one in such a way that the acceptance of one precludes the
possibility of the acceptance of another. Under the accept reject decision all

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independent projects that satisfy the minimum investment criterion should be

improvement.
ii) Mutually Exclusive project decision
Projects that complement one another so that the approval of one precludes the
approval of the others are said to be mutually exclusive. There is just one option
available, and the alternatives are mutually exclusive. Let's say a business plans to
purchase each with a distinct adoption cost at first. Only one of the three machines—
representing mutually exclusive alternatives—can be chosen. One could argue that the
accept/reject decisions are influenced by the mutually exclusive project decisions.
iii) Capital rationing decision
In a situation where the firm has unlimited funds all independent investment
proposals yielding return greater than some pre-determined levels are accepted.
However, this situation does not prevail in most of the business firms in actual
practice. They have a fixed capital budget.
For these restricted funds, a lot of investment plans are complete; the company
has to ration them. When a company has more accepted investment than it can
finance, it engages in rationing—allocating cash to projects in a way that optimizes
long-term results. It deals with the capital rationing employees' accept-reject ranking
of the proposals that are acceptable for investment.
The project can be ranked on the basis of a predetermined criterion such as the
rate of return. The project is ranked in the descending order of the rate of return.
Problems and Difficulties in Capital Budgeting:
The problems in capital budgeting decision may be as follows:
a). Future Uncertainty:
Capital budgeting decision involves long term commitments. However, there
is lot of uncertainty in the long term uncertainty may be with reference to cost of the
project, future expected returns, future competition, legal provision, political situation
etc.,
b). Time Element:
The implication of a capital budgeting decision is scattered over long period.
The cost and benefit of a decision may occur at different point of time. The cost of
project id incurred immediately. However, the investment is recovered over number

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of fears. The future benefits have to be adjusted to make them comparable with the
cost. Long the time period involved, greater would be the uncertainty.
c). Difficulty in Qualification of impact
The finance manager can have trouble putting project costs and benefits into
numerical terms. For instance, the new product that a company plans to introduce may
cause sales of other products that the company now sells to rise or fall. As the sales of
the other than the introduction of the new items are launched, it is exceedingly
difficult to determine the level of influence.
Assumption in capital budgeting:
The capital budgeting decision process is a multi-faceted and analytical
process. A number of assumptions are required to be made. The assumption
constitutes a general set of condition with in which the financial aspects of different
proposals are to be evaluated. Some of these assumptions are.
1. Certainty with respect to cost and benefits
It is very difficult to estimate the cost and benefit of a proposal beyond 2-3
year in future. However, for a capital budgeting decision, it is assumed that the
estimate of cost and benefits are reasonably accurate and certain.
2. Profit motive
Another assumption is that the capital budgeting decisions are taken with a
primary motive of increasing the profit of the firm. No other motive or goal influences
the decision of the finance manager.
3. No capital Rationing
The capital budgeting choices made in this chapter are predicated on the idea
that capital is not scarce. It is assumed that a proposal would be approved or denied
based alone on its merits. The suggestions won't be taken into account in conjunction
with one another in order to make the most use of the funding that is available.
Capital budgeting process:
Capital budgeting is complex process as it involves decision relating to the
investment of current funds for the benefits for the benefits to be achieved in future
and the future are always uncertain. However, the following procedure may be
adopted in the process of capital budgeting.
i) Identification of investment proposals:

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Finding investment proposals is the first step in the capital budgeting process.
Proposals on possible investment opportunities may come from any officer within the
firm or from upper management. The head of the department evaluates different
suggestions based on company strategies and submits recommendations to the capital
expenditure planning.
ii) Screening proposals
The expenditure planning Committee screens the various proposals received
from different departments. The committee reviews these proposals from various
angles to ensure that these are in accordance with the corporate strategies or selection
criterion of the firm and also do not lead departmental imbalances.
iii) Evaluation of various proposal
The next step in the capital budgeting process is to various proposals. The
method which may be used for this purpose such as payback period method, rate of
return method, N.P.V and I.R.R. etc.,
iv) Fixing priorities
After evaluating various proposals, the unprofitable uneconomical proposals
may be rejected and it may not be possible for the firm to invest immediately in all the
acceptable proposals due to limitation of funds. Therefore, it essential to rank the
project/proposals after considering urgency risk and profitability involved in there.
Final Approval and Preparation of Capital Expenditure Budget:
Submissions that satisfy the assessment and other requirements are authorized
for incorporation into the capital budget. The amount projected to be spent on fixed
assets throughout the budget year is specified in the expenditure budget.
Implementing proposals
Preparation of a capital expenditure budget and incorporated of a particular
proposal in the budget doesn’t authorize to go ahead with the implementation of the
project.
A request to the capital expenditure committee, which assesses the project's
profitability under the modified conditions, for permission to spend the money should
be made. It is important to distribute responsibilities throughout project
implementation in a way that minimizes needless delays and overspending. Project
implementation can be controlled and monitored with the use of network techniques
like PERT and CPM.

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Performance Review
The review of the project's performance, which is done by comparing actual
and budgeted expenses as well as actual projected returns, is the lost step in the capital
budgeting process. If there are any negative variations, they should be investigated
and their reasons found so that future corrective action can be implemented.
Methods for Techniques of Capital Budgeting
There are many methods for the evaluating the profitability of investment
proposals the various commodity used methods are
Techniques of Capital Budgeting

Traditional Method Modern method

1. Payback period 1. N.P.V
2. Accounting Rate of Return 2. I.R.R
3. P.I
Traditional Methods: -
1. Payback period method (P.B.P)
2. Accounting Rate of return method (A.R.R)
Modern or Discounting techniques:
1. Net present value method (N.P.V)
2. Internal Rate of Return method (I.R.R)
3. Profitability index method (P.I)
I. Traditional Methods or Techniques:
As the name itself suggests, these techniques do not discount the cash flows to
find out their present worth. There is two such techniques available i.e.,
Payback period method and
Accounting rate of return
These are essentially rules of thumb that intuitively grapple with the trade-off
between net investment and operating cash inflows.
1. Payback period method (PBP):
This method is popularly known as pay-off, pay out or replacement period
method also. It is the most popular and widely recognized traditional method of
evaluating capital projects. It represents the number of years required to recover the

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 Capital budgeting

original cash outlay invested in a project. It is based on the principle that every capital
expenditure pays itself back over a number of years.
Computation of Payback Period-
The pay-back period can be ascertained in the following manner:
1) Calculate annual net earnings (profits) before depreciation and after taxes;
these are called annual cash inflows.
2) Divide the initial outlay (cost) of the project by the annual cash inflow,
where the project generates constant annual cash inflows.
Thus, where the project generates constant cash inflows:
Cash Outlay of the project or Original cost of the Asset
Payback Period = _______________________________________________
Annual Cash Inflows

Acceptance rule:
 Accept if PB < Standard payback
 Reject if PB > standard payback
Advantages of Pay-Back Period Method:
1) Simple to Operate:
The most significant merit is that it is simple to understand and easy to
calculate. Its simplicity is considered as a virtue, which is evident from the popularity
with business executives.
2) Calculation Costs Low:
Its calculation costs less while the other sophisticated techniques require lot o
analyst’s time and even use of computers.
Risk of Obsolescence High:
This method is ideally suitable in those industries where the risk of
obsolescence is high. There is no guarantee that the same technology would continue,
in future. In such industries, projects that have shorter payback period only are to be
financed.
Disadvantages of Pay-Back Period Method:
1) Cash flows not considered:

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 Capital budgeting

Cash inflows during the course of the project are not taken into account at all.
The cash inflows following the repayment term are not taken into consideration. Put
another way, even though the cash inflows are still there beyond the typical
repayment period of, say, five years, they are disregarded. Considering that it
disregards the time value of money, this approach is inappropriate for determining the
project's profitability.
2) Equal Weightage to all Cash Flows:
It fails to consider the pattern of cash inflows i.e., magnitude and timing of the
cash flows. It gives equal weights to all the cash inflows though they may happen at
different periods of time.
3) Difficulty in fixing Standard Period:
The firm may experience administrative difficulty to fix the standard payback
period, as there is no rationale in fixing the period.
4) Not consisting with Shareholders’ Wealth Maximization:
The payback period is not consistent with the maximization of the
shareholders’ wealth.
Suitability
In the following situations, pay-back period method may be successfully
employed.
If the project's liquidity is crucial to the company, the payback period
calculation will be helpful.
The payback period should be taken into consideration if projects run the risk
of failing completely all at once due to changes in technology, shifts in customer
attitudes, government takeover of the business, etc.
High external financing costs also make the pay-back period a useful
consideration.
For projects involving very uncertain returns, especially when returns
become increasingly more uncertain in future time periods, the method is suitable.
2. Accounting rate of return (or) Average rate of return:
This approach accounts for the projected returns on investment over the course
of the investment. Because the accounting concept of profit—net profit after tax and
depreciation—being applied in place of cash inflows under the Accounting Rate
Return technique, it is sometimes characterized as such.

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 Capital budgeting

This technique ranks different projects based on their rate of return or rate of
earnings. In comparison to a project with a lower rate of return, the one with the
greater rate of return is chosen. The choice of whether to accept or reject a proposal
can also be made using this process. After calculating the expected return, the project
that yields a greater expected rate of return than the cut off rate—a minimum rate set
by the company—is approved, while the one that yields a lower expected rate of
return than the minimum rate is rejected.
Avg. annual after depreciation & taxes/ No. of years
Average rate of return = ___________________________________________
Average cash outlays /2
Acceptance rule:
i) Average if ARR> minimum rate
ii) Reject if ARR < minimum rate
Projects with lesser returns are rejected, and a minimum rate of return is
predetermined. Cut-off rate is another name for the rate of return. When multiple
projects are submitted, only one of them can be approved. The projects are then
ranked according to their rates; the project with the highest rating is placed higher.
The projects may be approved based on the availability of cash, or all projects
offering the minimal rate may be chosen.
Advantages of Accounting Rate of Return:
1) Easy to Operate:
It is very simple to understand and easy to operate.
2) Considers Profitability:
In comparison to the pay-back period method, it provides a more accurate
picture of profitability since it computes the rate of return using the project's whole
earnings, not only the earnings up to the pay-back period.
3) Based on financial data:
As this method is based upon accounting concept of profits, it can be readily
calculated from the financial data.
Disadvantages of Accounting Rate of Return:
1) Ignores the Time Value of Money:
This method also like pay-back period method ignores the time value of
money as the profits earned at different points of time are given equal weight by

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average the profits. It ignores the fact that a rupee earned today is of more value than
a rupee earned a year after, or so.
Not consider Cash Flows:
It does not take into consideration the cash flows which are more important
than the accounting profits.
Ignores the Project Period:
It doesn't take into account the time frame during which earnings are made, so
a 20% rate of return over 2.5 years can be seen preferable than an 18% rate of return
over 12 years. This is incorrect since the risk associated with a project increases with
its duration.
4) Not suitable for investment in parts:
This method cannot be applied to a situation where investment in a project is
to be made in parts.
Suitability:
If the project life is not more, the method can be suitable to have a rough
assessment of the internal rate of return. The method is used generally as a
supplementary tool only.
II. Discounted cash flow techniques:
The classic approaches to capital planning, such as the pay-back method and
the accounting rate of return method, have significant drawbacks in that they
prioritize the present income stream above the future. The time value of money,
which states that money gained today is worth more than money earned five years
from now, is not taken into account by these methods. Both profitability and the time
value of money are taken into consideration by the time-adjusted or discounted cash
flow methodologies. These techniques, which are also known as contemporary
approaches of capital budgeting, are gaining popularity every day. The discounted
cash flow techniques are listed below.
There are three types of discounted cash flow techniques. They are
Net present value method (N.P.V)
Internal Rate of Return method (I.R.R)
Profitability index method (P.I)
1. Net Present Value:

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 Capital budgeting

The net present value approach is a contemporary technique for assessing

investment pitches. By adding the element of time, this method tries to compute the
return on investments while accounting for the time value of money. It acknowledged
that rupees earned now have a higher value than those earned tomorrow. Each year's
net present values of all inflows and outflows that occur over the course of the project
are calculated individually by discounting these flows using either the firm's cost of
capital or a predetermined rate.
The difference between P.V of cash flows and P.V of ash out flows in equal to
NPV the firms’ opportunity cost of capital being the discount rate.

Net present Value = Present Values of __ Present Values of Cash

Cash in flows out flows

Steps for Calculation of NPV:

The following are the necessary steps to be followed for adopting the net
present value method or evaluating investment proposals.
1) The cut-off rate of the discount rate is the suitable interest rate that should
be chosen as the minimum required rate of return. The minimal rate should be such
that an investor feels it is not profitable for him to invest below it. Either the market
interest rate for long-term loans or the investor's opportunity cost of capital should be
reflected in the discount rate..
2) Determine the discounted rate and use it to calculate the present value of the
entire investment expenditure, or cash outflows. The present value and the investment
cost must match if the entire amount is to be invested in the first year.
3) Compute the present values of total investment proceeds, i.e., cash 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 present value of cash outflows for each project.
5) The proposal may be approved if the net present value is positive or zero,
that is, if the present value of the cash inflows is greater than or equal to the present
value of the cash outflows. However, the plan ought to be turned down if the present
value of the cash inflows is smaller than the present value of the cash outflows.

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 Capital budgeting

6) To select between mutually exclusive projects, projects should be ranked in

order of net present values, i.e., the first preference should be given to the project
having the maximum positive net present value.
The present value of Re. 1 due in any number of years can be found with the
use of the following mathematical formula.
1
PV = ----------
(1+r) n

Where, PV = Present Value

r = Rate of interest / Discount Rate
n = Number of years
Acceptance rule:
i) Accept if NPC > 0 (i.e., NPV is Positive)
ii) Reject if NPV < 0 (i.e., NPV is negative)
iii) Project may be accepted if NPV = 0.
Features of NPV Method:
The NPV of simple project monotonically decreases as the discount rate
increases. The decrease in the NPV, however, is at a decreasing rate.
The NPV method is based on the assumption that the intermediate cash
inflows of the project are re-invested at a rate of return equal to the firm’s cost of
capital.
NPV Method can be used to accept/ reject the project: The project would be
accepted as the NPV is positive and reject if NPV is negative.
Advantages of Net Present Value Method:
1) Recognition of Time Value of Money:
It can be used in situations where there are consistent cash withdrawals and
irregular cash inflows or cash flows at different times since it acknowledges the time
value of money.
2) All Cash Flow Considered:
It takes into account the earnings over the entire life of the project and the true
profitability of the investment proposal can be evaluated.
3) Profitability objectives Achievement:
It takes into consideration the objective of maximum profitability.
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 Capital budgeting

4) Value Additivity principle:

It satisfies the value-additivity principle (i.e., NPV of two or more projects can
be added).
Disadvantages of Net Present Value Method:
1) Difficult to understand:
As compared to the traditional methods, the net present value method is more
difficult to understand and operate.
2) May not provide good results:
When comparing projects with different life spans, it might not produce the
best results since a project with a greater net present value but a longer realization
period would not be as desired as one with a lower net present value realized over a
much shorter asset life. Some when comparing projects with different financial
investments.
3) Difficulty in determining discount rate:
It is not easy to determine an appropriate discount rate.
Suitability:
When funds and other resources are not limited, the approach is thought to be
the most appropriate. If management is free to choose any number of projects, it may
accept any project as long as it has a positive net present value. Given that it also
covers the cost of capital, the project with "zero" net present value may be the final
one to be approved. The ultimate goal of every business venture is to maximize the
wealth of its shareholders and the market value of its equity shares. This approach
will achieve this goal.
2. Internal Rate of return:
Another contemporary form of capital planning that accounts for the time
value of money is the internal rate of return method. Another name for it is discounted
flow with a time-adjusted rate of return. yield methods based on trial and error and
discounted rate of return. By discounting a project's future cash flow at a predefined
rate known as the "cut-off rate," the net present value is calculated using the net
present value method. However, the hit and trail approach is used under the internal
rate of return method to discount a project's cash flows at an appropriate rate, meaning
that the computed net present value equals the invested amount.Under this method,
since the discount rate is determined internally, this method is called as the internal

20
 Capital budgeting

rate of return method. The internal rate of return can be defined as that rate of
discount at which the present value of cash inflows is equal to the present value of
cash outflows.

Present Values of Lower Rate − Initial investment

I.R.R= Lower Rate + -----------------------------------------------------------------X Dif. rate
Present Values of Lower Rate – Present Values of
Higher Rate
Total Cash inflows
Fake Annuity table project = -------------------------
No. of years
Initial Investment
Pay Back Period Method = -----------------------
Fake Annuity
Steps for calculation of IRR:
The following steps are required to practice the internal rate of return method.
1) Determine the future net cash flows during the entire economic life of
the project. The cash inflows are estimated for future profits before depreciation but
after taxes.
2) Determine the rate of discount at which the value of cash inflows is
equal to the present value of cash outflows. This may be determined as explained after
step (4).
3) Accept the proposal if the internal rate of return is higher than or equal
to the minimum required rate of return, i.e., the cost of capital or cut off rate and
reject the proposal if the internal rate of return is lower than the cost of cut-off-rate.
4) In case of alternative proposals select the proposal with the highest
rate of return as long as the rates are higher than the cost of capital or cut-off-rate.
Acceptance Criterion:
The computed internal rate of return and the needed rate of return will be
contrasted. The minimal rate of return that can be anticipated from an investment—
which could be equal to the company's cost of capital—is known as the necessary rate
of return. In case the internal rate of return equals or exceeds the required rate, the
project may be accepted, otherwise rejected. In the event of several alternatives,

21
 Capital budgeting

projects may be ranked according to their internal rates of return – the project with the
highest internal rate is ranked first and, so on. Acceptance of more than one project
may follow in order of priority.
Advantages of Internal Rate of Return Method:
1) Recognition of Time Value:
Like that net present value method, it takes into account the time value of
money and can be usefully applied in situation with even as well as un even cash flow
at different periods of time.
2) Evaluate True profitability:
It considers the profitability of the project for its entire economic life and
hence enables evaluation of true profitability.
3) Cash flows:
All the cash flows occurring over the entire life of the project are considered
for calculating rate of return.
4) Shareholders’ Wealth Maximization:
It is consistent with the objective of shareholders’ wealth maximization.
5) Proposal Selection:
It helps in selecting the proposals, which is expected to earn more than the
required rate of return.
6) More Practical:
Since IRR is expressed as a percentage, it is easy to compare IRR of different
projects and make proper selection, in the order of ranking.
Disadvantages of Internal Rate of Return Method:
1) Difficult to Understand:
It is difficult to understand and is the most difficult method of evaluation of
investment proposals.
2) Earnings are reinvested:
This method is based upon the assumption that the earning is reinvested at the
internal rate of return for the remaining life of the project, which is not a justified
assumption particularly when the average rate of return earned by the firm is not close
to the internal rate of return. In this sense, Net Present Value method seems to be
better as it assumes that the earnings value method seems to be better as it assumes
that the earnings are reinvested at the rate of firm’s cost of capital.

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 Capital budgeting

3) Difference in Results:
The results of NPV method and IRR method may differ when the projects
under evaluation differ in their size, life and timings of each flow.
3. Profitability Index:
It is also a time-adjusted method of evaluating the investment proposals.
Profitability Index also called as Benefit-Cost Ratio (BC) or ‘Desirability factor’ is
the relationship between present value of cash inflows and the present value of cash
outflows. Thus
Present value of Cash inflows
Profitability Index = ____________________________
Present value of Cash Outflows
The profitability index may be found for net present values of inflows
NPV (Net Present Value)
P.I. (Net) = _____________________
Initial Cash Outlay

OR

PV of Cash Inflows
P.I. (Net) = _____________________ P.I. (Net) = P.I. (Gross)
--- 1
Initial Cash Outlay

The net profitability index can also be found as Profitability Index (gross)
minus one.
The proposal is accepted if the profitability index is more than one and is
rejected in case the profitability index is less than one. The various projects are ranked
under this method in order of their profitability index, in such a manner that one with
higher profitability index is ranked higher than the other with lower profitability
index.
Acceptance rule:
Accept if PI > 1.0
Reject if PI < 1.0

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 Capital budgeting

Project may be accepted if P.I. = 1.0

Advantages of Profitability Index:
It is consistent with the goal of maximizing the shareholder’s wealth.
It uses cash flow.
It recognizes the time value of money.
Disadvantages of Profitability Index:
The main demerit of this method is that is requires detailed long term forecasts
of the incremental benefits and costs. It also poses difficulty in determining
appropriate discount rate.
Capital Budgeting Methods in Practice
In a study of the capital budgeting practices of fourteen media to large size
companies in India. It was found that all companies, except one, used payback with
payback and / or other techniques about two-thirds of companies used IRR and about
two-fifths NPV. IRR was found to the second most popular method.
The reasons for the popularity of payback in order of significance were stated
to be its simplicity to use and understand, its emphasis on the early recovery of
investment and focus on risk.
 It was also found that one – third of companies always insisted on the computation
of payback for all projects, one – third for majority of projects and remaining for
some of the projects for about two thirds of company’s standard payback ranged
between 3 and 5 years.
The lack of qualified professionals, the inability to grasp and use these
approaches, and the reluctance of upper management to adopt DCF techniques were
the main causes of the secondary role of DCF techniques in India. A sizable
manufacturing and marketing company stated that discounted cash flow
methodologies were unnecessary due to the nature of their operation. Another
organization, however, claimed that because replacement projects were carried out on
a regular basis, the discounted cash flow technique was not thought to be required
when assessing them.

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 Capital budgeting

CHAPTER –III
RESEARCH DESIGN & METHODOLOGY

3.1 STATEMENT OF THE PROBLEM

The value of the money and projected prospective income under the method
are increasingly sought after by sectors. I completed all capital budgeting techniques,
including NPV, IRR, PI, ARR, and PBM.

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 Capital budgeting

3.2 NEED FOR THE STUDY

Capital Making financial judgments in the first plane heavily relies on

budgetary decisions. These choices have an impact on a company's profitability. Due
in large part to their connection to fixed assets, they also affect the enterprise's ability
to compete. In a way, the company's real earning assets are represented by its fixed
assets.

3.3 OBJECTIVES OF THE STUDY

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 Capital budgeting

 To research the many funding options that the company has for its operations.
 To know the total value of the firm.
 To analyze earning per share under different capital budgeting from 2010-
2013.
 To examine Chaitanya Chemicals Ltd.'s capital budgeting
 To study the impact of liquidity and profitability of the Chaitanya Chemicals
Ltd.,
 To give guide lines for capital budgeting planning.

3.4 SCOPE OF THE STUDY

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 Capital budgeting

The scope and period of study is restricted to the following:

The scope of is restricted to Chaitanya Chemicals Ltd.'s operations. The data
is exclusive to Chaitanya Chemicals Ltd. and was gathered from primary and
secondary sources. Reduced current assets or current liabilities in the budget, as well
as their percentage contribution to the overall turnover, are all included in the overall
evaluation of current assets and current liabilities. This one would be able to gauge
the performance of current assets and current liabilities of the capital budgeting
requirements of Chaitanya Chemicals Ltd., and highlight the company. The annual
increase or decrease of current assets or current liabilities in the budget of Chaitanya
Chemicals Ltd. is being reviewed from this one. This project greatly deals with key
rations to obtain a clearer picture of different resources available and at the disposal of
the organization which will enable one to give appropriation suggestion to the
company to improve its performance if any.

3.5 RESEARCH METHODOLOGY

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 Capital budgeting

Sources of Data:
Following an examination of several data collection techniques, it was
determined that both primary and secondary data would work well in this survey.
Primary Data:
The primary data was collected mainly through interactions and discussions
with the company’s executives.
Secondary Data:
The organization's year-by-year annual reports contain balance sheets and
profit and loss accounts, which are sources of secondary data. A major factor in
establishing the framework for managerial choices is financial statements.
Financial performance evaluation is the process of identifying the financial
strengths and weakness of the firm by properly establishing relationship between the
items of the balance sheet and the profit and loss account.
TOOLS AND TECHNIQUES

 The data collected for the study is presented in the form of tables and simple
bar diagrams.

3.6 LIMITATIONS OF THE STUDY

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 Capital budgeting

 The study is carried out in a brief amount of time. The study might not be
comprehensive in every way.
 Chaitanya Chemicals Ltd.'s annual reports, internal reports, and other data
sources were used for the study, and analysis was done in accordance with the
data.
 Figures whatever appearing is too rounded to the nearest rupee thousands.
 Because the records and statements have their own preparational constraints,
the data is secondary in nature.

CHAPTER –IV
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 Capital budgeting

INDUSTRY & COMPANY PROFILE

INDUSTRY PROFILE
There have been numerous instances since the Industrial Revolution of how
fresh discoveries have contributed to global economic growth. There was no true
definition of expansion prior to that time, other than through exploration, conquest,
and theft. The majority of people were aware that they were born into a specific life
status. It is no accident that Adam Smith's "The Wealth of Nations" was published in
1776, marking the start of the modern period. His insight into an economic structure
capable of supporting and advancing this revolution is something we continue to owe
to him. It is a wonder that growth rates have increased so dramatically since then,
given how quickly the world's population was expanding.
Despite the fact that the majority of the early industrial revolution inventions
were empirical rather than scientific, science has played a significant role in current
technologically oriented industry and, consequently, in the significant economic
growth previously discussed. This is especially true in the twentieth century. As the
first science-based industry, we made the decision a few years ago to investigate the
chemical business in order to shed light on this topic. It started as a science-based
enterprise in the United Kingdom in 1856 when William Henry Perk discovered
synthetic mauve, although it has older scientific underpinnings that we will touch on
briefly.
Our new book, Chemicals and Long-Term Economic Growth, edited by
Professor Nathan Rosenberg of Stanford and us, was released in 1998 by John Wiley
and Sons in association with the Chemical Heritage Foundation. It provides an
overview of this amazing evolution. Some of these comments are owed to that study.
The eighteenth century saw the beginning of the science of chemistry. Antoine
Lavoisier was the first chemist to be genuinely scientific; he measured and observed
chemical reactions in a methodical manner. Regretfully, he was executed by guillotine
during the 1794 revolution—not for his scientific expertise, but rather because he
worked as an excise officer for the Ancient Regime to support himself.
Lavoisier had followers. The young German Justus von lei big, himself a
student of Lavoisier’s follower, Joseph Gay-Lussac established the systematic
teaching of chemistry at the University of Giessen in the early 1830s.In so doing, he
originated the concept of the research university, the institutional framework that

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 Capital budgeting

would lead the German to dominate in chemistry until late in the nineteenth century.
That lineage has continued: M.I.T”s Warren K. Lewis, the founder of modern
chemical engineering, received his doctorate in chemistry at the University of
Breslau, as did many of his colleagues in other German universities
August Wilhelm von Hofmann, Liebig's assistant, was hired by the British in
1845 to head the newly formed Royal College of Chemistry. Perkin was a student of
Hofmann's. From Lavoisier to Gay-Lussac to Hofmann to Perkin—each building on
his predecessor to the earliest stages of the first science-based industry—we may thus
trace the intellectual chain in this way.
Our study focused on four representative countries that differentiated
themselves from one another and are therefore valuable for historical purposes, so
illustrate how the influences external and internal to the chemical firms of the world
came to the affect the growth of the industry. These countries were Britain, Germany,
the United States and Japan.
The early version of the inorganic chemical industry was in some sense closer
to mining that the science –based chemistry of today. Perkin’s discovery in 1856
launched the modern chemical industry.
Up until the 1870s, Britain was the industrial leader in dyestuffs. For England,
these were the best of times. The country was wealthy. Its organic chemical sector,
which produced dyes, possessed the greatest technological know-how, the greatest
supply of coal, a basic raw material, and the largest consumer base (textiles).
However, those benefits were lost, and by the end of the 1880s, the Germans were in
control of the organic chemistry sector. Around 140,000 tons of dyes were produced
by German firms by 1913, compared to 10,000 tons in Switzerland and 4,400 tons in
Britain. With the exception of local explosives manufacturing, American industry was
a major producer of basic inorganic chemicals, but its organic chemical needs were
primarily met by imports, particularly German dyestuff.

EVOLUTION OF INDUSTRY STRUCTURE:

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 Capital budgeting

Two principal driving forces have been behind the industry’s growth in the past
half of century:
 The field of polymer science is responsible for creating the synthetic fibers,
resins, adhesives, paints, and coatings that are practically synonymous with
"modern" materials.
 Engineering with chemicals. which enabled these materials to be produced at a
price point that would guarantee their success (Aurora and Gambardella,
1998)
Polymer products are made from petrochemicals as raw materials. The first
nation to establish a petrochemicals sector was the United States, which started doing
so early in the century and possesses large deposits of natural gas and oil. The
structure of the industry and technology were significantly impacted by World War II.
The U.S. government supported extensive initiatives for the development and
manufacturing of synthetic rubber as part of the war effort, which increased demand
for oil for aviation fuel. Following the war, there was an enormous increase in the
demand for automobiles and fuel. By 1950, natural gas and oil accounted for half of
all organic compounds produced in the United States. By 1960, the percentage had
reached about 90% (Chapman 1991). Numerous oil corporations, including Shell,
Exxon, Amoco, BP, and Arco, emerge as significant manufacturers of basic and
intermediate chemicals made from feedstocks obtained from petroleum.
The chemicals industry in Germany and Britain rebuilt and grew
rapidly, shifting its organic chemical production from coal to petrochemicals nearly as
quickly as had the United States. During the 1950s and 1960s, Japan made an
astonishingly rapid entry into petrochemicals, leading to a rapid growth of the
chemical industry. Apart from the three main keiretsu (Mitsui, Mitsubishi, and
sumitomo), several other companies, such as Asahi Chemical plants (Hikino et al,
1998)
The technological lead of U.S. chemical producers in petrochemicals was
eroded as oil companies and engineering design firms diffused the technology
internationally. Technology for producing a variety of imported products became
more widely available.

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 Capital budgeting

Moreover, the development of a world market in oil meant that the oil and natural gas
endowments of the United States did not prove to be an overwhelming of comparative
advantage:
By the end of the 1960s, European countries and Japan had successes in
closing much of the gap with the United States. Since then, relative shares in world
output have largely remained constant, although in some sectors, such as
pharmaceuticals, some relative changes have occurred.
Technology spread more extensively than it had ever done after the industry's
major technological drive in the 1950s and 1960s. In addition to SEFs' efforts,
traditional sorts of inventions saw their payoffs reduced by heightened competition
and weaker demand growth. The process of commercialization grew more costly and
demanded ever-deeper market and consumer analysis. The industry, driven in part by
the constant pressure from shareholders and their representatives, is overcapacity.
Numerous companies saw significant reorganizations of their product lines, which
were followed by numerous mergers, acquisitions, and divestitures as well as the
emergence of brand-new companies in the market.
During this phase, many firms cut down on R&D and refocused R&D
expenditures on shorter-term projects and away from more fundamental research. In
the past couple of years, there are some indications that the industry may be entering a
new phase of technological change, and R&D spending appears to be picking up also,
as well as increased activity in transporter acquisitions in addition to domestic ones.
The adjustment o the new equilibrium was slow and painful. Economies of
large-scale production meant that existing producers had sunk large investments in
capacity, especially in the basic intermediates. The problem was magnified because
many chemical and petrochemical operations were highly integrated, both vertically
and horizontally.
The restructuring process sheds light on the relative strategic significance of
various investment kinds. As the high technology industry evolves, so do the
characteristics of corporate governance and strategy. The industry rationalized
capacity during the first phase of restructuring by gradually eliminating outdated and
less effective capacity. By the middle of the 1980s, it looks that the United States had
completed this phase of the restructuring. It was followed by a restructuring in the
corporate sector that reached its peak in the United States in the late 1980s, but

34
 Capital budgeting

continues today. Restructuring in Western Europe appears to have lagged behind the
United States by about five years or so.
The industries with the most intense rivalry, basic and intermediate
petrochemicals, have seen the most notable reorganization. A number of established
chemical companies in the US and Europe are pulling out of some of their commodity
chemical operations and shifting their attention downstream to industries where better
profits can be achieved through product differentiation based on quality and
performance. Oil companies like Shell, BP, Exxon, Arco, and Amoco (which will
soon be absorbed by BP-Amoco) as well as other companies like Vista, Quantum,
Cain, Sterling, and Huntsman have replaced them. A large number of the latter are
new companies that have taken over the commodity chemicals businesses that
companies like Conoco, Texaco, Monsanto, and USX were leaving behind. In Europe
as well, new focused firms such as Borealis, Clarian, and Montello have been formed
by merging businesses of existing companies. The new companies seem to be
separating into those that produce high value added, specialty chemicals and those
that manufacture larger-volume commodity chemicals.

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 Capital budgeting

CHEMICAL INDUSTRY MAP IN INDIA

36
 Capital budgeting

COMPANY PROFILE
In 1991, Chaitanya Chemicals was founded with the humble goal of producing
barium chloride. Co-founders Mr. S.V. Rama Moorthy and Mr. G.V. Chandra Mouli
are in charge of the business. Chaitanya Chemicals is currently the biggest producer
of barium chloride. Sodium hydroxide, Sodium sulfide, barium carbonate, barium
nitrate, barium hydroxide, and barium sulfide Located in Kadapa, Andhra Pradesh,
South India, Chaitanya Chemicals is currently exporting to quality-conscious clients
in the USA, Japan, Singapore, Middle East, France, Taiwan, Germany, and other
countries. As of right now, all barium chloride that leaves Indian borders is produced
there.a. Our hometown of Kadapa is the site of the world's second-largest baryte
mine, producing all of the barytes used to make all barium salts. Because of the best
raw materials available (free of strontium and other heavy metals), the management's
dedication to excellence, and the enthusiastic teamwork of every employee, Chaitanya
Chemicals can now compete with the world's top suppliers in terms of both quality
and competitiveness..
History of Chaitanya Chemicals
In 1991, Chaitanya Chemicals was founded with the humble goal of producing
barium sulphide. Today, Chaitanya Chemicals is the biggest producer of barium
chloride and sodium hydro sulphide in India thanks to their unwavering commitment
to quality since their founding, highly motivated workforce, and cutting edge
management under the direction of Mr. S.V. Rama Moorthy and Mr. G.V. Chandra
Mouli. With cutting-edge production equipment and first-rate research and
development to support it, Chaitanya Chemicals is now known throughout India for
producing sodium hydrosulfuride and barium chloride and exporting its goods to
nations in North America, Europe, and the Middle East.
Established in 1991 Chaitanya chemicals today is the largest manufacturer of
Barium Chloride (15000 MT per annum) and sodium Hydro (10000 MT per annum)
in India. The company is led by the co-founders of Mr.Rama moorthy and Mr.
Chandra mouli.
Chaitanya chemicals today manufacture:
 Barium Chloride
 Barium carbonate
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 Capital budgeting

 Barium nitrate
 Barium Hydroxide
 Barium sulphide
 Sodium Hydro sulphide &
 Sodium sulphide.
Chaitanya chemicals are currently exporting to quality conscious customers in
USA, Japan, Singapore, Middle East, France, Taiwan, Germany etc. Till to dates
all Barium chloride leaving Indian shores is manufactured at Chaitanya Chemicals
South India's Kadapa, Andhra Pradesh is home to Chaitanya Chemicals. Our native
town of Kadapa is the mining location for barites, which are the basic material used to
make all barium salts. India is the world's second-largest producer of barites. The best
raw materials available (free of strontium and other heavy metals), the management's
dedication to excellence, and the enthusiastic teamwork of the entire workforce have
elevated Chaitanya Chemicals to the level of the world's top suppliers in terms of both
quality and competitiveness.
CHAITANYA CHEMICAL (NEW UNIT)
Year of Establishment : 2009

Products : Barium chloride, Barium Carbonate, Barium sulphide, Sodium

hydrosulphide, Sodium sulphide

Capacity : Barium chloride -10,000 MT per annum

Barium Carbonate-5000 MT per annum
Barium Sulphide-20,000 MT per annum
Sodium Hydrosulphide-3000 MT per annum
Sodium sulphide- 3000 MT per annum

Certificates : In process

No of employees : 75

Location : Plot # 5 &6, IDA, Kadapa, Andhra Pradesh

This is the latest addition to our manufacturing plants. This plant is equipped with state of
the art infrastructure. Production line is totally automated thus avoiding human errors.

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 Capital budgeting

CHAITANYA CHEMICAL

Year of 1987
Establishment
Products Barium chloride (dihydrate and anhydrous), Sodium
hydrosulphide, Sodium sulphide
Capacity Barium chloride -5000 MT per annum Sodium Hydrosulphide-
1500 MT perannum Sodium sulphide- 1000 MT per annum
Certificates ISO 9001:2000,
No of employees 75
Location Rami Reddy Kottalu, Vallur Mandal, Kadapa, Andhra Pradesh

This is the first of our plants. We have been exporting Barium chloride from
this plant for the past six years.
CHAITANYA INDUSTRIES

Year of Establishment : 2004

Products : Barium sulphide

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 Capital budgeting

Capacity : Barium sulphide -9000 MT per

annum
Certificates : -----
No. of Employees : 45
Location : Plot # 9, IDA, Kadapa. Andhra
Pradesh
Quality of Chaitanya chemicals products
Chaitanya Chemicals has upheld the highest standards of quality control since
its founding. Chaitanya Chemicals has a dedicated team of employees that keep an
eye on the production process and finished goods in order to maintain the high
standards. At Chaitanya Chemicals, client satisfaction is our top priority. We promise
to produce products of the highest caliber, custom-made to meet our clients' needs.
At Chaitanya Chemicals, we foster an environment where all employees can
contribute to the contentious development of our business processes because we
believe that every person in the firm is significant. Chaitanya Chemicals aspires to be
the most dependable barium salt supplier in India and around the world. In order to
accomplish our aim, we want to provide our clients with high-quality goods that are
supplied on time. We also want to reduce costs by continuously improving our
business processes, which will increase Chaitanya Chemicals' competitiveness in the
worldwide market.
Chaitanya Chemicals Products
1. Barium Chloride Hydrous (BaCI2, 2H2O)
Description:
White crystalline powder free flowing production capacity is 5000 tones per
annum.
Applications:
 Removing sulphate ions from brine solutions in color-alkali plants, which are
used as pigments, is one kind of water treatment.
 Used in the production of states, peroxides, and hydroxides
 Used as a catalyst in petrochemical products

Specifications:
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 Capital budgeting

Purity Min 99%

Sodium Max 0.03%
Calcium as ca Max 0.003%
Magnesium Max 0.01%
Sulphur as s Max 0.02%
Iron as fee Max 0.005%
Strontium Max 0.005%

2. Barium chloride Anhydrous (Bacl2):

Description: White crystalline powder free from moisture and is free flowering.
Applications:
 As one of the incredible in heart treatment salts.
Possess nearly identical specs to the hydrous substance of barium chloride. There is
less than 0.5% of moisture in the air.
3. Sodium Hydro Sulphate (NaHS or NaSH)
Description:
Clear lemon yellow solution free from any suspension impurities.
Production capacity of 400 tons per month.
As 31% solution, as 71% flakes (yellow)
Applications:
As source of Hydrogen Sulphate

 Used in tanneries for Dearing of hides

 As a reducing agent in chemical processes

Specifications:
Nash solution flake Min 31%,Min71%
Na2s content Less than1%
Iron as Fe Less than 0.1%
Color Lemon yellow transparent
Ammonia ,Caustic and Mercaprians Almost free

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 Capital budgeting

4. Sodium Sulphate flakes (Na2s Flakes)

Description:
Clear lemon yellow solutions free from any suspension impurities.
Production capacity of 400 tons per month.
As 31% solution, as 71% flakes (yellow)
Applications
 Used in dyes, intermediate and in tanning industry

Specifications:
Na2S% 58-60 Grade I
50-52 Grade II

Both red and yellow (iron Free) Flakes Available

5. Barium Sulphate precipitated (BaSO4):

Marketed under the name Balance Fixed. 350 tons can be produced each month. Our
barium sulfate is produced on a nanoscale, with an average particle size of less than
0.8 microns.
Applications:
 Used in powder coatings.
 Used in paints and pigments.
 Used in batteries
 Printing links.
We produce different grades of Barium Sulphate for different applications. Please
contact us for specification and further details.
6. Barium sulphate precipitated (Epoxy putty grade):

This material has flower oil absorption and has higher bulk density when
compared to powder coating grade.
Applications: As a filter in epoxy putties
Color White powder free from order
PH Between 6.5 and 8
Oil Absorption per 100 ml 12gmd to 15gmd
Bulk Density 1.4 to 1.65
Mesh in BSS -0-100 0.3%
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 Capital budgeting

100-200 0.7%
200-300 2.5%
Carbonates Nil

We also process heavier grades and natural grades of Barium sulphate which
are used as filters in paints, powder coating and crockery’s.
7. Barium Nitrate:

This material is the form of clean White crystal free from foreign matter. The
particle size of the material will be as per the requirement.
Applications:
 Used in explosive and pyrotechnic compositions.
Specifications:
Moisture 0.5%
Matter insoluble in water (total) 0.5%
Matter insoluble in water (organic) 0.1%
Hygroscopic 0.5%
Chloride (as NaCI) 0.25%
Chlorates To pass net
Nitrites (KNO2) 0.03%
Sodium compounds 0.5%
Ammonium compounds (as NH3) 0.01%
Calcium compounds (as calcium Nitrate) 0.05%
Barium Nitrate content as Ba (No3)2 99.00%
Chaitanya Chemicals Vision:

Our goal is to become the world's most dependable and well-known provider
of barium salts, which we hope to do by putting quality first and fostering a
collaborative environment. Our goal is to be India's leading supplier of barium
chemicals and your one-stop shop for all things barium. In order to do this, we are
working to broaden our product offering and expect to become more visible on the
global market by promising the best quality, the most quantity, the best quote, and the
finest service.
COMPETITORS:
1. M/S VISHNU CHEMICALS
43
 Capital budgeting

2. M/S ATHIYAPPA CHEMICALS

MANAGEMENT OF CHAITANYA CHEMICALS
1. Managing partner : S.V. Rama Moorthy
2. Executive Partner : G.V. Chandra Mouli
3. Management Representative : S. Guru Shankar

44
 Capital budgeting

CHAPTER -V
DATA ANALYSIS & INTERPRETATION
EVALUATION OF INVESTMENT PROPOSAL:
A corporate firm receives numerous ideas for different projects that it can
support at any one time. However, the firm's funding is always finite, therefore it isn't
feasible to contribute to every application at once. Therefore, it is crucial to choose
the competing alternatives that offer the greatest benefits among the many that are
offered. The distribution of available non-economic resources, which affect capital
budgeting decisions, is the fundamental component of capital budgeting. The
profitability of the potential investment is a critical factor influencing capital
budgeting decisions. However, since risk and profitability are correlated—that is,
greater risk equals better profitability—the proposal's risk cannot be disregarded.
There are many evaluating profitability of capital investment proposals. The
various commonly used methods are as follows:
I. Traditional Methods: -
1. Pay back period method (P.B.P)
2. Accounting Rate of return method (A.R.R)
II. Modern or Discounting techniques:
1. Net present value method (N.P.V)
2. Internal Rate of Return method (I.R.R)
3. Profitability index method (P.I)
I. Traditional Methods
1. Payback period method (PBP):
This technique is sometimes referred to as the replacement period method,
pay-off method, or pay out method. It is the most well-liked and well-known
conventional technique for assessing capital projects. It shows how many years a
project will take to recoup its initial financial investment. It is predicated on the idea
that capital expenses always pay for themselves over a period of years.
Computation of Payback Period-
The pay-back period can be ascertained in the following manner:

45
 Capital budgeting

1) Calculate annual net earnings (profits) before depreciation and after taxes;
these are called annual cash inflows.
2) Divide the initial outlay (cost) of the project by the annual cash inflow,
where the project generates constant annual cash inflows.

Thus, where the project generates constant cash inflows:

Cash Outlay of the project or Original cost of the Asset (Co)

Payback Period = _______________________________________________
Annual Cash Inflows (Ci)

Calculation of Payback Period

Income
Year Depreciation Cash inflow
(PAT)
(1) (2) (3) (4)
2019 13897597 123052249 136949846

2020 86900563 136307132 223207695

2021 238465730 147009114 385474844

2022 470434575 170026464 640461039

809698465 576394959 1386093424

Cash Outlay of the project or Original cost of the Asset (Co)

Payback Period = _______________________________________________
Annual Cash Inflows (Ci)

Total Cash Outlay = Rs. 809,698,465

Total Cash inflow for the first 3 years= Rs.136,949,846+223,207,695+385,474,844
Rs.745,632,385

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 Capital budgeting

Up to the third year the total cost is not recovered but the total cash inflows for
the four years are Rs. 745632385+640461039= Rs.1386093424 i.e., 64066080 more
than the cost of the project. So the pay back period is somewhere between 3 and 4
years. Assuming that the cash inflows occur evenly through out the year, the time
required to recover Rs. 64066080 will be (64066080/640461039) = 0.10.
Hence pay back period is 3 years and 10 days.
Criteria for evaluation: -
The payback period computed for a project is less than the pay back period set
by management of the company, it would be accepted. A project actual pay back
period is more than the determined period by the management, it will be rejected.
Decision:
The standard payback period is set by Penna Cement Ltd., for considering the
expansion project is four years, where as actual payback period is 3 years 10 days.
Hence the project is accepted.
2. Accounting rate of return (or) Average Rate of Return (ARR):
This method takes into account the earnings expected from the investment
over their whole life. It is known as Accounting Rate Return method for the reason
that under this method, the accounting concept of profit (net profit after tax and
depreciation) is used rather than cash inflows.

Avg. annual after depreciation & taxes/ No. of years

Average rate of return = ___________________________________________
Average cash outlays /2

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 Capital budgeting

Present values
Present values of
Year Cash outlay Cash Inflows of Cash
@ 10%
Inflows
(1) (2) (3) (4) (5)
0 809698465 - 1.00 -

2019 - 136949846 0.909 124487410

2020 - 223207695 0.826 184369556.1

2021 - 385474844 0.751 289491607.8

2022 - 640461039 0.683 437434889.6

0 1035783464

Average Profits after taxes & Depreciation / No. of years

ARR = _________________________________________________ X 100

Average Investment

Average Investment = Original Investment /2

= 809698465/2
= 404849233
1035783464/4
ARR = _______________ X 100
404849233

= 63.96%

Criteria for evaluation:

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 Capital budgeting

This approach accepts ARRs that are more than the management-established
minimum rate of return. If the project's ARR is less than the management-set
minimum rate, it is rejected.
Decision:
The standard ARR set by Penna Cement Ltd., management is 21%. The actual
ARR is 63.96% is higher than the standard ARR set by the management, hence we
accept the project.
II. Modern or Discounting techniques:
1. Net Present Value (NPV):
The net present value approach is a contemporary technique for assessing
investment pitches. By adding the element of time, this method tries to compute the
return on investments while accounting for the time value of money.
The difference between Present Values of cash inflows and Present Values of
cash out flows in equal to Net Present Value the firms’ opportunity cost of capital
being the discount rate.

Net Present Value = Present Values of __ Present Values of

Cash in flows Cash out flows

Present values
Present values of
Year Cash outlay Cash Inflows of Cash
@ 12%
Inflows
(1) (2) (3) (4) (5)
0 809698465 - 1.00 -

2019 - 136949846 0.892 122159263

2020 - 223207695 0.797 177896533

2021 - 385474844 0.711 274072614

2022 - 640461039 0.635 406692760

0 980821170

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 Capital budgeting

Net Present Value = Present Values of __ Present Values of

Cash in flows Cash out flows
= 980821170 __ 809698465
= 171122705

Years 2019 2020 2021 2022

Present Values of
122159263 177896533 274072614 406692760
Cash Inflows

NET PRESENT VALUE

500000000
P.V. of Cash

400000000
inflows

300000000
200000000 Years
100000000
0 P.V. of Cash
1 2 3 4 Inflows

Years

Criteria for evaluation:

If the Net Present Value is more than zero or zero, the project is accepted, if
not it is rejected.
OR

50
 Capital budgeting

The project will be accepted if the present value of cash inflows exceeds the
present value of cash outflow.
Decision:
The project is accepted due to the more than zero or the value is positive.
2. Internal Rate of return:
Another contemporary form of capital planning that accounts for the time
value of money is the internal rate of return method. It is also referred to as the trail
and error yield method and the time adjusted rate of return discounted flow
discounted rate of return yield method.
The internal rate of return can be defined as that rate of discount at which the
present value of cash inflows is equal to the present value of cash outflows.
Steps for calculation of IRR:
The following steps are required to practice the internal rate of return method.
1) Determine the future net cash flows during the entire economic life of
the project. The cash inflows are estimated for future profits before depreciation but
after taxes.
2) Determine the rate of discount at which the value of cash inflows is
equal to the present value of cash outflows. This may be determined as explained after
step (4).
3) Accept the proposal if the internal rate of return is higher than or equal
to the minimum required rate of return, i.e., the cost of capital or cut off rate and
reject the proposal if the internal rate of return is lower than the cost of cut-off-rate.
4) In case of alternative proposals select the proposal with the highest
rate of return as long as the rates are higher than the cost of capital or cut-off-rate.
Total Cash inflows
I. Determine fake annuity table = _________________
No. of years
1386093424
= ------------------ = 346523356
4

Initial Investment

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 Capital budgeting

II. Payback Period = __________________

Fake Annuity

809698465
= ------------------ = 2.33
346523356
The Payback period factor 2.33 which lies in between the corresponding
discounting factors for 4 years is 2.404 at 24% which is a lower interest rate and 2.241
at 28% which is at highest interest rate.
III. Determine appropriate Internal Rate of Return by using the present values of
factor table.
Present values
Present values of
Year Cash outlay Cash Inflows of Cash
@ 24%
Inflows
(1) (2) (3) (4) (5)
0 809698465 - 1.00 -

2019 - 136949846 0.806 110381575.9

2020 - 223207695 0.650 145085001.8

2021 - 385474844 0.524 201988818.3

2022 - 640461039 0.423 270915019.5

0 728370415.5

Net Present Value = Present Values of __ Present Values of

Cash in flows Cash out flows
= 728370415.5 __ 809698465
= 81328049.5

Year Cash outlay Cash Inflows Present values of Present values

@ 28% of Cash
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 Capital budgeting

Inflows
(1) (2) (3) (4) (5)
0 809698465 - 1.00 -

2019 - 136949846 0.781 106957829.7

2020 - 223207695 0.610 136156694

2021 - 385474844 0.477 183871500.6

2022 - 640461039 0.373 238891967.5

0 665877991.8

Net Present Value = Present Values of __ Present Values of

Cash in flows Cash out flows
= 665877991.8 __ 809698465
= 143820473.2

Present Values of Lower Rate − Initial investment

I.R.R= Lower Rate + ------------------------------------------------------------ X Dif. Rate
Present Values of Lower Rate – Present Values of
Highest Rate
Here,
Difference rate = 28% ----- 24% = 4%
Present Values of Lower Rate value = 728370415.5
Present Values of Higher Rate Value= 665877991.8
Lower Rate = 24
Initial Investment = 809698465
Substitute the values in above formula;

728370415.5 ---- 809698465

I.R.R = 24 + ---------------------------------------- X 4
728370415.5 ---- 665877991.8

81328049.5
= 24 + ------------------ X 4
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 Capital budgeting

62492423.7

325312198
= 24 + ------------------
62492423.7

= 24 + (-) 5.205
= 24 --- 5.205
= 18.795%

Criteria for evaluation:

When the IRR exceeds the cost of capital or the cutout rate, the project is
approved under this technique. When the IRR is lower than the cost of capital, the
project may not be approved.
Decision:
Because the project's internal rate of return (IRR) exceeds its cost of capital, it is
approved. Although the management set the cost of capital at 15%, the actual figure is
higher than expected. As a result, the proposal is approved.
3. Profitability Index:
It is also a time-adjusted method of evaluating the investment proposals.
Profitability Index also called as Benefit-Cost Ratio (BC) or ‘Desirability factor’ is
the relationship between present value of cash inflows and the present value of cash
outflows. Thus
Present value of Cash inflows
Profitability Index = ____________________________
Present value of Cash Outflows
The profitability index may be found for net present values of inflows
NPV (Net Present Value)
P.I. (Net) = _____________________
Initial Cash Outlay
OR

PV of Cash Inflows
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 Capital budgeting

P.I. (Net) = _____________________ P.I. (Net) = P.I. (Gross) --- 1

Initial Cash Outlay

Table:
Year Present Values of Cash Inflows
(1) 2
2019 122159263

2020 177896533

2021 274072614

2022 406692760

980821170

Present Values of Cash Inflows = 980,821,170

Present Values of Cash Outflows = 809,698,465

980,821,170
Profitability Index = _____________
809,698,465
= 1.211
NPV
P.I. (Net) = ------------------------------------------
Present values of Cash outflows

171122705
= ------------------------------------------ = 0.211
809698465

OR

P.I. (Net) = Profitability Index ---- 1

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 Capital budgeting

= 1.211 --- 1
= 0.211
Criteria for evaluation:
The proposal is accepted if the profitability is more than one, and is rejected in
case of the profitability index is less than one.
Decision:
This proposal rejected because less than one.

CHAPTER -VI
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 Capital budgeting

FINDINGS, SUGGESTIONS & CONCLUSION

FINDINGS:

1. The calculated payback period is 3 years 10 days. But standard payback period
was 4 years of Penna Cement Ltd.,

2. The Average rate of return is 63.96%.

3. The NPV is actually getting 171122705 is positive.

4. The internal rate of return is worked for the project is 18.795% but the
expected IRR is 15% is less than the actual IRR.

5. The profitability Index (gross) is 1.211 but the net profitability Index is 0.211.

6. Project cash flows continuously increasing.

7. Up to the total cost of the project is Rs.809698465/-. But the total cash inflows
for the three years is in the Rs.745,632,385/-. So the pay back period is more
than three years.

8. The cost of the project is high.

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 Capital budgeting

SUGGESTIONS
1. 1. It is recommended that the management of Chaitanya Chemicals Ltd. set a
4-year payback period for the expansion project. However, the actual Payback
Period is shorter than expected at 3 years and 10 days. Setting a four-year
repayment time is advised.
2. To increase the Average rate of return because the ARR is 63.96% only so
better concentration on ARR.

3. Since the project's Net Present Value is positive, it is advised that similar
initiatives be chosen.

4. When compared to the management criterion for the IRR, the internal rate of
return is in a favorable position. Thus, it is preferable to keep a strong position
given the state of the market.

5. The Profitability Index is disapproved since there isn't enough appropriate

action taken to raise it.

6. The rate of depreciation is lower. So that cash inflows increased.

7. The cost of the capital fixed by the 15%. It is actually less than the actual
percent.

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 Capital budgeting

CONCLUSION

According to the study conducted by Chaitanya Chemicals Ltd., project cash

flow forecasting entails a number of estimates and the participation of several
departments and individuals. The finance manager's job is to make sure that the
forecasts are based on a consistent set of economic assumptions, keep the exercise
focused on pertinent variables, minimize the inherent bias in cash inflow forecasting,
and coordinate the efforts of various departments and gather information from them.
In the study I know that the company is following payback period. Based on the
data shows that the company can use any criteria to get return on the investment.
The project “A study on Capital Budgeting” in CHAITANYA CHEMICALS
LTD., it is suggested to hold the company is the same situation.

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 Capital budgeting

ANNEXURE- I -ANNUAL REPORTS

BALANCE SHEET AS AT 31ST MARCH 2019, 31ST MARCH 2020,
31ST MARCH 2021 & 31ST MARCH 2022.
Particulars Schedule 2019 2020 2021 2022

1. SOURCES OF FIUNDS:
Share Capital 42796.14 42796.14 42796.14 42796.14
Share application money 0 0 0 0
Reserve and surplus 21901.93 21901.93 21901.93 38050.42
64698.07 64698.07 64698.07 80846.56
Loan funds:
Secured loans 17431.03 1533.07 12876.51 4168.45
Un secured loans 9767.41 9868.55 3678.89 12286.48
Deferred Tax Liability 0 0 0 5659.63
27198.44 25198.68 16655.40 22114.29
TOTAL 91896.51 89896.69 81253.47 102960.85
2. APPLICATIONSOF FUNDS
Fixed Assets:
Gross block 53550.07 54205.96 53811.03 89683.71
Less: Depreciation 19787.74 22537.12 24043.25 29850.93
Net Block 33762.33 31668.84 29767.78 59832.78
Capital work-in-progress 140.42 289.62 3453.60 320247.06
33902.75 31958.46 33221.38 80079.84
Investments 36557.57 36723.60 42083.62 10051.06
Advance / Expenses 0 0 0 0
Current Assets, loans and advances:
Inventories 2503.20 3114.57 2889.51 3971.01
Sundry debtors 2467.39 934.79 1866.11 2531.00
Cash and Bank balance 1290.71 1383.35 1576.48 12012.16
Loans and Advances 1906.20 5284.23 3095.64 8821.93
8167.50 10725.94 9427.74 27336.1
Current Liabilities and Provisions:
Current liabilities 3381.69 3758.62 5061.79 131132.52
Provisions 127.90 289.62 326.73 1373.63
3509.59 3922.48 5388.52 14506.18
Net current assets 4657.91 6803.46 4039.22 12829.95
Miscellaneous Expenses 169.10 67.10 0 0
Profit and Loss Account 16609.18 14344.07 1909.25 0

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 Capital budgeting

TOTAL 91896.51 89896.69 81253.47 102960.85

ST
PROFIT & LOSS ACCOUNT FOR THE YEAR 31ST MARCH 2019, 31 MARCH 2020,
31ST MARCH 2021 & 31ST MARCH 2022.

Particulars Schedule 2019 2020 2021 2022

INCOME:
Sales (Gross) 35851.44 39889.97 47306.18 50309.92
Less: Excise Duty 6830.29 7284.81 7616.56 6388.76
Sales (Net) 29021.15 32605.16 39689.62 43921.16
Other Income 236.60 419.40 457.41 432.61
TOTAL 29257.75 33024.56 40147.03 44353.77
EXPENDITURE
Purchase of finished goods for 155.08
1574.29 3288.27 1753.71
resale
Manufacturing and other expenses 25591.08 28082.30 29552.25 26109.26
Depreciation 2850.33 2839.05 2859.77 2200.41
Interest and other finance charges 2949.46 2333.38 2234.88 990.68
(Increase) / Decrease in stocks of 459.71
92.77 (244.60) (145.11)
work-in-process and finished goods
TOTAL 32005.66 34921.99 37690.57 30908.95
Loss before extraordinary item /
1897.43 2456.46 13444.82
Profit / (loss) for the year 2747.91
Extraordinary item- Compensation
paid to employees under Voluntary
207.49 0 0
Retirement and others schemes / 0
Provision for tax
Profit or loss before tax for the year 0 0 0 13444.82
Current tax 0 0 0 982.00
Fringe Benefit Tax 0 0 65.00 28.00
Profit /(Loss) for the year 0 2104.92 2265.11 12434.82
Debit balance brought forward from
11756.35 14504.26 (16069.18) (14344.07)
previous year
Debit balance carried to balance
14504.26 16609.18 14344.07 1909.25
sheet

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 Capital budgeting

ANNUAL CASH INFLOWS FOR THE YEAR ENDED

2019, 2020, 2021 & 2022

Income
Year Depreciation Cash inflow
(PAT)
(1) (2) (3) (4)
2019 13897597 123052249 136949846

2020 86900563 136307132 223207695

2021 238465730 147009114 385474844

2022 470434575 170026464 640461039

809698465 576394959 1386093424

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 Capital budgeting

ANNEXURE - II
BIBLIOGRAPHY

Sl. Name of the Text Book Name of the Author Publication Edition &
No. Year
D. Chandra
2nd
1. Financial Management D. Chandra Bose Bose
Cost and Management S.P. Jain & 5th
2. Kalyani
Accounting K.L. Narang
M Y Khan &
3. Financial Management TMH 5th
P K Jain

Financial Management I M Pandey Vikas 4th

4.

WEBSITES:
1. www.chaitanyachemicals.com
2. www.google.com
3. www.wikipedia.com

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