1. 1
A SUMMER INTERNSHIP
CAPITAL BUDGTING
INDIAN OIL CORPORATION LIMITED
PUNJAB TECHNICAL
K.C COLLEGE OF ENGINEERING $ IT ,
NAWANSHAHR,PUNJAB.
IN PARTIAL FULFILMENT OF TWO
MASTER OF BUSINESS ADMINISTRATION
UNDER THE GUIDANCE O
MR.PANKAJ KUMAR MEEN
(CHARTERED ACCOUNTANT)
SUBMITTED TO:-(H.O.D)
MR.SACHIN VERMA
PROJECT REPORT
ON
AT
UNIVERSITY
AL YEAR FULL TIME
COURSE
(FINANCE)
OF SUBMITTED BY
MEENA AKHILESH KUMAR
T) ROLL NO 1315536
2. 2
PREFACE
In today‘s era of globalization and competition, coping up with technological
advancement, which is undergoing evolution at a very fast rate, holds the key to
the survival and growth of any organization. Installing technology, well-equipped
facilities or going for modification in the existing ones are the means
to attain better performance efficiency and hence further the value addition.
Indian Oil, the largest commercial enterprise of India (by sales turnover) is
India‘s sole representative in Fortunes prestigious listing of world‘s 500 largest
corporations, ranked 135th for the year 2007. To maintain strategic edge in the
market place, Indian Oil has given importance to capital budgeting because
capital investment decisions often represent the most important decisions taken
by an organization, and they are extremely important, they sometimes also pose
difficulties. The evaluation of projects should be performed by a group of
experts who have no axe to grind. It is necessary to ensure that an impartial
group scrutinizes projects and that objectivity is maintained in the evaluation
process. A company in practice should take all care in selecting a method or
methods of investment evaluation. The criterion selected should be a true
measure of the investment‘s profitability (in terms of cash flows), and it should
lead to the net increase in the company‘s wealth (that is, its benefits should
exceed its cost adjusted for time value and risk). It should also be seen that the
evaluation criteria do not discriminate between the investment proposals. They
should be capable of ranking projects correctly in terms of profitability. The
NPV method is theoretically the most desirable criterion as it is a true measure
of profitability; it generally ranks projects correctly and is consistent with the
wealth maximization criterion
3. 3
ACKNOWLEDGEMENT
This training part of MBA programme taught me a lot to understand the key of
success in the organization. One of them is teamwork. Teamwork is ability to
work together towards a common vision. It is a fuel that allows common people
to attain results. Therefore, I would like to thank all management team of
Indian Oil Corporation Limited who help me to achieve this result. This
project is not an individual effort but a collection of efforts by each & every
member associated with it. Working with Barauni Refinery, IOCL has been an
educative, interesting and motivating experience. I would hereby like to extend
my gratitude to the following people without whose cooperation and help at
every stage, successful completion of the project would not have been possible.
It is my privilege to express my deep gratitude to Mr. Pankaj Kumar
Meena(CA at IOCL) who gave me such a great opportunity & infrastructure to
do this project and also for his kind cooperation & help throughout the project. I
would like to express my profound gratitude & a sincere thanks to Mr. Anurag
Soni (SFM at IOCL), for his valuable time & educative guidance. Their
constant support, innovative ideas & practical approach helped me to make the
project more objective. I would also take this opportunity to thank my college
K.C COLLEGE OF ENGINEERING $ IT ,NAWANSHAHR,PUNJAB. to
put the theoretical inputs gathered at the institute to practice. I also feel a sense
of gratitude towards Prof. SACHIN VARMA who took personal interest in the
progress of this report.
4. 4
ABSTRACT
A project work is a mandatory requirement for the Business Management
Programme. This type of study aims at exposing the young prospective
executive to the actual business world. This project gives me knowledge about
the capital budgeting decisions of the company. Capital Budgeting decisions
may be defined as the firm’s decision to invest its current funds most efficiently
in the long-term assets in anticipation of an expected flow of benefits over a
series of years. It is very effective way to judge a company’s investment
decision prospects, as cash is like life-blood for any company. The report
initially begins with the company profile, followed by the detailed analysis of
company, like businesses of the company, products offered by the company,
financials of the company, etc. The report involves a lot of research to
understand what exactly capital budgeting is, why companies require research
and analysis to invest funds in projects , what are the ideal situation for
Investment a Company should maintain, etc. .Various tools, including financial
tools, are used in this project to calculate and compare the returns.
5. 5
CERTIFICATE
Certified that this project report titled “A study on Capital Budgeting at Indian
Oil Corporation Limited” is the bonafide work of AKHILESH KUMAR
(MBA-2013-2015), student of MBA FINANCE, at K.C COLLEGE OF
ENGINEERING $ IT.KARYAM ROAD,NAWANSHAHR, PUNJAB ,carried
out the research under my supervision during her internship programme.
Certified further, that to the best of my knowledge the work reported herein
does not form part of any other project or dissertation on the basis of which a
degree or award was confirmed on an easier occasion on this or any other
candidate.
PANKAJ KUMAR MEENA
6. 6
CONTENTS
PARTICULARS PAGE NO.
1. - INTRODUCTION OF THE COMPANY
A) Introduction of the company 7-18
B) SWOT ANALYSIS 18-20
C) Introduction of Barauni Refinery 21-25
2. INTRODUCTION OF THE TOPIC
A. CAPITAL BUDGUTING 25-26
B. CAPITAL BUDGUTING TECHNICQUE 27
C. FINANCIAL EVALUTION 27-28
D. NET PRESENT VALLUE 28-31
E. INETRNAL RATE OF RETURN 31-37
F. CORPORATE OBJECTIVE 38-40
G. FINANCIAL OBJECTIVE 39-40
H. SUMMERY OF FINANCIAL ANALYSIS 40-42
7. 7
INTRODUCTION 0F THE COMPANY
HISTORY OF INDIAN OIL CORPORATION LTD.
The Indian Oil Corporation Ltd. operates as the largest company in India in
terms of turnover and is the only Indian company to rank 88th in the Fortune
"Global 500" listing. The oil concern is administratively controlled by India's
Ministry of Petroleum and Natural Gas, a government entity that owns just over
90 percent of the firm. Since 1959, this refining, marketing, and international
trading company served the Indian state with the important task of reducing
India's dependence on foreign oil and thus conserving valuable foreign
exchange. That changed in April 2002, however, when the Indian government
deregulated its petroleum industry and ended Indian Oil's monopoly on crude
oil imports. The firm owns and operates seven of the 17 refineries in India,
controlling nearly 40 percent of the country's refining capacity.
8. 8
HISTORY OF OIL INDUSTRY IN INDIA
In 1881, Assam Railway & Trading co. began laying of tracks in Assam
One day, one of the elephants wandered away, to come back with
its feet smeared by slimy oil
Backtracking led to the discovery of oil in Borbhil, near present day
Digboi
A Canadian driller, Willey Leove hollered at native boys, “Dig boy
dig”
Digboi became the birth place of India s oil industry
In 1890s, crude oil distillated at Margherita, 16 km away from
Digboi, in cast iron pans, called „Stills
Digboi Refinery of Assam Oil Company (AOC) commissioned at its
present location in 1901 with 500 bbl/day capacity
AOC nationalised and its Refining and Marketing functions merged
with IOC in October, 1981
Digboi refinery is one of the oldest refinery in the world that is still
working
At the time of independence, India s oil industry was fully controlled
by international oil cartel
In 1956, Industrial Policy Resolution was passed, which laid the
foundation of national oil industry
The resolution stated – “Oil is of vast importance in the world today.
A country that does not produce its own oil is in a weak position. From
the point of view of defence, the absence of oil is a fatal weakness”.
Exploration & production was put into Schedule – „A , meaning
thereby that only state would operate in this field
Soon thereafter, ONGC was formed for oil exploration and drilling
9. Indian Oil Refineries were formed in 1958 for refining and
manufacturing of petroleum products, with Shri Feroze Gandhi as its
Chairman
This was followed by the formation of Indian Oil Co. in 1959, for
marketing and distribution of petroleum products
In 1960, Indian Oil Co. signed a historic agreement with soviet
Union for import of 1.5 MMT of SKO, HSD, and ATF over a period of 4
years on „ rupee payment basis . This initiated the end of to the
monopoly of foreign oil companies
On 1st September 1964, as a step towards achieving improved
efficiency, Indian Refineries and Indian Oil Co. were merged. Indian Oil
Corporation Ltd. (IOC) was born.
9
10. 10
INDIAN OIL CORPORATION LTD.
Indian Oil Corporation Ltd. (Indian Oil) was formed in 1964 through the
merger of Indian Oil Company Ltd. (Estd. 1959) and Indian Refineries Ltd. (Estd.
1958).
At Indian Oil, corporate social responsibility (CSR) has been the cornerstone
of success right from inception in the year 1964. The Corporation’s objectives in
this key performance area are enshrined in its Mission statement: "…to help
enrich the quality of life of the community and preserve ecological balance and
heritage through a strong environment conscience”
.From a fledgling company with a net worth of just Rs. 45.18 crore and sales
of 1.38 million tonnes valued at Rs. 78 crore in the year 1965, Indian Oil has
since grown over 3000 times.
Indian Oil Corporation Ltd. (Indian Oil) is India's largest commercial
enterprise, with a sales turnover of Rs. 2,47,479 crore (US $ 61.70 billion) and
profits of Rs. 6,963 crore (US $ 1.74 billion) for the year 2007-08.
Indian Oil is also the highest ranked Indian company in the prestigious
Fortune 'Global 500' listing, having moved up 19 places to the 116th position in
2008. It is also the 18th largest petroleum company in the world.
Indian Oil has ambitious investment plans of Rs. 43,250 crore in the next five
years. By 2011-12, the Indian Oil Group, with 80 MMTPA refining capacity in
its fold, would be playing a key role in realising India’s bid to emerge as an
export-oriented hub for finished products.
PRODUCTS
Indian Oil is not only the largest commercial enterprise in the country it is the
flagship corporate of the Indian Nation. Besides having a dominant market
share, Indian Oil is widely recognized as India’s dominant energy brand and
11. customers perceive Indian Oil as a reliable symbol for high quality products and
services.
Benchmarking Quality, Quantity and Service to world-class standards is a
philosophy that Indian Oil adheres to so as to ensure that customers get a truly
global experience in India.
Indian Oil is a heritage and iconic brand at one level and a contemporary, global
brand at another level. While quality, reliability and service remains the core
benefits to the customers.
11
Auto gas
Indian Oil Aviation Service
Bitumen
High Speed Diesel
Bulk / Industrial Fuel
Indene Gas
SERVO Lubricants & Greases
Marine Fuels & Lubricants
MS / Gasoline
Petrochemicals
12. 12
Special Products
Superior Kerosene Oil
Crude Oil
13. 13
HISTORY
Indian
Refineries
Ltd.
1958
Indian Oil
Company Ltd.
1959
MERGE
Indian Oil
Corporation Ltd.
1ST SEPTEMBER 1964
14. 14
CORPORATE STRUCTURE
CORPORATE
DIVISIONS
BOARD
Finance including
International Trade /
Information Systems /
Optimization / Corporate
Affairs
Human Resource including
Corporate Communications
Planning & Business
Development
Refineries (including
AOD s Digboi
Refinery)
Pipelines
Marketing (including
AOD s Marketing)
R&D
15. 15
REFINERIES DIVISION
REFINERIES HQ , NEW DELHI
TECHN
ICAL
PROJE
CTS
MATER
IALS
HR Finance S &
EP
M & I
REFINERIES
DIGBOI
GUWAHATI
BARAUNI
GUJARAT
HALDIA
MATHURA
PANIPAT
BONGAIGAON
16. 16
MISSION OBJECTIVES AND OBLIGATIONS OF THE
COMPANY
MISSION
To achieve international standards of excellence in all
aspects of energy and diversified business with focus on
customer delight through value of products and services,
and cost reduction
To maximise creation of wealth, value and satisfaction for
the stakeholders
To attain leadership in developing, adopting and
assimilating state-of-the-art technology for competitive
advantage
To provide technology and services through sustained
Research and Development
To foster a culture of participation and innovation for
employee growth and contribution
To cultivate high standards of business ethics and Total
Quality Management for a strong corporate identity and
brand equity
To help enrich the quality of life of the community and
preserve ecological balance and heritage through a strong
environment conscience.
OBJECTIVES
To serve the national interests in the oil and related sectors
in accordance and consistent with Government policies.
To ensure and maintain continuous and smooth supplies of
petroleum products by way of crude refining, transportation
and marketing activities and to provide appropriate
assistance to the consumer to conserve and use petroleum
products efficiently.
To earn a reasonable rate of interest on investment.
To work towards the achievement of self-sufficiency in the
field of oil refining by setting up adequate capacity and to
build up expertise in laying of crude oil petroleum product
pipelines.
To create a strong research and development base in the
field of oil refining and stimulate the development of new
17. 17
product formulations with a view to minimise/eliminate
their imports and to have next generation products.
To maximise utilisation of the existing facilities in order to
improve efficiency and increase productivity.
OBLIGATIONS
Towards customers and dealers
To provide prompt, courteous and efficient service and
quality products at fair and reasonable prices
Towards suppliers
To ensure prompt dealings with integrity, impartiality and
courtesy and promote ancillary industries.
Towards employees
Develop their capability and advancement through
appropriate training and career planning.
Fair dealings with recognised representatives of employees
in pursuance of healthy trade union practice and sound
personnel policies.
18. 18
VALUES
Care – Stands for
Concern
Empathy
Understanding
Cooperation
Empowerment
Innovation –Stands for
Creativity
Ability to learn
Flexibility
Change
Passion - Stands for
Commitment
Dedication
Pride
Inspiration
Ownership
Zeal & Zest
Trust - Stands for
Delivered Promises
Reliability
Dependability
Integrity
Truthfulness
Transparency
19. 19
SWOT ANALYSIS
STRENGTHS
HIGH FOREIGN EXCHANGE DEBT.
IOCL has managed to significantly cut its borrowing cost due to high share of foreign
exchange debt. Its share of foreign exchange borrowings is increasing with foreign exchange
loans crossing 50% of its total debt compared to 42% at the end of the last financial year.
HIGHEST MARKET SHARE
As India's flagship national oil company, Indian Oil accounts for 56% petroleum products
market share, 42% national refining capacity and 67% downstream pipeline throughput
capacity.
FOREIGN SUBSIDIARIES AND JOINT VENTURES
Indian Oil is strengthening its existing overseas marketing ventures. The Corporation has
launched eleven joint ventures (listed separately) in partnership with some of the most
respected corporate from India and abroad .
WEAKNESSES
STRINGENT CORPORATE POLICIES
The decisions relating to administration are taken at the corporate
level. Even minor proposals are to be referred to the top management.
This leads to a delay in decision-making.
LACK OF MARKETING EFFORTS
20. 20
Among the public sector oil companies, Indian Oil Corporation is the
only one to follow a weak marketing strategy. It in only in the recent
years that the company has started to market its products. However,
still the efforts seem to be weak when compared with the competitors
like BPCL and HPCL.
PROMOTION POLICY
The employees are promoted mainly on the basis of experience and
not on the efforts and initiatives displayed by the employee in his
work. This results in demotivation and lack of interest for their work
on the part of the hardworking employees, who then tend to shift jobs
to satisfy their need for self-esteem.
OPPORTUNITIES
Exploration and Production
Indian Oil is metamorphosing from a pure sectoral company with
dominance in downstream in India to a vertically integrated,
transnational energy behemoth. The Corporation is making
investments in E&P and import/marketing ventures for oil and gas in
India and abroad, and is implementing a master plan to emerge as a
major player in petrochemicals by integrating its core refining
business with petrochemical activities.
THREATS
Entry of Big Private players
The opening up of the oil sector for private players poses a threat even
for this well-established company.
21. 21
INTRODUCTION TO BARAUNI REFINERY
The barauni refinery in eastern india was commissioned in 1964 with
a capacity of 2.0 mmtpa. The refining capacity was increased to 3.0
mmtpa by 1969 and
fluidised catalytic cracker) and hydrotreater facilities for diesel
quality improvement have been added. With the commissioning of
the 6.0 mmtpa haldia-barauni crude oil pipeline, the refinery now
received imported crude for processing. A cru (catalytic reformer
unit) was also added to the refinery in 1997 for production of
unleaded motor spirit. Projects are also planned for meeting future
fuel quality requirements. Barauni refinery supplies distillate
products beside eastern india to northern india through a product
pipeline to kanpur in uttar pradesh.
The year 2008-09 saw barauni refinery achieve the highest ever-crude
throughput of 5.94 mmt, beating the previous best of 5.63 mmt, which
was achieved in 2007-08, along with sustaining the distillate yield of
more than 85% (i.e. 85.7%) year after year
22. 22
barauni refinery achieved lowest ever 65.5 mbn of energy in the
year 2008-09. It reduced energy consumption by almost 10% over the
previous fiscal year of 2007-08. It excellence safety record during the
year 2008-09 is another feather. Barauni refinery coker unit was
declared as a zero steam leak unit it has avoided any accidents in the
unit during the year 2008-09
barauni petrochemicals plant is in the country the second oil
refinery in the public sector and forms an important part of the
indian petrochemical industry indian oil corporation ltd is speeding
up work on the high sulphur crude maximization project at its barauni
refinery in bihar. The project is estimated to cost rs 790 crore.
23. 23
FINANCIAL MISSIONS:
To provide high quality financial staff support for
decision-making and control to all levels of
management—corporate, divisional, unit and location to
enable the achievement of overall corporate objectives
and goals.
To play a lead role in scanning the domestic and
international financial environment, the formulation and
implementation of all financial policies and plans for
different time spans consistent with and conducive to the
business plans for expansion, diversification, productivity
etc.
To inculcate financial awareness, cost benefit attitudes
and system orientation in the entire organization.
FINANCE DIVISION
1: MAIN ACCOUNTS
For assets management, they prepare the master of assets, which includes name,
cost centre and other details for capitalization of assets. Further, receiving debit,
credit notes and reconciliation also form a part of this section.
2: PURCHASE
Accounting of cash purchases made by the materials department.
Arrangement for insurance of transit risk.
Maintenance of books of accounts.
Sales tax matters.
3: WORKS
Mainly deals with payment or running contracts. Its considers only plants
maintenance, roads, painting, welding, water etc.
4: PAYROLL
Rules for pay and allowance are prescribed by head office from time to time.
The eligibility for special type of allowance such as special allowances, shift
allowance etc. is determined by personnel department
24. 5: STORES AND MODVAT
Under this scheme, a manufacturer can take credit of excise duty paid on raw
materials and components used by him. The normal excise duty rate is 16%.
However it depends upon the Tariff class under which the product is classified.
6: TA/LTC/MEDICAL
This section also deals encashment of LTC and medical payment.
7: MISCELLANEOUS SECTION
Accounting of cash imp rest and advances for company expenses;
Passing of bills of miscellaneous nature
Miscellaneous recoveries from outsiders
8: PRODUCTION ACCOUNTING
Crude oil quantity and value accounting for the receipts,
consumption and stock.
Accounting of consumptions of own fuel/products.
Valuation of closing stocks i.e. Raw Material, ISD, Finished
Goods
Preparation of Cost Sheet and Cost Audit Performa
Monitoring of Revenue Budget, Preparation of Revenue Budget.
9: CASH / BANK
No fixed limit is established by the organization for making payments. The
organization has special current accounts with State Bank of India. These
accounts are the sources of payments.
10&11: PROJECT (WORKS) & PROJECT (PURCHASE)
12: PF & ADVANCES
24
25. 25
EXECUTIVE SUMMARY
Fortune 500 88th
position IN 2012-2013
Indian Oil
_ Indian Oil is India's flagship national oil company with business interests
straddling the entire hydrocarbon value chain – from refining, pipeline Barauni
Refinery – In harmony with nature- Rs.
5005cr
Other IOCL refineries (such as Gujarat Refinery, Bongaigaon Refinery) are also
in initial stage of adopting this modification.
10 OF INDIA'S 22 REFINERIES CAPACITY 65.7 MMPTA
MARKETING 49% SHARE
REFINING 31% SHARE
PIPELINE 71% SHARE
13thTPM National Conference
KAIZEN THEME:
Improvement in efficacy of Steam distribution system for
reduction in Energy Loss by Converting existing Condensing
cum Extraction Turbine into Back Pressure Turbine.
BARAUNI REFINERY
INDIAN OIL CORPORATION LIMITED
Estd Year-1964
Location,Bihar (India)
26. 26
INTRODUCTION OF THE TOPIC
CAPITAL BUDGETING
Capital budgeting refers to the process we use to make decisions concerning
investments in the long-term assets of the firm. The general idea is that the
capital, or long-term funds, raised by the firms are used to invest in assets that
will enable the firm to generate revenues several years into the future. Often the
funds raised to invest in such assets are not unrestricted, or infinitely available;
thus the firm must budget how these funds are invested.
IMPORTANCE OF CAPITAL BUDGETING
A bad decision can have a significant effect on the firm’s future operations. In
addition, the timing of the decisions is important. Many capital budgeting
projects take years to implement. If firms do not plan accordingly, they might
find that the timing of the capital budgeting decision is too late, thus costly with
respect to competition. Decisions that are made too early can also be
problematic because capital budgeting projects generally are very large
investments, thus early decisions might generate unnecessary costs for the firm.
Indian oil has given importance for capital budgeting because capital investment
decisions often represent the most important decisions taken by an organization,
and they are extremely important, they sometime also pose difficulties.
27. 27
Capital Budgeting Techniques
o Replacement decision—a decision concerning whether an existing asset
should replaced by a newer version of the same machine or even a different type
of machine that does the same thing as the existing machine. Such replacements
are generally made to maintain existing levels of operations, although
profitability might change due to changes in expenses (that is, the new machine
might be either more expensive or cheaper to operate than the existing
machine).
o Expansion decision—a decision concerning whether the firm should increase
operations by adding new products, additional machines, and so forth. Such
decisions would expand operations.
o Independent project—the acceptance of an independent project does not
affect the acceptance of any other project—that is, the project does not affect
other projects. For example, if you have a large sum of money in the bank that
you would like to spend on yourself
FINANCIAL EVALUATION
After determination of cash flow as per methodology enumerated
above, the next logical step is to financially evaluate the proposal.
The evaluation shall be carried out through following two
methods: (a) Internal Rate of Return (ROI/ROE) (b) Net Present
Value (NPV) [62]
Both the above methods fully recognize the timing of cash flows
through the process of discounted cash flows.
TECHNIQUES
In this section, the basic techniques that are used to make capital budgeting
decisions are described. To illustrate the techniques, let’s assume a firm is
considering investing in a project that has the following cash flows:
Year Expected After-Tax
(t) Net Cash Flows, t CF
0 $(5,000)
1 800
2 900
3 1500
4 1200
5 3200
28. $(5,000) represents the net cost, or initial investment, that is required to
purchase the asset—the parentheses indicate that the cash flow is negative. If
the firm’s required rate of return is 12 percent, the cash flow time line for the
asset is: 0 CF.
PAYBACK PERIOD
The number of years, including the fraction of the year, it takes to recapture the
initial investment. The following table shows the payback for this project:
Year Expected After-Tax Cumulative CF
(t) Net Cash Flows, t CF
0 $(5,000) (5,000)
1 800 (4200)
2 900 ( 3300)
3 1500 (1800)
4 1200 (600)
5 3200 2600
This table shows that the payback period is between four years and five years.
The actual payback is:
Payback period= (Number of years before recovery of original investment)
+
( Amount of investment/total cash flow during payback year)
=4 + $600/$3200
=4.19 years.
As the computation shows, it takes a little more than four years for the firm to
recapture its original investment for this project. The acceptance rule for
payback can be stated as follows: Accept the project if Payback, PB < some
number of years set by the firm This project would be acceptable if the firm
wants to recapture its investments’ costs within five years, but it would not be
acceptable if the firm wants to recapture the costs within three years.
28
NET PRESENT VALUE (NPV)—
To determine the NPV of a project, you need to compute the present value of all
the future cash flows associated with the project, sum them up, and then
subtract (or add a negative amount to) the initial investment of the project. The
resulting value represents the amount by which the firm’s value will increase,
on a present value basis, if the firm invests in the project. For example, if the
29. NPV of a project is $1,000, then the value of the firm should increase by $1,000
today. Thus, a project is acceptable if its NPV is positive. If a project has a
positive NPV, then it generates a return that is greater than the cost of the funds
29
that are used to purchase the project.
(a) The present value of a future sum of money can be found by
discounting it to the present point in time or Year ‗O‘ at the
required rate of return/ discount rate. Required rate of return
shall not be less than cost of capital. (b) Under this method, the
present value of each years‘ net cash flow is calculated, starting
from the year ‗0‘ till complete project life i.e. 15 years. This
discounting rate adopted shall be the Hurdle Rate.
(c) If the project has a positive Net Present Value, the project is
considered to be commercially viable.
According to the acceptance criterion, the project in our example should be
purchased. Remember that if the firm accepts a project with a positive NPV its
value should increase, and vice versa. Therefore, if the project had a negative
NPV it would not be acceptable because such a project would decrease the
value of the firm.
The easiest way to compute the NPV for a project is to use the cash flow
register on your Capital Budgeting calculator. Refer to the instructions that
came with your calculator to determine how to use the CF register. If you have a
Texas Instruments BAII PLUS, you can use the steps given in the ―Time
Value of Money section of the notes. The inputs should be CF0 = –5,000, CF1
= 800, CF2 = 900, CF3 = 1,500, CF4 = 1,200, CF5 = 3,200, and I = 12. Press
the NPV key (or CPT, then the NPV key) to find NPV = 77.82. You can also
use a spreadsheet to compute NPV. Using Excel, you could set up the
spreadsheet as follows:
30. To solve for the present value of the future cash flows, put the cursor in cell D3
and click on the ―Financial function named NPV. In the box that appears
input the following cell locations
The range B3:B7 contains the values of the cash flows for Year 1 through Year
5 because the NPV function programmed into the spreadsheet computes the
present value of the future cash flows only. When you click ―OK you will
see the result of the computation, which is $5,077.82, appear in cell D3. But,
because this result represents the present value of the future cash flows, you
need to add CF0 to the result to include the amount of the initial investment. In
this case, the computation is completed in cell D4, where CF0 is added to the
30
31. result of the NPV computation that appears in cell D3. Cell D4 should now
show the correct answer for the NPV, which is $77.82
We can use the present values of the future cash flows to compute the
discounted payback. To do so, we simply apply the concept of the traditional
payback to the present values of the future cash flows as follows:
YEAR CASH FLOW PV OF CF CUMULATIVE
31
PV
0 $(5000) $(5000) $(5000)
1 800 714.29 (4285.71)
2 900 717.47 ( 3568.24)
3 1500 1067.67 (2500.57)
4 1200 762.62 (1737.95)
5 3200 1815.77 77.82
Thus, the discounted payback is
Payback period= (Number of years before recovery of original investment) +
( Amount of investment/total cash flow during payback year
=4 + $1,737.95/$1,815.77
=years 96 .4
When using the discounted payback, a project is acceptable if its payback is less
than its life. In this case, 4.96 years is less than five years, so the project is
acceptable. Notice, however, we could have made the decision by looking at the
last line of the column labeled ―Cumulative PV because that value is the
NPV. So, if you set up the problem as we did in the above table and the ending
value for the ―Cumulative PV is greater than zero, then NPV > 0 and the
project is acceptable.
INTERNAL RATE OF RETURN (IRR)
It was mentioned above that a project that has a positive NPV generates a return
that is greater than the cost of the funds used to purchase the project. The IRR is
defined as the rate of return the firm would earn, on average, if it purchases the
project. To determine the IRR, we want to compute the rate of return that causes
the NPV of the project to equal zero, or where the present value of the future
cash flows equals the initial investment. In other words.
(a) Internal Rate of Return (IRR) is the discounting rate at which present value
of cash inflow is equal to the present value of cash outflow. In other words, the
32. discount rate that yields a ZERO Net Present Value is called Internal Rate of
Return. (b) IRR shall be computed for all capital investment proposals and
indicated in the Capital Investment Proposals.
It is not easy to solve for the IRR without a calculator because you have to use a
trial-and-error method—that is, plug in various values for IRR until the right
side of the equation equals the left side of the equation. With a financial
calculator, however, it is very easy to solve for IRR.
Follow the same steps you would to compute the NPV, but press the IRR key
(or CPT and then the IRR key) instead of the NPV key. You should find that
IRR= 12.5%. Using a spreadsheet to compute the IRR for the project, set up the
problem as before
To solve for the internal rate of return for this project, put the cursor in cell D5
and click on the ―Financial function named IRR. In the box that appears
input the following cell locations:
32
33. The range B2:B7 contains the values of all the cash flows for the project.
When you click ―OK, the answer, 12.50%, will appear in cell D5. A project
is acceptable using IRR if its IRR is greater than the firm’s required rate of
return—that is, IRR > r. Remember that the IRR represents the rate of return the
firm will earn if the project is purchased. So, simply stated, the project must
earn a return that is greater than the cost of the funds used to purchase it. In our
example, IRR = 12.5%, which is greater than r = 12%, so the project is
acceptable.
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36. 36
ANALYSIS
The project is accepted if the internal rate of return is higher or equal to the
minium required rate of return .the minimum required rate of return is also
know as cut off rate of firm cost of capital.
A project shall be rejected if its irr is lower than the cut off rate. As the irr is
found to be higher than the cut off rate the project is accepted
37. 37
COMPARISON OF THE NPV AND IRR METHODS
Summarizing what we have discussed to this point, we know that a project is
acceptable if its NPV is greater than zero. If a project has an NPV greater than
zero, then it generates a return that is greater than the cost of the funds used to
purchase the project. We also know that a project is acceptable if its IRR is
greater than the firm’s required rate of return. When a project has an IRR
greater than the required rate of return, then it generates a return that is greater
than the cost of the funds used to purchase the project. As you can see by the
italicized phrases, accepting a project using the NPV technique provides the
same benefit as accepting a project using the IRR technique. As a result, both
the NPV technique and the IRR technique should always give the same
accept/reject decision—that is, if a project is acceptable using the NPV method,
it also is acceptable using the IRR method, and vice versa. As we will discover
shortly, however, when comparing two or more projects, the two techniques do
not always agree as to which project is best.
For debt-financed projects, Debt Service Coverage Ratio (DSCR) is
also to be calculated, so as to ascertain the debt serving
capability of the project. DSCR is calculated as under: Profit after
tax+ Depreciation + Interest on long term loan Interest on long
term loan + Loan Repayment installment Break-ever analysis is a
tool to ascertain the level of sales required to meet the funds
requirement (fixed + variable). This can be used as a sensitive
analysis tool and can be computed as under: Total fixed cost
Break Even Units = (BEU)/( Unit Selling Price – Unit Variable
cost )
BEUs are minimum sales units at which, project is just meeting
its funds requirement and there is no loss or gain.
The computed IRR shall be compared with Benchmark IRR
(hurdle rates). Hurdle rates shall be calculated based on
Weighted Average Long Term Cost of Capital (WACC) along with
project specific risk premium. Hurdle rates shall be revised
annually after approval of competent authority.
38. 38
CORPORATE OBJECTIVES
To serve the national interests in the Oil and related sectors in accordance and
consistent with Government policies.
To ensure and maintain continuous and smooth supplies of petroleum products
by way of crude refining, transportation and marketing activities and to provide
appropriate assistance to the consumer to conserve and use petroleum products
efficiently.
To earn a reasonable rate of interest on investment.
To work towards the achievement of self-sufficiency in the filed of Oil refining
by setting up adequate capacity and to build up expertise in laying of crude and
petroleum product pipelines.
To create a strong research and development base in the field of Oil refining
and stimulate the development of new product formulations with a view to
minimize/eliminate their imports and to have next generation products.
To maximize utilization of the existing facilities in order to improve efficiency
and increase productivity.
To optimize utilization of its refining capacity and maximize distillate yield
from refining of crude to minimize foreign exchange outgo.
To minimize fuel consumption in refineries and stock losses in marketing
operations to effect energy conservation.
To further enhance distribution network for providing assured service to
customers throughout the country through expansion of reseller network as per
Marketing Plan/Government approval.
39. To avail of all viable opportunities, both national and global, arising out of the
liberalization policies being pursued by the Government of India.
To achieve higher growth through integration, mergers, acquisitions and
diversification by harnessing new business opportunities
39
FINANCIAL OBJECTIVES
To ensure adequate return on the capital employed and maintain a reasonable
annual Dividend on its equity capital.
To ensure maximum economy in expenditure.
To manage and operate the facilities in an efficient manner so as to generate
adequate internal resources to meet revenue cost and requirements for project
investment, without budgetary support.
To develop long-term corporate plans to provide for adequate growth of the
activities of the corporation.
To endeavor to reduce the cost of production of petroleum products by means
of systematic cost control measures.
To endeavor to complete all planned projects within the stipulated time and cost
estimates.
41. SUMMARY OF FINANCIAL ANALYSIS
For the purpose of financial analysis of capital investment
proposals, cash flow estimates shall be prepared for the full
project life. These cash flow estimates along with calculation of
ROI/ROE, NPV, DSCR & Break Even analysis shall be attached
to the proposal. While considering the base case, capacity
utilization shall not be more than 90% (2nd year onwards) through
out the project life cycle for all projects. A statement of
assumptions made for Financial Analysis shall be enclosed. In
summary it may be stated that the more sophisticated and
mathematical methods of investment appraisal, particularly NPV
and IRR can have extremely useful applications so long as they
are used appropriately. Divisions while using these methods shall
have an appreciation of limitations of these methods. Though
these methods do reckon time value of money, but results of
these methods largely depend on the accurate forecasting of the
future cash flow. Therefore, it is important that utmost care is
exercised in correctly estimating the future cash flows.
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BIBLIOGRAPHY
INTERNET
GOOGLE
WWW.IOCL.IN
WWW.GOOGLE.COM
I. M. Pandey – Financial Management
Khan And Jain –Financial Management
iocl.in
investopedia.com
