DEFINITIONS:

“Capital Budgeting is long term planning for making and financing proposed capital
outlays”. - T. Horngreen

FEATURES OF CAPITAL BUDGETING “Capital Budgeting consists in planning the

development of available capital of the purpose of maximizing the long-term profitability
of the concern”. - R.M. Lynch

“The capital budget is essentially a list of what management believes to be worthwhile

projects for the acquisition of new capital assets together with the estimated cost of each
product”. - Rovert N. Anthony

From the above definitions it is clear that it is the planning of available financial resources and
their long-term investment with a view to maximize the profitability of the firm.

DECISIONS:

1) It involves exchange of current funds for the benefit to be achieved in future.

2) The future benefits are expected to be received or realized over a series of years.
3) The funds are invested in non flexible and long-term activities.
4) It involves huge funds.
5) They have a long-term and significant effect on the profitability of the concern.

NEED AND SIGNIFICANCE OF CAPITAL BUDGETING:

The following are the reasons for placing great importance of capital budgeting decisions:

1) Large Investment: Capital budgeting decisions generally involve large investment of

funds, but the funds available with the firm are always limited. Hence it is very important
for a firm to plan and control its capital expenditure.

2) Irreversible Decisions: The capital budgeting decisions are irreversible decisions and the
amounts invested cannot be taken back without a substantial loss as it is difficult to
dispose them off and its conversion into other uses may not be financially feasible.
3) Long term effect on profitability: Capital budgeting decisions have a long-term and
significant effect on the profitability of a concern. Not only the present earning of the
firm are affected by the investment in fixed assets but also the future growth and
profitability of the firm depends on the investment decisions taken today.
4) Long term commitment of funds: Capital expenditure involves not only large amount of
funds for long term and more or less on permanent basis. The long term commitment
of funds increases the financial risk involved in the investment decisions greater the
risk involved, greater the need for careful planning of capital expenditure.
5) Effect on future capital structure: By taking a capital expenditure decision, a firm
commits itself to a sizable amount of fixed costs in terms of labour, supervisor’s salary,
insurance, rent of building etc., and if the investment in future turns out to be
unsuccessful the firm will have to bear the burden of fixed costs unless the assets is
completely written off.

6) National importance: Capital budgeting decisions are of national importance because it

determines employment opportunities, economic activities and economic growth.

7) Other factors: Such as uncertainties of future, higher degree of risk involved etc.,

CRITERIA FOR CAPITAL BUDGETING DECISIONS

Potentially, there is a wide array of criteria for selecting projects. Some shareholders may want
the firm to select projects that will show immediate surges in cash inflow, others may want to
emphasize long-term growth with little importance on short-term performance. Viewed in this
way, it would be quite difficult to satisfy the differing interests of all the shareholders.
Fortunately, there is a solution.
The goal of the firm is to maximize present shareholder value. This goal implies that projects
should be undertaken that result in a positive net present value, that is, the present value of the
expected cash inflow less the present value of the required capital expenditures. Using net
present value (NPV) as a measure, capital budgeting involves selecting those projects that
increase the value of the firm because they have a positive NPV. The timing and growth rate of
the incoming cash flow is important only to the extent of its impact on NPV.
Using NPV as the criterion by which to select projects assumes efficient capital markets so that
the firm has access to whatever capital is needed to pursue the positive NPV projects. In
situations where this is not the case, there may be capital rationing and the capital budgeting
process becomes more complex.
It is not the responsibility of the firm to decide whether to please particular groups of
shareholders who prefer longer or shorter term results. Once the firm has selected the projects to
maximize its net present value, it is up to the individual shareholders to use the capital markets to
borrow or lend in order to move the exact timing of their own cash inflows forward or backward.
This idea is crucial in the principal-agent relationship that exists between shareholders and
corporate managers. Even though each may have their own individual preferences, the common
goal is that of maximizing the present value of the corporation.

 Constraints. The amount of capital that can be raised is limited, imposing a constraint on
the choices. As firm's debt is increased, its debt-equity ratio and debt-servicing
requirements increase, making it harder to raise additional debt. Equity investors also
want to earn a return on their investment. To safeguard their return, equity investors are
likely to make a limited investment.
 Similarly, there are constraints with personal budget, at least in the short run. Since
income is limited, it's important to allocate it among different uses: living expenses, debt
repayment, and contributions to a savings plan.

 Project ranking. How to allocate the investment capital raised depends on the set of
investment opportunities? Project ranking is a means of allocating investment capital to
those projects that contribute the most value to the business.

In a similar fashion, personal budgeting relies on allocating the limited resources to their
best use. Debts can be ranked with those bearing the highest after-tax interest rate at the
top of the list. We tend to pay off debts with the higher interest rates first, or invest if we
can earn a higher return than the interest rate owed on our debt. To help identify our best-
performing investments, we can rank them, with those earning the highest after-tax return
at the top of the list.

 Measurement. There is a variety of methods available for measuring the firm's return on
an investment project. Three major methods useful in measuring a project's value are the
payback, net present value, and IRR methods.

The following table summarizes the major pros and cons of the three project-ranking techniques
identified:

Method Advantages Disadvantages

 Payback Simplest method to use. Ignores subsequent cash
outflows. Does not use DCF
analysis.

IRR Ranks projects by rate of return. Company can have more or

Can compare to hurdle rate to less return than IRR of the
make accept-reject decision. project. Need to measure the
hurdle rate.

Net present value Uses DCF analysis. Ranks Negligible.

projects by net present value.

Decisions may be undertaken for projects to either expand the business or to replace worn-out
equipment. As a start-up business or one in the early stages of growth, most likely concern is the
first kind of project.

In either case, estimation of the cash flows over the number of years it is expected to either incur
from the project is important. It has to be kept in mind that an expansion project is intended to
add sales; as a result, it is desired to add those incremental sales to the estimate of cash inflows.
For example, if we expect to receive $250,000 a year in additional sales from a new project,
those sales represent our cash inflows.

Cash flows are the proverbial "bird in the hand." Cash can be used to pay bills or vendors, make
additional capital investments, or earn interest income if invested in safe short-term investments.
Because of a preference to think in terms of cash flows, the IRR and net present value methods
are superior to the payback method.

Hurdle rate is an important part of using either the IRR or net present value method. The hurdle
rate is the most appropriate interest rate to use when evaluating investments. Often times, the
hurdle rate is the opportunity cost of investment capital, the rate of return that can be earned on
the next-best alternative investment.

The predictability, or certainty, of receiving a certain amount of cash flows also influences the
hurdle rate: if cash flows are less certain, one would want to discount by a slightly higher interest
rate. If cash flows are relatively certain, it may be desired to discount by a slightly lower rate.
For example, we may consider adding 0.50% to a hurdle rate of 8% to adjust for less-predictable
cash flows.

 Payback period (PAB):

The payback period is defined as the number of years required for recovering the original cash
outlay invested in a project. If a project generates constant annual cash inflow, the PBP can be
computed by dividing the initial cash outlays by the annual cash inflow.

 NET PRESENT VALUE (N P V);

N P V is the excess of the present value of cash inflow over the present value of cash outflow of
the project. The present value is calculated by applying a suitable discount rate.

 Decision rule; Accept the project if N P V is positive . Reject it if N P V is

negative. Zero N P V means no addition in wealth, therefore the decision –maker will
be indifferent.

Accept if N P V is > 0

Reject if N P V is < 0
 Indifferent if N P V is = 0

INTERNAL RATE OF RETURN (IRR);

The net present value presupposes the knowledge of the discount rate at time of evaluation of the
project . It also gives an absolute value with which most managers are not comfortable . Instead,
a discount can be found at which the present value of cash inflow matches the present value of
outflow. This discount rate is called the internal rate of return(IRR). IRR is the rate at which the
project N P V is zero.

IRR is calculated with trial and error . Start with any discount rate and calculate the NPV . If the
NPV is positive, try another higher discount rate, and go on trying out different rate till a rate is
found at which the NPV is exactly zero.

evaluating the projects. It covers all the aspects of the project and help in mitigating the risks.
This project includes step wise analysis of Dadri-Panipat R-LNG starting from need &
justification to sensitivity analysis. At the end it may be concluded that project financing is a
good method for financing and
Balance Sheet
View: Annual Data | Quarterly Data All numbers in thousands
Period Ending Mar 31, 2010 Mar 31, 2009 Mar 31, 2008 Mar 31, 2007
Assets
Current Assets
Cash And Cash
15,984,000   10,052,000   10,602,000   10,767,000  
Equivalents
Short Term
179,367,000   170,008,000   159,132,000   144,586,000  
Investments
Net Receivables 164,210,000   136,447,000   147,242,000   72,888,000  
Inventory 410,765,000   282,369,000   372,211,000   289,897,000  
Other Current
59,000,000   45,860,000   52,627,000   49,467,000  
Assets
Total Current Assets 829,327,000   644,735,000   741,815,000   567,605,000  
Long Term Investments 34,931,000   143,231,000   48,493,000   48,535,000  
Property Plant and
-  -  -  - 
Equipment
Goodwill 489,000   524,000   473,000   623,000  
Intangible Assets -  -  -  - 
Accumulated
-  -  -  - 
Amortization
Other Assets -  -  -  - 
Deferred Long Term
-  -  -  - 
Asset Charges
1,547,119,000   1,261,679,000  
Total Assets 1,364,569,000   1,041,551,000  
Liabilities
Current Liabilities
Accounts Payable 207,190,000   206,258,000   209,589,000   150,645,000  
Short/Current Long
494,726,000   473,469,000   388,209,000   294,811,000  
Term Debt
Other Current
211,258,000   146,621,000   138,677,000   147,415,000  
Liabilities
Total Current
731,311,000   641,318,000   602,311,000   450,060,000  
Liabilities
Long Term Debt 218,685,000   192,743,000   140,037,000   148,475,000  
Other Liabilities -  -  -  - 
Deferred Long Term
185,000   383,000   1,251,000   1,584,000  
Liability Charges
Minority Interest -  -  -  - 
Negative Goodwill -  -  -  - 
1,022,496,000  
Total Liabilities 909,525,000   825,484,000   676,109,000  
Stockholders' Equity
Misc Stocks Options
-  -  -  - 
Warrants
Redeemable Preferred
-  -  -  - 
Stock
Preferred Stock -  -  -  - 
Common Stock 25,144,000   15,433,000   15,433,000   15,190,000  
Retained Earnings 482,825,000   419,796,000   406,380,000   337,253,000  
Treasury Stock 16,654,000   19,815,000   14,382,000   13,000,000  
Capital Surplus -  -  -  - 
Other Stockholder
-  -  -  - 
Equity
Total Stockholder
-  -  -  - 
Equity
Net Tangible Asset