Documente Academic
Documente Profesional
Documente Cultură
Project Report
On
CAPITAL BUDGETING
At
DR. REDDYS LABORATORIES LIMITED
Dissertation Submitted
In The Partial Fulfillment for the Award of the Degree
In Finance
Submitted By
Under the guidance of
FinanceManager
At Dr. Reddys, FTO-III, Bachupally
CERTIFICATE
This is to certify that the Project Work entitled CAPITAL BUDGETING at
Dr. Reddys, FTO III, Bachupally , is a bonafied work of
submitted in partial fulfillment of the requirements for the award of the degree of
Masters Programme In International Business for the academic year
(External Examination)
(Department of Management
Studies)
DECLARATION
I hereby declare that the project report titled CAPITAL BUDGETING submitted in
partial fulfillment of the requirements for the Post Graduation of Masters Programme In
International Business, from a bonafide work carried out by me under the guidance of
Mr. T. Koteshwar Rao, Managing Director of Finance, Dr. Reddys Laboratories Limited,
FTO III, Bachupally Hyderabad.
I also declare that this is the result of my own effort and is not submitted to any other
University for the award of any other Degree, Diploma, Fellowship or prizes.
Place:
ACKNOWLEDGEMENT
I take this opportunity to acknowledge, all the people who rendered their valuable advice in
bringing the project to function.
As part of curriculum at college. The project enables us to enhance our skills, expand our
knowledge by applying various theories, concepts and laws to real life scenario which
would further prepare us to face the extremely Competitive Corporate World in the near
future.
I express my sincere gratitude to the staff of COLLEGE Hyderabad. I specially thank the
management and staff of Dr. Reddys for creating out the study and for their guidance and
encouragement that made the project very effective and easy.
I sincerely express my gratitude to Mr. Koteshwar Rao, Finance, Manager
Dr. Reddys, for his valuable guidance and cooperation throughout my project work.
I would like to thank Mr. Koteshwar Rao, Mr. Kalyan Kumar and Mr. Doki Srinivas ,
for guiding and directing me in the process of making this project report and for all the
support and encouragement.
I am grateful to our Internal Faculty, faculty in MPIB Department for his support and
assistance in my project work.
I have tried my level best to put my experience and analysis in writing this report. I am
grateful to Dr. Reddys as an organization and its various employees for helping me to learn
and explore many fields.
INDEX
I.
Introduction
Definition of Capital Budgeting
Scope of the study
Objective of the study
Need for the study
Limitations of the study
Methodology
II.
Industry Profile
History of the Pharmaceuticals Industry
Major players of the World Pharmaceuticals Industry
The Indian Pharmaceuticals Industry
III.
Company Profile
About the Company
Page No.
Board of Directors
Strategic Business Units
Key Milestones
Department
IV.
V.
VI.
Capital Budgeting
Findings and Suggestions
Bibliography
INTRODUCTION
Definition of Capital Budgeting
Capital budgeting (or investment appraisal) is the planning process used to determine
whether a firm's long term investments such as new machinery, replacement machinery, new
plants, new products, and research development projects are worth pursuing. It is budget for
major capital, or investment, expenditures
NEED and IMPORTANCE FOR CAPITAL BUDGETING
Capital budgeting means planning for capital assets. The importance of capital budgeting
can be well understood from the fact that an unsound investment decision may prove fatal to
the very existence of the concern. The need, significance or importance of capital budgeting
arises mainly due to the following:
1. Large Investments: Capital budgeting decisions involves large investment of funds but
the funds available with the firm are always limited and demand for funds far exceeds
the resources. Hence, it is very important for the firm to plan and control its capital
expenditure.
2. Long Term Commitment of Funds: It increases the financial risk involved in the
investment decision.
3. Irreversible Nature: The capital expenditure decisions are of irreversible in nature .
Once the decision for acquiring a permanent asset is taken, it becomes very difficult to
dispose of these assets without incurring heavy losses.
4. Long Term Effect on Profitability: Capital budgeting decisions have a long - term
and significant effect on the profitability of a concern. Not only are the present earnings
of the firm affected by the investments in capital assets.
5. Difficulties of Investment Decision: The long term investment decisions are difficult to
be taken because decision extends to a series of years beyond the current accounting
period.
Main Objective: The main Objective of the project is to understand why Payback period is
better than other capital budgeting techniques from the companys point of view.
Sub Objectives: To know the investment criteria done by Dr. Reddys lab while evaluating a project.
a) To study the financial feasibility of the proposal.
b) To find out the benefits that the company is going to get from the new projects.
c) To critically evaluate a project using different types of capital budgeting techniques. and
to arrive at the right conclusion.
INDUSTRY
PROFILE
Intermediates
Drug Discovery
&
Development
API
Finished Dosages
Branded
Generics
(source: )
Achievements of the industry during the last three decades have been spectacular by
any standards, from a mere processing industry it has grown into a sophisticated sector with
advanced manufacturing technology, modern equipment and stringent quality control.
Rank
1
2
3
4
5
Company
Revenue 2008
Ranbaxy Laboratories
Dr. Reddys Laboratories
Cipla
Sun Pharma Industries
Lupin Laboratories
(Rs in crore)
Rs. 25,196.48
Rs. 4,162.25
Rs, 3,763.72
Rs. 2,463.59
Rs. 2.215,52
6
Aurobindo Pharma
Rs. 2,080.19
7
Glaxo SmithKline Pharma
Rs. 1,773.41
8
Cadila Healthcare
Rs. 1,613.00
9
Aventis Pharma
Rs. 983.80
10
Ipca Laboratories
Rs. 980.44
Source: http://specials.rediff.com/money/2008/jun/11sld01.htm
Table 1:
Top 10 Indian Pharmaceuticals Companies, 2008
India's potential to further boost its already-leading role in global generics
production, as well as an offshore location of choice for multinational drug manufacturers
seeking to curb
Over-the-Counter Medicines
The Indian market for over-the-counter medicines (OTCs) is worth about $940
million and is growing 20 percent a year, or double the rate for prescription medicines. the
government is keen to widen the availability of OTCs to outlets other than pharmacies, and
the Organization of Pharmaceutical Producers of India (OPPI) has called for them to be sold
in post offices.
Developing an innovative new drug, from discovery to worldwide marketing, now
involves investments of around $1 billion, and the global industry's profitability is under
constant attack as costs continue to rise and prices come under pressure. Pharmaceutical
production costs are almost 50 percent lower in India than in Western nations, while overall
R&D costs are about one-eighth and clinical trial expenses around one-tenth of Western
levels.
India's largest-selling drug products are antibiotics, but the fastest growing are Diabetes,
cardiovascular and central nervous system treatments.
The industry's exports were worth more than $3.75 billion in 2005-06 and they have
been growing at a compound annual rate of 22.7 percent over the last few years, according
to the government's draft National Pharmaceuticals Policy for 2007, published in January
2007. The Policy estimates that, by the year 2010, the industry has the potential to achieve
$22.40 billion in formulations, with bulk drug production going up from $1.79 billion to
$5.60 billion: India's rich human capital is believed to be the strongest asset for this
knowledge-led industry. Various studies show that the scientific talent pool of 4 million
Indians is the second-largest English-speaking group worldwide, after the USA.
VAT :
In April 2005, the government introduced value-added tax for the first time and
abolished all other taxes derived from sales of goods. So far, 22 states have implemented
VAT, which is set at 4 percent for medicines. This led to pharmaceutical wholesalers and
retailers cutting their stocks dramatically, which severely affected drug manufacturers' sales
for several months.
Opportunities
The main opportunities for the Indian pharmaceutical industry are in the areas of:
COMPANY PROFILE
improve the quality of life and Dr. Reddys had more than three decades of creating safe
pharmaceutical solution with the ultimate purpose of making the world a healthier place. Dr.
Reddys competencies cover the entire pharmaceutical value chain API and Intermediates,
Finished Dosages (Branded and Generic) and NCE research.
Dr. Reddys research centre uses cutting-edge technology and has discovered
breakthrough pharmaceutical solutions in select therapeutic areas. In a short span of
operations, Dr. Reddys have filed for more than 75 patents. Dr. Reddys is the first Indian
company to out-license an NCE molecule for clinical trials. To strengthen their research
arm, it has set up a research subsidiary, Reddy US Therapeutics Inc., in Atlanta, USA
Dr. Reddys export API, branded formulations and generic formulations to
over 60 countries.The company exports API, branded formulations and generic
formulations to over 60 countries. The inherent strength lies in identifying relevant API and
formulations, and selling them at affordable prices across the world. A few of our API such
as Norfloxacin, Ciprofloxacin and Enrofloxacin enjoy a large customer base. The finished
dosages have an enviable track record. Some of them such as Nise, Omez, Enam, Stamlo,
Stamlo Beta, Gaiety and Ciprolet are among the top brands in India, and many have
become household names in near-regulated countries too.
The generic formulations have also become very popular in quality-conscious
regulated markets such as the US and Europe. All this has been possible because of our
innovative and sustained marketing efforts.
The company set to spread our wings further and touch more lives across the
globe.
Generics;
Chairman
G V Prasad
The Company had also appointed KPMG as independent auditors for the purpose of issuing
opinion on the financial statements prepared under the US GAAP.
Albania
Cayman islands
Belarus
Cambodia
China
Dmpr
Ghana
Iraq
Kenya
Mauritius
Romania
Sri Lanka
Sudan
Guyana
Jamaica
Kyrgyzstan
Myanmar
Russia
St.Kitts
Tanzania
Haiti
Kazakhstan
Malaysia
Oman
Singapore
St.lucia
Trinidad
Uganda
Ukraine
Uzbekistan
Venezuela
Vietnam
Yemen
SHARE CAPTIAL :
(Rs in Thousands)
PARTICULARS
Equity
Debt-long Term
Total Share Capital
2004-05 2005-06
2006-2007
2007-08
479827
501114
964692
1176665
576
471085
414604
321604
480403
972199
1379296
1498269
1200000
1000000
800000
Equity
600000
Debt
400000
200000
0
2004
2005
2006
2007
Graph 1:
Source
CURRENT FINANCIAL POSITION OF DR.REDDYS LAB
Shareholding Pattern on May 29, 2009
Promoters Holding:
No. Of Shares
Individual Holding
4,489,484
39,978,328
Companies
Sub Total
Indian Financial
Institutions
Banks
Mutual Funds
Sub Total
% of Shares
2.66
23.73
44,467,812
22,524,568
13.37
312,746
0.19
10,764,293
6.39
33,601,607
19.95
38,985,964
23.14
3,097,432
1.84
24,903,193
14.78
66,986,589
39.76
23,412,769
13.90
168,468,777
100.00
Foreign Holding:
Foreign Institutional
Investors
NRIs
ADRs / Foreign National
Sub Total
Indian Public &
Corporates
Total
Table 3:
Source
1) 2008 - 2009, the company launched 116 new generic products, filed 110 new generic product
registrations and filed 55 DMFs globally.
2) The Board of Directors of the Company have recommended a final dividend of Rs.
6.25 (125%) per equity share of Rs. 5/- face value, subject to the approval of
shareholders at the ensuing Annual General Meeting.
3) Revenues in India increase to Rs. 8.5 billion ($167 million) in FY09 from Rs.8.1billions
($158 million), representing a growth of 5%.
5) New products launched in the last 36 months contribute 14% to total revenues in FY09
Dr. Reddys
Extracted from the Audited Income Statement for the year ended March 31,
2009
FY 09
Particulars
Revenues
($)
(Rs.)
FY 08
(Rs.)
(%)
Growth
%
($)
983
50,006 100
39
Cost of revenues
648
32,941
47
484
24,598 49
34
Gross profit
718
36,500
53
499
25,408 51
44
413
21,020
30
331
16,835 34
25
79
4,037
69
3,533
14
62
3,167
59
3,011
213
10,856
16
90
Operating Expenses
253
(8)
(402)
(1)
773
39,333
57
453
23,067 46
46
2,341
Finance Income(b)
(9)
(482)
(1)
Finance expenses(c)
33
1,668
21
1,080
54
23
1,186
(10)
(521)
(1)
24
1,100
71
(70)
56
2,864
19
972
75
3,836
76
3,846
(0)
(10)
(0)
75
3,836
Attributable to:
Equity holders of the company
Minority interest
Exchange rate
169
(0.6)
169
(30.7)
0.4
50.87
22.8
50.87
Notes
:
(a)
(b)
(c)
($)
(Rs.)
($)
(Rs.)
110
5,603
146
7,421
10
530
93
4,753
282
14,368
134
6,823
Inventories
260
13,226
219
11,133
410
20,881
330
16,765
387
19,701
380
19,352
118
5,987
107
5,427
Total Equity
827
42,045
931
47,350
CAPITAL BUDGETING
In modern times, the efficient allocation of capital resources is a most crucial function of
financial management. This function involves organizations decision to invest its resources
in long-term assets like land, building facilities, equipment, vehicles, etc. The future
development of a firm hinges on the capital investment projects, the replacement of existing
capital assets, and/or the decision to abandon previously accepted undertakings which turns
out to be less attractive to the organization than was originally thought, and diverting the
resources to the contemplation of new ideas and planning. For new projects such as
investment decisions of a firm fall within the definition of capital budgeting or capital
expenditure decisions.
Capital budgeting refers to long-term planning for proposed capital outlays and their
financing. Thus, it includes both rising of long-term funds as well as their utilization. It may,
thus, be defined the firms formal process for acquisition and investment of capital. To be
more precise, capital budgeting decision may be defined as the firms decision to invest its
current find more efficiently in long-term activities in anticipation of an expected flow of
future benefit over a series of years. The long-term activities are those activities which
affect firms operation beyond the one year period. Capital budgeting is a many sided
activity. It contains searching for new and more profitable investment proposals,
investigating, engineering and marketing considerations to predict the consequences of
accepting the investment and making economic analysis to determine the profit potential of
investment proposal.
The basic features of capital budgeting decisions are:
1. Current funds are exchanged for future benefits.
2. There is an investment in long term activities.
3. The future benefits will occur to the firm over series of years
Capital budgeting (or investment appraisal) is the planning process used to determine
whether a firm's long term investments such as new machinery, replacement machinery, new
plants, new products, and research development projects are worth pursuing. It is budget for
major capital, or investment, expenditures.
Capital budgeting process
The capital budget process is usually a multi-step process, including:
additional or new products, renting or owning premises for opening new branches,
etc.
Guideline No.4:
Consider the opposite of rule no 3 re: the existing sales might reduce with the
introduction of the new products. Factored the loss of revenue from such existing
products into the capital budgeting analysis.
Guideline No.5:
Ignore sunk costs and consider only those costs which are relevant to the
projects.
Guideline No.6:
Incorporate any NET additional working capital requirements into the capital
budgeting analysis for example the need to have additional inventories, accounts
receivables and or cash (increase in current assets) minus additional financing
from accounts payable, bank borrowings (current liabilities) .
Guideline No.7:
Excludes Interest Payments as this is already reflected in the discount rate (this
rate implicitly accounts for the cost of raising the financing).
APPRAISAL CRITERIA
A number of criteria have been evolved for evaluating the financial desirability of a
project. The important investment criteria, classified into two broad categoriesnondiscounting criteria and discounting criteriaare shown in exhibit subsequent sections
describe and evaluate these criteria in some detail:
Evaluation Criteria
These criteria can be classifies as follows:
Payback
Period
Accounting Rate
of Return
(ARR)
Discounting Criteria
Profitability
Index
(PI)
Internal
Rate of
Return
(IRR)
Net Present
Value
(NPV)
Annual
Capital
Charge
Method
Independent
Projects
IRR
Acceptable
Not Acceptable
MIRR
Acceptable
Not Acceptable
NPV
Acceptable
Acceptable
Acceptable
Payback
*Scale Differences
Acceptable
Many formal methods are used in capital budgeting, including the techniques such as
Discounting Criteria
These methods use the incremental cash flows from each potential investment, or project.
Techniques based on accounting earnings and accounting rules are sometimes used - though
economists consider this to be improper - such as the accounting rate of return, and "return
on investment."
Non-Discounting Criteria
Simplified and hybrid methods are used as well, such as
Payback Period
Discounting Criteria
1. Net Present Value
Each potential project's value should be estimated using a discounted cash flow (DCF)
valuation, to find its net present value (NPV). (First applied to Corporate Finance by Joel
Dean in 1951). This valuation requires estimating the size and timing of all of the
incremental cash flows from the project. These future cash flows are then discounted to
determine their present value. These present values are then summed, to get the NPV. See
also Time value of money. The NPV decision rule is to accept all positive NPV projects in
an unconstrained environment, or if projects are mutually exclusive, accept the one with the
highest NPV (GE).
The NPV is greatly affected by the discount rate, so selecting the proper rate - sometimes
called the hurdle rate - is critical to making the right decision. The hurdle rate is the
minimum acceptable return on an investment. It should reflect the riskiness of the
investment, typically measured by the volatility of cash flows, and must take into account
the financing mix. Managers may use models such as the CAPM or the APT to estimate a
discount rate appropriate for each particular project, and use the weighted average cost of
capital (WACC) to reflect the financing mix selected. A common practice in choosing a
discount rate for a project is to apply a WACC that applies to the entire firm, but a higher
discount rate may be more appropriate when a project's risk is higher than the risk of the
firm as a whole. The formula is as follows:
PV =
1
(1+r)n
Example
Assuming that the cost of capital is 6% for a project involving a lumpsum cash outflow of
Rs.8,200 and cash inflow of Rs.2,000 per annum for 5 years, the Net Present Value
calculations are as follows:
a) Present value of cash outflows Rs.8200
b) Present value of cash inflows
Present value of an annuity of Rs.1 at 6% for 5 years=4.212
Present value of Rs.2000 annuity for 5 years = 4.212 * 2000 = Rs.8424
c) Net present value = present value of cash inflows - present value of cash
outflows = 8424 -8200 = Rs.224
Since the net present value of the project is positive (Rs.224), the project is accepted.
2. Profitability Index
Profitability index identifies the relationship of investment to payoff of a proposed project.
The ratio is calculated as follows:
Decision Rule
A. "Capital Rationing" Situation
Example
A new machine costs Rs.8,200 and generates cash inflow (after tax)per annum of
Rs.2,000 during its life of 5 years. Let us assume that the cost of capital for the
company is 6%.
The present value of the cash inflows at 6% discount rate is 2000 * 4.212 = 8424.
The present value of outflow is 8,200. The profitability index is (8424/8200) =
1.027.
Decision Rules
A. "Capital Rationing" Situation
Select those projects whose IRR (r) = k, where k is the cost of capital.
Arrange all the projects in the descending order of their Internal Rate of Return.
Select projects from the top till the capital budget allows.
Accept every project whose IRR (r) = k, where k is the cost of capital.
Example
The interest factor 4.1 for a 5 year project corresponds to a discount rate of 7%. So the IRR
of the project is 7%. An interest factor of 4.100 indicates that the present value of one Rupee
annuity for 5 years at 7% is equivalent to 4 rupees and ten paise .
MIRR is the discount rate that makes the future value of the project equal to its initial cost.
MIRR requires a reinvestment rate.
There are 3 basic steps of the MIRR:
(1) Estimate all cash flows as in IRR.
(2) Calculate the future value of all cash inflows at the last year of the projects life.
(3) Determine the discount rate that causes the future value of all cash inflows
determined in step 2, to be equal to the firms investment at time zero. This discount
rate is known as the MIRR.
Decision rule
Take the project if MIRR is larger than the required rate.
Disadvantages
MIRR cannot rank mutually exclusive projects.
5. Equivalent Annuity Method
The equivalent annuity method expresses the NPV as an annualized cash flow by dividing it
by the present value of the annuity factor. It is often used when assessing only the costs of
specific projects that have the same cash inflows. In this form it is known as the equivalent
annual cost (EAC) method and is the cost per year of owning and operating an asset over its
entire lifespan.
It is often used when comparing investment projects of unequal lifespan. For example if
project A has an expected lifetime of 7 years, and project B has an expected lifetime of 11
years it would be improper to simply compare the net present values (NPVs) of the two
projects, unless the projects could not be repeated.
The use of the EAC method implies that the project will be replaced by an identical project.
Real Options
Real options analysis has become important since the 1970s as option pricing models have
gotten more sophisticated. The discounted cash flow methods essentially value projects as if
they were risky bonds, with the promised cash flows known. But managers will have many
choices of how to increase future cash inflows, or to decrease future cash outflows. In other
words, managers get to manage the projects - not simply accept or reject them. Real options
analyses try to value the choices - the option value - that the managers will have in the
future and adds these values to the NPV.
Ranked Projects
The real value of capital budgeting is to rank projects. Most organizations have many
projects that could potentially be financially rewarding. Once it has been determined that a
particular project has exceeded its hurdle, then it should be ranked against peer projects (e.g.
- highest Profitability index to lowest Profitability index). The highest ranking projects
should be implemented until the budgeted capital has been expended.
Non-Discounting Criteria
1. Payback Period
Payback period is the time duration required to recoup the investment committed to a
project. Business enterprises following payback period use "stipulated payback period",
which acts as a standard for screening the project. Of Technology Madras
Computation of Payback Period
When the cash inflows are uniform the formula for payback period is
Cash Outlay of the Project or Original Cost of the Asset
Annual Cash Inflow
When the cash inflows are uneven, the cumulative cash inflows are to be arrived at
The payback period is stated in terms of years. This can be stated in terms of
periods.
Select those projects from the top of the list till the capital budget is exhausted.
Decision Rules
Mutually Exclusive Projects
In the case of two mutually exclusive projects, the one with a lower payback period is
accepted, when the respective payback periods are less than or equivalent to the stipulated
payback period.
Determination of Stipulated Payback Period
decision-maker.
It is cost effective. It can be used even by a small firms having limited manpower
Liquidity requirement requires earlier cash flows. Hence, enterprises having high
liquidity requirement prefer this tool since it involves minimal waiting time for
recovery of cash outflows as the emphasis is on early recoupment of investment.
early recovery, it often rejects projects offering higher total cash inflow.
Investment decision is essentially concerned with a comparison of rate of return
promised by a project with the cost of acquiring funds required by that project.
Payback period is essentially a time concept; it does not consider the rate of return.
Example
There are two projects (project a and b) available for a Company, with a life of 6
years each and requiring a capital outlay of rs.9,000/- each; and additional working
capital of rs.1000/- each.
The cash inflows comprise of profit after tax + Depreciation + Interest (Tax
adjusted) for five years and salvage value of Rs.500/- for each project plus working
capital released in the 6th year. This company has prescribed a hurdle payback
period of 3 years. Which of the two projects should be selected?
Example - Data
Project A
Year 1
3,000
Year 2
3,500
Year 3
3,500
Year 4
1,500
Cumulative
Cash Inflows
of Project A
3,000
6,500
10,000
11,000
Project B
2,000
2,500
2,500
2,500
Cumulative
Cash Inflows
of Project B
2,000
4,500
7,000
9,500
Year 5
1,500
Year 6
3,000
Payback
Period
13,000
16,000
3 years
3,000
5,500
12,500
18,000
4 years & 2
months
Example
Payback period for Project A = 3 years (cumulative cash inflows = outflows)
Payback period for Project B = 4 years + 500/3000 = 4 years and 2 months.
(Note: Interpolation technique is used here to identify the exact period at which cumulative
cash inflows will be equal to outflows. The amount required to equate is Rs.500, while the
returns from the 5th year is 3,000. Hence the addition time duration required to compute the
payback period is (500/3000) x 12 which is 2 months. The interpolation technique is used
based on the assumption that cash inflows accrue uniformly throughout the year.)
The investment decision will be to choose Project A with a payback period of 3 years
and reject Project B with a payback period of 4 years and 2 months.
2. Discounted Payback Period
In investment decisions, the number of years it takes for an investment to recover its initial
cost after accounting for inflation, interest, and other matters affected by the time value of
money, in order to be worthwhile to the investor. It differs slightly from the payback period
rule, which only accounts for cash flows resulting from an investment and does not take
into account the time value of money. Each investor determines his/her own discounted
payback period rule and, as such, it is a highly subjective rule. In general, however, shortterm investors use a short number of years or even months for their discounted
payback period rules, while long-term investors measure their rules in years or even
decades.
Accounting profits are different from the cash flows from a project and hence, in many
instances, accounting rate of return might not be used as a project evaluation decision.
Accounting rate of return does find a place in business decision making when the returns
expected are accounting profits and not merely the cash flows.
Computation of Accounting Rate of Return
The accounting rate of return using total investment.
or
Sometimes average rate of return is calculated by using the following
formula:
=
Decision Rules
A. Capital Rationing Situation
1
Select the projects whose rates of return are higher than the cut-off rate.
Select projects starting from the top of the list till the capital available is exhausted.
It Is Easy To Calculate.
The Percentage Return Is More Familiar To The Executives.
The definition of cash inflows is erroneous; it takes into account profit after tax only.
Example
There are two projects (Project A and B) available for a business enterprise, with a
life of 6 years each and requiring a capital outlay of Rs.9,000/- each and additional
working capital of Rs.1000/ each. The cash inflows comprise of profit after tax +
depreciation + interest (Tax adjusted) for five years and salvage value of Rs.500/- for
each project at year 6 plus working capital released also in the 6th year.
Net Profit After Tax
Year
Project A
Project B
1,580
280
2,080
1,080
2,080
1,080
80
1,080
80
2,580
80
1,880
5,980
7,980
5,980/6 = 996.6
7,980/6 = 1330
Taking into account the working capital released in the 6th year and salvage value of the
investment, the total investment will be (10,000- 1,500) Rs.8500 and the average investment
will be (8500/2) Rs.4250 for each project.
The rate of return calculations are:
Net profit after tax as a percentage of total investment
Project A
Project B
1330 * 100 = 15.6%
8500
The investment decision will be to select Project B since its rate of return is higher than that
of Project A if they are mutually exclusive. If they are independent projects both can be
accepted if the minimum required rate of return is 11.7% or less.
Difficulties in Capital Budgeting
a)
General difficulties:
b) Measurement problem:
While calculating the NPV, IRR, PAY BACK PERIOD, AND PROFITABILITY
INDEX, we have to be very much careful with the calculations values throw it is a very
difficult job to remember many values at a time but we have to be care full because it will
effect on the total output of project in decision making.
Quotations from Gland, for the following products: (Indian manufacturing charges)
Liquid Vial (Zoledronic Acid)
Lypo Vial (Amifostin)
PFS (Enoxaparin Na)
$0.75
$1.00
$0.50
Contract Manufacturing
Type of Vial
Equivalent Injection
USD
CC
CC (In Rs)
Freigh
t
Non
Lyophilised
0.75
30.00
10.00
Lyophilised
Amifostin Lyo
1.00
40.00
10.00
Prefilled
Syringes
Enoxaparin Na
0.50
20.00
10.00
Royalty
(Rs)
-
CC = Conversion Cost
Total cost incurred would be: Rs. 120
And if the product is manufactured at Dr. Reddys, then what is the cost the organization is
going to incur:
Estimated in New Project
CC
Type of Vial
Equivalent
Injection
Non Lyophilised
Zoledronic Acid
Liq
Lyophilised
Amifostin Lyo
Prefilled Syringes
Enoxaparin Na
Depreciation
Freight Total
Savings
CC
5.18
10.00
15.18
24.82
5.18
10.00
15.18
34.82
5.18
10.00
15.18
14.82
Rs. 45.54
From the above table, we can observe that if Dr. Reddys go for manufacturing the product
then they have a total savings of Rs.74.46.
So its beneficial for the company to go for manufacturing the product.
Type of Vial LL Location Equivalent Injection USD CC CC (In Rs) Frieght Royalty (Rs) Equivalent Injection
60
50
40
Prices 30
20
10
Liquid
Lypo
Pfs
Description
Amount (Ph 1)
Amount (Ph 2)
Civil
Partitions
HVAC
Equipments
Mechanical
Electrical
Utility
Validation
Instruments - QC
Revenue
Revenue QC
Consultant Fees
Contingency
1,112
500
400
2,410
200
270
125
70
100
100
20
150
250
100
654
30
10
Total
5,707
824
30
(Rs. In Lakhs)
Class of Asset
Buildings
Buildings
Plant & Mach
Plant & Mach
Plant & Mach
Electrical Equip
Plant & Mach
Plant & Mach
Lab Equip
Buildings
Lab Equip
Buildings
Plant & Mach
Policy
(Life in
Years)
Life
20 to 50
Phase 2
Amount
Dep
per
year
Amount
35
186.24
5.32
10.00
29
3 to 15
345.50
38.39
72.40
04
5 to 15
10
27.00
2.70
5 to 15
10
12.00
1.20
570.74
47.61
82.40
33
Dep per
year
0.
8.
8.
Year
FY
09
FY
10
FY
11
FY 12
FY
13
FY
14
FY
15
FY 16
FY
17
Total
47.61
47.61
47.61
47.61
47.61
47.61
47.61
333.2
7
8.33
8.33
8.33
8.33
8.33
41.65
55.94
55.94
55.94
55.94
55.94
374.9
2
47.61
47.61
0.07
1.53
2.45
3.57
0.33
0.20
0.00
8.15
0.94
0.59
0.08
0.13
0.85
0.28
0.14
0.08
0.12
0.00
3.21
11.36
No. Of people
Average salary per
head
Payroll Cost p.a.
Production
Manpower cost per
unit
100
250,000
25,000,000
Average annual production from fy 11 to fy
17
18,000,000
1.39
FY
11
1.39
FY
12
1.50
FY
13
1.62
FY
14
1.75
FY
15
1.89
FY
16
2.04
FY
17
2.20
Utility cost
1.56
1.64
1.72
1.81
1.90
1.99
2.09
Depreciation
2.32
2.32
2.32
2.32
2.32
2.32
2.32
Others
QC/QA
4.20
2.73
1.15
0.95
0.72
0.71
0.69
8.19
6.81
6.83
6.82
7.06
7.30
5.87
4.49
4.51
4.50
4.74
4.98
7.14
15
20
15
50
(Rs. in Millions)
Inflow
Liquid
Vials
Tax
Lypo
Vials
PFS
SEZ
1
260.37
3
4
5
6
7
8
9
10
57.40
DCF @
0%
Discounte
d In flow
Cum
Discntd In
flow
(260.37
)
1.00
(260.37)
(260.37)
(260.37)
(520.74)
2
260.37
Net In
Flow
(260.37
)
1.00
1.00
(520.74)
143.88
2.45
11.75
158.09
1.00
158.09
(362.65)
183.42
7.50
15.93
149.46
1.00
149.46
(213.19)
225.06
18.95
26.94
270.95
1.00
270.95
57.76
258.27
24.12
33.25
315.65
1.00
315.65
373.41
397.02
66.60
53.43
517.05
1.00
517.05
890.45
416.89
70.72
28.03
515.64
1.00
515.64
1,406.09
437.36
74.24
29.35
540.95
1.00
540.95
1,947.04
238.5
8
Net In
DCF
Flow
@
0%
(25.00)
1.00
(25.00)
1.00
1.00
1.00
1.00
(15.80)
1.00
Discntd
In flow
(25.00)
(25.00)
1.00
(15.80)
Cum
Discntd
In flow
(25.00)
(50.00)
(50.00)
(49.00)
(64.80)
100.04
1.00
100.04
35.24
143.67
1.00
143.67
178.91
219.42
1.00
219.42
398.33
228.88
1.00
228.88
627.21
238.58
1.00
238.58
865.79
Payback is 5 Years 2
Months
Total Project - Payback period computation
Outflow
Year
Project
Cost
Inflow
Liquid
Vials
Tax
Lypo
Vials
PFS
SEZ
Discntd
In flow
Cum
Discntd In
flow
(285.37
)
1.00
(285.37)
(285.37)
(285.37
)
-
1.00
(285.37)
(570.74)
285.37
3
DCF @
0%
285.37
2
Net In
Flow
1.00
(570.74)
4
143.88
2.45
1.00
11.75
159.09
1.00
159.09
(411.65)
183.42
7.50
9.20
15.93
133.66
1.00
133.66
(277.99)
225.06
18.95
100.04
26.94
370.98
1.00
370.98
93.00
5
82.40
6
7
258.27
24.12
143.67
33.25
459.32
1.00
459.32
552.31
397.02
66.60
219.42
53.43
736.47
1.00
736.47
1,288.78
416.89
70.72
228.88
28.03
744.51
1.00
744.51
2,033.30
437.36
74.24
238.58
29.35
779.54
1.00
779.54
2,812.83
8
9
10
Payback period:
The Cash Outflow is the project cost i.e., the investment done by the company.
Calculation of Inflows:
The company has made a market research and has given the estimated volumes for the
product from US, EU and RoW (Rest Of World).
And then has multiplied it with the savings of each product to get the inflows.
For example:
Volumes of US (liquid vials) :
5.8
24.82
143.88
Inflows
Tax
Outflow
Year
Project
Cost
Lypo
Liquid Vials
Vials
PFS
SEZ
Net
Inflows
DCF
@
14%
Discounted
Inflow
1
285.37
(285.37)
1.00
(285.37)
285.37
(285.37)
0.88
(250.32)
0.77
2
3
4
-
143.88
2.45
1.00
11.75
159.09
0.67
107.38
183.42
7.50
9.20
15.93
133.66
0.59
79.14
225.06
18.95
100.04
26.94
370.98
0.52
192.68
258.27
24.12
143.67
33.25
459.32
0.46
209.26
397.02
66.60
219.42
53.43
736.47
0.40
294.32
416.89
70.72
228.88
28.03
744.51
0.35
261.00
437.36
74.24
238.58
29.35
779.54
0.31
239.71
5
82.40
6
7
8
9
10
NPV of the CC Savings
Inflows
Tax
194.65
Year
1
2
3
4
5
6
7
8
9
10
Project
Cost
Liquid
Vials
Lypo
Vials
PFS
Net In
Flow
SEZ
Discntd In
flow
DCF
285.37
(285.37) 1.00
(285.37)
285.37
(285.37) 0.75
(213.19)
0.56
143.88
2.45
1.00
11.75
159.09
0.42
66.33
82.40
183.42
7.50
9.20
15.93
133.66
0.31
41.64
225.06
18.95
100.04
26.94
370.98
0.23
86.33
258.27
24.12
143.67
33.25
459.32
0.17
79.85
397.02
66.60
219.42
53.43
736.47
0.13
95.65
416.89
70.72
228.88
28.03
744.51
0.10
72.24
437.36
74.24
238.58
29.35
779.54
0.07
56.51
NPV of CC savings
0%
IRR of CC savings
34%
When a new proposal comes to Dr. Reddys then it goes through several important decisions
before selecting the proposal.
Lets us assume that a proposal has come to Dr. Reddys
1. First the proposal goes to the Business Development team.
2. Business Development team with the help of market research team, does the necessary
market survey about the project such as
How many alternative products are already in the market?
About the product and its prices.
About its demand.
About its competitors.
which they disclose it in their annual report.
Once the project is evaluated then they decide from their organizations point of view.
Investment required in the project.
Time of the proposal
3. Then they prepare a strategic report with all the details such as profits, cost, etc., based
on it they decide whether to manufacture the product or get it dont on the contract basis.
4. If the product is to be manufactured then the manufacturing team decides the cost of
materials required, machines, power, buildings, etc., which help them to arrive at the
project cost.
5. Now the project comes to the finance department, where payback period, taxes,
depreciation, etc., is found out with the coordination with IPDO (Integrated Product
Development Operations) team.
6. Generally 2 years payback period is considered ideal at Dr. Reddys because as these are
fast moving products and chances are there that may be your competitors may go a step
ahead in producing the product.
7. Now after all the figures and facts are found out, the proposal goes to Managing
Director. Presentation is made to him with all the details which shows the pros and cons
of the proposal..
8. Then suggestions are given by the management, budget is decided and a final decision is
taken by the management whether to consider the proposal or reject it.
Company is getting its Discounted Pay Back within 5.75 years even after
discounting cost of capital.
NPV (Net Present Value) of the company is positive 194.65 so project the project
can be approved.
PI (Profitability Index) is good because company is making money. Hence, the
project can be approved.
IRR (Internal Rate of Return) is more than the cost of capital 34% so approve the
project.
Decision
Method
Result
Approve? Why?
Payback
4.33
years
Yes
Discounted
Payback
5.75
years
Yes
NPV
194.65
Yes
Profitability
Index
1.2980
Yes
IRR
34%
Yes
Dr. Reddys takes Payback period method only into consideration because they want their
returns at the earliest as Pharmacy industry is a fasting moving industry with lot of
innovative ideas year after year.
Bibliography
The information required for successful completion of the project has been collected
through primary and secondary sources.