INTRODUCTION

Finance in the modern business world is regarded as life blood of a business

enterprise; finance function has become so important that it has give birth to financial
management as a separate subject. So this subject is acquiring universal applicability.
Financial management is that managerial activity, which is concerned with the planning
and controlling of the firm's financial resources, as a separate activity of recent origin it
was a branch of its own, and it draws heavily on economics for its theoretical
concepts.
Financial

management

is

broadly

concerned

with

the acquisition and use of

funds by a business firm. It deals with

1. How large should the firm be and how fast should it grow?
2. What should be the composition of the firm's avels?
3. What should be the mix of the firm's financing?
4. How should the firm analysis, plan and control its financial affairs?
While the first three questions express Ezra Solomon's conception of financial
management as discussed in his clerical work. "The theory of financial
management" the forth one represents an addition that is very relevant in the light of
the responsibilities shouldered by finance managers in practice.
Key activities of financial management
The three broad activities of financial management
Financial analysis, planning and control.
Management of the firm's asset structure.
Management of the firm's financial structure
Financial Analysis, Planning And Control
Finance analysis, planning and control are concerned with

Assessing the finance performance and conciliation of the firm.

Forecasting and planning the finance future of the firm.
Estimating the financing needs of the firm.
Instituting appropriate systems and control to ensure that the actions of the firm.

The modern thinking in financial management accords a far greater importance to

management in decision making and formulation of policy. Financial management
occupies key position in top management and plays a dynamic role in solving complex
management problems. They are now responsible for snapping the fortunes of the
enterprise and are involved in allocation of capital.

Nature of financial management

Financial management is that managerial activity which is concerned with
the planning and controlling of the financial resources. Though it was a branch of
economics ti ll 1890, as a separate activity or discipline it is of recent origin still, it
has no unique body of knowledge of its own and draws heavily on economics for its
theoretical concept even today. Financial management is that managerial activity
which is concerned with the planning and controlling of the firms financial
resources.
Business finance may further sub divided into various categories personal
finance, partner ship finance and corporate or company finance as separate activity
it is of recent origin. The finance in the modern world is the life of the business economy.
We can't imagine a business without finance because it is actual point of all business
activities. Finance function has not unique body it is part of economics,
accounting marketing, product and quantitative methods.

Management Of The Firm's Asset Structure Involves

Management of the firm's asset structure involves
1. Determining the capital budget.
2. Managing the liquid resources.
3. Establishing the credit policy.
4. Controlling the level of inventories
Management of the firm's financial structure
Management of the firm's financial structure involves
1. Establishing the debt-equity ratio or financial leverage.
2. Determining the divided policy.
3. Choosing the specific instruments of financing.
4. Negotiating and developing relationship with various suppliers of capital.
2

NEED FOR THE STUDY

A project is an activity sufficiently self-contained to permit financial and
commercial analysis. In most cases projects represent expenditure of capital funds by preexisting which want to expand or improve their operation.
In general a project is an activity in which, we will spend money in expansion of
returns in which logically seems to lead itself planning. Financing and implementations as
a unit, is a specific activity with a specific point and a specific ending point intended to a
accomplish a specific objective of the study.
An efficient allocation of capital is the most important finance function in the
modern times. It involves decisions to commit the firms funds to the long-term assets.
Capitals budgeting for investment decisions are of considerable importance to the firm
since they tend to determine its value by influencing its growth, evaluation of capital
budgeting decisions.
A capital budgeting decisions may be defined as the firms decision to invest is
current funds most effectively & efficiently in the long term assets in anticipation of an
expected flow of benefits over a series of years. The long-term assets are those that affect
the firms operations beyond the one year period. The firms investment decisions would
generally includes expansion, acquisition modernization and replacement of long term
assets. Sale of a division or business is also an investment decision. Decision like the
change in the methods of sales distribution or an advertisement campaign or research and
development program have long-term implications for the firms expenditure and
benefits, and therefore they should also be evaluated as investment decisions.

OBJECTIVES OF THE STUDY

To present theoretical framework relating to capital budgeting
To evaluate the effectiveness of capital expenditure decisions of company.
To provide support in order to accomplished the overall goal of the capital
budgeting system of the company
To evaluate the elements consider by the of the company expansion project.
To offer findings, suggestions & conclusion based on the study.

SCOPE OF THE STUDY

The study of capital budgeting in Y.S.R. SPINNING & WEAVING MILLS (P)
LTD includes analyzing the investment decision of the firm. As substantial amounts are
tied up in such decision, it needs careful analysis and proper management in order to
minimize the manufacturing costs and maximize its profits. As the information available
is limited and the subject is vast the study is combined to overall capital budgeting
techniques followed at the firm.

METHODOLOGY OF THE STUDY

Methodology is a systematic process of collecting information in order to analyze
and verifies a phenomenon. The collection of data is two principle sources. They are
discussed as
I. Primary data
II. Secondary data

PRIMARY DATA
The primary data needed for the study is gathered through interview with
concerned officers and staff, either individually or collectively, sum of the information
has been verified or supplemented with personal observation conducting personal
interviews with concerned officers of finance department of Y.S.R. SPINNING &
WEAVING MILLS (P) LTD.
SECONDARY DATA
The secondary data needed for the study was collected from published sources
such as, pamphlets of annual reports, returns and internal records, reference from text
books and journal management.
Further data needed for the study was collected from: Collection of required data from annual records of the company.
Reference from text books and journals relating to financial management.

DIAGRAMATIC REPRESENTATION OF RESEARCH METHODOLOGY

Diagram

DATA
SOURCES

SECONDARY
SOURCES

PRIMARY
SOURCES

MANAGEMENT

RESPONDENTS

INSIDE
THE
COMPANY

PERSONAL
OBSERVA NCE

ANNUAL
REPORTS

OUT SIDE
THE
COMPANY

TEXT
BOOKS
JOURNALS

LIMITATIONS OF THE STUDY

The following the limitations of the study:

The project has to be completed with the available data given to us.
The period of study that is 4 weeks is not enough to conduct study of the project
The study is carried basing on the information and documents provided by the
organization
There was no scope of gathering current information, as the auditing has not been
done by time of project work.
The procedure has to be completed with the available data with us.

INDUSTRY PROFILE
INTRODUCTION
This section provides background information on the history, size, geographic
distribution, employment, production, sales, and economic condition of the textile
industry. The facilities described within the document are described in terms of their
Standard Industrial Classification (SIC) codes.
The textile industry is one of the oldest in the world. The oldest known textiles,
which date back to about 5000 B.C., are scraps of linen cloth found in Egyptian caves.
The industry was primarily a family and domestic one until the early part of the 1500s
when the first factory system was established. It wasnt until the Industrial Revolution in
England, in the 18th century, that power machines for spinning and weaving were
invented. In 1769 when Richard Arkwrights spinning frame with variable speed rollers
was patented, water power replaced manual power (Neefus, 1982).
In the early 17th century of colonial America, textiles were primarily
manufactured in New England homes. Flax and wool were the major fibers used,
however, cotton, grown primarily on southern plantations, became increasingly important
(Wilson, 1979). In 1782 Samuel Slater, who had worked as an apprentice to Arkwrights
partner, immigrated to America. In black stone River, Rhode Island, he started building
Arkwright machines and opened the fist English-type cotton mill in America (ATMI,
1997a). In the early nineteenth century, in Lowell, Massachusetts, the first mill in
America to use power looms began operations. It was the first time that all textile
manufacturing operations had been done under the same roof (Wilson, 1979 and ATMI,
1997a).
9

The twentieth century has seen the development of the fist manmade fibers (rayon
was first produced in 1910). Although natural fibers (wool, cotton, silk, and linen) are still
used extensively today, they are more expensive and are often mixed with manmade
fibers such as polyester, the most widely used Synthetic fiber. In addition, segments of the
textile industry have become highly automated and computerized (ATMI, 1997a).
The textile industry is characterized by product specialization. Most mills only
engage in one process or raw material. For example, a mill may be engaged in either
broadloom weaving of cotton or broadloom weaving of wool. Similarly, many mills
specialize in either spinning or weaving operations, although larger integrated mills may
combine the two operations. These large mills normally do not conduct their own dyeing
and fishing operations. Weaving, spinning, and knitting mills .usually send out their
fabrics to one of the approximately 500 dyeing and fishing plants in the United States.
Broadly defined, the textile industry consists of establishments engaged in
spinning natural and manmade fibers into yarns and threads. These are then converted (by
weaving and knitting) into fabrics. Finally, the fabrics and in some cases the yarns and
threads used to make them, are dyed and fished. The manufacturing of textiles is
categorized by the Office of Management and Budget (OMB) under Standard Industrial
Classification (SIC) code 22. The Standard Industrial Classification system was
established by OMB to track the flow of goods and services in the economy, by assigning
a numeric code to these good and services. SIC 22 is categorized .into nine three-digit
SIC codes. Due to the large number of processes used in the textile industry and the
limited scope of this notebook, the production of nonwoven synthetic materials and
carpets is not discussed in detail. The primary focus of this notebook is on weaving and
knitting operations, with a brief mention of processes used to make carpets. OMB is in
the process of changing the SIC code system to a system based on similar production.
10

Processes called the North American Industrial Classification System (NAICS). In the
NAIC system, textile mills (including fiber, yarn and thread mills, fabric mills, and textile
and fabric finishing and coating mills) be classified as NAIC 313. Textile product mills
(including furnishings, carpets, rugs, curtains, linens, bags, canvas, rope, twine, and tire
cord and tire fabric) will be classified as NAIC 314. This notebook covers the textiles
industry as defined by SIC 22. Less focus is given to SIC 229, Miscellaneous Textile
Goods in the Industrial Process.
Descriptions Section because the processes used and products manufactured vary
substantially within SIC 229. Products categorized under SIC 229 include coated fabrics,
not rubberized, tire cord-and fabrics, cordage and twine, and textile goods not elsewhere.
Classified it is important to note, however, that the Miscellaneous Textile Goods category
is covered in Section 11, Introduction to the Textile Industry; Section IV, Chemical
Release and Transfer Profile; Section VIII, Compliance Activities and Initiatives; and
other sections of this document. Industry sectors related to the textiles industry, but not
categorized under SIC 22 (and thus, not in the scope of this notebook) include the
manufacturing of clothing and apparel (SIC 23) and the manufacturing of rubber coated
textile goods (SIC 3069).

Product Characterization
Within the nine broad categories in the textile industry are 22 four-digit SIC codes
which more narrowly define the different types of products made Manufacturing
establishments within the textile industry are primarily involved In
1. Fiber preparation and manufacture of yam, thread, braids, twine, and cords;

11

2. Manufacture of knit fabrics, broad and narrow woven fabrics, as well as carpets
and rugs fiomyarn (Broad woven fabricsare generally greater than 12 inches in
width, whereas narrow woven fabrics are less than 12 inches in width.);
3. Dyeing and fishing if beers, yarns, fabrics, and knitted goods;
4. Coating, water proof and treating fabrics;
5. Integrated manufacture of knit apparel and other products foam yarn; and
6. Manufacture of felt, lace, nonwoven, and other miscellaneous textile products.
More detailed information on the industrial processes used to produce the various
textile products.

Geographic Distribution
The geographic distribution of the textile industry in the U.S. is largely governed
by its history in this country. The industry began in New England and moved to the South
as cotton became the primary source of fibers. The five major states for employment in
the textile industry are North Carolina, Georgia, South Carolina, Alabama, and Virginia.
Though the majority of mills are located in the South, northern states such as Maine,
Massachusetts, New York, New Jersey, Rhode Island, and Pennsylvania are still
important to the textile industry. Many finishing and dyeing (SIC 226) operations are
located in New Jersey. Narrow fabrics and manmade fiber mills (SIC 224) are more
concentrated in Rhode Island and Pennsylvania. Knitting mills (SIC225) and
miscellaneous textile mills (SIC 229) are scattered through several southern and northern
states.

12

According to the 1992 Census of Manufacturers for SIC 22 (the most recent
census data available), there were a totalof5,584 establishments in the textile
manufacturing industry. A large proportion ofthese were knitting mills (SIC 225) and yam
and thread mills (SIC 228). Together these categories accounted for almost 50 percent of
the total number of establishments in the industry. 'They also accounted for the largest
portion of the employment and value of shipments in the textile industry. The knitting and
yam and thread mills categories accounted for 46 percent of the 614,000people employed
in the industry, and40 percent of the $70.5 million in value of shipments, in 1992.

Economic Trends
Throughout the 1990s, the textile industry indicators have shown improvements.
The year 1994 was a peak year for all indicators including exports, capital expenditures,
employment, and mill fiber consumption. In 1994, mill fiber consumption set a record
with a 6 percent increase to 16.1billion pounds. In1995, fiber consumption decreased by
1.7 percent only to increase by 1 percent in 1996 (ATMI,1997b). Both 1994 and 1996
were record years for fiber consumption and were a substantial improvement over the
recession years in the early part of the decade. The industry has also experienced a shift
towards increasing international trade with countries such as Canada and Mexico (ATMI,
1996)

Domestic Economy
The textile industry spends four to six percent of sales on capital expansion and
modernization, down ffom eight to ten percent during the expansionary phase of the
1960s and 1970s. Most recent capital expenditure has paid for mill modernization and
factory automation (EPA, 1996). According to the American Textile Manufacturers
13

Institute (ATMI), the largest trade association for the industry, capital expenditures by
domestic textile companies have increased in recent years reaching $2.9 billion in 1995
(ATMI, 1997b). The increase in capital expenditures has led to an increase in
productivity. Between 1975 and 1995, looms productivity, measured in Square yards of
fabric per loom, increased by 267 percent and was up 10.5 percent in 1996 (ATMI,
1997b). In the same period, productivity of broad woven fabric. Mills, measured by an
index of output per production employee hour, increased by 105 percent, and productivity
of yarn spinning mills increased by 88 percent (ATMI, 1996). Industry also reports
spending more than $25 million each year on pollution and safety controls.
Economies of scale in textile manufacturing are significant and limit entry into
the market. The cost of a new fiber plant, for example, is approximately $100 million.
Costs of raw materials are equity volatile and typically account for 50 to 60 percent of the
cost of the fished product. To hedge against supply shocks and to secure supply, many
producers are vertically integrated backward into chemical intermediates (and in the case
of companies such as Phillips and Amoco, all the way to crude oil). Forward integration
into apparel and product manufacture (e.g. carpeting) also is not uncommon. (US EPA;
1996).

INDUSTRIAL PROCESS DESCRIPTION

This section describes the major industrial processes in the textile industry,
including the materials and equipment used and the processes employed. The section is
designed for those interested in gaining a general understanding of the industry, and for
those interested in the interrelationship between the industrial process and the topics
described in subsequent sections of this profile -- pollutant outputs, pollution prevention
opportunities, and Federal regulations. This section does not attempt to replicate
14

published engineering information that is available for this industry. Refer to Section IX
for a list of reference documents that are available. Note also that Section V, Pollution
Prevention Opportunities, provides additional information on trade-offs associated with
the industrial processes discussed in this section. This section describes commonly used
production processes, associated raw materials, the byproducts produced or released, and
the materials either recycled or transferred off-site.
This discussion identifies where in each process wastes may be produced. This
section concludes with a description of the potential fate (via air, water, and soil
pathways) of process-specific waste products.
Natural Fibers
Yarn formation can be performed once textile fibers are uniform and have
cohesive surfaces. To achieve this, natural fibers are first cleaned to remove impurities
and are then subjected to a series of brushing and drawing steps designed to soften and
align the fibers. The following describes the main steps used for processing wool and
cotton. Although equipment used for cotton is designed somewhat differently from that
used for wool, the machinery operates in essentially the same fashion.

Opening / Blending. Opening of bales sometimes occurs in conjunction with the

blending of fibers. Suppliers deliver natural fibers to the spinning mill in compressed
bales. The fibers must be sorted based on grade, cleaned to remove particles of dirt, twigs,
and leaves, and blended with fibers from different bales to improve the consistency of the
fiber mix. Sorting and cleaning is performed in machines known as openers. The opener
consists of a rotating cylinder equipped with spiked teeth or a set of toothed bars. These
teeth pull the un baled fibers apart, fluffing them while loosening impurities. Because the
feed for the opener comes from multiple bales, the opener blends the fibers as it cleans
and opens them.
15

Carding. Tufts of fiber are conveyed by air stream to a carding machine, which
transports the fibers over a belt equipped with wire needles. A series of rotating brushes
rests on top of the belt. The different rotation speeds of the belt and the brushes because
the fibers to tease out and align into thin, parallel sheets. Many shorter fibers, which
would weaken the yam, are separated out and removed. A further objective of carding is
to better align the fibers to prepare them for spinning. The sheet of carded fibers is
removed through a funnel into a loose ropelike strand called a sliver. Opening, blending,
and carding are sometimes performed in integrated carders. That accepts raw fiber and
output carded sliver

Combing. Combing is similar to carding except that the brushes and needles are finer
and more closely spaced. Several card slivers are fed to the combing machine and
removed as a femur, cleaner, and more aligned comb sliver. In the wool system, combed
sliver is used to make worsted yam, whereas carded sliver is used for woolen yam. In the
cotton system, the term combed cotton applies to the yam made from combed sliver.
Worsted wool and combed cotton yarns are finer (smaller) than yam that has not been
combed because of the higher degree of fiber alignment and father removal of short
fibers.

Drawing:- Several slivers are combined into a continuous, ropelike strand and fed to a
machine known as a drawing frame (Wingate, 1979). The drawing frame contains several
sets of rollers that rotate at successively faster speeds. As the slivers pass through, they
are further drawn out and lengthened, to the point where they may be five to six times as
long as they were originally. During drawing, slivers from different types of fibers
(e.g., cotton and. polyester) may be combined to form blends. Once a sliver has been
drawn, it is termed a roving.
16

Drafting:- Drafting is a process that uses a frame to stretch the yam further. This
process imparts a slight twist as it removes the yam and winds it onto a rotating spindle.
The yarn, now termed a roving in ring spinning operations, is made up ofa loose
assemblage of fibers drawn into a single strand and is about eight times the length and
one-eighth the diameter of the sliver, or approximately as wide as a pencil
(Wingate,1979). Following drafting, the ravings may be blended with other fibers before
being processed into woven, knitted, or nonwoven textiles.

Spinning.- The fibers are now spun together into either spun yams or filament yams.
Filament yams are made from continuous h e strands of manmade fiber (e.g. not staple
length fibers). Spun yarns are composed of overlapping staple length fibers that are bound
together by twist. Methods used to produce spun yams, rather than filament yams, are
discussed in this section. The ravings produced in the drafting step are mounted onto the
spinning frame, where they are set for spinning. The yarn is first fed through another set
of drawing or delivery rollers, which long then and stretch it still further. It is then fed
onto a high-speed spindle by a yarn guide that travels up and down the spindle. The
difference in speed of travel between the guide and the spindle determines the amount of
twist imparted to the yarn. The yarn is collected on a bobbin. In ring spinning, the sliver is
fed from delivery rollers through a traveler, or wire loop, located on a ring. The rotation
of the spindle around the ring adds twist to the yam. This is illustrated in Figure 4(1).
Another method, shown in Figure 4(2), is open-end spinning, which accounts for more
than 50 percent of spinning equipment used (ATMI, 1997b). In this method, sliver passes
through rollers into a rotating funnel-shaped rotor.

17

The sliver hits the inside of the rotor and rebounds to the left side of the rotor,
causing the sliver to twist. Open-end spinning does not use rotating spindles since the
yarn is twisted during passage through the rotor,

Manmade Fibers
Although not classified under SIC 22, manmade fiber production is briefly
discussed in the following paragraphs to describe the upstream processing of textiles.
Manmade fibers includes
1. Cellulosic fibers, such as rayon and acetate, which are created by reacting
chemicals with wood pulp; and
2. Synthetic fibers, such as polyester and nylon, which are synthesized from organic
chemicals.

Y.S.R.SPINNING & WEAVING MILLS PVT.LTD

PROFILE
18

We have achieved a great height of success due to the hard work of Mr. Y. Sridhar
Reddy, the chairman and Mr. Y. Srinivasulu Reddy, the managing director of the
company. We have a highly skilled team of employees, who carries loads of experience in
this field. We have a strong infrastructural base, which is well equipped with the
advanced machineries. We always endeavor to provide the best and pure fabrics to our
customers and thus always check the quality content of the fabric.
We are engaged in the manufacturing of a wide range of fine cotton fabrics. Our
fine cottons fabrics have a remarkable characteristic of providing smoothness and
softness to the body. We are reckoned as one of the leading cotton fabrics manufacturers,
based in India. Our cotton fabric is used by big companies for production of various types
of garments. We have also become one of the foremost organic cotton yarn suppliers in
India. Our organic cotton is grown without the use of any harmful pesticides & chemicals
and thus this leads to the increase in its quality
Mr. Yerram Sridhar Reddy started his business as cotton commission agent in
1977 at his native place Idupulapadu, Inkollu Mandalam, Prakasam District, Andhra
Pradesh, and planned to forward integration of Ginner in 1983. He started a firm Sri
Srinivasa Trading Company in 1989, supplied cotton bales to various spinning mills in
Tamilnadu and Andhra Pradesh.
It was in the year 1999, he established a Spinning Mill at Ganapavaram village
with a capacity of 4500 spindles. His hard work, innovative thoughts and strategic
approach has made Y.S.R. Spinning & Weaving Mills Pvt. Ltd., turn in to one of the
leading suppliers of 100% cotton yarns to many domestic and exported oriented weaving
mills in and around the country.

Mission

19

 To manufacture a high quality yarn thereby withstanding high level of

competitiveness.
Developing a long term relationship with our customers and suppliers.
To use latest technological strategies during production thereby forming an
innovative approach.
To provide a safe, fulfilling and rewarding work environment for our employees.
Servicing and supporting the communities in which we operate

Vision
The company has a vision to excel in all fields of textile industry and agriculture
produce basis.
We will be intensely customer focused and will offer products and services which
provide the best value for our customers.

Spinning Division
Y.S.R. Spinning & Weaving Mills Pvt. Ltd., has installed state of art machines and
has a capacity to produce wide range of cotton yarns. Our machinery lines up using the
most equipment sourced from the best vendors.
Currently the company produces 8.5 tons of 100% cotton yarn per day, with a
capacity of 25514 spindles and 1050 rotors.

Weaving Division

20

Quality

Y.S.R. Spinning & Weaving Mills Pvt. Ltd., has installed 8 numbers PICANOL
Omni plus Air jet Weaving Machines to produce Grey fabric.

Policy:
Quality is integral to everything at Y.S.R We adopt

holistic quality assurance

system and an integrated system which covers the entire production process. All lots are
tested before giving to the mixing.We believe quality is a continual process. With a focus
clearly an delivering quality products and services, we integrate to constantly innovate
and excel. As a result our clients are assured of top notch quality that is consistent across
our product range.

Value:
By a clear comprehension of the market dynamics and the assimilation of the
cutting edge technology we assure the highest quality standards are met at all times.

Cotton Fabrics

21

We are happy to acquaint ourselves as one of the salient cotton fabric

manufacturers in India. Our cotton fabrics include organic cotton fabrics and white cotton
fabrics. We use pure and good quality yarn for making the fabric. Our fabric provides
immense comfort to the users. It gives soothing effect to the body and will be the right
choice in the hot and sweaty summers. Our cotton fabrics are light in weight in
comparison to its thickness. Our cotton fabric is easily washable and its significant feature
is its durability. We ensure our customers to provide good quality cotton fabric on time
and that too at moderate prices.

Products
We offer an exclusive collection of white cotton fabrics of all sizes. Our white
cotton fabric is made up of pure cotton. We also deal with the manufacturing and
supplying of organic cotton yarn. We provide organic cotton yarn in all shades. We use
environment friendly procedure for producing our organic cotton yarn. Below listed are
the two divisions that look after our manufacturing processes.

Spinning Division:
22

Our major counts range from 24s to 80s both carded and combed cotton yarns.
Adding to these counts we have the setup of doubling of yarns in Ring Doubling yarns.
Production Capacity
Ring Spun Yarns
Open End Spinning
Ring Doubling

5 tons
2 tons
1.5 tons

Weaving Division:
We are having Air jet weaving machines, which we can produce all types of
constructions as per buyer requirements. Presently we are producing 2000 meters of
40sCX40Sc-132X72-63 grey fabric and available this fabric in finished form also.

We provide the best quality cotton yarn that includes organic cotton yarn and
cotton blended yarn. Cotton yarn is produced from genuine quality fiber, cotton yarn is its
high tensile strength and its superior quality. Our cotton yarn is used by various industries
for manufacturing the best quality garments which is obtained from the seed hair of the
cotton plant. Our cotton yarn is used to manufacture genuine quality cotton fabrics. The
23

significant feature of our. We are widely known as one of the prominent cotton yarn
suppliers from India.

Welcome to the flourishing world of Y.S.R. Spinning & Weaving Mills Pvt. Ltd.
We were established in 1999, with a spindle capacity of 4500 spindles. After expansion
made in 2003 and 2006, it was now 25514 spindle and 1030 rotors and 8 numbers of air
jet weaving machines to produce 5 tons of ring spun, 2 tons of open end, 1.5 tons of ring
doubling and 2000 meters of fabric per day. In spinning department the mill has a
complete range of LMW, Trumac machines from blow room to spinning departments and
in weaving department PICANOL omniplus air jet weaving machine.

Our best quality products are the key of our success and fame. The quality of our
products has helped us in standing amongst the major companies in this field. The
company has a strong clients based at different regions of Andhra Pradesh, Gujarat,
Karnataka, Maharashtra, West Bengal, Orissa and Tamil Nadu. We are known as one of
the best cotton yarn manufacturers in India due to the fine quality of our cotton yarn. We
provide genuine quality cotton blended yarn, which is used to make superior quality
garments.

We are also widely renowned as one of the best cotton fabric suppliers in India.
Our cotton fabric is highly admired by our clients due to its durability and supreme
quality.

REVIEW OF LITERATURE
24

NATURE OF CAPITAL BUDGETING DECISIONS:

The investment decision of a firm are generally know as the capital budgeting or
capital expenditure decisions. A capital budgeting decision may be defined as the firms
decision to invest its current funds most effectively in the long term assets in anticipation
of an expanded flow of benefits over a series of years. The long term asset are those that
affect the firms operational beyond the one year period.
Investment decisions generally include expansion, acquisition modernization and
replacement of the long term asset sale of a division or business (divestment) is also an
investment decision. Decision like the change in the method of sales distribution or an
advertisement campaign or a research and developing program have long term
implication for the firms expenditures and benefits and therefore they should also be
evaluated as investment decision.
The argument that capital is a limited resource is true of any form of capital,
whether debt or equity (short-term or long-term, common stock) or retained earnings,
accounts payable or notes payable, and so on. Even the best known firm in an industry or
a community can increase its borrowing up to a certain limit. Once this pint has been
reached, the firm will either be denied more credit or be charged a higher interest rate,
making borrowing a less desirable way to raise capital.

CAPITAL BUDGETING PROCESS:

25

Capital budgeting is a complex process as it involves decisions relating to the

investment of current funds for the benefits to be achieved in future and the future is
always uncertain. However, the following procedure may be adapted in the process of
capital budgeting. There are five stages in the capital budgeting.

Identification
of investment
opportunities

Assembling of
investments

Decision
making

Performance
review

Implement
action

Preparation of
capital
budgeting

Identification of investment opportunities:

The capital budgeting process begins with the identification of potential
investment opportunities. Typically, the planning body (it may be an individual or
committee organized formally or informally) develops estimates of future sales which
identifying required investment in plant and equipment.
Identification of investment ideas it is helpful to:
Monitor external environment regularly to scout investment opportunities.
Formulate a well defined corporate strategy based on through analysis of
strengths, weaknesses, opportunities and threats.
Share corporate strategy and respective with persons.
Motivate employees to make suggestions.
Assembling of investments
Investment proposal identified by the production department and other department
are usually submitted in a standardized capital investment proposal form. Generally, most
of the proposal, before they reach the capital budgeting committee or viewed from

26

different angle. It also helps in creating a climate for bringing about co-ordinations of
inters related activities.
Investment proposals are usually classified into various categories for facilitating
decision making, budgeting and control.
Replacement investments
Expansion investment
New product investment
Obligatory and welfare investment

Decision making:
A system of rupee gateways usually characterized capital investment decision
making. Under this system executive are vested with the power to pay investment
proposals up to certain limits.

Preparation of capital budgeting:

Projects involving smaller outlays and which can be decided by executives at
lower levels are often covered by a blanket appropriation for expenditures action. Projects
involving larger outlays are included in the capital budget after necessary approvals.
Before under facing such projects an appropriation order is usually required. The purpose
of this check is mainly to ensure that the funds position of the firm satisfactory at the time
of implementation.

Implementation action:
Translating an investment proposal into a concert project is a complex, time
consuming and risk fraught task.
Adequate formulation of projects

27

The major reasons for delay is insinuate formulation of projects but differently, if
necessary home work in terms of preliminary comprehensive and detailed formulation of
the project.

Use of the principal of responsibility accounting:

Assigning specific responsibility to project managers for completing the project
within the defined time frame and cost limits is helpful for expeditious execution and cost
control.

Use of network techniques:

For project planning and control several network techniques like PERT
(Programmed evolution review techniques) and CPM (Critical path method) is available.

Performance review:
Performance review or post completion is a feed back device. It is a means for
comparing actual performance with projected performance. It may be conducted, most
appropriately. When the operation of the project have been stabilized. It is useful in
several ways
It throws light on how realistic were the assumption underlying the project.
It provided a documented log of experience that is highly valuable for decisional
making.

Components of capital budgeting:

Initial investment outlay:
It includes the cash required to acquire the new equipment or build the new plant
less any net cash proceeds from the disposal of the replaced equipment. The initial outlay
also includes any additional working capital related to the new equipment. Only changes
that occur at the beginning of the project are included as part of the initial investment
28

outlay. Any additional working capital needed or no longer needed in a future period is
accounted for as a cash outflow or cash inflow during the period.
Net cash benefits or savings from the operations:
This component is calculated as under:
(The incremental change in operating revenues minus the incremental change in
the operating cost=incremental net revenue) minus (taxes) plus or minus (Changes in the
working capital and other adjustments).

Terminal cash flow:

It includes the net cash generated from the sale of the assets, tax effects from the
termination of the asset and the release of networking capital.
The net present value techniques:
Although there are several methods used in capital budgeting, the net present
value technique is more commonly used. Under this method a project with a positive
NPV implies that it is worth investing in.

Basic steps of capital budgeting:

1. Estimate the cash flows.
2. Assess the risk nests of the cash flows.
3. Determine the appropriate discount rate.
4. Find the PV of the expected cash flows.
5. Accept the project if PV of inflows> costs. IRR> Hurdle Rate and/or
payback<policy.

29

Faced with limited sources of capital, management should carefully decide

whether a particular project is economically acceptable. In the case of more than one
project, management must identify the projects that will contribute most to profits and,
consequently, to the value (or worth) of the firm. This, in essence, is the basis of capital
budgeting.

Investment decisions- capital budgeting

Capital budgeting is vital in marketing decisions. Decisions on investment, which
take time to measure, have to be based on the returns which that investment will make.
Unless the project is for social reasons only, if the investment is unprofitable in the long
run, it is unwise to invest in it now.
Often, it would be good to know the present value of the future investment is, or
how long it will take to mature (give returns). It could be much more profitable putting
the planned investment money in the bank and earning interest, or investing in an
alternative project.
Typical investment decisions include the decision to build another grain silo,
cotton gin or cold store or invest in a new distribution depot. At a lower level, marketers
may wish to evaluate whether to spend more on advertising or increasing the sales force,
although it is difficult to measure the sales to advertising ratio.

Chapter objective:
This chapter is intended to provide:
An understanding of the importance of capital budgeting in marketing decision
making.
An explanation of the different types of investment project.
30

 An introduction to the economic evaluation of investment proposals.

The importance of the concept and calculation of net present value and internal
rate of return in decision making.
The advantages and disadvantages of the payback method as a technique for initial
screening of two or more competing projects.

Structure of the chapter:

Capital budgeting is very obviously a vital activity in business. Vast sums of
money can be easily wasted if the investment turns out to be wrong or uneconomic. The
subject matter is difficult to grasp by nature of the topic covered and also because of the
mathematical content involved. However, it seeks to build on the concept of the future
value of money which may be spent now. It does this by examining the techniques of net
present value, internal rate of return and annuities. The timing of cash flows are important
in new investment decisions and so the chapter looks at this payback concept. One
problem which plagues developing countries is inflation rates which can, in some cases,
exceed 100% per annum.

Capital budgeting versus current expenditures:

A capital investment project can be distinguished from current expenditures by two
features:
a) Such projects are relatively large.
b) A significant period of time (more than one year) elapses between the investment
outlay and the receipt of the benefits.
As a result, most medium sized and large organizations have developed special
procedures and methods for dealing with these decisions. A systematic approach to capital
budgeting implies:
31

a) The formulation of long term goals.

b) The creative search for and identification of new investment opportunities.
c) Classification of projects and recognition of economically and/or statistically
dependent proposals.
d) The estimation and forecasting of current and future cash flows.
e) A suitable administrative framework capable of transferring the required
information to the decision level.
f) The controlling of expenditures and careful monitoring of crucial aspects of
project execution.
g) A set of decision rules which can differentiate acceptable from unacceptable
alternatives is required.
The last point (g) is crucial and this is the subject of later sections of the chapter.

The classification of investment projects:

a) By project size:
Small projects may be approved by departmental managers. More careful analysis
and board of directors approval is needed for large projects of say, half a million
dollars or more.

b) By type of benefit to the firm:

An increase in cash flow.
A decrease in risk
An indirect benefit (showers for workers, etc).

32

c) By degree of dependence:
Mutually exclusive projects (can execute project A or B, but not both)
Complementary projects: taking project A increases the cash flow of
project B
Substitute projects: taking project A decreases the cash flow of project B

d) By degree of statistical dependence:

Positive dependence
Negative dependence
Statistical dependence

e) By type of cash flow:

Conventional cash flow: Only one change in the cash flow sign.
e.g. -/++++ or +/----, etc
Non- Conventional cash flow: More than one change in the cash flow sign.
e.g. +/-/+++ or -/+/-/++++, etc
The economic evaluation of investment proposals:
The analysis stipulates a decision rule for:
I) Accepting or
II) Rejecting

Investment projects:
The time value of money:
Recall that the interaction of lenders with borrowers sets an equilibrium rate of
interest. Borrowing is only worthwhile if the return on the loan exceeds the cost of the
borrowed funds. Lending is only worthwhile if the return is at least equal to that which
can be obtained from alternative opportunities in the same risk class.
33

The interest rate received by the lender is made up of:

I.

The time value of money: The receipt of money is preferred sooner rather
than later. Money can be used to earn more money. The earlier the money is
received, the greater the potential for increasing wealth. Thus, to forego the use of
money, you must get some compensation.

II.

The risk of the capital sum not being repaid: This uncertainty requires a
premium as a hedge against the risk; hence the return must be commensurate with
the risk being undertaken.

III.

Inflation: Money may lose its purchasing power over time. The lender must be
compensated for the declining spending/purchasing power of money. If the lender
receives no compensation, he/she will be worse off when the loan is repaid than at
the time of lending the money.

Future values/compound interest:

Future value (FV) is the value in dollars at some point in the future of one or more
investments.
The general formula for computing future value is as follows:
FVn = V0 (1+r)n
Where
V0 is the initial sum invested is the interest rate, n is the number of periods for
which the investment is to receive interest.

Thus we can compute the future value of what V0 will accumulate to in n years
when it is compounded annually at the same rate of r by using the above formula.
34

We can derive the present value (PV) by using the formula:

FVn = V0 (1+r)n
By denoting Vo by PV we obtain:
FVn = PV (1+r)n

Rationale for the formula:

As you will see from the following exercise, given the alternative of earning 10%
on his money, an individual (or firm) should never offer (invest) more than $10.00 to
obtain $11.00 with certainty at the end of the year.

Net Present Value (NPV):

The NPV method is used for evaluating the desirability of investments or projects.
Where
Ct = the net cash receipt at the end of year t
I0 = the initial investment outlay
r = the discount rate/the required minimum rate of return on investment
n = the project/investments duration in years
Decision rule:
If NPV is positive (+): accept the project
If NPV is negative (-): reject the project

d) Perpetuities:
Perpetuities in an annuity with an infinite life. It is an equal sum of money to be
paid in each period forever.

35

e) The internal rate of return (IRR):

Refer students to the tables in any recognized published source.
The IRR is the discount rate at which the NPV for a project equals zero. This means
that the present value of the cash inflows for the project would equal the present
value of its outflows.
The IRR is the break even discount rate.
The IRR is found by trail and error

Net Present Value vs Interal Rate of Return:

Independent vs dependent projects
NPV and IRR methods are closely related because:
I. Both are time-adjustment measures of profitability.
II. Their mathematical formulas are almost identical.

So, which leads to an optimal decision: IRR or NPV?

a) NPV vs IRR: Independent projects:
b)
Independent project: Selecting one project does not preclude the choosing of the
other.
With conventional cash flows (-|+|+) no conflict in decision arises; in this case
both NPV and IRR lead to the same accept/reject decisions.
NPV vs IRR independent projects
If cash flows are discounted at k1, NPV is positive and IRR> k1: accept project
If cash flows are discounted at k2, NPV is negative and IRR< k1: reject project
Mathematical proof: for a project to be acceptable, the NPV must be positive,
36

i.e., where R is the IRR.

Since the numerators Ct are identical and positive in both instances:
Implicitly/intuitively R must be greater than k (R>k).
If NPV=0 then R=K: the company is indifferent to such a project.
Hence, IRR and NPV lead to the same decision in this case.

b) NPV vs IRR: Dependent projects:

NPV clashes with IRR where mutually exclusive projects exist.
Up to a discount rate of k0: project B is superior to project A, therefore project B is
referred to project B.
Beyond the point k0: project A is superior to project B, there project is preferred to project
B.
The two methods do not rank the projects the same.
Differences in the scale of investment
NPV and IRR may give conflicting decisions where projects differ in their scale of
investment.

The payback period (PP):

The CIMA defines payback as the time it takes the cash inflows from a capital
investment project to equal the cash outflows, usually expressed in years. When deciding
between two or more competing projects, the usual decision is to accept the one with the
shortest payback.
Payback is often used as a first screening method. By this, we mean that when a
capital investment project is being considered, the first question to ask is: How long will
it take to payback its cost? The company might have a target payback, and so it would
reject a capital project unless its payback period was less than a certain number of years.
Advantages of payback method:
37

Payback can be important: long payback means capital tied up and high
investment risk. The method also has the advantage that it involves a quick, simple
calculation and an easily understood concept.

The average rate of return- (ARR):

The ARR method (also called the return on capital employed(ROCE) or the return
on investment (ROI) method) of appraising a capital project is to estimate the accounting
rate of return that the project should yield. If it exceeds a target rate of return, the project
will be undertaken.

The payback and ARR methods in practice:

Despite the limitations of the payback method, it is the method most widely used
in practice. There are a number of reasons for this:
It is particularly useful approach for ranking projects where a firm faces liquidity
constraints and requires fast repayment of investments.
It is appropriate in situations where risky investments are made in uncertain
markets that are subject to fast design and product changes or where future cash
flows are particularly difficult to predict.
The method is often used in conjunction with NPV or IRR methods and act as a
first screening device to identify projects which are worthy of further
investigation.
It is easily understood by levels of management.
It provides an important summary method: how quickly will the initial investment
be recouped?

38

The field of capital budgeting is both comprehensive and challenging. It is clearly

plays a vital role in assigning most business firms to achieve there various goals (e.g.,
profitability, growth, stability, risk reduction, social goals, etc) it has been closely allied to
the economic problem. This is rather broadly defined as the allocation of scarcer
resources among competing alternatives.

Capital budgeting may be defined as the planning, evaluation and selection of

capital expenditure proposal as distinguished from operating year, capital expenditures
represent outlay whose principal benefits will be recognized over longer period of time.
Decision relating to capital expenditures as opposed to those for operating expenditures,
are generally irreversible and they require careful selection techniques and procedures.

Capital budgeting is commonly referred to as fixed asset management, when

integrated with the financial managers goal of attending proper combination of assets
( i.e., optimal asset mix), fixed asset assume a great deal of significance. Fixed assets are
also frequently termed as the earning asset of the firm since they usually generate large
returns. Since assets are the sources of revenue generation for the firm and fixed asset its
principal sources, it appears logical that future sales growth is heavily correlated with the
expansion of capital expenditures.

39

WHAT IS CAPITAL BUDGETING?

Capital budgeting is a required managerial tool. One duty of a financial manager
is to choose investments with satisfactory cash flows and rates of return. Therefore, a
financial manager must be able to decide whether an investment is worth undertaking and
be able to choose intelligently between two or more alternatives. To do this, a sound
procedure to evaluate, compare, and select projects is needed. This procedure is called
capital budgeting.

Capital is a limited resource

In the form of either debt or equity, capital is a very limited resource. There is a
limit to the volume of credit that the banking system can create in the economy.
Commercial banks and the other lending institutions have limited deposits from which
they can lend money to individuals, corporations and governments. In addition, the
Federal Reserve System requires each bank to maintain part of its deposits as reserves.
Having limited resources to lend, lending institutions are selective in extending loans to
their customers. But even if a bank were to extend unlimited loans to a company, the
management of that company would need to consider the impact that increasing loans
would have on the overall cost of financing.
In reality, any firm has limited borrowing resources that should be allocated
among the best investment alternatives. One might argue that a company can issue an
almost unlimited amount of common stock to raise capital. Increasing the number of
shares of company stock, however, will serve only to distribute the same amount of
equity among a greater number of share holders. In other words, as the number of shares

40

of a company increases, the company ownership of the individual stock holder may
proportionally decrease.

DEFINITION
Capital budgeting is defined as the firm decision to invest its current funds most
effectively in long term activities in anticipation of an expected flow of future benefit
over a serious of year.

Capital budgeting includes are those expenditure which are expected to produce
benefits to the firm over more than one year, and encompasses both tangible and
intangible assets. Many companies follow the traditional benefits occurring only the
expenditure on tangible fixed assets.

Capital budgeting involves the process of planning expenditure whose returns are
expected to extend beyond one year.
-Weston & Brigham
Capital budgeting is long term planning for making and financing proposed
capital outlay.
-Charles T.Horngeren

41

TYPES OF CAPITAL BUDGETING:

Capital budgeting decisions are of paramount importance in financial decision
making. In first place they affect the profitability of the firm. They also have a bearing on
the competitive position of the firm because they relate to fixed assets. The fixed assets
are true goods than can ultimately be sold for profit. Generally the capital budgeting of
investment decision includes addition, deposition, modification and replacement of fixed
assets

EXPANSION

DIVERSIFICATION

Types of capital
budgeting
decisions
REPLACEMENT

RESEARCH AND
DEVELOPMENT

MISCELLANEOUS
PROPOSAL

42

Expansion:
The company may have to expand its production capacities on accounts of high
demand for its products or inadequate production capacity. This will need additional
capital equipment.

Diversification:
A company may intend to reduce it risk by operating in several activities. In such
a case capital investment may become necessary for purchases of new machinery and
facilities to handle the new product.

Replacement:
The replacement of fixed assets in place of existing assets, either being worn out
or become out dated on account of new technology.

Research and Development:

Large sums of money may have to be spent for research and development, in case
those industries where technology is rapidly changing. In such cases large sums of money
are needed for research and development activities. So these are also included in the
proposal so Capital Budgeting.

Miscellaneous Proposals:
A company may have to invest money in projects, which do not directly helping
achieving profit-oriented goals. For example, installation of pollution control equipment
may be necessary on account of legal requirements. Therefore, funds are required for such
proposal also.
43

TYPES OF CAPITAL BUDGETING:

There are many methods of evaluating profitability of capital investment
proposals. The various commonly used methods are as follows.

Traditional methods or non-discounted Techniques:

1. Payback Period Method or Pay out or Pay off Method.
2. Improvement of traditional Approach to Pay Back Period Method.
3. Rate of Return Method or Accounting Method.

Time-adjusted method or discounted Techniques:

4. Net present Value Method.
5. Internal Rate of Return Method.
6. Profitability index Method

44

Capital
Budgeting
Techniques

DCF criteria

Non- DCF
criteria

Net Present value

(NPV)

Pay Back Period

(PBP)

Internal Rate of
return(IRR)

Accounting Rate
of Return(ARR)

Profitability
Index
(PI)

TYPES OF CAPITAL BUDGETING:

Capital budgeting decisions are of paramount importance in financial decision
making. In first place they affect the profitability of the firm. They also have a bearing on
the competitive position of the firm because they relate to fixed assets. The fixed assets
are true goods than can ultimately be sold for profit. Generally the capital budgeting of
investment decision includes addition, deposition, modification and replacement of fixed
assets.

45

Types of Capital Budgeting:

Cost reduction program
Undertaking an advertising campaign
Replacement of assets
Obtaining new facilities or expanding existing ones
Merger analysis
Refinancing an outstanding debt issue
New and existing product evaluation
No profit investments(e.g., health and safety)

IMPORTANCE OF CAPITAL BUDGETING:

Capital budgeting decisions are among the most crucial and critical decisions and
they have significant impact on the future profitability of the firm. A special care should
taken while making capital decisions, because it influences all the branches of a company
such as production, marketing, personnel, etc. the other reasons for keeping more
attention on capital budgeting decisions include the following:

1. Long term implications:

2. Investment of large funds:
3. Irreversible decisions:
4. Most difficult to make:
5. Rising of fund

46

Factors Affecting Capital Budgeting:

While making capital budgeting investment decision the following factors or
aspects should be considered.
The amount of investment
Minimum rate of return on investment (k)
Return expected from the investments. (R)
Ranking of the investment proposals and
Based on profitability the raking is evaluated I.e., expected rate of return on
investment.
Factors Influencing Capital Budgeting Decisions:
There are many factors, financial as well as non-financial, which influence that
Budget decisions. The crucial factor that influences the capital expenditure decisions is
the profitability of the proposal. There are other factors, which have to be in
considerations such as.

1. Urgency:
Sometimes an investment is to be made due to urgency for the survival of the firm
or to avoid heavy losses. In such circumstances, the proper evaluation of the proposal
cannot be made through profitability tests. The examples of such urgency are breakdown
of some plant and machinery, fire accident etc.

2. Degree of Certainty:
Profitability directly related to risk, higher the profits, Greater is the risk or
uncertainty. Sometimes, a project with some lower profitability may be selected due to
constant flow of income.

3. Intangible Factors:
some times a capital expenditure has to be made due to certain emotional and
intangible factors such as safety and welfare of workers, prestigious project, social
welfare, goodwill of the firm, etc.,
47

4. Legal Factors:
Any investment, which is required by the provisions of the law, is solely
influenced by this factor and although the project may not be profitable yet the investment
has to be made.

5. Availability of Funds.
As the capital expenditure generally requires large funds, the availability of funds
is an important factor that influences the capital budgeting decisions. A project, how so
ever profitable, may not be taken for want of funds and a project with a lesser profitability
may be some times preferred due to lesser pay-back period for want of liquidity.

6. Future Earnings
A project may not be profitable as compared to another today but it may promise
better future earnings. In such cases it may be preferred to increase earnings.

7. Obsolescence.
There are certain projects, which have greater risk of obsolescence than others. In
case of projects with high rate of obsolescence, the project with a lesser payback period
may be preferred other than one this may have higher profitability but still longer payback period.

8. Research and Development Projects.

It is necessary for the long-term survival of the business to invest in research and
development project though it may not look to be profitable investment.

9. Cost Consideration.
Cost of the capital project, cost of production, opportunity cost of capital, etc. Are
other considerations involved in the capital budgeting decisions?

48

SIGNIFICANCE OF CAPITAL BUDGETING:-

Capital budgeting decisions deserve to be treated in a different manner as

there are conceptual problems involved which necessarily makes the decision process
more comple, while this makes things more difficult for the decision process maker, it
also makes the problem more challenging. There are several practical reasons for
placing greater emphasis on capital expenditure decisions. These are

LONG TERM PERIOD:The consequences of capital expenditure decisions extended far into
future. The scope of current manufacturing activities of a organization is governed
largely by capital expenditures in the past. Likewise, current capital expenditures
decision provides the frame work for future activities. Capital investment
decisions have an enormous bearing on the basic character of a organization.

IRREVESIBILITY:The markets are used for capital equipment in general is ill-organized.

Further, for some types of capital equipment, custom made to meet specific
requirements, the market may virtually be non-existent.

SUBSTANCIAL OUTLAY:Capital expenditure usually involves substantial outlays. An integrated steel plant,

for example, involves an outlay of several thousand millions. Capital costs tend to
increase with advanced technology.

49

RISK AND UNCERTANITY IN CAPITAL BUDGETING

All the techniques of capital budgeting require the estimation of future cash
inflows and cash outflows. The future cash inflows are estimated based on the following
factors.
1. Expected economic life of the project.
2. Salvage value of the assets at the end of economic life.
3. Capacity of the project.
4. Selling price of the product.
5. Production cost.
6. Depreciation rate.
7. Rate of Taxation
8. Future demand of product, etc.
But due to the uncertainties about the future, the estimates of demand, production,
sales, selling prices, etc. cannot be exact. For example, a product may become
obsolete much earlier than anticipated due to unexpected technological developments.
All these elements of uncertainty have to be take in to account in the form of forcible
risk while taking on investment decision. But some allowances for the elements of the
risk have to provide.
The following methods are suggested for accounting for risk in capital Budgeting.

1. Risk-Adjusted cut off rate or method of varying discount rate:

The simple method of accounting for risk in capital Budgeting is to increase the
cut-off rate or the discount factor by certain percentage on account of risk. The
projects which are more risky and which have greater variability in expected
returns should be discounted at a higher rate as compared to the projects which are
less risky and are expected to have lesser variability in returns.
The greatest drawback of this method is that it is not possible to determine
the premium rate appropriately and more over it is the future cash flow, which is
uncertain and requires adjustment and not the discount rate.
50

Risk Adjusted Cut off Rate

Decision

analysis
Decision Tree Analysis

Certainty Equivalent

Cofficient of
Suggestions
Co-

Efficient of
Method

RISK

&CAPITA BUDJECTION

vatiation
Accounting

risk
Variation
Method
Method
In
Capital Budgeting
Sensitivity Technique

Standard
Standard Deviation
Deviation
Method
Method

Probability Techniqu

Profitability Technique
51

2. Certainty Equivalent Method:

Another simple method of accounting for risk in capital budgeting is to reduce
expected cash flows by certain amounts. It can be employed by multiplying the expected
cash in flows certain cash outflows.
3. Sensitivity Technique:
Where cash inflows are very sensitive under different circumstances, more than
one forecast of the future cash inflows may be made. These inflows may be regards as
Optimistic, Most Likely, and Pessimistic. Further cash inflows may be discounted
to find out the Net present values under these three different situations. If the net present
values under the three situations differ widely it implies that there is a great risk in the
project and the investors decision to accept or reject a project will depend upon his risk
bearing abilities.
4. Probability Technique:
A probability is the relative frequency with which an event may occur in the
future. When future estimates of cash inflows have different probabilities the expected
monetary values may be computed by multiplying cash inflow with the probability
assigned. The monetary values of the inflows may further be discounted to find out the
present vales. The project that gives higher net present vale may be accepted.
5. Standard Deviation Method:
If two projects have same cost and there net present values are also the same,
standard deviations of the expected cash inflows of the two projects may be calculated to
judge the comparative risk of the projects. The project having a higher standard deviation
is set to be more risky has compared to the other.
6. Coefficient of variation Method:
Coefficient of variation is a relative measure of dispersion. If the projects have the
same cost but different net present values, relative measure, I,e. coefficient of variation
should be computed to judge the relative position of risk involved. It can be calculated as
follows.
52

Coefficient of Variation =

Standard Deviation
Mean

X 100

7. Decision Tree Analysis:

In modern business there are complex investment decisions which involve a
sequence of decisions over time. Such sequential decisions can be handled by plotting
decisions trees. A decision tree is a graphic representation of the relationship between a
present decision and future events, future decisions and their consequences. The
sequences of event are mapped out over time in a format resembling branches of a tree
and hence the analysis is known as decision tree analysis. The various steps involved in a
decision tree analysis are
1

Identification of the problem

Finding out the alternatives;

Exhibiting the decision tree indicating the decision points, chance events, and
other relevant date;

Specification of probabilities and monetary values for cash inflows;

Analysis of the alternatives.

Limitations of Capital Budgeting:

Capital Budgeting Techniques Suffer From the Following Limitations.
1

All the techniques of capital budgeting presume the various investment proposals
under consideration are mutually exclusive which may not practically be true in
some particular circumstances.

2. The techniques of capital budgeting require estimation of future cash inflows and
outflows. The future is always uncertain and the data collected for future may not
be exact. Obviously the results based upon wrong data may not be good.
3. There are certain factors like morale of the employees, goodwill of the firm, etc.,
which cannot be correctly quantified but which otherwise substantially influence
the capital decision.
4. Urgency is another limitation in the evaluation of capital investment decisions.
53

5. Uncertainty and risk pose the biggest limitation to the techniques of capital
budgeting.

STEPS INVOLVED IN THE CAPITAL EXPENDITURE

The various steps involved in the control of capital expenditure.
1. Preparation of capital expenditure.
2. Proper authorization of capital expenditure.
3. Recording and control of expenditure.
4. Evaluation of performance of the project.

OBJECTIVES OF CONTROL OF CAPITAL EXPENDITURE

In the following all the main objectives are on control of capital expenditure: To
make an estimate of capital expenditure and to see that the total cash outlay is with in the
financial resources of the enterprise.

1. To ensure timely cash inflows for the projects so that non-availability of cash may
not be a problem in the implementation of the project.
54

2. To ensure all the capital expenditure is properly sanctioned.

3. To properly co-ordinate the projects of various departments.
4. To fix priorities among various projects and ensure their follow up.
5.

To compare periodically actual expenditure with the budgeted ones so as to avoid

any excess expenditure.

6. To measure the performance of the project.

7. To ensure that sufficient amount of capital expenditure is incurred to keep pace
with the rapid technological developments.
8. To prevent over expansion.

CAPITAL BUDGETING PROCESS

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

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
55

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 yields a rate of return higher than the minimum
required rate of return of capital are accepted and the rest rejected. If the proposal is
accepted the firm makes investment in it, and the rest are 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 away
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 there
profitability.
56

METHODS OF CAPITAL BUDGETING AND EVALUATION

TECHNIQUES
Traditional Methods:
i)

Average Rate of Return.

ii)

Pay-Back Period Method

Time Adjusted Method or Discounted Method:

i)

Net Present Value Method

ii)

Internal Rate of Return

iii)

Net Terminal Value Method

iv)

Profitability Index.

PROFITABILITY

TRADITIONAL METHODS
1. Average Rate of Return:
The average rate of return (ARR) method of evaluating proposed capital
expenditure is also know as the accounting rate of return method. It is based upon
accounting information rather than cash flows. There is no unanimity recording the
definition of the rate of return.
ARR =

Average annual profits after taxes

___

X 100

Average investment over the life of the project

The average profits after taxes are determined by adding up the after-tax profits
expected for each year of the projects life and dividing by the number of the years. In the
case of annuity, the average after tax profits is equal to any years profit.
57

The average investment is determined by dividing the net investment by two. This
averaging process assumes that the firm is suing straight line depreciation, in which case
the book value of the asset declines at a constant rate from its purchase price to zero at the
end of its depreciable life. This means that, on the average firms will have one-half of
their initial purchase prices in the books. Consequently if the machine has salvage value,
then only the depreciable cost (cost salvage value) of the machine should be divide by
two in ordered to ascertain the average net investment, as the salvage money will be
recovered only at the end of the life of the project.
Therefore an amount equivalent to the salvage value remains tied up in the project
though out its lifetime. Hence no adjustment is required to sum of salvage value to
determine the average investment. Like wise if any additional net working capital is
required in the initial year, which is likely to be released only at the end of the projects
life. The full amount of working capital should be taking determining relevant investment
for the purpose of calculating ARR. Thus,
Average investment = Net Working Capital + Salvage Value + (initial cost of
machine value)
Accept Reject Value:
With the help of ARR, the financial maker can decide whether to accept or
reject the investment proposal. As an accept reject criterion, the actual ARR would be
compared with a predetermined or a minimum required rate of return or cut off rate. A
project would qualify to be accepted if the actual ARR is higher than the minimum
desired ARR. Other wise, it is liable to be rejected. Alternatively the ranking method can
be used to select or reject proposals under consideration may be arranged in the
descending order of magnitude, starting with the proposals with the highest ARR and
ending with the proposal with the lowest ARR. Obviously projects having higher ARR
would be preferred with projects with lower ARR.

2. Pay Back Period:

The Pay Back method is the second traditional method of capital budgeting. It is
the simplest and, the most widely employed quantitative method for apprising capital
expenditure decisions. This method answers the question. How many years will it for the
58

cash benefits to pay the original cost of an investment, normally disregarding salvage
value? Cash benefits represent CFAT ignoring interest payment. Thus the pay back
method measures the number of years required for the CFAT to pay back the original out
lay required in an investment proposal.
There are two ways of calculating the pay back period. The first method can be
applied when the cash flow stream is in the nature if annuity for each year of the projects
life that is CFAT is uniform. In such a situation the initial cost of the investment is divided
by the constant annual cash flow;
Investment
For example, an investment of Rs. 40,000 in a machine is expected to produce
CFAT of Rs 8,000 for 10 years.
PB = 40000
8000

= 5YRS

The second method is used when project cash flows are not uniform (mixed
stream) but vary form year to year. In such a situation, PB is calculated by the process of
cumulating cash flows till the time when cumulative cash flow become equal to the
original investment outlay.

Accept Reject Criteria:

The pay back period can be use as a decision criterion to accept or reject
investment proposals. One application of this technique is to compare the actual pay back
with a predetermined pay back that is the pay back set up by the management in terms of
the maximum period during which the initial investment will be recovered. If the actual
pay back period less than the predetermined pay back, the project would be accepted. If
not, it would be rejected. Alternatively, the pay back can be used as a ranking method.
When mutually exclusive projects are under consideration, then may be ranked according
length of pay back period. Thus, the project has having the shortest pay back may be
assigned rank one followed in that order so that the project with the longest pay back
would be ranked last. Obviously, projects with shorter payback period will be selected.

DISCOUNTED CASH FLOW/ TIME ADJESTED TECHNIQUES:

59

1. Net Present Value Method:

The net present value is a modern method of evaluating investment proposals. This
method takes into consideration the time value of money and attempts to calculate the
return on investments by introducing the factor of time element. It recognizes the fact that
rupee earned today is worth more than the same rupee earned tomorrow. Net present
values of all inflows and outflows of cash occurring during the life of the project is
determined separately for each year by discounting these flows by the firms cost of
capital or a pre determined rate. The following are the Net Present value method of
evaluating investment proposals:
1) First of all determined an appropriate rate of interest that should be selected as
minimum required rate of return called cut off rate of interest in the market and the
market- on long term loans or it should reflect the opportunity cost of capital of the
investor.
2) Compute the present value of total investment outlay, I,e., cash outflows at the
determined discount rate. If the total investment is to be made in the initial year, the
present value shall be as the cost of investment.
3) Compute the present value of total investment proceeds I,e., inflows (profit before
depreciation and after tax) at the above determined discount rate.
4) Calculate the Net present value of each project by subtracting the present value of cash
inflows from the value of cash outflows for each project.
5)If the Net present value is positive or zero, I.e., when present value of cash inflows
either exceeds or is equal to the present values of cash outflows, the proposal may be
accepted. But in case the present value of inflows is less than the present value of cash
outflows, the proposal should be rejected.
6) To select between mutually exclusive projects, projects should be ranked in order of
net present values, i.e., the first preferences to be given to the project having the
maximum net present value.
The present value of re.1 due in any number of years may be found with the use of
the following the mathematical formula:
PV= 1/(1+r) n
60

Where,
PV = present value
R

= rate of interest/ Discount rate

N = number of years

2. Internal Rate of Return:

The second discounted cash flow or time-adjusted method of appraising capital
investment decisions is the internal rate of return method. This technique is also known
as yield on investment, marginal efficiency of capital, marginal productivity of capital,
rate of return method. This technique is also known a yield on investment, marginal
efficiency of capital, and marginal productivity of capital, rate of return, time-adjusted
rate of return and so an.
Like the present value method the IRR method also considers the time value of
money by case of the net present value method, the discount rate is the required rate of
return and being a predetermined rate, usually the cost of capital, its determinants are
external to the proposal under consideration. The IRR, on the other hand it is based on
facts, which are internal to the proposals. In other words while arriving at the required
rate of return for finding out present values the cash inflows as well as outflows are not
considered. But the IRR depends entirely on the initial outlay and the cash proceeds of
the projects, which is been evaluated of acceptance or rejection. It is therefore
appropriately referred to as internal rate of return.
The internal rate of return is usually the rate of return that a project earns.
It is defined as the discount rate ( r ) which equates the aggregate present value of the
Net cash inflows ( CFAT ) with the aggregate present value of cash outflows of a
project. In other words it is that rate which gives the project of Net present value is zero.

Accept Reject Criteria:

The use of the IRR, as a criterion to accept capital investment decisions,
involves a comparison of the actual IRR with the required rate of return also then the cut
off rate or hurdle rate. The project would quality to be accepted if the IRR
(r) Exceeds the cut off rate.
61

(k). If the IRR and the required rate of return are equal the firm is different as to whether
to accept or reject the project.

3. Net Terminal Method:

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

Accept Reject Criteria:

The decision rule is that if the present value of the sum total of the compounded
reinvested cash inflows (PVTS) is greater than the present value of the outflows (PVO),
the proposed project is accepted otherwise not.
PVTS>PVO accept
PVTS<PVO reject.
The firm would be indifferent if both the values are equal. A variation of the
terminal value method (TV) is the net terminal value (NTV). Symbolically it can be
represented as NTV = (PVTS PVO). If the NTV is the positive accept the project, if the
negative reject the project.

4.

Profitability Index:
The time adjusted capital budgeting is Profitability Index (P1) or Benefit Cost

Ratio (B / C). It is similar to the approach of NPV. The profitability index approach
measures the present value of returns per rupee invested, while the NPV is based on the
differences between the present value of future cash inflows and the present value of cash
outflows. A major shortcoming of the NPV method is that, being an absolute measure; it
is not reliable method to evaluate project inquiring different initial investments. The PI
method proves a solution to this kind of problem. It is, in other words, a relative measure.
It may be defined as the ratio, which is obtained by dividing the present value of future
cash inflows by the present value of cash inflows.
PI

= Present value of cash inflows

Present value of cash outflows
62

This method is also known as B / C ratio because the numerator measures benefits
and the denominator costs.
Accept Reject Criteria:
Using the B / C ratio or the PI, a project will quality for acceptance if its PI
exceeds one. When PI equals 1 (one), the firm is indifferently to the project.
When PI is greater than, equal to or less than 1 (one), the Net present value is
greater than, equal to or less than zero respectively. In other words, the NPV will be
positive when the PI is greater than 1 (one); will be negative when the PI is less than 1.
Thus, the NPV and PI approach give the same results regarding the investments
proposals.

63

CAPITAL COMMITMENT PLAN:The progress of projects included in the capital budget, a capital commitment plan
is issued three times a year. The commitment plan lays out the anticipated implementation
schedule for there current fiscal and the next three years. The first commitment plan is
published within 90days of the adoption of the capital budget. Updated commitment plans
are issued in January & April along with the companys budget proposals.
The commitment plan translates the appropriations approved under the adopted
capital budget into schedule for implementing individual projects. The fact that funds are
appropriated for a project in the capital budget does not necessarily mean that work will
start or be completed that fiscal year. He choice of priorities and timing of projects is
decided by office management & budget in consultation with the agencies along with
considerations of how much the managing director thinks the organization can afford to
append on capital projects overall.
The capital commitment plan lays out the anticipated implemented schedule for
capital projects and is one source of information on how far along projects are although
not a consistent or always useful one. The adopted commitment plan is usually published
in September, & then updated in January & April.
In the capital budgeting for every two adjacent years there will be gap. The gap
between authorized commitments and the target is presented in capital commitment plan
as diminishing over the course of the year plan, in practice many of the unattained
commitments will be rolled over into the next years plan, so that the current year gap
will remain large. The gap has grown in recent year exceeding in last two executive
capital plans.

KINDS OF CAPITAL BUDGETING:Capital budgeting refers to the total process of generating, evaluating,
selecting and following up an capital expenditure alternatives. The firm allocates or
budgets financial resources to new investment proposals. Basically, the firm may be
confronted with three

64

TYPES OF CAPITAL BUDGETING DECISIONS:

The accept or reject decision,

The mutually exclusive choice decisions, and

The capital rationing decision

DIFFICULTIES OF CAPITAL BUDGETING:While capital expenditure decisions are extremely important, they also pose
difficulties which stem from three principal sources:

Identifying & measuring the costs & benefits of a capital expenditure proposal
tends to be difficult

There is great deal of uncertainty for capital expenditure decision which involves
cost & benefits that extend far into the future

It is impossible to product exactly what will happen in the future

The time period creates some problems in estimating discount rates & establishing
equivalences.

LIMITATIONS OF CAPITAL BUDGETING:Capital budgeting techniques suffer from the following limitations:

All the techniques of capital budgeting presume that various investment proposals
under consideration are mutually exclusive which may not practically be true in
some particular circumstances.

The techniques of capital budgeting require estimation of future cash inflows and
outflows. The future is always uncertain and the data collected for future may not
be exact. Obliviously the results based upon wrong data may not be good.

There are certain factors like morale of the employees, goodwill of the firm, etc.,
which cannot be correctly quantified but which otherwise substantially influence
the capital decision.

Urgency is another limitation in the evaluation of capital investment decisions.

Uncertainty and risk pose the biggest limitation to the techniques of capital
budgeting.
65

COST EFFECTIVE ANALYSIS:-

In the cost effectiveness analysis the project selection or technological choice,

only costs of two or more alternatives choices are considering treating the benefits as
identical. This approach is used when the acquisition of how to minimize the costs for
undertaking an activity at a given discount rates in case the benefits and operating costs
are given, one can minimize the capital cost to obtain given discount.

PROJECT PLANNING:The planning of a project is a technically pre-determined set of inter related

activities involving the effective use of given material, human, technological and financial
resources over a given period of time. Which in association with other development
projects result in the achievement of certain predetermined objectives such as the
production of specified goods and services?
Project planning is spread over a period of time and is not a one shot activity. The
important stages in the life of a project are:

Its identification

Its initial formulation

Its evaluation

Its final formulation

Its implementation

Its completion and operation

The time taken for the entire process is the gestation period of the project. The

process of identification of a project begins when we are seriously trying to overcome

certain problems. They may be non-utilization to overcome available funds. Plant
capacity, expansion etc,

66

CRITERIAN TABLE:In the evaluation process or capital budgeting techniques there will be a
criteria to accept or reject the project. The criteria will be expressed as:
Criterian/Method

Accept

Pay Back Period (PBP)

Accounting
Rate
Return (ARR)

Reject

<Target Period
of > Target Rate

Net Present Value (NPV)

>0

Indifferent

>Target Period

=Target period

< Target Rate

=Target rate

< 0

=0

Internal Rate of Return >Cost Of Capital <Cost Of Capital =cost of capital

(IRR)
Profitability index (PI)

>1

<1

67

=1

DATA ANALYSIS & INTERPETION

IMPORTANCE OF INVESTMENT DECISION

Investment decisions require special attention because of the following reasons.
They influence the firms growth in the long term.
They affect the risk of the firm.
They involve commitment of large amount of funds
They are irreversible, or reversible at substantial loss.
They are among the most difficult decisions to make.

INVESTMENT EVALUATION CRITERIA:

Three steps are involved in the evaluation of investment.
1. Estimation of cash flows
2. estimation of the required rate of return (the opportunity cost of capital)
3. application of a decision rule for making the choice.

EVALUTION OF INVESTMENT PROPOSAL:

At each point of time a business firm has a number of proposals regarding various
projects in which it can invest funds. But the funds available with the firm are always
limited and it is not possible to invest funds in all the proposals at a time. Hence, it is very
essential to select from amongst the various competing proposals, those which give the
highest benefits. The crux of the capital budgeting is the allocation of available non
economic, which influence the capital budgeting decision is the profitability of the
prospective investment. Yet the risk involved in the proposal cannot be ignored because
profitability and risk are directly related, i.e., higher profitability, the risk vice versa.
There are many evaluating profitability of capital investment proposals. The
various commonly used methods are as follows:

68

Non DCF criteria:

(A) Pay Back Period:
The payback period one of the most popular and widely recognized traditional
methods of evaluation investment proposals. Payback period is the number of years
required to recover the original cash outlay invested in a project.
If the project generates constant annual cash flows, the payback period can be
computed by dividing cash outlay by the annual cash inflows.
Pay Back Period

Co

= Initial investment

= Annual cash inflows

Initialinvestment C 0

Annualcash inf lows C

In the case of un equal cash inflows, the payback period can be found out by
adding up the cash inflow until the total is equal to the initial cash outlay.
(B) Average Rate of Return (ARR)
The accounting rate of return (ARR) also known as the return on investment
(ROI) uses accounting information, as revealed by financial statements, to measure to
profitability of an investment. The accounting rate of return is the ratio of the average
after fax profit divided by the average investment. The average investment would be
equal to half of the original investment if it were depreciated constantly.
ARR =

AverageInc ome
x100
Averageinv estment

CRITERIAN TABLE:
In the evaluation process or capital budgeting techniques there will be a criteria to
accept or reject the project. The criteria will be expressed as:
Criterian / Method
Pay Back Period (PBP)
Accounting Rate of Return (ARR)
Net Present Value (NPV)
Internal Rate of Return (IRR)
Profitability Index (PI)

Accept
<Target Period
>Target Rate
>0
> Cost of Capital
>1

NON DCF CRITERIA:

69

Reject
> Target Period
< Target Rate
<0
<Cost of Capital
<1

Table
(a) PAY BACK PERIOD (PBP)

INCOME
YEARS

DEPRECIATION

(PAT)

(Rs)

(Rs)
2007-08
2008-09
2009-10
2010-11
2011-12
2012-13

8,55,63,456
3,13,32,218
3,00,76,560
9,63,75,756
16,07,26,312
16,32,00,297

Initial outlay

42,86,36,698

Payback period

4+0.18

CUMULATIVE

CASH

CASH

INFLOW

INFLOWS

(Rs)

3,34,32,278
3,43,24,543
3,63,65,282
4,28,42,688
4,42,13,353
6,21,69,556

(Rs)
11,89,95,734
18,46,52,495
25,10,94,337
39,03,12,781
59,82,52,446
82,36,22,299

11,89,95,734
6,64,56,761
6,64,41,841
13,92,18,444
20,79,39,665
22,53,69,853

3,83,23,917
20,79,39,665

4.18 Months

Criteria for evaluation:The payback period computed for a project is less than the payback period set by
management of the company, it would be accepted. A project actual payback period is
more than the determined period by the management, it will be rejected.
Decision:The standard payback period is set by Y.S.R. Spinning & Weaving Mills (P) Ltd
for considering expansion project is six years, whereas actual payback period is 4.18
months. Hence we accept the project.

Table
(b) AVERAGE RATE OF RETURN (ARR)
YEARS
2007-08
2008-09
2009-10

INCOME
8,55,63,456
3,13,32,218
3,00,76,560

DEPRECIATION
3,34,32,278
3,43,24,543
3,63,65,282
70

CASH IN FLOWS
5,12,38,313
-29,92,325
-62,88,722

2010-11
2011-12
2012-13

9,63,75,756
16,07,26,312
16,32,00,297

4,28,42,688
4,72,13,353
6,21,69,556

5,35,33,068
11,35,12,959
10,10,30,741

Average profit
X 100
Average investment

ARR =

31,00,34,034
5,16,72,339
6

Average Profit =

Initial Out lay 42,86,36,689 and Converted into Average Investment

Average investment =

42,86,36,689
2

= 21,43,18,349

5,16,72,339

ARR = 21,43,18,349 X 100

= 0.2411 x 100
= 24.11
Average

ROI

profit

= Initial investment X 100

5,16,72,339

= 42,86,36,698 X 100
= 0.1205 x 100
= 12.05

Criteria for evaluation:According to this method ARR is higher than minimum rate of return established
by the management are accepted. It reject the project have less ARR then the minimum
rate set by the management.

Decision:-

71

The standard ARR set by Y.S.R. Spinning & Weaving Mills (P) Ltd management
is 21%. The actual ARR is 24.11% is higher than the standard ARR set by the
management, hence we accept the project.

(b) Internal Rate of Return (IRR):

The internal rate of return (IRR) method is another discounted cash flow
technique which takes account of the magnitude and thing of cash flows, other terms used
to describe the IRR method are yield on an investment, marginal efficiency of capital, rate
of return over cost, time adjusted rate of internal return and so on.
C fi

NPV

1 k
i 0

SV WC
1 k n

Where
Cfi

= Cash flows occurring at different point of time

= The discount rate

= Life of the project in year

Co

= Cash outlay.

SV & WC

= Salvage value and working capital at the end of the n years.

IRR

A
H L
a b

Where
L

= Lower discount rate at which NPV is positive

= Higher discount rate at which NPV is negative

= NPV at lower discount rate, L

= NPV at higher discount rate, H

(c) Profitability Index (PI)

Yet another time adjusted method of evaluating the investment proposal is the
benefit cost (B/C) ratio or profitability Index (PI) profitability index is the ratio of the
present valued of cash inflows, at the required rate of return, to the initial cash out of the
investment.
PV of Cash inf lows

PI

Initial Cashoutlay

72

Where
PV

= Present Value

DCF criteria:Table
(a) Net Present Value:YEAR
2007-08
2008-09
2009-10
2010-11
2011-12
2012-13
TOTAL

CASH INFLOWS
11,89,95,734
6,56,56,761
6,64,41,842
13,92,18,444
20,79,39,665
22,53,69,853

DCF (12%)
0.893
0.797
0.712
0.636
0.567
0.507

PRESENT VALUE
10,62,63,190.5
5,23,28,438.52
4,73,06,591.5
8,85,42,930.38
11,79,01,790.1
11,42,62,515
52,33,05,456

NPV = Total PV Initial Outlay

NPV

52,33,05,456 - 42,86,36,698

9,79,68,758

Criteria for evaluation:In case of calculated NPV is positive or zero, the project should be accepted. If
the calculated NPV is negative, the project is rejected.

Decision:The project is accepted due to calculated NPV is positive.

DCF Criteria:
(a) Net Present Value (NPV): Value of Discount
The Net Present Value (NPV) method is the classic method of evaluating the
investment proposals. If is a DCF technique that explicitly recognizes the time value at
different time periods differ in value and comparable only when their equipment present
values are found out.
NPV

C3
Cn
C1
C2

C
2
3
1 k 1 k 1 k
1 k n 0

NPV

1 k

i 0

C1

C0

73

Where
NPV

= Net Present Value

Cfi

= Cash flows occurring at time

= The discount rate

= Life of the project in year

Co

= Cash outlay

Table
(a) INTERNAL RATE OF RETURN:YEARS
2007-08
2008-09
2009-10
2010-11
2011-12
2012-13
TOTAL

CASH INFLOWS
11,89,95,734
6,56,56,761
6,64,41,842
13,92,18,444
20,79,39,665
22,53,69,853

DCF (10%)
0.909
0.826
0.751
0.683
0.621
0.564

PRESENT VALUE
10,81,67,122.2
5,42,32,484.59
4,98,97,823,34
9,50,86,197.25
12,91,30,532
12,71,08,597.1
56,36,22,756.5

YEARS
2007-08
2008-09
2009-10
2010-11
2011-12
2012-13
TOTAL

CASH INFLOWS
11,89,95,734
6,56,56,761
6,64,41,842
13,92,18,444
20,79,39,665
22,53,69,853

DCF (14%)
0.877
0.769
0.675
0.592
0.519
0.423

PRESENT VALUE
10,43,59,258.7
5,04,90,049.21
4,48,48,243.35
8,24,17,319
10,79,20,686
9,53,31,447
48,53,31,447

N.P.V. atLowerRate

x difference Between Discount

I.R.R. = Lower rate + Difference
Between
P.V. Factors

Rate
56,36,22,756.5 - 52,33,05,456

IRR

= 14 56,36,22,756.5 - 48,53,67,003.26 X 14 10
=

10

3,70,17,300.5
X4
7,82,55,753.24

74

=
=
=

10+0.473(4)
10+1.892
11.892

Criteria for evaluation:In this method the project is accepted when IRR is higher than its cost of capital or
cut out rate. If the project is not accepted when the IRR is less than cost of capital

Decision:The project is accepted because of the calculation IRR is higher than its cost of
capital. The cost of capital fixed by management is 10%, the actual is more than its
standard. Hence, the project is accepted.

Table
(c) PROFITABILITY INDEX:YEARS
2007-08
2008-09
2009-10
2010-11
2011-12
2012-13

CASH IN FLOW (Rs)

11,89,95,734
6,56,56,761
6,64,41,842
13,92,18,444
20,79,39,665
22,53,69,853

PV of cash inf low

PI

Initial cash outlay

82,36,22,299

= 42,86,36,698
=

1.92

Criteria for evaluation:-

75

A project can be accepted if its PI index is greater than one. If the PI is less than
one we should reject the project.

Decision:Profitability index of proposed expansion project is found our 1.92 this is more
than the PI. Hence we accept the project.

FINDINGS
From the study it has been observed that the ABC analysis in the year 2004-05
indicates that the category A items forms a proportion i.e. 21% of total units of
inventory, but represents highest ratio 76% of total value. On the other hand
category C items represent 32% of total units and only 6% of total value. B
items occupies in between i.e. 47% of total units and 18% of total value.

From the study it has been observed that the ABC analysis in the year 2005-06
indicates that the category A items forms a proportion of 21% of total units of
inventory, but represents highest ratio 75% of total value. On the other hand a C
item occupies 33% of total units and 9% of total value. Category B items
represents 46% of total units and only 16% of total value.

76

 From the study it has been observed that the ABC analysis in the year 2006-07
indicates that the category A items forms a proportion of 16% of total units of
inventory, but represents highest ratio 70% of total value. On the other hand B
items occupies 51% of total units and 22% of total value and category C items
represents 33% of total units and a nominal value of 8% of total value.

From the study it has been observed that the ABC analysis in the year 2007-08
indicates that the category A items forms a proportion i.e. 17% of total units of
inventory, but represents highest ratio 71% of total value. On the other hand
category C items represent 33% of total units and only 9% of total value. B
items occupies in between i.e. 50% of total units and 20% of total value.

From the study it has been observed that the ABC analysis in the year 2008-09
indicates that the category A items forms a proportion i.e. 21% of total units of
inventory, but represents highest ratio 67% of total value. On the other hand
category C items represent 11% of total units and only 9% of total value. B
items occupies in between i.e. 68% of total units and 24% of total value.

For the period of the study on an average A category items of total inventory
comprises of 19% of total units and 71% of total value.

For the period of the study on average B category items of total inventory
comprises of 49% of total units and 20% of total value.

77

SUGGESTIONS
It is suggested that YSR Spinning &Weighing mills pvt ltd. needs to have a strict
inventory control and better inventory management in relation to category A
which includes cotton lint, cotton yarn, cotton seed oil.
It has been recommended that YSR Spinning &Weighing mills pvt ltd. needs to
give nominal importance and moderate control in relation to category B which
includes cotton seed extraction.
It is suggested that YSR Spinning &Weighing mills pvt ltd. needs to give least
importance in relation to category C which includes cotton seed, linters, cotton
seed hull.
It has been recommended that the company needs to maintain the inventory
turnover ratio at optimum level.

78

 It is suggested that the inventory to current assets has to be maintained optimum

level.
It is suggested that the company has to maintain same level of inventory and total
assets as to retain the inventory to total assets ratio.
It has been recommended that the inventory to working capital ratio of YSR
Spinning &Weighing mills pvt ltd. should be improved.

CONCLUSION
The economic life of any company depends on some important financial
aspects like profits, expenses, turnover etc. A careful analysis of these areas is very much
essential for the success and survival of the company. For this purpose Inventory
management with help of technique like ABC analysis is to be carried out. A study of this
type is very much useful to any company to keep in to the different financial aspects and
to take some measures to improve.

In my view the inventory management of the company is supplying a vital

information about the inventory of the company in all aspects as per the ABC analysis.
The company as maintain optimum level of inventory as for the requirements and reached
their goals.
79

BIBLIOGRAPHY
Books:
BOOK TITLE
FINANCIAL

NAME OF THE
AUTHOR
IM PANDAY

MANAGEMENT
FINANCIAL

PRASANNA

MANAGEMENT
FINANCIAL

CHANRDRA
M.Y.KHAN &

MANAGEMENT
FINANCIAL

JAIN
V.K.BHALLA

MANAGEMENT
FINANCIAL

SUDARSANA

MANAGEMENT

REDDY

80

EDITION NO

PUBLICATION

NINTH
EDITION

VIKAS
PUBLISHING

SEVENTH
EDITION

TATA MCGRAWHILL EDITION

FIFTH
EDITION

TATA MCGRAWHILL EDITION

SIXTH
EDITION

ANMOL
PUBLISHING

FOURTH
EDITION

HIMALAYA
PUBLICATIONS

WEBSITES:
www.ysrmills.com
www.aboutcotton.com
www.google.com

JOURNALS:
ECONOMIC TIMES
TIMES OF INDIA
BUSINESS LINE

81