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INTRODUCTION
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CAPITAL BUDGETING
The term Capital Budgeting refers to long term planning for proposed capital outlay
and their financial. It includes raising long-term funds and their utilization. It may be
defined as a firm’s formal process of acquisition and investment of capital.
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NEED FOR THE STUDY
3
METHODOLOGY
Primary sources
Secondary sources
The secondary data have been collected through the various books,
magazines, broachers & websites
The efficient allocation of capital is the most important financial function in the
modern times. it involves decision to commit the firm’s since they stand the long-term
assets such decision are of considerable importance to the firm since they send to
determine its value and size by influencing its growth, probability and growth.
The scope of the study is limited to collecting the financial data of HDFC for four
years and budgeted figures of each year.
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LIMITATION OF THE STUDY
Lack of time is another limiting factor, i.e., the schedule period of 8 weeks
are not sufficient to make the study independently regarding Capital
Budgeting in HDFC.
The busy schedule of the officials in the HDFC is another limiting factor.
Due to the busy schedule officials restricted me to collect the complete
information about organization.
Non-availability of confidential financial data.
The study is conducted in a short period, which was not detailed in all
aspects.
All the techniques of capital budgeting are not used in HDFC. Therefore it
was possible to explain only few methods of capital budgeting.
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CHATPER-2
REVIEW OF LITERATURE
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CONCEPT OF CAPITAL BUDGETING:
The term 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 is the decision making process by which the firm evaluate the purchase
of major fixed assets firm’s decision to invest its current funds of. It involves addition,
disposition, modification and replacement of long term or fixed assets. However, it
should be noted that investment in current assets necessitated on account of
investment in a fixed asset, it also to be taken as a capital budgeting decision.
Capital budgeting is a many sided activity. It includes searching for new and more
profitable investment proposals, investigating engineering and marketing
considerations predict and making economic analysis to determine the potential of
each investment proposal.
RISK: A long term commitment of funds may also change the risk complexity
of the firm. If the adoption of the investment increases average gain but causes
frequent fluctuations in its earnings the firm will become more risky. Thus
investment decisions shape the basic risk character of the firm.
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carefully and make an advance arrangement for procuring finances internally
or externally.
The capital budgeting decisions are often said to be the most important part of
corporate financial management. Any decision that requires the use of resources is a
capital budgeting decision; thus the capital budgeting cover everything from abroad
strategic decisions at one extreme to say computerization of the office, at the other.
The capital budgeting decisions affect the profitability of a firm for a long period,
therefore the importance of these decisions are obvious. There are several factors and
considerations which make the capital budgeting decisions as the most important
decisions of a finance manager. The need and importance of capital budgeting may be
stated as follows:
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a capital budgeting decision, a finance manager in fact makes a commitment
to its future implications.
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limited and the demand for funds far exceeds the resources. Hence, it is very
important for a firm to plan and control its expenditure.
There are several methods for evaluating and ranking the capital investment
proposals. In case of all these method the main emphasis is on the return which will
be derived on the capital invested in the projects. In other words, the basic approach is
to compare the investment in the project with the benefits derived there from.
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Capital budgeting techniques
TRADITIONAL OR NON-DISCOUNTING:
Initial investment
Pay back period =________________
Annual cash flow
11
Accept reject rule:
Many firms use the pay back period as accept/reject criterion as well as a method of
ranking projects.
If the pay back period calculated for the project is less than the maximum or
standard payback period set by the management, it would be accepted
If not it would be rejected
As a ranking method it gives highest to the project which has the shortest
payback period and lowest ranking to the project with highest payback period
In case of two mutually exclusive projects, the project with the shortest
payback period will be selected.
DISADVANTAGES:
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It does not take into account the cash inflows earned after
the pay back period and hence the true profitability of the
project cannot be correctly assessed.
This method ignores the time value of the money and does
not consider the magnitude and timing of cash inflows.
It does not take into account the cost of capital, which is
very important in making sound investment decision.
It is difficult to determine the minimum acceptable pay
back period, which is subjective decision .
It treats each assets individual in isolation with other
assets, which is not feasible in real practice.
The accounting rate of return (ARR), also known as the return on investment
(ROI), used accounting information, as revealed by financial statements, to measure
the profitability of an investment.
The accounting rate of return is found out by dividing the average after
tax profit by the average investment. The average Investment would be equal to half
of the original investment if it is deprecited constantly.
Alternatively, it can be found out dividing the total of the investment’s book value
after depreciation by the life of the project. The accounting rate of return, thus, is an
average rate and can be determined by the following equation:
Average annual income (after tax & depreciation)
ARR= ____________________ x 100
Average investm
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As an accept or reject criterion, this method will accept all those projects whose ARR
is higher than the minimum rate established by the management and reject those
projects which have ARR less than the minimum rate.
This method would rank a project as number one if it has highest ARR
and lowest rank would be signed to the project with lowest ARR.
EVALUATION OF ARR METHOD
ADVANTAGES:
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DISCOUNTED CASH FLOW METHOD
Net present value method is the classic economic method of evaluating the
investment proposals. It is considered as the best method of evaluating the capital
investment proposal. It is widely used in practice. The cash inflow to be received at
different period of time will be discounted at a particular discount rate.
It is one of the discounted cash flow techniques explicitly recognizing the
time value of money. It correctly postulates that cash flows arising at different time
periods differ in value and are comparable only when their equivalent present values
are found out.
The following steps are involved in the calculation of NPV:
An appropriate rate of interest should be selected to discount cash flows.
Generally it is referred to the cost of capital.
The present value of cash inflow will the calculated by using this discounted
rate.
Net present value should be found out by subtracting present value of cash out
flows from present value of cash inflows.
The net present value is the difference between the total present value of future cash
inflows and the present value of future cash outflows.
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Net present value is used as an accept or reject criteria.
In case NPV is positive (NPV›0) the project is selected for investment
If NPV is negative (NPV<0) the project is rejected
A project may be accepted if NPV=0
The positive net present value is contribute to the net wealth of the shareholders
which should result in the increased price of a firm’s share.
The NPV method can be used to select between mutually exclusive projects the
one with the higher NPV should be selected. Using the NPV method, project
would be ranked in order of net present values; that is first rank will be given to
the project with highest positive present value and so on.
ADVANTAGES:
It recognizes the time value of money and is suitable to apply in a situation
with uniform cash outflows and uneven cash inflows.
It takes in to account the earnings over the entire life of the project and gives
the true view if the profitability of the investment
Takes in to consideration the objective of maximum profitability.
DISADVANTAGES:
More difficult to understand and operate.
It may not give good results while comparing projects with unequal
investment of funds.
It is not easy to determine an appropriate discount rate
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The internal rate of return (IRR) method is another discounted cash flow
technique which takes account of the magnitude and timing of cash flows. Internal
rate of return is that rate at which the sum of discounted cash inflows equals the sum
of discounted cash outflows.
It is the rate of discount which reduces the net present value of an investment to zero.
It is called internal rate because it depends mainly on the outlay and proceeds
associated with the project and not on any rate determined outside the investment.
Other terms used to describe the IRR method are yield of an investment, marginal
efficiency of capital, rate of return over cost, time adjusted rate of return and so on.
The concept of internal rate of return is quite simple to understand in the case of a one
period project.
CALCULATION OF INTERNAL RATE OF RETURN:
Present value at
Lower rate __ cash out flow
Lower rate + ____________________________ X diff. in the
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Present value __ present value rates
At lower rate at higher rate
The more simple words, IRR can be calculated by trial an error method
Which means the unknown discount factor which makes NPV=0 con be
calculated by substituting various values which is tedious process. Therefore the
above method may be used.
The accept or reject rule, using the IRR method, is to accept the project if its
internal rate of return is higher than the opportunity cost of capital(r>k) note k is also
known as the required rate of return, or cutoff, or hurdle rate.
The project shall be rejected if its internal rate of return is lower than the
opportunity cost of capital (r<k). The decision maker may be indifferent if the internal
rate of return is equal to opportunity cost of capital.
Thus, the IRR rule is
Accept if r>k
Reject if r<k
May accept if r=k
ADVANTAGES:
It takes into account, the time value of money and can be applied in situation
with even and even cash flows.
It considers the profitability of the projects for its entire economic life.
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The determination of cost of capital is not a pre-requisite for the use of this
method.
It provide for uniform ranking of proposals due to the percentage rate of
return.
This method is also compatible with the objective of maximum profitability.
DISADVANTAGES:
It is difficult to understand and operate.
The results of NPV and IRR methods may differ when the projects under
evaluation differ in their size, life and timings of cash flows.
This method is based on the assumption that the earnings are reinvested at
the IRR for the remaining life of the project, which is not a justified
assumption.
3. PROFITABILITY INDEX:
It is the ratio of the present value of cash inflows, at the required rate of return, to
the initial cash out flow of the investment. It may be the gross or net. Net=gross-1
The formula to calculate benefit cost ratio or profitability index is as follows:
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The following are the PI acceptance rules:
o Accept if PI>1
o Reject if PI<1
o May accept if PI=1
When PI is greater than one, then the project will have net present value.
EVALUATION OF PI METHOD:
ADVANTAGES:
Unlike net present value, the profitability index method is used to rank the
projects even when the costs of the projects differ significantly.
It recognizes the time value of money and is suitable to applied in a situation with
uniform cash outflow and uneven cash inflows.
It takes into account the earnings over the entire life of the project and gives the
true view of the profitability of the investment.
Takes into consideration the objectives of maximum profitability.
DISADVANTAGES:
More difficult to understand and operate.
It may not give good results while comparing projects with unequal investment
funds.
It is not easy to determine and appropriate discount rate.
It may not give good results while comparing projects with unequal lives as the
project having higher NPV but have a longer life span may not be as desirable as a
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project having some what lesser NPV achieved in a much shorter span of life of
the asset.
The capital budgeting decisions are not critical and analytical in nature, but also
involve various difficulties which a finance manger may come across. The problems
in capital budgeting decision may be as follows:
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ASSUMPTION IN CAPITAL BUDGETING:
The capital budgeting decision process is a multi-faceted and analytical
process. A number of assumptions are required to be made. These assumptions
constitute a general set of condition within which the financial aspects of different
proposals are to be evaluated. Some of these assumptions are:
1 Certainity with respect to cost and benefits : it is very difficult to estimate the
cost and benefits of a proposal beyond 2-3 years in future. However, for a capital
budgeting decision, it is assumed that the estimate of cost and benefits are
reasonably accurate and certain.
2 Profit motive: Another assumption is that the capital budgeting decisions are
taken with a primary motive of increasing the profit of the firm. No other motive or
goal influences the decision of the finance manager.
b) EXISTING FIRM: A firm which is already existing may also required to take
various decisions from time to time to meet the challenges of competition or
changing environment. These decision may
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I. REPLACEMENT AND MODERNIZATION DECISION: The main
objective of modernization and replacement is to improve operating
efficiency and reduce costs. Cost savings will reflect in the increased profits,
but the firm’s revenue may remain unchanged. Assets become outdated and
obsolete with technological changes. The firm must decide to replace those
asserts with new assets that operate more economically.
II. EXPANSION: Some times, the firm may be interested in increasing the
installed production capacity so as to increase the market share. In such a
case, the finance manager is required to evaluate the expansion program in
terms of marginal costs and marginal benefits.
The capital budgeting decision may also classified from the point of view of
the decision situation as follows:
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a) MUTUALLY EXCLUSIVE DECISIONS:
c) INDEPENDENT PROPOSALS:
These are proposals which do not compete with one another in a way that
acceptance of one precludes the possibility of acceptance of another. In case of
such proposals the firm may straight “accept or reject” a proposal on the basis of a
maximum return on investment required.
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d) ACCEPT-REJECT DECISIONS:
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EXPENDITURE INCREASING REVENUE:
Such capital expenditure reduces the total cost and there by adds to the total
earnings of the firm. For example, when an asset is worn out becomes obsolete, the
firm has to decide whether to continue with it or replace it by a new machine.
While taking such a decision the firm compares the required cash outflows
for the new machine with the benefit in the form of reduction in operating costs as a
result of replacement of the old machine by a new one. The firm will replace the
machine only when it finds it beneficial.
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ranking of the project can be done on the basis of profitability index or IRR. The
procedure to select the package of projects will relate to whether the project is
divisible or indivisible, the objective being the maximization of total NPV by
exhausting the capital budget is as far as possible.
It should consider all the cash flows to determine the true profitability of the
project.
It should provide for an objective and unambiguous way of separating good
projects from bad projects
It should help ranking of projects according to their profitability.
It should recognize the fact that bigger cash flows are preferable to smaller
ones and early cash flows are preferable to later ones.
It should help to choose among mutually exclusive projects that project which
maximizes the shareholder’s wealth.
It should be a criterion which is applicable to any conceivable investment
project independent of others.
Choosing among several alternatives.
A criterion which is applicable to any conceivable project.
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CHAPTER-3
COMPANY PROFILE
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COMPANY PROFILE:
HDFC Bank Ltd is a major Indian financial services company based in Mumbai. The
banking and financial services including commercial banking and treasury operations.
The Bank at present has an enviable network of 2201 branches and 7110 ATMs spread
in 996 cities across India. They also have one overseas wholesale banking branch in
Bahrain, a branch in Hong Kong and two representative offices in UAE and Kenya.
The Bank has two subsidiary companies, namely HDFC Securities Ltd and HDB
Financial Services Ltd. The Bank has three primary business segments, namely
banking, wholesale banking and treasury. The retail banking segment serves retail
customers through a branch network and other delivery channels. This segment raises
deposits from customers and makes loans and provides other services with the help of
specialist product groups to such customers. The wholesale banking segment provides
loans, non-fund facilities and transaction services to corporate, public sector units,
Credit/Charge cardholders. The Bank's shares are listed on the Bombay Stock
Exchange Limited and The National Stock Exchange of India Ltd. The Bank's
American Depository Shares (ADS) are listed on the New York Stock Exchange
(NYSE) and the Bank's Global Depository Receipts (GDRs) are listed on
Ltd. In the year 1994, Housing Development Finance Corporation Ltd was amongst
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the first to receive an 'in principle' approval from the Reserve Bank of India to set up a
bank in the private sector, as part of the RBI's liberalization of the Indian Banking
January 1995. In the year 1996, the Bank was appointed as the clearing bank by the
NSCCL. In the year 1997, the launched retail investment advisory services. In the
year 1998, they launched their first retail lending product, Loans against Shares. In the
year 1999, the Bank launched online, real-time NetBanking. In February 2000, Times
Bank Ltd, owned by Bennett, Coleman & Co. / Times Group amalgamated with the
Bank Ltd. This was the first merger of two private banks in India. The Bank was the
first Bank to launch an International Debit Card in association with VISA (Visa
Electron). In the year 2001, they started their Credit Card business. Also, they became
the first private sector bank to be authorized by the Central Board of Direct Taxes
(CBDT) as well as the RBI to accept direct taxes. During the year, the Bank made a
Solutions Pvt Ltd for developing and offering products and services facilitating on-
line accounting and banking services to SMEs. During the year 2001-02 the bank was
listed on the New York Stock Exchange. Also, they made the alliance with LIC for
providing online payment of insurance premium to the customers. During the year
2002-03, the Bank increased the number of branches from 171 Nos to 231 Nos and
the size of the Bank's ATM network expanded from 479 Nos to 732 Nos. They also
expanded their presence in the 'merchant acquiring' business. During the year 2003-
04, the Bank expanded the distribution network with the number of branches
increased from 231 Nos to 312 Nos and the size of the Bank's ATM network increased
from 732 Nos to 910 Nos. In September 2003, they entered the housing loan business
through an arrangement with HDFC Ltd, whereby they sell HDFC Home Loan
product. During the year 2004-05, the Bank expanded the distribution network with
the number of branches increased from 312 Nos to 467 Nos and the size of the Bank's
ATM network increased from 910 Nos to 1147 Nos. During the year 2005-06, the
Bank launched the 'no-frills account', a basic savings account offering to the customer.
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Also, the distribution network was expanded with the number of branches increased
from 467 Nos (in 211 cities) to 535 Nos (in 228 cities) and the number of ATMs from
1147 Nos to 1323 Nos. During the year 2006-07, the distribution network was
expanded with the number of branches increased from 535 Nos (in 228 cities) to 684
Nos (in 316 cities) and the number of ATMs from 1323 Nos to 1605 Nos. They
commenced direct lending to Self Help Groups. Also, they opened a dedicated branch
for lending to SHGs, in Thudiyalur village (Tamil Nadu). In September 28, 2005, the
Bank increased their stake in HDFC Securities Ltd from 29.5% to 55%.
Consequently, HDFC Securities Ltd became a subsidiary of the Bank. During the year
2007-08, the Bank added 77 Nos new branches take the total to 761 Nos branches.
Also, 372 Nos new ATMs were also added taking the size of the ATM network from
1605 Nos to 1977 Nos. HDB Financial Services Ltd became a subsidiary company
with effect from August 31, 2007. In June 2, 2007, the Bank opened 19 branches in a
day in Delhi and the National Capital Region (NCR). During the year 2008-09, the
Bank expanded their distribution network from 761 branches in 327 cities to 1,412
branches in 528 Indian cities. The Bank's ATMs increased from 1,977 to 3,295 during
the year. As per the scheme of amalgamation, Centurion Bank of Punjab Ltd was
amalgamated with the Bank with effect from May 23, 2008. The appointed date for
the merger was April 01, 2008. In October 2008, the bank opened their first overseas
commercial branch in Bahrain. The branch offers the bank's suite of banking services
including treasury and trade finance products for corporate clients and wealth
management products for Non-resident Indians. During the year 2009-10, the Bank
expanded their distribution network from 1,412 branches in 528 cities to 1,725
branches in 779 cities. The Bank's ATMs increased from 3,295 Nos to 4,232 Nos
during the year. During the year 2010-11, the Bank expanded their distribution
network from 1,725 branches in 779 cities to 1,986 branches in 996 Indian cities. The
PROMOTERS:
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HDFC is India's premier housing finance company and enjoys an impeccable track
record in India as well as in international markets. Since its inception in 1977, the
Corporation has maintained a consistent and healthy growth in its operations to
remain the market leader in mortgages. Its outstanding loan portfolio covers well over
a million dwelling units. HDFC has developed significant expertise in retail mortgage
loans to different market segments and also has a large corporate client base for its
housing related credit facilities. With its experience in the financial markets, strong
market reputation, large shareholder base and unique consumer franchise, HDFC was
ideally positioned to promote a bank in the Indian environment.
Core Values
2013
Dun & Bradstreet Polaris - Best Private Sector Bank Technology Adoption
Financial Technology - Best Private Sector Bank Retail
Banking Award 2013 - Overall Best Private Sector Bank
Institutional Investor
- Best Bank in Asia
- Mr. Aditya Puri - Best CEO
Forbes Asia
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Fab 50 Companies List for the 7th year
Sunday Standard Best
Banker Awards - Best Private Sector Bank: Large
- Safest Bank: Large
- Mr. Aditya Puri: Top Achiever
2012
33
of the Year 2012
CNBC TV18's India Best Best Private sector Bank
Banks and Financial
Institutions Awards 2012
Mint-Aon Hewitt study on Our Bank among India's six best managed
India's Best Managed Boards Boards 2012
2012
Forbes Asia Fab 50 Companies - Winning for the 6th year
IBA Banking Technology - Best Online Bank
Awards 2011 - Best use of Business Intelligence
- Best Customer Relationship Initiative
- Best Risk Management & Security Initiative
- Best use of Mobility Technology in Banking
Dun & Bradstreet Banking - Overall Best Bank
Awards 2012 - Best Private Sector Bank
- Asset Quality - Private Sector
- Retail Banking -Private Sector
IDRBT Banking Technology Best Bank in 'IT for Operational Effectiveness'
Excellence Awards 2011-12 category
Asia Money 2012 Best Domestic Bank in India
India's Top 500 Companies Best Bank in India
-Dun & Bradstreet Corporate
Awards
Finance Asia - Best Managed Company
- Best CEO - Mr. Aditya Puri
UTI Mutual Fund CNBC TV - Best Performing Bank - Private
18 Financial Advisor Awards
2011
Asian Banker International - Best Retail Bank in India
Excellence in Retail Financial - Best Bancassurance
Services Awards 2012 - Best Risk Management
5th Loyalty Summit award Customer and Brand Loyalty
Skoch foundation 2012 SHG/JLG linkage programme
ICAI Awards 2011 Excellence in Financial Reporting
34
FINANCIAL INFORAMTION:
Sales rise 16.35% to Rs 10093.34 crore
Net profit of HDFC Bank rose 27.07% to Rs 1982.32 crore in the quarter ended
September 2015 as against Rs 1559.98 crore during the previous quarter ended
September 2014. Total Operating Income rose 16.35% to Rs 10093.34 crore in the
quarter ended September 2015 as against Rs 8674.82 crore during the previous
quarter ended September 2014.
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CHATPER-4
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Various methods are used for ascertainment of profitability of capital expenditure. The
practical usage of these methods are discussed here under:
This method represents the ratio of average annual profit (after taxes)
to the average investment in the project. It is calculated
A.R.R = ----------------------------------------------X100
TO ILLUSTRATE:
10000
Average rate of return = ------- * 100 = 20%
50000
This method is based on accounting information rather upon cash flows. This
method is simple and makes use of readily available accounting information. Once
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average return is expected it can be readily compared with the expected return, to
determine whether a particular proposal for capital expenditure should be accepted or
rejected.
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PAY BACK METHOD:
This method tells us the number of years required to recover the initial
investment of that asset. It is calculated
Initial investment
Pay back period =________________
Annual cash flow
The shorter the payback period, the less risky the investment and greater its
liquidity.
TO ILLUSTRATE:
100000
400000
= 3 + 0.25 years
40
DISCOUNTED PAY BACK PERIOD
41
Amount to be received in 5th year = 145100
(2000000-1854900)
145100
248400
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NET PRESENT VALUE :
The Net present Value (NPV) method is the classic economic method of
evaluating the investment proposals. It is one of the discounted cash flow technique
explicitly recognizing the time value of money.
It correctly postulates that cash flows arising at different time periods differ in value
and the comparable only when their equivalent present values are found out.
To illustrate:
A project requires an initial investment of RS. 50000 and is likely to generate the
following CFATS.
Year 2009-10 2010-11 2011-12 2012-13 2013-14 2014-15
CFATS 10000 12000 18000 25000 8000 4000
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NET PRESENT VALUE:
YEAR CASH INFLOW PV @ 10% PV OF CASH
INFLOW
2009-10 10000 0.909 9,090
2010-11 12000 0.826 9,912
2011-12 18000 0.751 13,518
2012-13 25000 0.683 17,075
2013-14 8000 0.621 4,968
2014-15 4000 0.564 2,256
= 6,819
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PROFITABILITY INDEX METHOD:
PV of cash inflows
PV of cash outflows
TO ILLUSTRATE:
45
Present value of cash outflows= RS.40,000+15,020=55,020
RS.64,880
RS.55,O20
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INTERNAL RATE OF RETURN (IRR):
The Internal Rate of Return (IRR) method is another discounted cash flow technique,
which makes account of the magnitude and timing of cash flows. Others terms used to
describe the IRR Method are yield on investment, marginal efficiency of capital, rate
of return over cost and so on. The concept of internal rate of return is quite simple to
understand in the case of one-period projects
TO ILLUSTRATE:
A project requires an initial investment of RS. 5000 and is likely to generate the
following CFATS
In this project as the cash inflows are not constant we calculate fake back period.
INITIAL INVESTMENT
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FAKE PBP= AVERAGE CASH INFLOW
= 6125 = 1225
5
FAKE PBP = 5000 = 4.0816 YEARS
1225
Locate a discount factor in PV of annuity table nearest to 4.0816 against 5 years
At 6% 4.0816
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INFLOW
2010-11 1000 0.943 943
2011-12 1045 0.890 930
2012-13 1180 0.840 991
2013-14 1125 0.792 970
2014-15 1675 0.747 1251
To increase the PV of cash inflow, we decrease the rate let the new rate be 6%
IRR = LR + ----------------------------------------------------------------------(HR-LR)
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PV of cash inflows at lower rate–PV of cash inflows at higher rate
WHERE,
LR= Rate of interest that is lower of the two rates at which PV of Cash inflows have
been calculated.
=7–6
=1
85
IRR = 6% + ----- * 1
146
= 6 + 0.58
= 6.58%
SUMMARY
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PARTICULARS COMPUTATIONS
AVERAGE RATE OF RETURN 20
PAY BACK RERIOD 3.25
DISCOUNTED PAY BACK PERIOD 4.58
NET PRESENT VALUE 6,819
PROFITABILITY INDEX 1.18
INTERNAL RATE OF RETURN 6.58
OBSERVATIONS:
The PBP of the project is 3.25 and the discounted payback period is 4.58 yrs
which is less than the life of the project
The ARR of the project is 20%
The NPV of the project is more than the “0” i.e. 6,819
The PI is more than 1 i.e. 1.18
The IRR is 6.58%
In consideration with the above points it can be said that the project can be accepted
as it is satisfying all the required conditions.
HDFC involved in industrial financing. They extend term loans for acquiring fixed
assets and also working capital term loans. When they are to extend term loans for
acquiring fixed assets like land building, machinery etc they appraise the project to
establish the financial, economic and technically viability of the project while
extending long term loans HDFC use capital budgeting techniques. The basic idea of
using capital budgeting is to compare ,whether, the amount invested on the project at
certain rate of return is more or less when compared to the required rate of return
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At HDFC internal rate of return method is used to appraise an industrial project. The
internal rate of return calculated is compared with the required rate of return. If the
internal rate of return calculated is more than the required rate of return, the project is
accepted if not, it should be rejected. Here it needs to be explained the meaning of
required rate of return. Generally, the concern’s required rate of return is the concern’s
cost of capital and the cost of capital is the rate of return on a project that will have
unchanged the market price of shares. Thus, the cost of capital is the required rate of
return needed to justify the use of capital.
The cost of capital on term loans is the interest rate that is changed on disbursal of
funds. HDFC change interest rates ranging from 11% to 14.5% depends upon the
nature of the project and scheme of financial assistance. Therefore the cost of capital
on loans and advances is the interest rate changed by the term lending institutions.
Hence, the required rate of return is the interest rate changed by the financial
institutions for extending term loan assistance. For example, if the HDFC changes
interest at 14%, then the concern’s cost of capital or required rate of return is 14%.
This required rate is compared at the concern’s internal rate of returns. Extending or
rejecting the proposal depends upon the more or less of the IRR over the cost of
capital. Therefore the viability of the project is determined among other parameters
with reference to the rate of earnings over the desired rate of return that is the earnings
expected over the cost of capital of the project that is interest rate. It is always seen
that the earnings made by the project is more than the interest rate to accept the
project other wise the project is rejected.
M/S ventech private limted has approached HDFC for a term loan RS. 1500 lakhs for
expansion of their existing paper mill at hyderabad. The total project cost of the
expansion is worked at RS.2060 lakhs and the over all project cost is worked at
RS.3003 lakhs as given below:
(RS in lakhs)
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Project cost Existing Proposed Total
The project has been appraised by HDFC and worked out the following economics for
the project:
(RS. In lakhs)
ADMINISTRATIVE EXPENSES (B)
FINANCIAL EXPENSES
Interest on term loans 230.00
Interest on bank borrowing 65.00 295.00
868.00
Depreciation 355.00
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Operating profit 513.00
Provision for taxation 173.00
Profit after tax 340.00
54
E.B.I.T 808 914 937 963 981.01 995 1003 1008
DEPRECIATION 355 311 267 229 196.35 169 145 124
TOTAL 1163 1225. 1204 1191 1177.37 1163 1148 1132
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The procedure adopted for calculating IRR is as given:
1) The project cost is arrived at, which consists of both fixed and current
assets. In the instant case, the fixed assets comprised of RS.2683.00
lakhs and current assets comprised of RS.320.00 lakhs.
2) The following assumptions are made:
a) The life of the project is assumed at 15 years
b) The residual value of fixed assets at the end of 15 years is
taken as ‘NIL’ excluding cost at lond.
c) The realizable value of current assets is at 100%
d) The interest rate changed for the term loan being sanctioned
is assumed at 12%.
e) The term loan being sanctioned is expected to be repaid in a
period of 8 years.
3) The outlay is expected to be spend in a period of 3 years as
Follows:
(RS. In lakhs)
O year 2683
1st year 920
3rd year 52
------
3655
-------
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IRR can be calculated manually or by using computers. The IRR is
calculated by using computer as follows is as under:
Observations:
1) The IRR for the instant project proposal is worked out at 34.5%
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2) The cost of capital or cutt off rate is interest rate charged by HDFC that is
12%
3) Since the IRR is more than the cost of capital the project is accepted for
financial assistance
Suitability of IRR technique to project finance:
In view of the above HDFC is using IRR technique for their project finance
proposals.
CHATPER-5
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FINDINGS, SUGGESTIONS &
CONCLUSIONS
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FINDINGS
HDFC has been instrumental in industrial development of Andhra Pradesh.
During the 25th of its long saga, the corporation has financed above RS6000 cr
to nearly 86000 cr enterprises.
The corporation has completed 25 years of service and to mark this occasion
Golden Jubilee Celebration was conducted during 2010-2011
HDFC has achieved tremendous results during 2010-2011 in its key areas of
operation. There is a 26% growth in sanction, 21% in disbursements over the
previous year.
The evaluation techniques are broadly classified into two types i.e traditional
technique and discounted cashflow technique.
The traditional technique includes net pay back period, average rate of return
The discounted cashflow technique includes Net Present Value, Internal Rate
Of Return, Profitability Index.
HDFC worksout Internal Rate Of Return in appraisal of the project among the
capital budgeting technique.
An accept-reject criteria has been applied for all the capital budgeting
methods.
The result in this case study suggest that the project can be accepted.
The corporation may consider using of other capital budgeting techniques like
Pay Back Period, Average Rate Of Return, Net Present Value, Profitability
Index in the appraisal of the project, which will enhance the quality of the
appraisal.
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SUGGESTIONS
2. The management has physically verified the stock of finished goods and
work-in-progress at the end of the year.
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CONCLUSIONS
An empirical study of the practices of the Capital Budgeting for evaluation of
investment proposals in the corporate sector in India has been made in the preceding
chapters. Comparison, wherever possible, has been made with the practices and
procedures in the foreign countries. It has to be noted that conclusions based upon a
study of this type have to be taken as indicative of broad trends only. However, the
results of this study do indicate that majority of large scale companies in India are
aware of the need for a well formulated capital budgeting decisions. It is proposed to
review the important findings of this study and venture to outline some suggestions
and recommendations for the benefit of academicians, industry as well as for post
doctoral research. An in-depth analysis has been carried out to observe the trend and
insight into factors that influence capital budgeting decisions. The results of the
survey and its analysis have been provided. The companies in India do have specific
amount of average size of annual capital budget and all project size requires formal
quantitative analysis. However, such analysis and use of capital budgeting method
differ on the basis of nature and size of a particular project under consideration.
Surprisingly, the companies under study in India seem to be planning one year in
advance only but here also the period of planning is different for different projects.
This may be due to volatile business environment. The authority to take
final capital budgeting decision rests with the chief finance officer and top
management officials of all the organizations under study.
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BIBLIOGRAPHY
63
BIBLIOGRAPHY
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