A Project Report

On
CAPITAL BUDGETING
Of

Odisha Power Generation Corporation Ltd.

(Submitted for the Partial Fulfillment of the
Requirements of Master of Business Administration
Programme under Utkal University)

Submitted By:
Ashish Kumar Sahoo
Roll No- 13-MBA-004(13209V132014)

Faculty Guide:

Corporate Guide:

Dr. (Mr) Dasarathi Sahu

Gyanendra Mishra

Mr.

ACKNOWLEDGEMENT
Words are indeed inadequate to convey my deep sense of gratitude to all those who have
helped me in completing this summer project to the best of my ability. Being a part of this
project has certainly been a unique and a very productive experience on my part.
I would like to express my sincere gratitude to Sri B.B. Mishra (HOD, Department of
Business Administration, Utkal University) for helping me complete the project in a
successful manner.
I am really thankful to Sri Basant Kumar (Training & Placement Officer, Department of
Business Administration, Utkal University) for giving me the opportunity to work in my
preferred choice of esteemed organization, and assisting me in this project and sharing his
valuable suggestions and experience for the completion of the same.
I would also like to thank my guide Dr. (Mr) Dasarathi Sahu (Lecturer, Department of
Business Administration, Utkal University) for making all kinds of arrangements to carry
out the project successfully and for providing her constant guidance and help to solve all
kinds of queries regarding the project work. His systematic way of working and
incomparable guidance has inspired the pace of the project to a great extent.
Last, but not the least, I would like to thank all the Teachers & Staff Members of MBA
Department, Utkal University for their moral support and help in all respects for the
completion of my work.
Above all in my heart I am quite thankful to my parents, friends, etc whose support directly
or indirectly went into the successful completion of the project.

Ashish Kumar Sahoo

DECLARATION
I, Ashish Kumar Sahoo, student of Department of Business
Administration, Utkal University hereby declare that the project entitled
CAPITAL BUDGETING is the record of authentic work carried out by
me, during the academic year 2013- 2014 and has not been submitted to any
other university or institutes towards the award of any other degree.
An attempt has been made by me to provide all relevant and important details
regarding the topic to support the theoretical edifice with concrete research
evidence. This will be helpful to clean the fog surrounding the various aspects
of the topic.
I hope that this project will be beneficial for the organization.

Bhubaneswar

Name: Ashish Kumar Sahoo

Roll No.: 13MBA004 (13209V132014)
Department of Business Administration
Utkal University, Vani Vihar
Bhubaneswar

C E R T I F I C AT E
This is to certify that the report of the project submitted is an outcome of the Summer
Internship Training entitled Capital Budgeting carried out by Ashish Kumar Sahoo,
bearing Roll No.: 13MBA004 (13209V132014) under my guidance and supervision for
the partial fulfillment of MBA under Department of Business Administration, Utkal
University, Vani Vihar, Bhubaneswar (Odisha), India.
To the best of my knowledge the report,
1. Embodies the work of the candidate himself.
2. Has duly been completed.
3. Fulfils the requirement of the Ordinance relating to the MBA degree of the
University and,
4. Is up to the desired standard for the purpose of which is submitted.

Name: Dr. (Mr) Dasarathi Sahu

Designation: Lecturer

Utkal University
Vani Vihar
Bhubaneswar (Odisha)
3

TO WHOMSOEVER IT MAY CONCERN

This is to certify that Mr Ashish Kumar Sahoo has successfully completed the project
work titled Capital Budgeting in partial fulfilment of the requirement for the summer
training of Master of Business Administration

in Department of Business

Administration Utkal University, Vani Vihar, Bhubaneswar (Odisha) under my

supervision from 2nd May, 2014 to 30th June, 2014

Signature of the Mentor

(Mr. Gyanendra Mishra)

Date:
Place: OPGC LTD.,

Zone-A, 7th Floor,

Submitted By

Fortune Tower,
BBSR-751004

INDEX
S. No:

CONTENTS

PAGE NO.
CHAPTER-1
6 - 14

Introduction
Objectives of the study
Need of the study
Scope of the study
Importance of the study
Limitations of the study
Methodology
CHAPTER-2
15 - 35
Review of Literature
CHAPTER-3
36 - 43
Company profile
CHAPTER-4
44 - 56
Data Analysis and Interpretation

CHAPTER-5
57 - 71
Findings
Suggestions
Conclusion
Bibliography

CHAPTER-1

INTRODUCTION

INTRODUCTION
Capital budgeting is an essential part of every companys financial
management. Capital budgeting is a required managerial tool. One duty
of financial manager is to choose investment with satisfactory cash flows
with high returns. Therefore a financial manager must be able to decide
whether an investment is worth undertaking and able to decide and be
able to choose intelligently between two or more alternatives.
Capital

budgeting

involves

the

planning

and

control

of

capital

expenditure. It is the process of deciding whether or not to commit

resources to a particular long term project whose benefits are to be
realized over a period of time.

A capital budgeting decision is defined as the firms decision to invest its

current funds efficiently in the long-term assets in anticipation of an
expected flow of benefits over a series of years. The firms investment
decisions would generally include expansion, acquisition, modernization,
and replacement of the long-term assets. They are the assessment of
future events, which are difficult to predict. It is really complex problem
to estimate the future cash flow of an investment.
The investment decision of a firm is generally know as Capital Budgeting
or Capital Expenditure Decision. Capital budgeting is also known as
7

Investment

Decision

Making,

Capital

Expenditure

Decisions,

Planning Capital Expenditure and Analysis of Capital Expenditure.

Capital budgeting is finance terminology for the process of

deciding whether or not to
undertake an investment project.

A logical prerequisite to the analysis of investment opportunities is the

creation of investment opportunities. Unlike the field of investments,
where the analyst more or less takes the investment opportunity set as a
given, the field of capital budgeting relies on the work of people in the
areas

of

industrial

engineering,

research

and

development,

and

management information systems (among others) for the creation of

investment opportunities. As such, it is important to suggest that
students keep in mind the importance of creativity in this area, as well as
the importance of analytical techniques.
Budgeting requires the company to look ahead and formalize future
goals. It is the planning process used to determine whether an
organizations

long

term

investments

such

as

new

machinery,

replacement machinery, new plants, new products, and research

development projects are worth pursuing. It is budget for major capital,
or investment, expenditures.
Capital budgeting techniques

based on accounting earnings

and

accounting rules are sometimes used - though economists consider this

to be improper - such as the accounting rate of return, and return on
investment.

OBJECTIVES OF THE STUDY

To study the relevance of capital budgeting in evaluating the

project.
To study the techniques of capital budgeting for decision-making.
To analyze the present value of rupee invested.
To make suggestions if any for improving the financial positions of
the company.
To study the relevance of capital budgeting in evaluating the project
for project finance.
To understand the practical usage of capital budgeting techniques.
To understand the nature of risk and uncertainty.
To analyze the strengths and weakness of existing Techniques in
capital
budgeting.
To measure the profitability of the project by considering all cash
flows.
To make recommendations and to improve further process of capital
budgeting.

 To evaluate capital projects using traditional methods of investment

appraisal and discounted cash flows methods.

NEED FOR THE STUDY

The project study is undertaken to analyze and understand the

Capital

Budgeting

process

in

ODISHA

POWER

GENERATION

CORPORATION LTD, which gives mean exposure to practical

implication of theory knowledge.
To know about the companys operations of using various Capital
budgeting techniques.
To know how the company gets funds from various resources.
The financial department can implement and can get positive
results by maintaining proper financial reports.
To analyze the proposal for expansion or creating additional
capacities.
To make financial analysis of various proposals regarding capital
investment so as to choose the best out of many alternatives
proposals.

10

SCOPE OF THE STUDY

Preparation of capital budgeting is an important tool for
efficient
and effective managerial decisions.
So in every organization they have to examine the capital budgeting
process, therefore the financial manager must be able to decide whether
an investment is worth undertaking and able to decide and be able to
choose intelligently between two or more alternatives.

The process by which companys appraise investment decision, in

particular by which capital resources are allocated to specific

projects.
Capital budgeting requires firms to account for the time value of
money and project risk, using a variety of more or less formal

techniques.
Capital budgeting decisions affect the profitability in terms of
interest of the firm. They also have a bearing on the competitive

position of the enterprise. Its a diversification burden.

Capital investment involves cost and the majority of the firms have
scarce capital resources.

11

Capital budgeting is a complex process as it involves decisions

relating to the investment of huge resources for the benefit of

achievement in future as it is always uncertain.

Understanding the importance of the capital budgeting in Odisha
Power Generation Corporation Ltd.

IMPORTANCE OF THE STUDY

Capital budgeting is of paramount important in financial decision making:

Decisions affect the probability of the firm, as they also have a
bearing on the competitive positions of the enterprises.
A capital expenditure decision has its effect over a long time and
inevitable affects the company future cost structure.
The capital investments firm acquires the long-lived assets that
generate the firms future cash flows and determine its level of
profitability.
Proper capital budgeting analysis is critical to a firms successful
performance because capital investments decisions can improve
cash flows.
Capital investment involves cost of majority of the firms have
scarce capital resources.
Capital decisions are not easily reversible, without much financial
loss to the firm.

12

 To make financial analysis of various proposals regarding capital

investment so as to choose the best out of many alternatives
proposals.

LIMITATION OF THE STUDY :

Lack of time is the major limiting factor, i.e., the schedule period of
6 weeks are not sufficient to make the study independently
regarding Capital Budgeting in OPGC Ltd.
The busy schedule of the officials in the OPGC Ltd. is another
limiting factor. Due to the busy schedule time taken to collect
complete information about organization.
Non-availability of confidential financial data.
The study is conducted in a short period, which was not detailed in
all aspects.
All the techniques of capital budgeting are not used in OPGC.
Therefore it was possible to explain only few methods of capital
budgeting.
The formula has been used according to the availability of the data.

13

 Since the procedures and policies of the company does not allow
disclosing of all financial information and has to be completed with
the available data collected with the maximum effort.

RESEARCH METHODOLOGY
SOURCES OF DATA:
The following research methodology has been adopted to achieve the
aforesaid objective. The information for this report has been collected
through the primary and secondary sources.
Primary sources:
Primary sources is also called as first handed information as the data is
collected through the observation in the organization and interviews with
officials. By asking, questions with the accounts and other persons in the
financial department. A part from these some information is collected
through the seminars, which were held by Odisha Power Generation
Corporation Ltd.
Secondary sources:

14

These secondary data is existing data which is collected by others that is

sources are financial journals, annual reports of the OPGC LTD.

Research Design:

Research design -

Analytical.

Analytical tool budgeting.

Capital Budgeting, analyzing the capital

Techniques-

Traditional and Modern methods.

Data Sources Company records, annual

Secondary data has been collected from

reports.

CHAPTER 2
15

REVIEW OF LITERATURE

CAPITAL BUDGEING:
INTRODUCTION
An efficient allocation of capital is the most important finance function in
modern times. It involves decisions to commit firms funds to long-term
assets. Such decisions are tend to determine the value of company/firm
by influencing its growth, profitability & risk.
Investment decisions are generally known as capital budgeting or capital
expenditure decisions. It is clever decisions to invest current in long term
assets expecting long-term benefits. Firms investment decisions would
generally include expansion, acquisition, modernization and replacement
of long-term assets.
Such decisions can be investment decisions, financing decisions or
operating decisions. Investment decisions deal with investment of
organizations resources in Long term (fixed) Assets and / or Short term
(Current) Assets. Decisions pertaining to investment in Short term Assets
fall under Working Capital Management. Decisions pertaining to

16

investment in Long term Assets are classified as Capital Budgeting

decisions.
Capital budgeting decisions are related to allocation of investible funds to
different long-term assets. They have long-term implications and affect
the future growth and profitability of the firm.
In evaluating such investment proposals, it is important to carefully
consider the expected benefits of investment against the expenses
associated with it. Organizations are frequently faced with Capital
Budgeting decisions. Any decision that requires the use of resources is a
capital budgeting decisions. Capital budgeting is more or less a
continuous process in any growing concern.
For Example: Purchase of Land is an example of Capital Budgeting
decision. Similarly replacement of outdated equipment with modern
machines, purchase of a brand or business, computerization and
networking the organization, investment in research and development of
a product launch of a major promotional campaign etc are all example of
Capital Budgeting decisions.
However, in all cases, the decisions have a long-term impact on the
performance of the organization. Even a single wrong decision may in
danger the existence of the firm as a profitable entity.
Some of the examples of Capital Expenditure are
i.
ii.
iii.

Cost of acquisition of permanent assets as land and buildings.

Cost of addition, expansion, improvement or alteration in the fixed
assets.
R&D project cost, etc.,

REVIEW OF LITERATURE

Introduction
One of the three major decisions made by managers is the decision to
invest in fixed assets. Investments in fixed assets involve large capital
outlays and the consequences of these investments decisions impact a
firms operations for a very long time. Therefore a variety of quantitative
and analytical techniques are applied by managers in project selection to
enable them to make good decisions in this area.

17

Literature
It is widely accepted that discounted cash flow methods are the best way
to evaluate capital budgeting proposals. While several decades ago
discounted cash flow methods may not have been widely used (Istvan,
1961) more recent studies (Kim, Crick and Kim, 1986) suggest that
increasingly firms are adopting discounted cash flow analysis. Much of
the empirical research on capital budgeting practices adopted by
corporate managers is based on US data (See for example Mukherjee and
Hingorani, 1999.) A few studies such as those by Payne, Heath, and Gale
(1999), Jog and Srivastava (1995) and Keste et. al (1999), examine
capital budgeting practices followed by firms in different countries such
as Canada, Australia, Hong Kong, Indonesia, Malaysia, Philippines and
Singapore. This study examines managerial behavior and preferences
with respect to the capital budgeting decision using a sample of German
firms. Our unique sample and the results of our analysis help to fill a gap
in finance literature and provide useful information to managers
contemplating German collaborations.

Capital budgeting is the process by which firms determine how to invest

their capital. Included in this process are the decisions to invest in new
projects, reassess the amount of capital already invested in existing
projects, allocate and ration capital across divisions, and acquire other
firms. In essence, the capital budgeting process defines the set and size
of a firms real assets, which in turn generate the cash flows that
ultimately determine its profitability, value, and viability.

In principle, a firms decision to invest in a new project should be made

according to whether the project increases the wealth of the firms
shareholders. For example, the Net Present value (NPV) rule specifies an
objective process by which firms can assess the value that new capital
investments are expected to create. As Graham and Harvey (2001)
document, this rule has steadily gained in popularity since Dean (1951)
formally introduced it, but its widespread use has not eliminated the
human element in capital budgeting. Because the estimation of a
projects future cash flows and the rate at which they should be
18

discounted is still a relatively subjective process, the behavioural traits of

managers still affect this process.

Studies of the calibration of subjective probabilities find that individuals

are overconfident in that they tend to overestimate the precision of their
knowledge and information (Fischhoff, Slovic, and Lichtenstein, 1977;
Alpert and Raffia, 1982). In fact, research shows that professionals from
many fields exhibit overconfidence in their judgements, including
investment bankers (Stael von Holstein, 1972), engineers (Kidd, 1970),
entrepreneurs (Cooper, Woo, and Dunkelberg, 1988), lawyers (Wagenaar
and Keren, 1986), negotiators (Neale and Bazerman,1990), and
managers (Russo and Schoemaker, 1992).

Several factors may explain why managers may also be expected to be

overconfident, especially in a capital budgeting context. First, capital
budgeting decisions can be complex. They often require projecting cash
flows for a wide range of uncertain outcomes.

Second, capital budgeting decisions are not well suited for learning. As
Kahneman and Lovallo (1993, p. 18) note, learning occurs when closely
similar problems are frequently encountered, especially if the outcomes
of decisions are quickly known and provide unequivocal feedback. In
most firms, managers infrequently encounter major investment policy
decisions, experience long delays before learning the outcomes of
projects, and usually receive noisy feedback.
Furthermore, managers often have difficulty rejecting the notion that
every situation is new in important ways, allowing them to ignore
feedback from past decisions altogether. Learning from experience is
highly unlikely under these circumstances (Einhorn and Hogarth,1978;
Brehmer, 1980).

Third, unsuccessful managers are less likely to retain their jobs and be
promoted. Those who succeed may become overconfident because of a
self-attribution bias. Most people overestimate the degree to which they
are responsible for their own success (Miller and Ross, 1975; Langer and
Roth, 1975; Nisbett and Ross, 1980). This self-attribution bias causes
19

successful managers to become overconfident (Daniel, Hirshleifer, and

Subrahmanyam, 1998; Gervais and Odean, 2001).

Fourth, managers may be more overconfident than the general

population because of a selection bias. Those who are overconfident and
optimistic about their prospects as managers are more likely to apply for
these jobs. Moreover, as Goel and Takor (2008) show, firms may
endogenously select and promote on the basis of overconfidence, as
overconfident individuals are more likely to have generated extremely
good outcomes in the past. Finally, as Gervais, Heaton, and Odean (2009)
argue, overconfident managers may simply be easier to motivate than
their rational counterparts and so hiring them is more appealing to firms.

Reviews and Appeals of Capital Budgeting

In the corporate finance capital budgeting survey literature the capital
budgeting process has been described in terms of four stages: (1)
identification, (2) development, (3) selection, and (4) control. The
identification stage comprises the overall process of project idea
generation including sources and submission procedures and the
incentives/reward system, if any. The development stage involves the
initial screening process relying primarily upon cash flow estimation and
early screening criteria. The selection stage includes the detailed project
analysis that results in acceptance or rejection of the project for funding.
Finally, the control stage involves the evaluation of project performance
for both control purposes and continuous improvement for future
decisions.

All four stages have common areas of interest including personnel,

procedures, and methods involved, along with the rationale for each. All
four stages are critical to the overall process, but the selection stage is
arguably the most involved since it includes the choices of analytical
methods/techniques used, how the cost of capital is determined, how
adjustments for projects risks are assessed and reflected, and how, if
relevant, capital rationing affects project choice. The selection stage has
also been the most investigated by survey researchers, particularly in the
area of selection techniques, resulting in a relative neglect of the other
stages. This in turn has led to appeals to future researchers to consider
the other stages in their survey research efforts.
20

THEOROTICAL FRAME WORK

Introduction
Capital Budgeting may also be defined as The decision making process
by which a firm evaluates the purchase of major fixed assets. It involves
firms decision to invest its current funds for addition, disposition,
modification and replacement of fixed assets.
Features of Capital Budgeting:
The important features, which distinguish capital budgeting decisions
from other day-to-day decisions, are
Capital budgeting decisions involve the exchange of current funds
for the benefits to be achieved in future.
They have a long terms significant effect on the profitability of the
concern.
They involve huge funds.
They are irreversible decisions.
They are strategic decisions associated with high degree of risk.
The funds are invested in long-term assets.
The future benefits will occur to the firm over a series of years.

IMPORTANCE OF CAPITAL BUDGETING:

The importance of capital budgeting can be understood from the fact
that an unsound investment decision may prove to be fatal to the very
existence of the organization.
There are several factors that make capital budgeting decisions among
the critical decisions to be taken by the management. The importance of
capital budgeting can be understood from the following aspects of capital
budgeting decisions:

1. Large investment:
Capital budgeting decision, generally involves large investment of funds.
But the funds available with the firm are scarce and the demand for
funds far exceeds resources. Hence, it is very important for a firm to
plan and control its capital expenditure.
2. Long term commitment of funds:

21

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 increases the financial risk involved in the investment decision.
3. Irreversible nature:
The Capital expenditure decisions are of irreversible nature. Once, the
decision for acquiring a permanent asset is taken, it becomes very
difficult to dispose of these assets without incurring heavy losses.
4. Long terms effect on profitability:
Capital budgeting decision has a long term and significant effect on the
profitability of a concern. Not only the present earnings of the firm are
affected by the investments in capital assets but also the future growth
and profitability of the firm depends up to the investment decision taken
today. Capital budgeting decision has utmost importance to avoid over or
under investment in fixed assets.
5. Difficulties of investment decision:
The long terms investment decisions are difficult to be taken because
uncertainties of future and higher degree of risk.
6. National Importance:
Investment decision though taken by individual concern is of national
importance because it determines employment, economic activities and
economic growth of any region/country.
7. After the Capacity and Strength to Compete:
Capital budgeting decisions affect the capacity and strength of a firm to
face competition. A firm may loose competitiveness if the decision to
modernize is delayed.

FACTORS INFLUENCING CAPITAL EXPENDITURE DECISIONS:

There are many, factors financial as well as non financial which influence
the capital expenditure decisions and the profitability of the proposal yet,
there are many other factors which have to be taken into consideration
while taking a capital expenditure decision. They are:
1. URGENCY:

22

Sometimes, an investment is to be made due to urgency for the survival

of the firm or to avoid heavy losses. In such circumstances, proper
evaluation cannot be made through profitability tests. Examples of such
urgency are breakdown of some plant and machinery, fire accidents etc.

2 .DEGREE OF UNCERTAINITY:
Profitability is directly related to risk, higher the profits, greater is the risk
or uncertainty Sometimes, a project with some lower profitability may be
selected due to constant flow of income as compared to another project
with an irregular and uncertain inflow of income.
3. INTANGIBLE FACTORS:
Sometimes, a capital expenditure has to be made due to certain
emotional and intangible factors such as safety and welfare of the
workers, prestigious project, social welfare, goodwill of the firm etc.
4. AVAILABILITY OF FUNDS:
As the capital expenditure generally requires the provisions of law is
solely influenced by this factor and although the project may not be
profitable, yet the investment has to be made.
5. AVAILABILITY OF FUNDS:
As the capital expenditure generally requires large funds the availability
of funds is an important factor that influences the capital budgeting
decisions. A project howsoever profitable may not be taken for want of
funds and a project with lesser profitability may sometimes be preferred
due to lesser pay back period for want of liquidity.
6. FUTURE EARNINGS:
A project may not be profitable as compared to another today, but it may
promise better future earnings. In such cases, it may be preferred to
increase future earnings.

ASSUMPTIONS IN CAPITAL BUDGETING:

The Capital Budgeting decision process is a multi-faceted and analytical
process. A number of assumptions are required to be made.
1. Certainty with respect to cost & Benefits: It is very difficult to
estimate the cost and benefits of a proposal beyond 2-3 years in future.
23

2. Profit Motive: Another assumption is that the capital budgeting

decisions are taken with a primary motive of increasing the profit of the
firm.

The activities can be listed as follows:

Dis-investments i.e., sale of division or business.

Change in methods of sales distribution.
Undertakings an advertisement campaign.
Research & Development programs.
Launching new projects.
Diversification.
Cost reduction.

PROBLEMS & DIFFICULTIES IN CAPITAL BUDGETING:

1. Future uncertainty: Capital Budgeting decisions involve long-term
commitments. There is lot of uncertainty in the long term. The
uncertainty may be with reference to cost of the project, future expected
returns, future competition, legal provisions, political situation etc.
2. Time Element: The implications of a Capital Budgeting decision are
scattered over a long period. The cost and benefits of a decision may
occur at different point of time. The cost of a project is incurred
immediately. However, the investment is recovered over a number of
years. The future benefits have to be adjusted to make them comparable
with the cost. Longer the time period involved, greater would be the
uncertainty.
3. Difficulty in Quantification of Impact: The finance manger may
face difficulties in measuring the cost and benefits of projects in
quantitative terms. Example: The new product proposed to be launched
by a firm may result in increase or decrease in sales of other products
already being sold by the same firm. It is very difficult to ascertain the
extent of impact as the sales of other products may also be influenced by
factors other than the launch of the new product.
RISK AND UNCERTAINITY IN CAPTIAL BUDGETING:
All the techniques of Capital Budgeting require the estimation of future
cash inflow and cash outflow. The cash flows are estimated, based on the
following factors.

24

Expected economic life of the project

Salvage value of the asset at the end of the economic life
Capacity of the project
Selling price of the product
Production cost
Depreciation rate
Rate of taxation
Future demand of the product, etc.,

But, due to uncertainties about the future, the estimates of demand,

production, sales, costs, selling price, etc cannot be exact. For example a
product may become obsolete much earlier than anticipated due to
unexpected technological developments.
All these elements of uncertainties have to be taken into account in the
form of forcible risk while taking a decision on investment proposals. It is
perhaps the most difficult task while making an investment decision. But
some allowances for the element of risk have to be provided.

CAPITAL EXPENDITURE CONTROL:

Capital expenditure involves non-flexible long term commitment of funds.

The success of an enterprise in the long run depends upon the
effectiveness with which the management makes capital expenditure
decisions. Capital expenditure decisions are very important as their
impact is more or less permanent on the well being and economic health
of the enterprise. Because, of its large scale mechanization and
automation and importance of capital expenditure for increase in the
profitability of a concern. It has become essential to maintain an effective
system of capital expenditure control.

OBJECTIVES OF CONTROL OF CAPITAL EXPENDITURE:

To make an estimate of capital expenditure and to see that the
total cash outlay is within the financial resources of the enterprise.
To ensure timely cash inflows for the projects so that non
availability of cash may not be a problem in the implementation of
the problem.
To ensure that all capital expenditure is properly sanctioned.
25

 To properly co-ordinate the projects of various departments.

To measure the performance of the project.
To ensure that sufficient amount of capital expenditure is incurred
to keep pace with the rapid technological development.
To prevent over expansion.

KINDS OF CAPITAL BUDGETING DECISIONS

The overall objectives of capital budgeting are to maximize the
profitability of a firm or the return on investment. These objectives can
be achieved either by increasing revenues or by reducing costs. This,
capital budgeting decisions can be broadly classified into two categories:
1. Increase revenue,
2. Reduce costs
The first category of capital budgeting decisions is expected to increase
revenue of the firm through expansion of the production capacity or size
of the firm by reducing a new product line.
The second category increases the earning of the firm by reducing costs
and includes decisions relating to replacement of obsolete, outmoded or
worn out assets. In such cases, a firm has to decide whether to continue
the same asset or replace it. The firm takes such a decision by evaluating
the benefit from replacement of the asset in the form or reduction in
operating costs and the cost\ cash needed for replacement of the asset.
Both categories of above decision involve investments in fixed assets but
the basic difference between the two decisions are in the fact that
increasing revenue investment decisions are subject to more uncertainty
as compared to cost reducing investments decisions.
Further, in view of the investment proposal under consideration, capital
budgeting decisions may be classified as:
1. Accept-Reject Decision:
Accept reject decisions relate independent projects do not compute with
one another. Such decisions are generally taken on the basis of minimum
return on investment. All those proposals which yield a rate of return
higher than the minimum required rate of return of capital are accepted
26

and the rest rejected. If the proposal is accepted the firm makes
investment in it, and if it is rejected the firm does not invest in the same.

2. Mutually Exclusive Project Decision:

Such decisions relate to proposals which compete with one another in
such a way that acceptance of one automatically excludes the
acceptance of the other. Thus one of the proposals is selected at the cost
of the other.
For ex: A company has the option of buying a machine. Or a second hand
machine, or taking on old machine hire or selecting a machine out of
more than one brand available in the market. In such a cases the
company can select one best alternative out of the various options by
adopting some suitable technique or method of capital budgeting. Once
the alternative is selected the others are automatically rejected.

3. Capital Rationing Decision:

A firm may have several profitable investment proposals but only limited
funds and, thus, the firm has to rate them. The firm selects the
combination of proposals that will yield the greatest profitability by
ranking them in descending order of their profitability.

FEATURES OF INVESTMENT DECISIONS:

The exchange of current funds for future benefits.
The funds are invested in long-term assets.
The future benefits will occur to the firm over a series of years.

IMPORTANT OF INVESTMENT DECISIONS:

They
They
They
They
They

influence the firms growth in long run.

affect the risk of the firm.
involve commitment of large amount of funds.
are irreversible, or reversible at substantial loss.
are among the most difficult decisions to make.

TYPE OF INVESTMENT DECISIONS:

27

 Expansion of existing business.

Expansion of new business.
Replacement & Modernization.

CAPITAL BUDGETING PROCESS:

Capital budgeting is a complex process as it involves decisions relating to
the investment of current funds for the benefit to be achieved in future
and the future is always uncertain.

However, the following procedure

may be adopted in the process of Capital Budgeting.

1. Identification of investment proposals:
The

capital

investment

budgeting
proposals.

process
The

begins

proposal

with
about

the

identification

potential

of

investment

opportunities may originate either from top management or from any

officer of the organization. The departmental head analysis the various
proposals in the light of the corporate strategies and submits the suitable
proposals to the capital expenditure planning.
2. Screening Proposals:
The expenditure planning committee screens the various proposals
received from different departments.

The committee views these

proposals from various angles to ensure that these are in accordance

with the corporate strategies or selection criterion of the firm and also do
not lead departmental imbalances.
3. Evaluation of Various Proposals:
The next step in the capital budgeting process is to evaluate various
proposals. The methods, which may be used for this purpose such as,
payback period method, Rate of return method, N.P.V and I.R.R etc.
28

4. Priorities:
After evaluating various proposals, the unprofitable uneconomical
proposal may be rejected but 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 projects/proposals after considering
urgency, risk and profitability involved there in.

5. Final Approval And Preparation of Capital Expenditure

Budget:
Proposals meeting the evaluation and other criteria are finally approved
to be included in the capital expenditure budget.

The expenditure

budget lays down the amount of estimated expenditure to be incurred on

fixed assets during the budget period.
6. Implementing Proposals:
Preparation of a capital expenditure budget and incorporation of a
particular proposal in the budget doesnt itself authorize to go ahead with
the implementation of the project. A request for authority to spend the
amount should be made to the capital expenditure committee, which
reviews the profitability of the project in the changed circumstances.
Responsibilities should be assigned while implementing the project in
order to avoid unnecessary delays and cost overruns.

Network

techniques like PERT and CPM can be applied to control and monitor the
implementation of the projects.
7. Performance Review:
The last stage in the process of capital budgeting is the evaluation of the
performance of the project. The evaluation is made by comparing actual
and budgeted expenditures and also by comparing actual anticipated
29

returns. The unfavorable variances, if any should be looked in to and the

causes of the same be identified so that corrective action may be taken
in future.

METHODS OR TECHNIQUES OF CAPITAL

BUDGETING PROCESS
There are many methods for evaluating the profitability of investment
proposals. The various commonly used methods are

Techniques of Capital
Budgeting Decisions

Traditional/NonDiscounting Cash flow

Methods

Payback
Period
Method

Accounting
Rate of
Return

Discounted Cash
Flow/Time Adjusted
Methods

Net
Present
Value
30

Internal
Rate of
Return

Profitabilit
y Index

Traditional methods/ Non- Discounting Cash flow Methods:

(I) Payback period method (P.B.P)
(II) Accounting Rate of return method (A.R.R)

Time adjusted or discounting techniques:

(I) Net Present value method (N.P.V)
(II) Internal rate of return method (I.R.R)
(III) Profitability index method (P.I)

1. PAY-BACK PERIOD METHOD:

The pay back sometimes called as payout or pay off period method
represents the period in which total investment in permanent
assets pay back itself.
This method is based on the principle that every capital
expenditure pays itself back within a certain period out of the
additional earnings generated from the capital assets.
Decision rule:
A project is accepted if its payback period is less than the period specific
decision rule. A project is accepted if its payback period is less than the
period specified by the management and vice-versa.

Pay Back Period= Initial Cash Outflow / Annual

Cash Outflow
ADVANTAGES:
Simple to understand and easy to calculate.

31

 In this method, as a project with a shorter payback period is

preferred to the one having a longer pay back period, it reduces
the loss through obsolescence.
Due to its short-term approach, this method is particularly suited to
a firm which has shortage of cash or whose liquidity position is not
good.
DISADVANTAGES:
It does not take into account the cash inflows earned after the
payback period and hence the true profitability of the project
cannot be correctly assessed.
This method ignores the time value of the money and does not
consider the magnitude and timing of cash inflows.
It does not take into account the cost of capital, which is very
important in making sound investment decisions.

2. ACCOUNTING RATE OF RETURN METHOD:

This method takes into account the earnings from the investment over
the whole life. It is known as average rate of return method because
under this method the concept of accounting profit (NP after tax and
depreciation) is used rather than cash inflows.
According to this method, various projects are ranked in order of the rate
of earnings or rate of return.
Decision rule:
The project with higher rate of return is selected and vice versa.
The return on investment method can be used in several ways, as

Average Rate of Return Method:

32

Under this method average profit after tax and depreciation is calculated
and then it is divided by the total capital out lay.
Average Annual profits (after dep. & tax)
Average rate of return= ---------------------------------------------------------100
Net investment

ADVANTAGES:
It is very simple to understand and easy to calculate.
It uses the entire earnings of a project in calculating rate of return
and hence gives a true view of profitability.
As this method is based upon accounting profit, it can be readily
calculated from the financial data.
DISADVANTAGES:
It ignores the time value of money.
It does not take in to account the cash flows, which are more
important than the accounting profits.
This method cannot be applied to a situation where investment in
project is to be made in parts.

3. NET PRESENT VALUE :

The Net Present value method is a classic economic method of
evaluating the investment proposals. It is one of the methods of
discounted cash flow. It recognizes the importance of time value of
money.
It correctly postulates that cash flows arising of different time period,
differ in value and are comparable only when their equivalent i.e.,
present values are found out.
The following steps are involved in the calculation of NPV:
Cash flows of the investment project should be forecasted based on
realistic assumptions.

33

 An appropriate rate of interest should be selected to discount the

cash flows, generally this will be the Cost of capital rate of the
company.
The present value of inflows and out flows of an investment
proposal, has to be computed by discounting them with an
appropriate cost of capital rate.
The Net Present value is the difference between the Present Value
of Cash inflows and the present value of cash outflows.
Net present value should be found out by subtracting present value
of cash outflows from present value of cash inflows. The project
should be accepted if NPV is positive.
n

CFt
.
t
t 0 1 k

NPV

NPV = Present Value of Cash inflow

Present value of the cash outflow

Cost often is CF0 and is negative.

n

CFt
CF0 .
t

k
t 1

NPV

Decision Rule:
Accept if NPV > 0
Reject if NPV < 0
May accept if NPV = 0

ADVANTAGES:
It recognizes the time value of money and is suitable to apply in a
situation with
uniform cash outflows and uneven cash inflows.

34

 It takes in to account the earnings over the entire life of the project
and gives the true view of the profitability of the investment.
Takes in to consideration the objective of maximum profitability.
DISADVANTAGES:
More difficult to understand and operate.
It may not give good results while comparing projects with unequal
investment of funds.
It is not easy to determine an appropriate discount rate.

4. PROFITABILITY INDEX METHOD OR BENEFIT COST RATIO

METHOD:It is also a time-adjusted method of evaluating the investment proposals.
PI also called benefit cost ratio or desirability factor is the relationship
between present value of cash inflows and the present values of cash
outflows. Thus

PI

CFt

1 k
t 1

CF0

Profitability index =
Initial Investment or cash outflows

Net profitability index =

index - 1

PV of cash inflows /

Profitability

ADVANTAGES:
Unlike net present value, the profitability index method is used to
rank the projects even when the costs of the projects differ
significantly.
It recognizes the time value of money and is suitable to apply in a
situation with uniform cash outflows and uneven cash inflows.

35

 It takes into an account the earnings over the entire life of the
project and gives the true view of the profitability of the
investment.
Takes into consideration the objective of maximum profitability.

DISADVANTAGES:
It may not give good results while comparing projects with Unequal
investment funds.
It is not easy to determine and appropriate discount rate.
It may not give good results while comparing projects with unequal
lives as the project having higher NPV but have a longer life span
may not be as desirable as a project having some what lesser NPV
achieved in a much shorter span of life of the asset.

5. INTERNAL RATE OF RETURN METHOD

The internal rate of return method is also a modern technique of
capital budgeting that takes in to account the time value of money.
It is also known as time-adjusted rate of return or trial and error
yield method.
Under this method the cash flows of a project are discounted at a
suitable rate by hit and trial method, which equates the net present
value so calculated to the amount of the investment.
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.

Decision Rule:
Accept the proposal having the higher rate of return and vice versa.

If IRR>K, accept project.

K = cost of capital.
If IRR<K, reject project.
DETERMINANTION OF IRR
36

a) When annual cash flows are equal over the life of the asset.
Initial Outlay
FACTOR =

--------------------------- x 100
Annual Cash Inflow

b) When the annual cash flows are unequal over the life of the asset:

PV of cash inflows at lower rate - PV of cash

outflows
IRR
=
LR
+
--------------------------------------------------------------------------------------x (Hr-Lr)
PV of cash inflows at lower rate-PV of cash inflows
at higher rate

The steps are involved here are

1. Prepare the cash flow table using assumed discount rate to
the net cash Flows to the present value.

discount

2. Find out the NPV, & if the NPV is positive, apply higher rate of
discount.
3. If the higher discount rate still gives a positive NPV, increase the
discount rate further. Until, the NPV becomes zero.
If the NPV is negative, at a higher rate, NPV lies between these
two rates.

ADVANTAGES:
It takes into account, the time value of money and can be applied
in situations with even and even cash flows.
It considers the profitability of the projects for its entire economic
life.
The determination of cost of capital is not a pre-requisite for the
use of this method.
It provides for uniform ranking of various proposals due to the
percentage rate of return.
37

 This method is also compatible with the objective of maximum

profitability.

DISADVANTAGES:
It is difficult to understand and operate.
The results of NPV and IRR methods may differ when the projects
under evaluation differ in their size, life and timings of cash flows.
This method is based on the assumption that the earnings are
reinvested at the IRR for the remaining life of the project, which is
not a justified assumption.

CHAPTER 3
COMPANY PROFILE

38

COMPANY PROFILE
Odisha Power Generation Corporation (OPGC) was incorporated on 14 th
November, 1984. OPGC started as a wholly owned Govt. company of the
state of Odisha with objective of establishing, operating and maintaining
thermal power generation stations. It is a maiden venture, the company
has set up two thermal power plants with a capacity of 210 MW each in
the IB Valley are of Jharsuguda District in the State of Odisha (Ib Thermal
Power Station) at a cost of Rs.11350 million. The locational advantage of
the power plant lies in its close proximity to the coal mines as well as to
the Hirakud reservoir. This gives the company the distinct advantage of
low cost of Raw Material leading to low cost generation.
THE PARTNERSHIP:
As a part of reforms in the energy sector of the state 49% of the equity
was divested in favour of a private investor i.e. AES Corporation, USA in
early 1999. AES is one of the largest global power company. It generates
and distributes electric power to millions of people in 26 countries. It has
123 countries power generation facilities. It generates over 44000MW of
electricity. It has 14 distribution companies. Odisha Power Generation
Corporation is seen making progress with its Ib Valley power plant
expansion project in Jharsuguda district.
THE PRESENT BUSINESS:
39

Today OPGC has firmly established its credentials as a successful power

generating company both technically & commercially by providing clean,
safe & reliable power. With the available resources and fuel security in
terms of allocation of captive mine, the Company has rightfully
capitalised on its credentials and experience to further expand its
capacity by adding 2X660 MW units.

Shareholder

Percenta
ge

No. of
Shares

Amount (In
Rs.)

Govt. of Odisha
AES India Pvt. Ltd.
AES OPGC Holding
(incorporated in
Mauritius)
Total

51
16.25
32.75

25,00,109
7,96,178
16,05,887

25,00,109,000
7,96,178,000
16,05,887,000

100

49,02,174

49,02,174,000

MISSION AND VISION

VISION

A world-class power utility committed to generate clean, safe and

reliable

power,

enhancing

value

for

all

stake

holders

and

contributing to national growth.

MISSION
To attain global best practices by adopting, innovating and
deploying cutting edge solutions.
To achieve excellence in reliability, safety and quality of power by
creating a culture of empowerment and high performance.
To be a responsible corporate citizen having concern
environment, society, employees and people at large.
CORE VALUES

Put safety first.

Honour of commitments.
Act with integrity.
40

for

Strive for Excellence.

Have Organizational Pride.
Foster Teamwork.

STRENGTH OF OPGC

This is a Pithead Power plant with coal field located nearby & a
Merry go round system for Coal transportation.

There is adequate water availability from the nearby Hirakud

Reservoir with an Intake Channel connected to Reservoir.

Long term PPA with the State Power Transmission utility i.e. GRIDCO
for 100% off-take.

Payment security mechanism comprising Escrow Account and

revolving Letter of Credit with GRIDCO.

Infrastructure like land and common facilities are already available

for expansion of two more units.

A Dedicated workforce of Young Engineers & support staff.

41

AWARDS AND RECOGNITIONS

OPGC received the CII award (1st) in Best Practices on SHE on 20th
Nov, evening from Honorable Chief Minister, Odisha with his
message "Well done OPGC & Congratulation".

OPGC received reorganization from AES Board of Directors for

achieving 5 Years without a lost time incident on February 3, 2009"

OPGC Received the Greentech Safety Award - 2008 Gold for

outstanding achievement in Safety Management.

OPGC received First Prize in Lowest weighted frequency rate of

Accident

by

Directorate

of

Factories

and

Boilers,

Odisha,

Bhubaneswar. The award was presented by the Honorable Minister

of State Ind. Labor and Employment, Government of Odisha in the
august presence of commissioner cum secretary.

42

OPGC received GREENTECH Safety GOLD Award-2007 on 22nd Feb

2007 at Mumbai from Greentech Foundation. OPGC received this
Award for last 3 consecutive years.

OPGC received GREENTECH Safety GOLD Award 2006 in Coal based

Power sector for outstanding achievement in safety management
from Greentech foundation.

OPGC received Safety Award from Directorate of Factories &

Boilers, Odisha for "1st Prize in Longest Accident Free Period
category for the yr.2004 ".

OPGC (ITPS) received "CII-Odisha Award for Best Practices in

Environment, Safety & Health (ESH)-Runner".

OPGC (ITPS) has been selected for the prestigious "Greentech

Environment Excellence Gold Award in Thermal Power Sector for
them year 2004-2005".

IBTPS has received OHSAS 18000 certification from BVQI from 05th
May 2005.

OPGC received "Greentech Safety Gold Award in Power Sector" for

the year 2004-05 in recognition to outstanding achievement in
Safety Management at IBTPS.

IBTPS has received State Safety Award for "Best Environment

Management" Year 2002-03 from Director of Factories Director of
Factories & Boilers, Odisha on 27th Nov'2004.

OPGC has received prestigious Greentech Environment Excellence

Gold Award in thermal power sector for the year 2003-04 in
recognition to Best Environment Management.

43

Environment

Management

System

(EMS)

established

&

implemented at ITPS was recommended for ISO 14001 certification

by BVQI in Oct'2004 after final audit conducted from 11-14th
Oct2004 & received the Certificate from 14th October 2004.

State Pollution & control Excellency Award 2003 for Implementation

of Environmental Pollution control measures & Constant effort for
protection of environment.

Pollution control appreciation award 2002 Promoted by Odisha

Pollution Control Board.

Meritorious Productivity Awards (promoted by CEA) for the year

1999-2000 Cash Award of Rs.8.31Lakhs, Silver shield & a Gold
medal.

Safety award from Chief inspector, Factories and Boiler Odisha for
the year 1999 for zero accident in industry.

Meritorious performance of Thermal Power Station from Ministry of

Power, Govt. of India (promoted by CEA) for the year 1998-99 -Cash
Award of Rs.4.09Lac and a Silver shield.

Incentive award from Ministry of Power, Govt. of India ( promoted

by CEA )for better performance of thermal power station for the
year 1997-1998 Cash Award of Rs.3.40 Lac.

Incentive award from Ministry of Power, Govt. of India (promoted by

CEA) for reducing specific fuel oil consumption during the year
1997-Cash Award of Rs.5.31 Lac.

Incentive award from Ministry of Power, Govt. of India (promoted by

CEA) for reducing specific fuel oil consumption during the year
1996 -Cash Award of Rs.7.53 Lac.

44

Corporate Social Responsibility (CSR)

OPGC's vision of sustainable growth drives both business decisions as
well as Corporate Social Responsibility (CSR) initiatives. Seeking to herald
an inclusive business paradigm, OPGC has CSR interventions that are
based on social, environmental and economic considerations and are
well-integrated into the decision-making structures and processes of the
organization.
OPGC works in the core sectors of Education, Community Health,
sustainable Livelihood development and rural infrastructure development
and its CSR efforts are primarily focused on protection of environment,
providing

infrastructure

support

in

our

operational

areas,

water

management, protection and preservation of our heritage, arts and

culture, promotion of sports, entrepreneurship building and sponsorship
of seminars, conferences, workshops etc.
The following CSR activities were undertaken by OPGC in the peripheral
villages of ITPS and Manoharpur coal block area.

ITPS Periphery

Organised Shishu Mela & Shishu Mohatsav on the occasion of 15th

August and 26th

January respectively in 36 periphery

schools.
Supply of furniture to 6 periphery schools.
Financial support to 5 periphery schools.
Supply of drinking water to 25 periphery villages.
Day to day maintenance of periphery pipelines for supply of
drinking water to 17
villages.

Installation of additional water tank at village Rengali.

45

Construction of boundary wall of Samali Temple at village Bhutia.

Earth work and strengthening the bund of Jamtudia Kanta (Pond) of

village Dhubadera.
Upgradation of periphery road from ITPS boundary towards

Adhapada.
Painting and distempering of boundary wall of Vattarika Temple at

Kumarbandh.
Construction of 2 nos. of bathing ghats at village Kantatikra.
Upgradation of internal road of village Sardhapali.
Repairing of Upper Primary School at village Banharpalli.
Renovation of leading channel of Baragad MIP.
Di-siltation of Hatipada Pond at village Adhapada.
Distribution of Mosquito net at village Bhaludole.
Dengue awareness campaign in the periphery villages.
Free Health Camps to 3 periphery Ashram Schools.
Anti-mosquito fogging spray in periphery villages.
Free Tailoring training to 130 women and adolescent girls of

periphery villages in two batches.

Supply of Sports Kits to 6 periphery villages.

Mines periphery

Socio economic survey report for MGR was finalized and submitted

to respective
Collectors.
Cleaning of roads and construction of fair weather roads were

completed.
Draft R&R Plan was prepared by Project Team and Architect for

design of R&R colony has been appointed.

As per directions of DTET, temporary ITC facilities likes; repairs &
modification of

buildings, electricity supply & laboratory

equipments were provided.

In addition a number of activities for promotion of sports and culture
were under taken in the form of organising sports tournament,
competition and sponsoring local cultural events.

46

This has helped maintaining healthy relationship with the people around
the plant area.

CHAPTER - 4
DATA ANALYSIS AND
INTERPRETATION

47

INTRODUCTION:
In OPGC Ltd. a number of new projects are going on. 3 examplary
projects are selected for the study. Some of the essential aspects of the
projects are Depreciation Rate, Corporate Income Tax Rate and The
Discounting Factor. The Depreciation rate considered is 4.75%, the
Corporate Income Tax Rate is 34% (approximately) and the Discounting
Factor is 15% which is normally followed by the corporate houses. The
following table gives the abstract for these projects of the company.

SL.
NO
.
01.

PROJECT NAME

Project A

BUDGET
ESTIMAT
ES
60 crores

DEPRECIAT
ION
4.75%

34%

15%

02.

Project B

25 crores

4.75%

34%

15%

03.

Project C

20 crores

4.75%

34%

15%

48

TAX

PV
FACTOR

1. Project A
(Estimated Budget Rs 60 crores )

Calculation of Cash Flow after Tax (CFAT)

Year

Total

PBDT

35.00

38.20

40.00

42.50

42.50

198.20

Less:
Dep
@
4.75%
PBT
Less:
Tax
@ 34%
PAT
Add:
Dep
CFAT
CCFAT

2.85

2.85

2.85

2.85

2.85

14.25

32.15
10.93

35.35
12.02

37.15
12.63

39.65
13.48

39.65
13.48

183.95
62.54

21.22
2.85

23.33
2.85

24.52
2.85

26.17
2.85

26.17
2.85

121.41
14.25

24.07
24.07

26.18
50.25

27.37
77.62

29.02
106.64

29.02
135.66

135.66

A. Calculation of pay back period:

The pay back period lies between 2 and 3 years. Therefore the exact pay
back period will be as follows:
Pay back period = Base year + required CFAT/Next year CFAT
Exact pay back period = 2 + 60 50.25/27.37
= 2 + 0.35
= 2.35
PBP = 2.35
49

B. Calculation of ARR:
ARR = AVERAGE ANNUAL PAT/ AVERAGE INVESTMENT 100
ARR= 24.282/30 100
= 80.94%
ARR = 80.94%

C. Calculation of NPV:
Year
0
1
2
3
4
5

Cash Flows

PV @ 15%

(60.00)
1.00
24.07
0.870
26.18
0.756
27.37
0.658
29.02
0.572
29.02
0.497
Total Cash Flow
NPV

PV of Cash
Flows
(60.00)
20.94
19.79
18.01
16.59
14.42
89.75
29.75

NPV = PV OF CASH INFLOW PV OF

CASH OUTFLOW
PV of cash flow @ 15% = 89.75
Cash Out Flow = 60.00
Therefore to decrease the cash flow we increase the rate. Let the new
rate be 18%
Year

Cash Flows

PV @ 18%

0
1
2
3
4
5

(60.00)
24.07
26.18
27.37
29.02
29.02

1.00
0.847
0.718
0.609
0.516
0.437
50

PV of Cash
Flows
(60.00)
20.38
18.79
16.66
14.97
12.68

Total Cash Flow

NPV

83.48
23.48

D. Calculation of IRR & IR:

The IRR is usually the rate of return that a project earns. PI measures the
present value of returns per rupee invested.
IRR = Ri +

PV of CF at Ri - PV of COF
(Rh Ri)
PV of CF at Ri PV of CF at Rh

IRR = 15 +

89.75 60
89.75 83.48

(18 15)

= 29.2
IRR = 29.2%

E. Calculation of Profitability Index:

PROFITABILITY INDEX (PI) = PV OF CASH INFLOWS/INTITAL CASH
OUTLAY
PI= 89.75/60
= 1.49
Profitability Index (PI) = 1.49 times

2. Project B
(Estimated Budget Rs 25 crores)
Calculation of Cash Flow after Tax (CFAT)
Year

Total

PBDT
Less:
Dep
@
4.75%
PBT
Less:
Tax
@ 34%
PAT

10.25
1.1875

15.84
1.1875

20.50
1.1875

20.50
1.1875

20.50
1.1875

87.59
5.9375

9.0625
3.08125

14.6525
4.98185

19.3125
6.56625

19.3125
6.56625

19.3125
6.56625

81.6525
27.7538
5

5.98125

9.67065

12.7462
5

12.7462
5

12.7462
5

53.8906
5

51

Add:
Dep
CFAT

1.1875

1.1875

1.1875

1.1875

1.1875

5.9375

7.16875
7.16875

13.9337
5
31.9606

13.9337
5
45.8943
5

13.9337
5
59.8281

59.8281

CCFAT

10.8581
5
18.0269

A. Calculation of pay back period:

The pay back period lies between 2 and 3 years. Therefore the exact pay
back period will
be as follows:
Pay back period = Base year + required CFAT/Next
year CFAT
Exact pay back period = 2 + 25.00 18.0269/13.93375
= 2 + 0.5 = 2.5
PBP = 2.5
B. Calculation of ARR:
ARR = AVERAGE ANNUAL PAT/ AVERAGE INVESTMENT
100
ARR = 10.77813/12.5 100
= 86.2%
ARR = 86.2%
C. Calculation of NPV:
Year
0
1
2
3
4
5

Cash Flows

PV @ 15%

(25.00)
1.00
10.25
0.870
15.84
0.756
20.50
0.658
20.50
0.572
20.50
0.497
Total Cash Flow
NPV

NPV = PV OF CASH IN FLOW PV OF CASH

OUTFLOW
PV of cash flow @ 15% = 31.29604
Cash Out Flow = 25.00

52

PV of Cash
Flows
(25.00)
8.9175
11.9750
13.489
11.726
10.1885
56.29604
31.29604

Therefore to decrease the cash flow we increase the rate. Let the new rate
be 18%
Year
Cash Flows
PV @ 18%
PV of Cash
Flows
0
(25.00)
1.00
(25.00)
1
10.25
0.847
8.68175
2
15.84
0.718
11.37312
3
20.50
0.609
12.4845
4
20.50
0.516
10.578
5
20.50
0.437
8.9585
Total Cash Flow
52.07587
NPV
27.07587

D. Calculation of IRR & IR:

The IRR is usually the rate of return that a project earns. PI measures the
present value of returns per rupee invested.
IRR = Ri +
(Rh Ri)

PV of CF at Ri - PV of COF

PV of CF at Ri PV of CF at Rh
IRR = 15 +

56.29604 25.00
56.29604 52.07587

(18 15)

= 37.23
IRR = 37.23%
E. Calculation of Profitability Index
PROFITABILITY INDEX (PI) = PV OF CASH
INFLOWS/INTITAL CASH OUTLAY
PI= 56.29604/25
Profitability Index (PI) = 2.25 times

3. Project C
(Estimated Budget Rs 20 crores)
Year
PBDT
Less:
Dep
@
4.75%
PBT

Calculation of Cash Flow after Tax (CFAT)

1
2
3
4
5
7.83
13.42
19.00
20.03
20.03
0.95
0.95
0.95
0.95
0.95

Total
80.31
4.75

6.88

75.56

12.47

18.05
53

19.08

19.08

Less:
Tax
@ 34%
PAT
Add:
Dep
CFAT
CCFAT

2.3392

4.2398

6.137

6.4872

6.4872

25.6904

4.5408
0.95

8.2302
0.95

11.913
0.95

12.5928
0.95

12.5928
0.95

49.8696
4.75

5.4908
5.4908

9.1802
14.671

12.863
27.534

13.5428
41.0768

13.5428
54.6196

54.6196

A. Calculation of pay back period:

The pay back period lies between 2 and 3 years. Therefore the exact pay
back period will be as follows:
Pay back period = Base year + required
CFAT/Next year CFAT
Exact pay back period = 2 + 20 14.671/12.863
= 2 + 0.4
= 2.04
PBP = 2.04
B. Calculation of ARR:
ARR = AVERAGE
INVESTMENT 100

ANNUAL

PAT/

AVERAGE

ARR = 9.97392/10 100

= 99.73%
ARR = 99.
C. Calculation of NPV:
Year
0
1
2
3
4
5

Cash Flows

PV @ 15%

(20.00)
1.00
7.83
0.870
13.42
0.756
19.00
0.658
20.03
0.572
20.03
0.497
Total Cash Flow
NPV

54

PV of Cash
Flows
(20.00)
6.8121
10.14552
12.502
11.45716
9.95491
50.87169
30.87169

NPV = PV OF CASH INFLOW PV OF CASH

OUTFLOW
PV of cash flow @ 15% = 30.87169
Cash Out Flow = 20.00
Therefore to decrease the cash flow we increase the rate. Let the new
rate be 18
Year

Cash Flows

0
1
2
3
4
5

PV @ 18%

(20.00)
1.00
7.83
0.847
13.42
0.718
19.00
0.609
20.03
0.516
20.03
0.437
Total Cash Flow
NPV

PV of Cash
Flows
(20.00)
6.63201
9.63556
11.571
10.33548
8.75311
46.92716
26.92716

D. Calculation of IRR & IR:

The IRR is usually the rate of return that a project earns. PI measures the
present value of returns per rupee invested.
IRR = Ri +
(Rh Ri)

PV of CF at Ri - PV of COF
PV of CF at Ri PV of CF at Rh

IRR = 15 +

50.87169 20.00
(18 15)
50.87169 46.92716

= 38.47
IRR = 38.47%

E. Calculation of Profitability Index

PROFITABILITY INDEX (PI) = PV OF CASH INFLOWS/INTITAL CASH

OUTLAY
PI = 50.87169/20
Profitability Index (PI) = 2.5

55

Comparative Analysis of all the 3 projects

Project
Names

Discount
ed
PBP
(years)

ARR
(%)

NPV
(Rs in
crores)

PI
(times)

IRR
(%)

2.35

80.94

29.75

1.49

29.2

2.5

86.2

31.29604

2.25

37.23

2.04

99.73

30.87169

2.5

38.47

56

PAY BACK PERIOD (YEARS)

3
2.5
2

PAY BACK PERIOD

(YEARS)

1.5
1

2.35

2.5

PROJECT A

PROJECT B

2.04

0.5
0
PROJECT C

INTERPRETATION:
3 projects are showing the positive values, therefore the projects
are accepted.
In project 3 we can recover the investment within a short period of
time i.e., 2.04 years, when compare with the other projects.

ARR (%)
120
100
80

ARR (%)

60
40

80.94

86.2

PROJECT A

PROJECT B

99.73

20
0
PROJECT C

57

INTERPRETATION:
When compare to all the projects of ARR, in the 3 project i.e., Project C
the ARR % is 99.73%, so in this project the average rate of return is
more.

PROJECTS NPV (Rs. In Crores)

31.5
31
30.5

PROJECTS NPV (Rs. In

Crores)

30

31.3

29.5
29

30.87

29.75

28.5
PROJECT A

PROJECT B

PROJECT C

INTERPRETATION:
The NPV should be greater than the cash outflow then only the project
should be accepted. All projects are showing the positive values only.
When compare to all the projects the NPV value is more in 2nd project.

58

PROJECT IRR (%)

45
40
35
30
PROJECT IRR (%)

25
20
15

37.23

38.47

PROJECT B

PROJECT C

29.2

10
5
0
PROJECT A

INTERPRETATION:
When compare to all the projects the IRR percentage is more in 3rd
project i.e., 38.47, better we can choose the 3rd project.

PROFITABILITY INDEX (%)

3
2.5
2

PROFITABILITY INDEX
(%)

1.5
2.25

2.5

1.49
0.5
0
PROJECT A

PROJECT B

PROJECT C

INTERPRETATION:

59

When compare to all the projects the Profitability Index is more in 3rd
project i.e., 2.5 times. But we can choose the project 1, because we can
recover over investment with short period in this project i.e., 1.49 times.

CHAPTER 5
FINDINGS, SUGGESTIONS &
CONCLUSION

60

FINDINGS
The followings points were observed from the capital budgeting is as
follows:
The first project i.e., Project A is generating unequal cash flows for
5 years. The initial investment is Rs. 60 crores.
The ARR is 80.94% which is greater than the companys rate

of return.
The discounted pay back period is 2.35 years.
NPV and IRR are positive for the proposal.
The Profitability Index (PI) is 1.49 > 1.

Project B is experiencing the unequal cash flows and the initial

investment is Rs. 25 crores.
The ARR is 86.2% more than required rate of return.

Therefore, accept on ARR basis (traditional method).

NPV is positive for the project and the IRR > ARR.
The discounted pay back period is 2.5 years.
The Profitability of the project on every one rupee of its
investment is 2.25 times.

The 3rd project is Project C is also generating unequal cash flows

for 5 years. The initial investment is Rs. 20 crores.
The ARR is 99.73% which is greater than the required rate of

return.
The discounted pay back period is 2.04years.
NPV and IRR are positive for the proposal.
The Profitability Index (PI) is 2.5 times which is higher among all
projects. As its returns are high, the project is also risky.

61

SUGGESTIONS AND RECOMMENDATIONS

Few of my suggestions are based on the results observed in three of the
projects which were as follows:
In 1st project i.e., Project A is having a high Accounting Profit (ARR)
no 80.94%, NPV, IRR and PI are also positive. This is risky project as
its returns are also high. Therefore, the project is accepted.
Project B is profitable in all contexts.PBP, ARR, NPV, IRR and PI are
positive. As it returns are positive, accept the project.
The 3rd project is Project C is having a high Accounting Profit (ARR)
no 99.73% and remaining all techniques are positive, but this is a
risky project as its returns are high. Therefore, the project is
accepted.

62

CONCLUSION

When an organization is setting up a capital budgeting for the

business, they are planning for the outcome of the month. How
involved the project budgeting is individual will be depends on their
investment decisions in a business.
When making the capital budgeting decision, the financial manager
effectively analyzed the long term investment programmes, so that
it will improve the business over all.
Many businesses ignore or forget the other half of the budgeting.
Capital budgeting are too often proposed, discussed and accepted.
It can be used to influence managerial action for long-term
implications and affect the future growth and profitability of the
firm. Good management looks at what that difference means to the
business.
Remember to keep the records that have been created. The
company should have capital budgeting records of the projects
always on file, so that it gives the future course of action for the
investment proposal for long-term period.
Organizations must make sure that, more attention should be paid
upon the investment proposal or course of action whose benefits
are likely to be available in future over the lifetime of the project,
as the demand on resources is almost always higher than the
availability of resources.

63

BIBLIOGRAPHY
1. M. PANDEY: Financial Management: Vikas publishing house pvt. ltd,
9th edition.
2. PRASANNA CHANDRA: Financial Management: Tata McGraw-Hill, 7th
edition.
3. I.M. PANDEY: Financial Management: Tata McGraw-Hill, 4th edition.
4. Annual report of OPGC Ltd.

Websites:
www.google.com
www.opgc.co.in
www.studyfinance.com
www.wikipedia.org/wiki/capital_budgeting
www.eximfm.com/training/capital budgeting.doc
www.yahoofinance.com

64