A STUDY OF CAPITAL BUDGETING

With regards to

A report submitted in partial fulfillment of the requirements for the degree of Master of Business Administration
(FINANCE) BY

Y.SRAVANTHI
(09J81E0044)
P.INDRA REDDY MEMORIAL COLLEGE (Affiliated to JNTU University)

Hyderabad.
2009-20010

DECLARATION

I here declare that this project titled A STUDY OF CAPITAL BUDGETING with reference to BHEL submitted here is genuine and original and original work of mine. This project report is submitted in partial fulfillment of the requirement for the award of MASTER OF THE BUSINESS ADMINISTRATION degree from P.INDRA REDDY MEMORIAL ENGINEERING COLLEGE for the year 2009-2010. I also declare that this result of my own efforts and has not been submitted to any other university for any other degree of diploma.

(Y.SRAVANTHI) (09J81E0044)

ABSTRACT A budget is a plan of action which is expressed in a quantitative terms. The terms BUDGET have been derived from the French word bougette which means a little bag or a receptacle of Documents and Accounts. The budget provides a yard stick from which the performance can be evaluated. It is better to compare the actual results with the budget rather than with the past. Since the past results may not be suitable for current and expected conditions BHEL is one of the important Engineering industries in the World. It has three major plants in Haridwar, Hyderabad, and Tirchurapally. Today in the country BHEL is the mark of continuous effects to improve the service in the nation by consultancy, manufacturing and offering services in the power section I found that BHEL is well managed and audited public company. It has a very good financial structure. The solutions are obtained by proper specifications of the Boundary conditions. I have analysis in BHEL Hyderabad .The results provided by the analyses are compared with experimental value. As for my view of the project and research in which I found an increase in profit of the company and there are changes in the turnover of the company. I recommend some few changes in the management

ACKNOWLEDGEMENT

I express my deep sense of gratitude to the management of BHARAT HEAVY ELECTRICALS LIMITED for giving men an opportunity to study A STUDY OF CAPITAL BUDEGTING in their esteemed organization. I take this opportunity to acknowledge my sincere thanks to Mr.Arun Kumar who is my project guide and to all the Employees of BHELwhose cooperation and valuable guidance helped me to Enhance my knowledge in the subject of STUDY OF CAPITAL BUDGETING. I also would like to express my profouind to my college PIRMEC. I express my sincere thanks to the MR. D.H.B.R PRASAD, Head of the Department for his valuable gu idance for completion of the project. Lastly I would thank the representatives, worker unions and employees of BHEL, Hyderabad, who made this study success by giving their support directly and indirectly
Date: Place: Y.SRAVANTHI (09J81E0044)

Table of contents
CHAPTER 1: INTRODUCTION 9 - 10

1. 2. 3. 4. 5. 6.

Objective of the study Sources of data Methodologies of the study Scope of the study Period of study Limitations of the study 12 29

CHAPTER 2: CORPORATE PROFILE OF BHEL 1. History of BHEL 2. Sectors 3. Company vision, mission and objectives 4. SWOT analysis of BHEL CHAPTER 3: THEORITICAL ASPECTS OF CAPITAL BUDGETING 1. Financial Decision In A Firm 2. types of capital budgeting decisions 3. techniques of capital budgeting CHAPTER 4: BUDGETING IN BHEL HYDERABAD 1. Budgeting in BHEL, Hyderabad 2. Steps in budgeting process CHAPTER 5 ; DATA ANALYSIS AND CONCLUSIONS 1. Findings and conclusions 2. recommendations and suggestions CHAPTER 6 : Data analysis and interpretation 1. Summary 2. Bibliography

31 61

63 64

66 - 85 87 - 89

INTRODUCTION
Objective of the study

The objectives of the present study are to obtain a true insight into the financial and operational performance of BHEL, Hyderabad, using Budgetary Control as the tool. To offer suggestions for the improvement of financial performance.

Sources of Data
The data is collected with the Finance Department of BHEL, Hyderabad. Information has been obtained from the balance sheets and profit and loss accounts of the company. Information has been collected from the Annual Reports and the Ten Year Digest of the company. Information has also been gathered by talking to the personnel.

Methodologies of the study

The financial data of BHEL have been collected from the published annual reports, ten-year digest and the records, which were obtained from the administrative office for the selected period from 1999-2006. The information, which is not available in the annual reports and other records, has been collected by interviewing the officials of BHEL. The other information regarding the topic has been collected from books, journals etc. Revenue Budgeting is a technique to know how the capital is invested on various sectors of the company.

Scope of the study

It extends to the overall performance of BHEL

Period of Study
The period of study is confirmed to current period.

Limitations of the study

Since the study is based on the financial data that are obtained from the companys financial statements, the limitations of financial statements shall be equally applicable. The study has not been made on the financial results for the year 20082009, although BHEL, Hyderabad has prepared it. This is because they are subject to Government Audit, to be done by the Comptroller and Auditor General of India; hence the results are not final.

CORPORATE PROFILE OF BHEL

History of BHEL

BHARAT HEAVY ELECTRICALS LIMITED (BHEL) is one of the pioneers in engineering industries in the world. The vital role played by the BHEL today in the country is the mark of its continuous effects to improve the service in the nation by consultancy, manufacturing and offering services in Power section.

The success story of BHEL however goes back to 1956 when its first plant was set up in Bhopal .Three major plants in Haridwar, Hyderabad and Tiruchirapalli followed this. These plants have been the core of BHELs effects to grow and diversify and become one of the most Integrated Power and Industrial Equipment Manufacturers in the world. The company now has 14 manufacturing units, 8 service centers and 4 Power stations spread all over India and abroad. BHEL manufactures over 180 products under 30 major product groups and meet the needs of core sector like Power, Industry, Transmission, Defense, Telecommunications, Oil business etc. Its products have established on enviable reputation for high quality and reliability. This is due to the emphasis placed all along on Design, Engineering and manufacturing to International Standards by acquiring and adapting some of the best technologies developed in its own centers. BHEL has acquired ISO 9000 certification for Quality Management and ISO 14001 certification for Environment Management. BHEL caters to the needs of different sectors by Designing and Manufacturing according to the needs of its Clients in Power sector.

Sectors Power sector

10

Power is the core sector of BHEL and comprises of thermal, nuclear, gas, diesel and hydro business. BHEL has taken India from a position of total dependence on over seas sources to complete self-reliance in power plant equipment's. BHEL now has the capability to set up power plants from the concept to commissioning. Today BHEL sets account for nearly 65.2 % of the total installed capacity in the country. BHEL manufactures Boilers and auxiliaries, TG sets and associates control, piping and station C & I up to 500 MW units rating. BHEL possesses two streams of gas turbine technology. It can manufacture gas turbines up to 200 MW rating and has access to technology for higher size gas turbines. To give a thrust to the plant performance improvement of old fossil fuel plants and repair and service of GE design gas turbines - two joint venture companies have been floated with Siemens AG and GE respectively.

Industrial sector
BHEL contributes major capital equipment and systems like Captive Power plants,Centrifugal Compressors, Drive Turbines, Switchgear, Heavy castings and Forging etc.

11

Transmission sector
Equipment for High Voltage Direct Current Systems is being supplied for Economic Transmission of bulk Power over long distance.

OIL RIGS
BHEL has been supplying On-shore drilling rigs, X-MAS tree valves and Well heads up to a rating of 100PSI to Oil & Natural Gas Corporation Ltd (ONGC) and OIL India. It can also supply Sub sea well heads, super deep drilling rigs, Desert rigs and Hebi rigs.

Transportation sector

12

Most of the trains in the Indian Railways are equipped with BHEL Traction and Traction control equipment. Indias first Under-ground Metro at Calcutta runs on Drives and controls supplied by BHEL

Telecommunication

BHEL also manufactures MAX-L, MAX-XL system days drown CDOT technology and has plans to make other ranges of Telecommunication equipment as well.

Nces
Technologies have been developed and commercialized for exploiting Non-conventional and Renewable sources of Energy to serve remote and rural areas. These include Photo Voltaic cell, Solar Power

13

based Pumps, Lightning and Heating system .BHEL has also emerged as a major manufacturer of Wind Electric Generators up to 250KW.

International operations
BHEL has exported its equipment and services to over 50 countries .In Malaysia; BHEL has supplied 80% of the Boilers besides several Hydro sets and Gas Turbines. BHEL equipments are in operation in Mata, CY, Saudi Arabia, Oman, Egypt, Libya, Greece, Bangladesh, Sri Lanka, Iraq, Australia etc. BHEL exports turnkey Power projects of Thermal , Hydro , Gas based types, Substation projects , Rehabilitation projects besides a wide variety of products like Insulators, Transformers , Valves, Motors , Traction Generators and services for Renovation and Modernization and Operation Power station.

Research and Development (R & D)

BHEL is one of the few companies world wide involved in Development of Integrated Gasification Combined Cycle (IGCC) Technology, which word uses in clean Coal Technology .BHEL R & D efforts have produced several new products. Some of the recent successful R & D products are Automated Storage Retrieval Systems, Automated Guided Vehicles for Material Transportation, Automatic Robotic Welding Systems.

Human Resource Development (HRD)

The greatest strength of BHEL is its highly skilled and committed people. Every employee is given equal opportunity to develop himself and improve his position. Continuous training and retraining a positive work culture and participation style of management have led to the Development of a motivated work force and enhanced Productivity and Quality.

14

Company vision, mission and objectives Vision

A world Class, Innovative, Competitive and Profitable Engineering enterprise providing total Business Solutions.

Mission
To be the leading Engineering Enterprise providing Quality products systems and services in the field of Energy, Transportation, Industry, Infrastructure and other potential areas.

Values
Meeting commitments made to External and Internal customers. Faster learning, Creativity and Speed of response. Respect for Dignity and potential of Individuals. Loyalty and Pride in the Company. Team playing. Zeal to Excel Integrity and Fairness in all matters.

Objectives Growth
To ensure a steady growth by enhancing the competitive edge of BHEL in existing Business New areas and International operation so as to fulfill National expectations from BHEL.

15

Profitability
To provide a reasonable and adequate return on Capital employed, primarily through improvements in Operational efficiency, Capacity utilization and Productivity and generate adequate internal resources to finance the companys growth. Confidence in providing increased value for this money through International Standards of Product, Quality, Performance and Superior customer service.

Technology
To achieve Technology excellence in operations by development of Indigenous Technologies to and efficient absorption and adaptation of imported technologies to suit Business needs and priorities and provide a competitive advantage of the company.

Image
To fulfill the expectations which Stock holders like Government as own employees, customers and the country at large have from BHEL.

SWOT analysis of BHEL

The Strength, Weaknesses, Opportunities and Threats which are being experienced by BHEL as a growing concern have been summarized up in the following lines.

Strengths

Vast pool of Trained Man Power. Excellent state of art facilities. Good working atmosphere. Rapport between Management and Union. Product manufactured to International Quality.

16

Low labour Cost and Low manufacturing cost.

Weaknesses
Excess Man Power. Slippage in delivery commitments. System implementation inadequate. No Financial package. Inadequate compensation package to employees.

Opportunities
Growing Power Sector Machinery. Liberalization has opened up the market Navratna company status. Dominant player in Domestic Market. Expert potential growing.

Threats
Liberalization Entry of MNCs or Private sector more competition MNCs taking away good employees with attractive packages. Government taxation policy against manufacturing sector. Poor infrastructure. Dumping of goods. Attractive credit packages by FFI to MNCs. In spite of threats and stiff competition, BHEL is showing its performance in an accelerating rate.

17

Key facilities
45 CNC M/C Tools including CNC 5-axis M/c center 50 ton Balancing Tunnel. Vacuum bracing furnace. Impregnation plant of generation. Computerized attendance system. Series 39 main frame computers - with multiprocessor system : 25 GB Disc. Capacity Printers. CAD / CAM, PC LAN (LOCAL AREA NETWORK) More than 200 personal computers with data exchange facilities with main frame computer. - 200 remote terminals with 13 bulk

Welfare
Six schools, 2 junior college and 1 womens degree college. School for mentally retarded. Houses on ownership basis to employees: 1000 LIG, 2500 MIG and 460 HIG. Adopted 3 villages, provided basic amenities.

Range of products manufactured in BHEL

BHEL purchases of materials and components worth over Rs.3, 5000 Million (approx, US$900 million) per year. The suppliers are spread all over the world with 40% purchases source from outside India.

Thermal sets
Steam turbines and generators up to 500MW capacity to manufacture up to1000 MW unit size.

18

Hydro sets
Custom-built conventional hydro turbines of the Kaplan, Francis and Pell ton types with matching generators up to 200 `MW. Pump turbines with matching motor generators. Valves spherical, butterfly and rotary, auxiliaries for hydro stations

Equipment for nuclear power plant

Turbines and generators up to 500 MW capacity.

Steam generators for utilities up to 500 MW. Re heater / separator Heat exchangers and pressure vessel

Gas Turbines

Gas turbines for industry and utility applications, rating from 3 to 200MW (ISO) Boilers and pressure vessels Steam generators for utilities; range 30mw to 500mw for coal. Lignite and oil and natural gas or a combination of these fuels.

19

Steam generators for industrial applications. Range 15 tones / hour, using or a combination the following fuels, c Waste heat recovery boilers. Recovery boilers for paper industry, range from 100 to 1000 tones/day or dry solids. Pressure vessels. Flushed bed combustion boilers.

natural gas, industrial gases, wood and bagasse.

Heat exchangers
Surface condensers. Low pressure and high pressure heaters. Chimney and gland steam condensers. Tray type generator for tg sets. Coolers, condensers, separators and seal oil regulator tanks for refineries, fertilizer and chemical plants and utility sets Steam operated air ejectors.

Boilers Auxiliaries
FANS

Axial reaction fans of single stage and double stage for clean application with a capacity starting from 25 cu

per second.Pressure ranges from 120 to 1480 meters of gas column. Axial impulse fans for both clean air an meters of gas column. Single and double suction radial fans for clean air and dust laden hot gases up to 400 degree centigrade with capacity. Starting from 4cubic meters/second to 600 cubic meters/ second with pressure varying from 150 to 180 meters of gas column.

applications. The fan capacity varying from 7 cubic meters/ second to 600 cubic meters/ second with pressure ranging

Pulverizes

20

Slow and medium speed coal pulverizes up to a capacity of 100 tones/hour. Tube mills for pulverizing low grade coal with high ash content. Mechanical separators Gravimetric feeders. Electro static precipitators of any capacity with efficiency up to 99.9% for utility and industrial applications.

Values and soot bowlers

Long retractable soot blowers (travel up to 13MW), wall dislodges, rotary blowers and temperature probes and related control panels operating pneumatic, electric or manual mode. Snivel arm type soot blowers for generative air pre heaters. High pressure and low pressure by pass equipment for utilities. High and medium pressure values. Cast and forged steel, values of slide, globe, non return (swing check and

check) type for steam. Oil and gas duties up to 600 mm diameter, 250 kg? Sq.cm. and 540 degree centigrade temperat High capacity safety valves and automatic electrical operated pressure relief values for set pressure up to 200

And +temperatures up to 565 degree centigrade.

Safety relief valves for applications in power, process and all other industries. Maximum set pressures up to 175 k

and temperature up to 565 degree centigrade.

Pumps
starting water pump, emergency oil pump, lubricating oil pump, stand by oil pump. All these pumps are for various utility applications to suit up to 66 mw.

Boilers feed pumps, boiler booster pump, condensate pump, circulating water pump, condensate boos

21

Switch gear
Switch gear is of the following types Minimum oil circuit breakers(33KV-220KV) Sf6circuit breaker(132KV-400KV) vacuum circuit breaker(3.3 KV-33KV For various indoor and outdoor applications for voltage ratings up to 400KV.

Transformers
Power transformers for voltage up to 400kv,

Instruments transformers: current transformers (up to 400kv), electromagnetic voltage transformers (up to 400 KV Special transformers: Earthling, furnace, rectifier, freight, loco and ac multiple units transformers, electro static Transformers and reactors for HVDC Series and shunt reactor up to 400KV.

precipitators, traction load feeding transformers and cast coil dry type transformers.

Bus ducts
Bus ducts with associated equipment to suit generators power output of utilities up to 500 MW.

Capacitors
Power capacitors for industrial use up to 250 KV for application up to 400KV. Compiling/Ctv capacitors for high voltage up to 400KV. Electrolytic and paper capacitors for motor start and motor run duties.

Industrial sets
From 1.5MW to 120MW for various industrial application much as for sugar, petrochemicals, refineries, steel, paper, cement, and fertilizers etc.

22

Power devices

Silicon power diodes, thirstier power devices and solar photo voltaic cells. Large area devices for high power applications

Telecommunication
Switching systems (epbax, rax, sbm, max-l and XL)

Aviation
Light air craft

Training simulators
For defense For power plants.

Growth of BHEL, HYDERABAD

Situated thirty kilometers away from Hyderabad city, the sprawling BHEL complex at R.C. Puram came into existence in 1963. This plant was originally set-up to Manufacture 1.5 to 30, 60,110 MW Turbo Sets for Thermal Projects. Later on the unit has diversified in the fields of manufacturing Compressors for Fertilizers, Petrochemical & Oil Refineries. During 1980s plant has diversified on the field of Manufacturing Oil rigs, Bowl Mills and Heaters for Oil Sectors and Power Plants. In the later part of 1980s where the Technology form G.E. (USA), the Plant has observed the Technology of Manufacturing Gas based Turbines, which are lesser in cost and faster in commissioning. Manufacturing of Gas Turbines was given more trust in 1990s because of lesser plan allocation for the

23

Thermal power plants of NTPC & SEB. Already the unit has supplied more then 60 Gas Turbines of different capacities including exports to Malaysia. Due to the quick observation of technology as will as competition of (G.E-BHEL) Gas Turbines, the product has emerged as a prime production as far as the unit is concerned. In short time span, BHEL Hyderabad, while playing an active role in the power sector has become an integral part of the industrial scene in India. B.H.EL has been competing in global tenders for number of multilaterally aided power projects since 1977. Over the years, B.H.E.L success rate has been high as 85% to 90% in such tenders.

Objectives of B.H.E.L:
To achieve and maintain a leading position as supplies of Quality Equipment, systems and services to serve the National & International Markets in the field of Energy. The areas of interest would be Conversion, Transmission, and Utilization & Market Leadership.

Organization structure
B.H.E.L, a Public Sector Undertaking, is a Company form of Organization with Corporate Functions, Business Sectors and Operating Units under the control of Chairman & Managing Director reporting to the Board of Directors. Manager in-charge. Directors individually deal with corporate functions with the help of Executive Directors/ General Managers in-charge. Each unit is headed by an Executive Director / General

Finance department in BHEL HYDERABAD

The Finance Department at BHEL Hyderabad is headed by Additional General Manager/Finance. It is segregated into different sub groups reporting to Additional General Manager / Finance.

24

Finance Department is organized into Product Wing and Centralized Wing. Product Wing is divided into various products like TCGT, EM, HEF, PUMPS, SG, PULV, F&S, WORKS & MISC, ED&ST, BUDGET&MONITORING ETC. Each product group deals with all types of finance and accounting relating to that product wise concurrence to proposals for procurement and incurring expenditure, material accounting, cost accounting, sales accounting, budget preparation, and other miscellaneous activities relating to that product. Centralized Wing deals with all Establishment matters pertaining to all employees of the unit, Cash Management dealing with total cash management of the unit, Books Section deals with preparation of Annual Accounts and Taxation matters, Export Incentive Section deals with all Export Incentive matters, Stock Verification and Productivity groups related to those subjects. In addition, there is an Internal Audit, which audits all the functions of the unit and directly reporting to Corporate Office. As it is a product form of Organization, Financial Accounting system is desired to meet the requirement of operation. The flow of authority and responsibility has definite forms of hierarchy ranging from Additional General Manager to the Clerical Cadre. Though Formal Relation and Flow of Authority exist, informal relation between Supervisors & Subordinates is observed.

BUDGETING IN BHEL HYDERABAD

Budgeting in BHEL (Hyderabad)

Budget process in BHEL is a combination of traditional and Zero based budgeting.

Steps in budgeting process

Issue of Guidelines by corporate office. Issue of circulars to department, on the basis of guidelines from the corporate office.

25

Receipt of requisition from the department, along with necessary justification, for the expenditure to be allocated to their department. Discussion with the departments wherever necessary and finalizing the expenditure to be projected to the corporate office. Finalizing of turnover by P&D in consultation with various agencies like commercial, finance etc. Finalizing of operating results, cash budget, inventory budget, outstanding etc. Presentation of operating results, cash budget, inventory budget, outstanding etc. Presentation of budget to the corporate team. Approval by corporate office for the budget proposal. Preparation of monthly budgets.

Allocation of expenditure to the departments.

In BHEL
After the annual budget is approved by corporate office, all the budgets are broken down to month wise and submitted to corporate office, in addition the expenditure is further broken down to Dept. wise based on requirement projected by each Dept. at the time of budget preparation and is communicated to them.

26

THEORETICAL ASPECTS OF CAPITAL BUDGETING

FINANCIAL DECISION IN A FIRM Capital Budgeting Decisions The first and perhaps the most important decisions that any firm has to make is to define the business or businesses that it wants to be this decision has a significant bearing on how capital is allocated in the firm. CAPITAL BUDGETING Business firms have scarce resources that must be allocated among competitive uses. The financial management provides a framework for firms to take these decisions widely. The investments decision includes not only those that create revenues and profits but also those reduce cost. So, the investments decisions and the decisions relating to assets composition of the firm. A capital expenditure, from the accounting point of view, is an expenditure that it shown as an asset on the balance sheet. This asset, except in the case of a depreciable asset like land, is depreciated over its life. In

27

accounting the classification of an expenditure as capital or revenue expenditure is governed by certain conventions, by some provisions of law, and by the managements desire to enhance and depress reported profits. Often, outlays on R&D, major advertising campaign and reconditioning of plant and machinery may be treated as revenue expenditure for accounting purposes though they are expected to generate a stream of benefits in future and therefore, quality or being capital expenditure.

CAPITAL BUDGETING: THREE DISTINCTIVE FEATURES They have long-term consequences They often involve substantial outlay They may be difficult or expensive It involves exchange of current funds for the benefits to be achieved in future. Future benefits are expected to be realized over a series of years. There is relatively high degree of risk. They are invariable decisions. They have long-term and significant effect on profitability of the concern. They generally involve huge funds. IMPORTANCE Capital Budgeting is of paramount importance in financial decision-making. Capital Budgeting decision affects the profitability of the firm. They also have a bearing on the competitive position of the enterprise. Capital Budgeting decision determines the future destiny of the company. An opportunity investment decision can yield spectacular returns where as an ill advised and incorrect investment decision can endanger the very survival even of the large sized firms. A capital expenditure decisions has its effect over a long-term time span and inevitably affects the companys future cost structure. Capital investment decisions are not easily reversible, without much financial loss to the firm. Capital investment involves cost and the majority of the firms have scarce capital resources Capital investment decisions are of national importance because it determines employment, economic activities and economic growth. NEED FOR CAPITAL BUDGETING Capital Budgering decisions are vital to an organization as they include the decisions as to. Whether or not funds should be invested in long-term projects such as setting of an industry, purchase of plant and machinery etc. To analyse the proposal for expansion or creating additional capacities. To decide the replacement of permanent asset such as building regarding capital investment so as to choose the best out of many alternative proposals.

28

DIFFICULTIES: Capital Budgeting are not easy to take there are number of factors responsible for this: The benefits from investments are received in some future period. The future is uncertain. Therefore, an element of risk is involved. A failure to forecast correctly will lead to serious errors, which can be corrected lonely at a considerable expense. Problems are also arising because cost incurred and benefits received from Capital Budgeting decisions occur at different rime period. They are not logically comparable because of the time value of money. It is not often possible to calculate in strictly quantitative term all the benefits of the cost relating to a particular investment decision.

TYPES OF CAPITAL BUDGETING DECISIONS Accept-Reject Decisions: This is a fundamental Capital Budgeting Decision. If the proposal is rejected, the firm does not invest in it, so by applying this criterion all independent projects are accepted. Independent projects are projects that do not compete with one another in such a way the acceptance of project preclude the possibility of acceptance of another. Manually Exclusive Projects Decision: These are projects which compete with other projects in such a way that the acceptance of one will exclusive and only one may be chosen. Mutually exclusive investment decisions acquired significance when more than one proposal is acceptable under Accept-Budget criterion. Capital Rationing Decisions: Capital Rationing refers to situation in which the firm has more acceptable investments requiring greater anount of finance than is available with the firm. It is concerned with selection of group of investment proposals actable under Accept-Reject criterion under financial constraints.

TECHINQUES OF CAPITAL BUDGETING The Net Present Value technique involves discounting net cash flows for a project, then subtracting net investment from the discounted net cash flows. The result is called the Net Present Value(NPV). If the net present value is positive, adopting the project would add to the value of the company. Whether the company chooses to do that will depend on their selection strategies. If they pick all projects that add to the value of the company they would choose all projects with positive net present values, even if that value is just $1. On the other hand, if they have limited resources, they will rank the projects and pick those with the highest NPV's. The discount rate used most frequently is the company's cost of capital. For Example: What would the net present value for a project with a net investment of $40,000 and the following net cash flows be if the company's cost of capital is 5%? NCF's for year one is $25,000, for year two is $36,000 and for year three is $5000. Yr Net Cash Flows x PVIF@5% Discounted Cash Flows

29

1 2 3

$25,000 $36,000 $5,000

.952 .907 .864

$23,800 $32,652 $4,320

Total Discounted Cash Flows Discounted at 5% $60,772 Less: Net Investment $40,000 Net Present Value $20,772 Merits of NPV: 1) It recongnises the time value of money 2) It is sound method of appraisal as it considers the total benefits arising out of the proposal over its lifetime 3) Changing discount rate can be built into the NPV calculation by altering the denominators. This rate normally changers because longer the time span, lower the value of money and higher the discount rate. 4) This method is very useful for selction fo normally exclusive projects.

Demerits of NPV: i. ii. iii. iv. It is difficult to calculate to understand The present value method involves the calculation of required rate of return to discount the cash flows, which present serious problems. It is an absolute measure This method may not give satisfactory results in case of projects having different effective lives

IRR-INTERNAL RATE OF RETURN : The IRR of a project is the discount rate which makes its NPV equal to 0. Put differently, it is the discount rate which equates the present value of future cash flows with the initial investment. It is the value or r in the following equation, N Investment= -----------------? Ct T = -------------------------

30

Where, Ct = cash flow at the end of the year r = internal rate of return (IRR) t = life of the project by applying the following steps we can calculate IRR i. ii. Calculate cash flow after tax Calculate fake pay back period Initial investment Fake PBP = ----------------------------------Average cash flow

iii. iv. v. vi. vii.

Look for the factor in t he present value annuity table in the year column until you arrive at figure which is close to the fake PBP Note the corresponding percentage Calculate NPV at the percentage If NPV is positive take a rage higher and if NPV is negative lower and once again calculate NPV Continue step v. until we arrive at low rates one giving positive NPV and another giving negative NPV Actual IRR can be calculated by usling the formula, LR+PV of cash inflows at LR-PV cash outflows

IRR =---------------------------------------------------------------------------Pv of cash inflows at LR-PV of cash inflows at HR Where. R = interest rate LR = lower rate HR = higher rate ACCEPT OR REJECT CRITERION: If IRR>CC, Accept ( where CC = Cost of Capital) If IRR<CC, Reject

31

 MERITS OF IRR: 1) It recognises the time value of money 2) It considers all cash flows occurring over the entire life of the projects to calculate its return 3) It is consistent with the shareholders wealth maximization objective

DEMERITS OF IRR: 1) It gives misleading and inconsistent reslults when the NPV of a project does not decline with discount rates 2) It also fails to include a correct choice between mutually exclusive projects under certain situations

PI-PROFITABILITY INDEX METHOD: it is ratio of the present value of the cash inflows at the required rate of return to the initial cash outflow of the investment. Using the PI or Benefits Cost Ratio(BCR) a project will qualify often acceptance if its PI exceeds one. The NPV will be positive if it is greater than one and negative when PI is less than one.thus NPV & PI approaches give the same results regarding the investment proposal. The selection of project with the PI can also be done on the basis of ranging. PI depends upon cash inflows before depreciation and afrer tax.It takes into consideration the scrap value. The formula to calcualate PI or BCR is, Total present value of cash inflows PI = ---------------------------------------------------------Total present value of cash outflows MERITS OF PI: 1) It gives due consideration to the time value of money 2) Since the present value of cash inflows is divided by initial cash outflows it is a relative measure of the projects profitability DEMERITS OF PI: 1) It is difficult to understand

32

2) It involves more computation than taditional methods Payback Period: payback is formal and basic capital budgeting technique used to assess the viability of the project. It is defined as the time period required for the investments returns to cover its cost. Payback period is easy to apply and easy to understand technique; therefore, widely used by investors. Original investment PBP = ------------------------------------------Constant annual cash flows For example, an investment of $5000 which returns $1000 per year will have a five year payback period. Shorter payback periods are more desirable for the investors than longer payback periods. It is considered as a method of analysis with serious limitations and qualifications for its use. Because it does not properly account for the time value of money, risk and other important considerations such as opportunity cost. Discounted Payback Period:One of the limitations in using payback period is that it does not take into account the time value of money. Thus, future cash inflows are not discounted or adjusted for debt/equity used to undertake the project , inflation, etc. However, the discounted payback period solves this problem. It considers the time value of money, it shows the breakeven after covering such costs. This technique is somewhat similar to payback period except that the expected future cash flows are discounted for computing payback period.

ACCEPT OR REJECT CRITERION: the PBP method can be used as a decision criterion to accept or reject investment proposals. If a single investment is being considered, if the annual PBP is less than the predetermined PBP the project will be accepted, if not it would be rejected.
When the mutually exclusive projects are considered they may be ranked according to the length of the PBP and the project with shortest payback may be assigned. MERITS OF PBP: 1) It is the best method incase of evaluation of single project 2) It is easy to calculate and understand 3) It is based on the cashflow analysis DEMERITS OF PBP: 1) It completely ignores all cashflows after the PBP 2) It completely ignores time value of money ARR-AVERAGE RATE OF RETURN: ARR is also known as Average Rate of Return Method. It is based on accounting information rather than cashflows. ARR is a technique that helps us in knowing the particular project, from which decision can be made to accept or reject the investment proposal. According to ARR as

33

an Accept or Reject Criterion, the actual ARR would be compared with the predetermined or a minimum required rate of return or cut off rate. Aproject can be accepted if the actual ARR is higher than the minimum desired ARR, otherwise it is liable to reject. Average annual profits after tax ARR= ------------------------------------------------------- * 100 Average investment

ACCEPT OR REJECT CRITERION: The actual average rate of return is compared wit predetermined or minimum required rate of return of cut off rate. Aproject would qualify to be accepted if the actual rate of return is higher than the minimum desired average rate of return. If more than one alternative proposals are under consideration, the average starting with the highest average rate of return.
Merits of ARR: 1) It is simple to understand and easy to calculate 2) The entire stream of incomes is used to calculate the ARR

FINDINGS AND CONCLUSIONS

The study is concerned with the capital budgeting with reference to BHEL. The data is collected, organized, analyzed and interpreted. The following findings are obtained from the analysis of data.

The first project i.e., project 1 generated unequal cash flows for 10yrs. The initial investment is
Rs.5125lakhs. 1. the discounted PBP is 4.3yrs. the investment will recover in 4yrs and 2 months. 2. NPV and IRR are positive for the proposal and the required rate of return is 18.15% 3. The profitability index is 1.22 times >1. 4. the return on investment is 12.7%

34

*the second project i.e., generated unequal cash flows for 10yrs. The initial investment is Rs.10250lakhs. 1. the discounted PBP is 2.10yrs. the investment will recover in 2yrs and 10mnths 2. NPV and IRR are positive for the proposal and the required rate of return is 30.64% 3. The profitability index is 1.80 times >1 4. The return on investment is 22.3% The third project i.e., generated unequal cash flows for 10yrs. The initial investiment is Rs.40125 lakhs 1. total investment has been realized by 9yrs and 11 months which is almost the lifetime of the projects. So PBP is not good for this project 2. NPV is negative for the proposal also the rate of return is also very low which cannot be treated as a return at all 0.14% 3. the profitability index is 1.60 times, it is not good. 4. the return on investment is 1.6% only cannot be considered as a good investment at all the fourth project i.e., generated unequal cash flows. The initial investment is Rs.8125lakhs 1. the discounted PBP is 3.10 yrs. The investment will recover in 3yrs and 10 months

2. NPV and IRR are positive for the proposal then the required rate of return is 20.52% 3. the profitability index is 1.34 time, this is a moderate sign 4. the return on investment is 14.3% the fifth project i.e., generated unequal cash flows. the initial investment is Rs.9560lakhs 1. the discounted PBP is 54.0215yrs.The investment will recover in 5yrs and 25 days.i.e., a 1month

35

2. NPV and IRR are positive for the proposal. Then they required rate of return is 17% 3. the profitability index is 1.34 times, which is same as the fourth project 4. the return on investment is 17%

Since the minimum desirable ARR is not known, the ranking method can be used to select or reject proposal. Thus projects are arranged in the descending order of the magnitude starting with the proposal with the highest ARR, thus

rank 1 2 3 4 5

project project 2 project 5 project 4 project 1 project 3

ARR 22.30% 17% 14.30% 12.70% 1.60%

RECOMMENDATIONS AND SUGGESTIONS i.

First project in all contexts is a good investment. PBP is 4.3 years, NPV, IRR, ARR and PI are positive as its return are positive, therefore the project is accepted.

ii.

Second project in all contexts is good and better than any other projects. PBP is 2.10 years is having the lowest PBP of all the other projects. Also NPV, IRR, PI are indicating positive sign. The ARR is highest for this project and also IRR being >25 where in no other project has such good appraisal. Therefore the project is accepted.

36

iii.

In third project NPV and IRR are negative for the proposal. Here the value of investment is almost matching with the cash flows that are for 10years. Also the PBP suggests that the investment can be realized only after 9.11yrs. thus it a not at all a option for investment. The PI is 0.60<1 times, it is not a good sign. ROI is 1.6%, lower than all the projects, its indicating values are such so as to completely forbidden the project. Fourth project NPV is also showing a positive sign and IRR is 20.5% is a good sign of expected cash flows over the life of the environment. PI is 1.34>1, this is a good sign. PBP is 3.10 years is a good time suggesting the early realization of invested anount. ARR is 14.3% is also a good return but not a better one when compared to second and fifth projects. Since the IRR is good the project is expected to get profits so the project is accepted.

iv.

v.

Fifth project NPV and IRR are positive for the proposal. The PI is same as the fourth project 1.34 times, and tha ARR is 17%. The IRR is 17.05%. the PBP is 5years. If the choice has to be made above two projects are competing with each other. However when considered the fourth project cost is Rs.8125lakhs and that of the fifith project is Rs.9560lakhs. thus the project -4 will be taken keeping in view the PBP and the IRR. ARR may not be considered as it is not showing cash flows. The PI is same for the both. Incase if these projects all are mutually exclusive projects than the project-2 should only be accepted as this project is having a good IRR(30.64%), PBP(2.10yrs) and also good ARR (22%) and PI (1.80) greater than all the other projects. However if they are independent projects, than except the third project all the other projects can be accepted. But the details of outsourcing is not known, it is difficult to say whether the amount investment in the project is feasible to the company or not because it is not possible to give a recommendation about buy or make decision is concerned. The investment appraisal for the company shall not only include the aspects of PV and returns expected but also keep into mind the utilization of the investment to the possible extent. Care must be taken to see that the machinery purchased will not become worn out easily proper maintenance management must be considered for this is aspect for loing running of the firm.

vi.

vii.

viii.

ix.

x.

37

Recommendations
1. Budgeting in BHEL is mainly a performance based i.e., based on the performance, where as zero-based budgeting is ideal for the company like BHEL. 2. There should be effective co-ordination between the different departments like production sales, purchase, finance, marketing etc., this will enhance the efficiency of the organization. 3. There should be a proper budgeting control system. 4. To reduce the cash crunch it is necessary for BHEL to revamp the existing credit and budgeting policies. 5. ABC Analysis of inventing control should be adopted in BHEL. 6. A thorough review of operation on frequent intervals is required. These reviews should be made with the request of changing environment. 7. Orders received should be dispatched at proper time.

38

8. Job sequencing should be pre-determined and should follow up the sequential process, until the end of the job. Thus, the lead-time can be reduced. 9. There should be a proper communication between various departments and responsibility centers. 10. There should be well-organized manpower planning, especially with regard to production. 11. Education about the importance of budgeting should be communicated to all concerned authorities, involved directly or indirectly to word according, for the growth of the company. 12. The out-standing no. of days of turnover should be reduced to nearly 120-100 days, this will help to ease the burden of borrowed working capital. 13. Miscellaneous expenses have to be reduced.

Bibliography

1. Financial Management 2. Financial Management 3. Cost and Management Accounting 4. Annual Reports of BHEL 5. Budget Manuals of BHEL

R. K.Sharma ,Shashi K. Gupta I.M. Pandey Jayanta Mitra

39

www.ask.com www.wikipedia.com www.bhel.com www.google.com www.bhelhyderabad.com www.yahoogroups.com

40