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project on capital budgeting

project on capital budgeting

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  • 1. Rationale for the study As we know, investment decisions are critical for the success of any business firm.Finance is the backbone of every organization. Thus, for the success of business afinancial Growth of ours we need complete knowledge of transaction required. We notneed to know how money grows but also need to know instant gratification and live theuniversal principles of austerity and hard work all of which form the basis of achievingfinancial freedom. We all know that “A Rupee today is more valuable than a Rupee tomorrow” theentire would of the investment decision revolve around the “Time value concept ofmoney.” All of us are aware, the companies prepare capital investment decision and theyfollow that budget and they follow that budget throughout of the year in order to makeprofit and to reduce cost but most of us don’t know how actually things work. Theobjective of the study is to know how to take decisions and how a budget is prepared inbig organizations like Hindalco industries limited. During training of six weeks, I came toknow about how capital decision is prepared in Hindalco industries limited and howbudget is prepared in Hindalco industries limited and how to take investment decisionand analysis expenditure, how these expenditure are controlled. Every organization hasits own method to prepare budget so as to work efficiently and effectively. I also came toknow about how decision process start with the estimation and determination of cost andbenefits associated with different proposals. In this project, I have performed about decision making andunderstanding the investment paten of actives and analysis of capital expenditure .Organization can be done in many ways and out of those I choose some methods.By using weighted average cost of capitalBy using Net Present ValueBy using interest Rate of Return 1
  • 2. Title of the project“Capital Budgeting Tools and analysis of Capital Expenditures in Hindalco Industrieslimited”.Scope of studyAfter doing this project, while preparing the project analysis was on how to prepare acapital budget and how to take investment decision and analysis of capital expenditureand how expenditure can be controlled. The different department prepare budget with theusing of tools and then finally finance manager take investment decision. And be aware the concept of cost of capital has been used quiteoften without providing a good deal of explanation about, how it is obtained and learnabout the method of calculation component cost of capital and the weighted average costof capital.Objective of the studyThe main objective of the study is to understand how and from where an organizationarranged the funds.  To study about the investment decision and expenditure decisions.  An understanding of the importance of capital budgeting in marketing decisions.  Identify the steps involved in capital budgeting process. 2
  • 3. HINDALCO An industry leader in aluminium and copper, Hindalco Industries Limited, the metalsflagship company of the Aditya Birla Group is the worlds largest aluminium rollingcompany and one of the biggest producers of primary aluminium in Asia. A metalspowerhouse with a turnover Rs18856.30 crore. Its copper smelter is the world’s largestcustom smelter at a single location. Established in 1958, we commissioned our aluminium facility at Renukoot in easternUttar Pradesh, India in 1962. Later acquisitions and mergers, with Indal, Birla Copperand the Nifty and Mt. Gordon copper mines in Australia, strengthened our position invalue-added alumina, aluminium and copper products. The growth story for Aditya Birla Group’s flagship company, Hindalco, will remaininherently Indian. After posting impressive numbers, that saw its consolidated net profitsoaring eight-fold to Rs. 485 crore for the year ended March 31, Hindalco’s managementsaid they expect domestic demand to post a double-digit growth in the current financialyear. However, the rise in North America and Europe will be modest.Global aluminium demands fell about 8 per cent in 2009, after the global slowdown hitdemand — especially for raw materials — in the automotive and construction sectors.But, there is a clear pickup, with demand likely to rise close to 14 Percent in 2010, asChina and India see rapid expansion in their economies.Aluminium demand in India is very positive because of auto, construction and powersectors. Even globally, I would be very surprised if aluminium prices come down fromthe current levels,” managing director Debu Bhattacharya told reporters. “Copperdemand, too, is rising on the back of power projects.” 3
  • 4. Hindalco gets about 40% of its India revenue from aluminium, and is trebling capacity inIndia to 1.9 million tones by 2013 at a cost of about $5 billion. “Financial closures of allthe three Greenfield projects are on track. In fact, we have invested Rs.5, 000crorealready on the projects, as we are strongly committed to them. We raised Rs.2, 700crorefrom our QIP to meet any shortfall in equity funding. As of now, I see no requirement forany more equity funding,” said Sunirmal Talukdar, group executive president & chieffinancial officer, Hindalco.Novelis, has seen a remarkable turnaround with its adjusted Ebitda (earnings beforeinterest, depreciation, tax and amortisation) up 55 per cent in FY10 compared to theprevious year. The improved numbers and profitability have been a result of right sizingoperations and higher efficiency management and exploring new applications forAluminium rolled product maker Novelis, which Hindalco acquired in 2007, willprimarily see growth in the South American and Asian markets. Novelis will be investing$150 million in 2010-11 on capital expenditure. Significant chunk of that will be goinginto expanding rolling operations in Brazil, which is likely to get completed by late2012.Aluminium in sectors like auto. Cost-saving exercises also helped. Novelis forexample recycled 40 billion tonnes of used beverage cans (UBCs) in 2009, savingsignificant energy costs. Hindalco overviewHistory of our company and other corporate matters Our company is a flagship companyof the Aditya Birla Group and was incorpation on December 15, 1958 as HindustanAluminium Corporation Limited under the provisions of the Act. We changed our namefrom Hindustan Aluminium corporation Limited to Hindalco Industries Limited onOctober 9,1989, as we had expanded our line of products and also proposed to diversifyinto allied fields including aluminium foils, steel plant etc. The Equity shares of ourcompany with face value of Rs.10 each were first listed of BSE. The listing agreement 4
  • 5. was signed with BSE on January 28, 1960. Thereafter, the Equity Shares with Face valueof Rs.10 each were listed on the NSE. In 1962 we set up collaboration with Kaiser Aluminium and chemicals Corporation,USA when our integrated Complex at Renukoot came on stream with a smelter capacityof 20,000 MTPA. It has since grown to become the largest integrated aluminiumproducer in India with a smelting capacity of Renusagar power company Ltd.The company has grown manifold and is managed by board of directors, with Mr. KumarMangalam Birla as the chairman of the board of Directors. Day to day affairs of thecompany is managed by professional executives headed by Mr Ratan K. Shah as the chiefOperating Officer.The dream of the visionary GD Birla to locate an aluminium plant near Rihandpowerhouse comes true. The late Prime Minister, PT. JAWHERLAL NEHRU formallyinauguratedthe plant in January 1963. Going round the extensive work, Pandit ji saw his dream of abrighter feature of India take shape before his eyes.From the modest beginning giant witha capacity to produce 345000 tons of aluminium per annum.Aluminium and Power (Renukoot, U.P.) the company has sales and distributionnetwork that covers all India and includes five sales offices located in Mumbai,Delhi,Bangalore,Chennai,Uttar pradesh 5
  • 6. Hindalco business Hindalco in India enjoys a leadership position in aluminium. The company’s aluminiumunits across the country encompass the entire gamut of operations from bauxite miningalumina refining, aluminium smelting to downstream rolling, extrusion, foils and alloywheels , along with captive power plants and coal mines.The company has significant market share in the entire segment in which it operates. Itenjoys a domestic market share 42 % in primary aluminium, 63 %in rolled product , 20 %in extrusion,44%in foils and 31%in wheel.As step towards expanding the market for value added products and sevices. Hindalcohas launched sevelar brands in recent years, which include Aura for Alloy wheel, freshrapper for kitchen foil and ever last for roofing sheets. Our exclusive showroom, thealuminium gallery, seeks to promote Hindalco products to its customers. It is a platformfor the company to showcase quality audience in an appropriate ambience. The exhibitsinclude products to a quality audience in an appropriate ambience. The exhibits includeproducts like windows, doors, furniture, ladder, roofing sheets and ceiling and claddingpanels.Hindalco products are well received not only in the domestic markets, but also in theinternational market. The company’s metal is accepted for delivery under the high gradealuminium contract on the London Metal Exchange (LME). The company export about17% of its total sales volume of aluminum. The company’s alumina chemical business isa leader in manufacturing and marketing of specialty alumina and alumina hydrateproducts in the country. It has a market share of 90% in the country. These specialtyproducts find wide usage in diversified industries including water treatment chemicals,refractory, ceramics, cryolite, glass, filler and plastic, conveyor belts and cables amongothers. The company also exports these alumna chemical to over 30 country coveringNorth American, Western, Europe and the Asian region. 6
  • 7. ALUMINIUM MANUFACTURING IN HINDALCO Hindalco was among the first few alloy wheels companies to have obtained the ISO/TS16949 certification to meet the stringent standard in specialty alumina, primaryaluminium and downstream products. A part from being a dominant player in thedomestic market, Hindalco’s products as well accepted in international markets. Exportsaccount for more than 30% of total sales.Hindalco’s major products include standard and specialty grade alumina and hydrates,aluminium ingots, billets,wire rods, flat rolled products, extrusions, foil and alloyswheels. Hindalco is the world’s largest aluminium rolling company and one of thebiggest producers of primary aluminium in Asia. In India, Hindalco enjoys a ledershipposition in specialty alumina, primary aluminium and downstream products.Hindalco’s major products include standard and specialty grade alumina and hydratesaluminium ingots, billets, wire rods, flat rolled products, extrusions, foil and alloywheels.The integrated facility at Renukoot (uttar pradesh) houses an alumina refinery and analuminium smelter along with facilities for production of semi-fabricated products,namely, redraw rods, flat rolled products and extrusions. The plant is backed by a co-generation plant a 742 mw captive powerplant at Renusagar to ensure continuous andconsistent supply of power for smelter and other operations.# UTKAL ALUMINA INTERNATIONAL LIMITED, ORISSAA Rs 44 billion( $1 billion) greenfield joint venture with Alcan Inc, of canada in whichHindalco holds 55% equity. The proposed 1.5 million tonne alumina refinery is to be setup in Doragurha, Rayagada district of Orissa, sourcing bauxite from the rich reserves ofBaplimali Rayagada.# MADHYA PRADESH 7
  • 8. A Rs.77 billion($1.7 billion) project for a smelter-power complex in the siddhi district ofmadhya pradesh Aluminium smelter capacity of 325,000 tpa supported by a 750 mw coalbased captive power plant. The coal for the power plant will be sourced from Mahan coalcompany Ltd., a joint venture between Hindalco and Essar Group for mining of coal fromthe Mahan coal block.# JHARKHANDA Rs. 78 billion ($1.7 billion) project for a smelter- power complex in the latehar district.Aluminium smelter capacity of 325,000tpa supported by captive thermal power of 750mw.Globally the aditya birla group is : A metals powerhouse, among the world’s most cost- efficient aluminium and copperproducers. Hindalco-Novelis is the largest aluminium rolling company. It is one of thethree biggest poducers of primary aluminium in Asia, with the largest single locationcopper smelter. • No. 1 in viscose staple fibre. • The 4th largest producer of insulators. • The 4th largest producer of carbon black. • The 11th largest cement producer globally, the 7th largest In asia and the 2nd largest in India. • Among the world’s top 15 BPO companies and among India’s top four. • Among the best energy efficient fertilizer plants. In India the Aditya Birla Group is: • A premier branded garents player. • The second largest player in viscose filament yarm. • The second largest in the chlor-alkali sectors. • Among the top five mobile telephony companies. 8
  • 9. • A leading player in life insurance and assest management. • Among the top three supermarket chains in the retail business.Beyond Business—The Aditya Birla Group is • Working in 3700 villages. • Reaching out to seven million people annually through the Aditya Birla centre for community initiatives and rural development, spearheaded by Mrs. Rajashree Birla. • Focusing on healthcare, education, sustainable livehood, infrastructure and espousing social causes. • Running 41 schools and 18 hospitals. • Transcending the conventional barriers of business to send out a message that “WE CARE”. 9
  • 10. Bauxite mines Power station E Extrusion plant s Alumina Smelter R Alumina Refinery R R s F R s W F F J s R s ECopper Aluminusmelter Foils Extrusio Alumina Rolling Wheels Bauxite Power Coal m,refinery plant n plant refinery mill plant mines station mines smelter& jetty s R B 24 s F E R W 10
  • 11. PRODUCTS PERFORMANCE REVIEW Hindalco is one of the leading producers of aluminium and copper. Our aluminium unitsacross the globe encompass the entire gamut of operations, from bauxite mining, aluminarefining and aluminium smelting to downstream rolling, extrusions, foils, along withcaptive power plants and coal mines.Our copper unit, Birla Copper, produces copper cathodes, continuous cast copper rodsand other by-products, such as gold, silver and DAP fertilisers.Our units are ISO 9001:2000, ISO 14001:2004 and OHSAS 18001 certified. Several unitshave gone a step further with an integrated management system (IMS), combining ISO9001, ISO 14001 and OHSAS 18001 into one business excellence model. We have beenaccorded the Star Trading House status in India. Hindalcos aluminium metal is acceptedfor delivery under the High Grade Aluminium Contract on the London Metal Exchange(LME). Our copper quality standards are also internationally recognised and registered onthe LME with Grade A accreditation. Aluminium Hindalcos major products include standard andspeciality grade aluminas and hydrates, aluminium ingots, billets, wire rods, flat rolledproducts, extrusions and foil. The integrated facility at Renukoot houses an aluminarefinery and an aluminium smelter, along with facilities for the production of semi- 11
  • 12. fabricated products, namely, redraw rods, flat rolled products and extrusions. The plant isbacked by a co-generation power unit and a 742 MW captive power plant at Renusagar toensure the continuous supply of power for smelter and other operations. A strongpresence across the value chain and synergies between operations has given us adominant share in the value-added products market. As a step towards expanding themarket for value-added products and services, we have launched various brands in recentyears — Everlast roofing sheets, Freshwrapp kitchen foil and Freshpakk semi-rigidcontainers. COPPER Birla Copper, Hindalco’s copper unit, is located at Dahejin Gujarat, India. The unit has the unique distinction of being the largest single-locationcopper smelter in the world. The smelter uses state-of-the-art technology and has acapacity of 500,000 tpa. Birla Copper also produces precious metals, fertilizers andsulphuric and phosphoric acid. The unit has captive power plants for continuous powergeneration and a captive jetty to facilitate logistics and transportation. Birla Copperupholds its longstanding reputation for quality copper cathodes and continuous castcopper rods by assuring its management processes meet the highest standards. It hasacquired certifications such as ISO-9001:2000 (Quality Management Systems),ISO-14001:2004 12
  • 13. (Environmental Management System) and OHSAS-18001:2007 (Occupational Healthand Safety Management Systems). Mines Hindalco acquired two Australian copper mines, Nifty and Mt.Gordon, in 2003. The Birla Nifty copper mine consists of an underground mine, heapleach pads and a solvent extraction and electrowinning (SXEW) processing plant, whichproduces copper cathode. The Mt. Gordon copper operation consists of an undergroundmine and a copper concentrate plant. Until recently, the operation produced coppercathode through the ferric leach process.In 2004, a copper concentrator was commissioned to provide concentrate for use atHindalcos operations in Dahej. During FY2009, Mt. Gordon produced 17,815 tonnes ofcopper in concentrate. Both Nifty and Mt. Gordon have a long-term life of mine off-takeagreement with Hindalco for supply of copper concentrate to the copper smelter at Dahej. Cornerstones of growth Our well-crafted growth and integration hinges on the three cornerstones of costcompetitiveness, quality and global reach. We are also committed to the triple bottomline accountability of economic, environment and social factors. Care for the communityaround our operating units is best exemplified by our deep-rooted social commitment. 13
  • 14. Production profile The aluminium production process can be categorized into upstream and downstreamactivities. The upstream process involves mining and refining of Bauxite to Alumina,while the downstream process involves smelting, casting and fabrication.HINDALCO is amongst the best plants in producing the world class Aluminium at thelowest cost in India.The production of Aluminium is done in different stages.Normally the stage consists ofconversion of bauxite to alumina. Then alumina is converted into aluminium. Therefineries at Hindalco are well established and cost worthly.They are very efficient andwastage is very low. Hindalco refines bauxites primarily obtained from capative mines, to extractalumina,which is smelted into alumina ingots and are called billets.Hindalco smelts itsentire production of alumina into aluminium and does not engage in alumina trade. Production of Aluminium can be categorized into two stages:- # From Bauxite to Alumina # From Alumina to Aluminium 14
  • 15. Fully integrated operations - RenukootIndal synergies provide additional strength and operational flexibility. 15
  • 16. Hindalco alumina refinery process 16
  • 17. Al2O3 (Alumina) to Reduction Plant 17
  • 18. Reduction plant – process flow chart 18
  • 19. Integrated Operations of Hindalco at Renukoot Bauxite MinesCo-Generation Alumina refinery caustic soda from jointventrueRenusagar Aluminium smelter AluminiumFluoride(power plant) from j.v. Semi fabrication plantRedrow Rod Mills Rolling Mills Extrusionpresses Foils At. Wheel Plant 19
  • 20. Production Capacities Division Capacity LocationAlumina chemicals 1,160,000tpa 700,000tpa(Renukoot) 110,000 tpa (Muri) 350,000tpa(Belgaum)Primary aluminium 445,000tpa 345,000tpa(Renukoot) 2,000 tpa (Belgaum) 100,000tpa(Alupuram) 14,000tpa(Taloja)Extrusions 42,000tpa 30,000tpa(Renukoot) 12,000tpa(Alupuram)Rolled products 200,000tpa 80,000tpa(Renukoot) 45,000tpa(Belur) 45,000tpa (Taloja) 30,000tpa(Mouda)Wire Rods 64,000tpa 40,000tpa(Renukoot) 10,000tpa(Alupuram) 14,400tpa(Mouda)Aluminium foil 11,000tpa 5,000tpa(silvassa) 6,000tpa(kalwa)Aluminium wheels 300,000pcs SilvassaPower 1087.2mw 741.7mw(Renusagar) 78mw( Renukoot) 267.5mw(Hirakud)Copper cathodes 500,000tpa Dahej 20
  • 21. Vision mission and value “My objective has been to build a meritocracy…An organization is about people who make itAnd it would continue to be my focus” Kumar Mangalam Birla VisionTo be a premium metals major, global in size and reach, excelling in everything we do,and creating value for its stakeholders. MissionTo relentlessly pursue the creation of superior shareholder value, by exceeding customerexpectation profitably, unleashing employee potential, while being a responsiblecorporate citizen, adhering to our values. Values Integrity: Honesty in every action. Path to excellence Commitment: On the foundation of integrity, doing whatever it takes to deliver, aspromised. Passion: Missionary zeal arising out of an emotional engagement with work. Seamlessness: Thinking and working together across functional silos, hierarchy levels,businesses and geographies. Speed: Responding to stakeholders with a sense of urgency. Hindalco Today 21
  • 22. Aluminium has turned out to be the wonder metal of the industrialized world. No othersingle metal can do so many jobs, so well and so economically. Aluminium’s growth rateis the highest amongst the major basic metals today. Hindalco ranks is the largestAluminium producer in India, whose more than 58% sale is in value added product andhas more than 40% in total market share. The company’s fully integrated aluminiumoperations consists of the mining of Bauxite, conversion of Bauxite, into alumina,production of primary aluminium from alumina by electrolysis and production ofproperzi redraw rods, rolled products, extrusions and value added products like foil andwheels at silvassa. Hindalco’s integrated operation and operational efficiency have enabled the company tobe one of the world’s lowest cost producers of aluminium. The company’s cost efficiencyhas helped it to record an outstanding performance in the face of adverse marketconditions. Hindalco also owns a large captive thermal power plant at Renusagar thatmeets the power requirement of the company very effectively. Hindalco currently hasaluminium capacity of 3,45,000 MTPA.Ever last, a hindalco brand for aluminium-roofing sheets, offers ideal and economicalsolutions for all roofing and cladding needs. Hindalco also offers colors-coated and tiledroofing profiles.Conclusion of companyThe company has recorded a strong performance despite the challenging conditions incopper business posed by the falling tariffs as well as production related issues. Thesuccess of its cost optimization initiatives at its power plant in hirakud as well as higheroperating margins that the company has achieved.The company has also made good progress on the strategic growth projects that willpropel it into the league of global majors. Efforts towards obtaining relevant approvalsfor the expansions are moving at a fast pace.There have been significant developments during the year towards meeting the fundingobjectives of the same. The strong balance sheet, prudent financial practices as well asexpectations of improved operations give the confidence that your company will be ableto economically finance its growth plans. On the whole the companyis poised to deliversuperior value to its stakeholders on a continuing basis.OBJECTIVE This above report outlines the detailed guidelines,process flows and worksteps related to the capital expenditure investment analysis process at HINDALCOINDUSTRIES LIMITED. 22
  • 23. Capital budgetingCapital budgeting is a financial procedure to ensure that capital is allocated to valueadding opportunities. A capital budgeting/investment proposal should be accepted/rejected depending on whether it generates, over the life of investment, returns more thanits cost of capital.Capital expenditureWhenever we make expenditure that generates a cash flow benefit for more than oneYear, this is a capital expenditure. Capital expenditures often involve large cash outlayswith major implications on the future values of the company.Additionally, once we commit to making a capital expenditure it is sometimes difficult tobackout. Therefore, we need to carefully analyze and evaluate proposed capitalexpenditures.Investment decisions equire special attention because of thefollowing reasonsGrowth: The effects of investment decisions extend into the future and have to beendured for a longer period than the consequences of the current operating expenditure. Afirm’s decision to invest in long-term assets has a decisive influence on the rate anddirection of its growth.Risk: A long-term commitment of funds may also change the risk complexity of the firm.If the adoption of an investment increases average gain but causes frequent fluctuation inits earnings, the firm will become more risky. Thus, investment decisions shape the basischaracter of a firm.Funding: Investment decisions generally involve large amount of funds,which make itimperative for the firm to plan its investment programmes very carefully and make anadvance arrangement for procuring finances internally or externally. 23
  • 24. Irreversibility: Most investment decisions are irreversible. it is difficult to find a marketfor such capital items once they have been acquired. The firm will incur heavy losses ifsuch assets are scrapped.Complexity: Investment decisions are among the firm’s most difficult decisions. Theyare an assessment of future events, which are difficult to predict. It is really a complexproblem to correctly estimate the future cash flows of an investment. Economic, political,social, and technological forces cause the uncertainly in cash flow estimationTypes of investment decisions# Expansion of existing business# Expansion of new business# Replacement and ModernizationThe Three stages of capital budgeting analysisCapital Budgeting Analysis is a process of evaluating how we invest in capital assets; i.e.assets that provide cash flow benefits for more than one year. We are trying to answer thefollowing question:Will the future benefits of this project be large enough to justify the investment given therisk involved?It has been said that how we spend our money today determines what our value will betomorrow. Therefore, we will focus much of our attention on present values so that wecan understand how expenditures today influence values in the future. A very popularapproach to looking at present values of projects is discounted cash flows or DCF.However, we will learn that this approach is too narrow for properly evaluating a project.We will include three stages within Capital Budgeting Analysis:! Decision Analysis for Knowledge Building! Option Pricing to Establish Position! Discounted Cash Flow (DCF) for making the Investment Decision 24
  • 25. Decision AnalysisDecision-making is increasingly more complex today because of uncertainty.Additionally, most capital projects will involve numerous variables and possibleoutcomes. For example, estimating cash flows associated with a project involves workingcapital requirements, project risk, tax considerations, expected rates of inflation, anddisposal values. We have to understand existing markets to forecast project revenues,assess competitive impacts of the project, and determine the life cycle of the project. Ifour capital project involves production, we have to understand operating costs, additionaloverheads, capacity utilization, and startup costs. Consequently, we cannot managecapital projects by simply looking at the numbers; i.e. discounted cash flows. We mustlook at the entire decision and assess all relevant variables and outcomes within ananalytical hierarchy. In financial management, we refer to this analytical hierarchy as theMultiple Attribute Decision Model (MADM). Multiple attributes are involved in capitalprojects and each attribute in the decision needs to be weighed differently. We will use ananalytical hierarchy to structure the decision and derive the importance of attributes inrelation to one another. We can think of MADM as a decision tree, which breaks down acomplex decision into component parts. This decision tree approach offers severaladvantages:! We systematically consider both financial and non-financial criteria.! Judgments and assumptions are included within the decision based on expectedValues.! We focus more of our attention on those parts of the decision that are important.! We include the opinions and ideas of others into the decision. Group or team decision-making is usually much better than one person analyzing the decision.Therefore, our first real step in capital budgeting is to obtain knowledge about the projectand organize this knowledge into a decision tree. We can use software programs such asExpert Choice or Decision Pro to help us build a decision tree. 25
  • 26. Option PricingThe uncertainty about our project is first reduced by obtaining knowledge and workingthe decision through a decision tree. The second stage in this process is to consider alloptions or choices we have or should have for the project. Therefore, before we proceedto discounted cash flows we need to build a set of options into our project for managingunexpected changes. In financial management, consideration of options within capitalbudgeting is called contingent claims analysis or option pricing. For example, supposeyou have a choice between two boiler units for your factory. Boiler A uses oil and BoilerB can use either oil or natural gas. Based on traditional approaches to capital budgeting,the least costs boiler was selected for purchase, namely Boiler A. However, if weconsider option pricing Boiler B maybe the best choice because we have a choice oroption on what fuel we can use. Suppose we expect rising oil prices in the next five years.This will result in higher operating costs for Boiler A, but Boiler B can switch to a secondfuel to better control operating costs. Consequently, we want to assess the options ofcapital projects. Options can take many forms; ability to delay, defer, postpone, alter,change, etc. These options give us more opportunities for creating value within capitalprojects. We need to think of capital projects as a bundle of options. Three commonsources of options are:1. Timing Options: The ability to delay our investment in the project.2. Abandonment Options: The ability to abandon or get out of a project that has gone bad.3. Growth Options: The ability of a project to provide long-term growth despite negativeValues. For example, a new research program may appear negative, but it might lead toNew product innovations and market growth. We need to consider the growth options ofProjects. Option pricing is the additional value that we recognize within a project becauseit has flexibilities over similar projects. These flexibilities help us manage capital projectsand therefore, failure to recognize option values can result in an under-valuation of aproject.Discounted Cash FlowSo we have completed the first two stages of capital budgeting analysis: (1) Build and 26
  • 27. organize knowledge within a decision tree and (2) Recognize and build options withinour capital projects. We can now make an investment decision based on Discounted CashFlows or DCF. Unlike accounting, financial management is concerned with the values ofassets today; i.e. present values. Since capital projects provide benefits into the future andsince we want to determine the present value of the project, we will discount the futurecash flows of a project to the present. Discounting refers to taking a future amount andfinding its value today. Future values differ from present values because of the time valueof money. Financial management recognizes the time value of money because:1. Inflation reduces values over time.2. Uncertainty in the future.3. Opportunity Costs of money.Capital budgeting projects According to BrealeyCapital Budgeting Techniques: A variety of measures have evolved overtime to analyze capital budgeting requests. The newer methods use time value of moneyconcepts. Older methods, like the payback period, have the deficiency of not using timevalue techniques and will eventually fall by the wayside and be replaced in companies bythe newer, superior methods of evaluation.1. Net Present Value (NPV)Using the hurdle rate as the required rate of return, the net present value of an investmentis the present value of the cash inflows minus the present value of the cash outflows. Amore common way of expressing this is to say that the net present value (NPV) is thepresent value of the benefits (PVB) minus the present value of the costs (PVC). NPV =PVB – PVC 27
  • 28. By using the hurdle rate as the discount rate, we are conducting a test to see if the projectis expected to earn our minimum desired rate of return. Here are our decision rules: Should we expect to earn at least Accept theIf the NPV is: Benefits vs. Costs our minimum rate of investment? return?Positive Benefits > Costs Yes, more than AcceptZero Benefits = Costs Exactly equal to IndifferentNegative Benefits < Costs No, less than RejectRemember that we said above that the purpose of the capital budgeting analysis is to seeif the projects benefits are large enough to repay the company for (1) the assets cost, (2)the cost of financing the project, and (3) a rate of return that adequately compensates thecompany for the risk found in the cash flow estimates.Therefore, if the NPV is: • Positive, the benefits are more than large enough to repay the company for (1) the assets cost, (2) the cost of financing the project, and (3) a rate of return that adequately compensates the company for the risk found in the cash flow estimates. • Zero, the benefits are barely enough to cover all three but you are at breakeven - no profit and no loss, and therefore you would be indifferent about accepting the project. • Negative, the benefits are not large enough to cover all three, and therefore the project should be rejected.2. Internal Rate of Return (IRR) 28
  • 29. The Internal Rate of Return (IRR) is the rate of return that an investor can expect to earnon the investment. Technically, it is the discount rate that causes the present value of thebenefits to equal the present value of the costs. According to surveys of businesses, theIRR method is actually the most commonly used method for evaluating capital budgetingproposals. This is probably because the IRR is a very easy number to understand becauseit can be compared easily to the expected return on other types of investments (savingsaccounts, bonds, etc.).Test Interpretation of Results Next percentageResults to be tested?PVB > PVC The project is expected to A higher rate earn more than the percentage rate used for the testPVB < PVC The project is expected to A lower rate earn less than the percentage rate used for the testWhich Method Is Better: the NPV or the IRR?The NPV is superior to the IRR method for at least two reasons:Reinvestment of Cash Flows: The NPV method assumes that the projects cash inflowsare reinvested to earn the hurdle rate; the IRR assumes that the cash inflows arereinvested to earn the IRR. Of the two, the NPVs assumption is more realistic in mostsituations since the IRR can be very high on some projects.Multiple Solutions for the IRR: It is possible for the IRR to have more than onesolution. If the cash flows experience a sign change (e.g., positive cash flow in one year, 29
  • 30. negative in the next), the IRR method will have more than one solution. In other words,there will be more than one percentage number that will cause the PVB to equal the PVC.3. Payback PeriodSince it does not use the time value of money principle, the Payback Period is theweakest of the capital budgeting methods discussed here. By definition, the paybackperiod is the length of time that it takes to recover your investmentCapital Budgeting AnalysisWhenever we analyze a capital project, we must consider unique factors. A discussion ofall of these factors are beyond the scope of this course. However, three common factorsto consider are:! Compensating for different levels of risks between projects.! Recognizing risks that are specific to foreign projects.! Making adjustments to capital budgeting analysis by looking at the actual resultsRisk analysisWe previously learned that we could manage uncertainty by initiating decision analysisand building options into our projects. We now want to turn our attention to managingrisks. It is worth noting that uncertainty and risk is not the same thing. Uncertainty iswhere you have no basis for a decision. Risk is where you do have a basis for a decision,but you have the possibility of several outcomes. The wider the variation of outcomes,the higher the risk. Another way to adjust for risk is to understand the impact of risk onoutcomes. Sensitivity Analysis and Simulation can be used to measure how changes to aproject affect the outcome. Sensitivity analysis is used to determine the change in NetPresent Value given a change in a specific variable, such as estimated project revenues.Simulation allows us to simulate the results of a project for a given distribution of 30
  • 31. variables. Both sensitivity analysis and simulation require a definition of all relevantvariables associated with the project. It should be noted that sensitivity analysis is mucheasier to implement since sophisticated computer models are usually required forsimulation. 31
  • 32. Type of the projectThe project is descriptive and analytical in nature Sampling Plan:There has been no sampling plan as such as the study involves understanding the variousprocesses and analyzing them. The study involves the detailed analysis of secondary datacollected from various sources and therefore no sample size and plan has been considered Data source:Data has been collected from both primary and secondary source.Primary source:Information gathered by interview and discussing with the employees of financedepartment and my project guide.Secondary sourceAnnual reportsManuals of finance departmentInternal circulation bookletsInternet sites like www.google.com., www.solidconey or @indiatimes.comData has been collected through literature survey includes the collection of data fromvarious sources like handbooks. Study materials etc.Study ConductThe study has been conducted from information over a period of 3 years from financialyear2006-2007 to 2008-2009 32
  • 33. DurationPeriod of study during 25th may to 4th August2010.AssumptionsYear is taken of 360 daysAll purchases have been taken as credit purchases and all sales have been taken as creditsales. In the absence of relevant data the data from Internet site is taken as the relevantinformation.Methods of Quantative analysisCapital budgeting techniquesCalculation of weighted average Cost of capitalAnalysisFor the analysis data were used along with charts and necessary tables. Other than thesedifferent models are used to access the true financial position of the firm. The currentyear i.e. 2010 has not been taken into calculation because, at that time of preparation ofthis report annual closing accounting of the company was going on.Interpretation and recommendationAfter completion of the entire analysis, interpretation and recommendation were made onthe basis of figures and diagrams. Statistical tools like tables, charts are used forrepresentation of data. 33
  • 34. Business decisions that require capital budgeting analysis are decisions that involve inoutlay now in order to obtain some return in the future.This return may be in the form ofincreased revenue or reduced costs. Typical capital budgeting decisions include:Cost reduction decisionsShould new equipment be purchased to reduce costs?Expansion decisionsShould a new plan, warehouse, or other facility be acquired to increase capacity andsales?Equipment selection decision Which of several available machines should be the most cost effective to purchase?Lease or buy decisionsShould new equipment be leased or purchased?Equipment replacement decisionsShould old equipment be replaced now or later? The use of modified sensitivity analysisas it applies to ICO uncertainty in a capital budgeting analysis, consider the potentialpurchase of some equipment to be used in a project. The purchase price is known withcertainty to be Rs.60,00,000. The equipment has a useful life of five years and is in thethree-year property class for MACRS tax-depreciation purposes. Shipping andinstallation costs are "estimated" to be Rs.10,00,000 and Rs.20,00,000, respectively, andthe equipment has a zero expected final salvage value, five years from now. Noadditional "net" working capital is needed. The new equipment will generate estimatedadditional annual net operating cash flows, before consideration of depreciation and 34
  • 35. taxes, of Rs.30, 00,000 a year for five years. Assuming that the marginal tax rate equals40 percent, we can estimate the projects relevant incremental cash flows for the "basecase."IV.A. The Base Case: Net Present ValueExhibit 2 shows the projects 90,00,000 initial cash outflow under the "base case."Exhibit 2.The Expected Initial Cash Outflow Equipment cost (certain) = 60,00,000+ Capitalized expenditures:Shipping cost (estimate) = 10,00,000Installation cost (estimate) = 20,00,000 _______________= Initial cash outlay (ICO) = 90,00,000 = depreciable basis for tax purposesExhibit 3shows the expected the incremental future cash flows.Exhibit 3Expected Incremental Future Cash Flows 35
  • 36. END OF YEAR (in x10,000s) __________________________________________ 1 2 3 4 5Net change in operatingrevenue, excluding depreciation 300.00 300.00 300.00 300.00 300.00- Net increase in tax depreciation (299.97) (400.05) (133.29) ( 66.69) -- ___________________________________________________= Net change in income before taxes .03 (100.05) 233.31 300.00 166.71− (+) Net increase (decrease) in taxes (40% rate) (.01) 40.02 (66.68) (93.32) (120.00) ____________________________________________________= Net change in income after tax .02 ( 60.03) 100.03 139.99 180.00+ Net increase in tax depreciation 299.97 400.05 133.29 66.69 -- ___________________________________________________ ___________________________________________________= Incremental net cash flow for years 1 to 5 299.99 340.02 233.32 206.68 180.00.Exhibit 4 combines the ICO from Exhibit 2 with the annual operating cash flows fromExhibit 3, resulting in the total expected net incremental cash flows from the project.Exhibit 4. 36
  • 37. Expected Annual END OF YEAR (in x10,000s)Cash Flows 0 1 2 3 4 5Period ( 900.00) 299.99 340.02 233.32 206.68 180.00Net cash flowsFor an estimated initial cash outlay of 90,00,000, the firm expects to generate net cashflows of Rs(990),299.99 340.020, 233.320, 206.680, and 180 over the next five years.The firm’s weighted-average cost of capital is 13 percent. Given this "base case" data, thenet present value is 17,920. The typical capital budgeting response to the projectspositive net present value would be to signal project acceptance. However, given theuncertain estimates for two of the three ICO components, i.e., shipping and installation,we suggest that the capital budgeting analyst should defer an accept/reject decision untilthose uncertain estimates and their multi-year spillover effects are subjected to sensitivityanalysis.IV.B. Sensitivity AnalysisSensitivity analysis can be applied to our equipment purchases uncertain ICOcomponents to answer a few “what if” questions. What if, for example, our Rs10,00,000estimate for shipping cost turns out to be higher/lower? And, what if installation ishigher/lower than the Rs 20,00,000 we originally thought? To answer those “what if”questions, we first perform new NPV calculations in which we change our two variablesof concern (shipping and installation) individually by, for example,-30%, -20%, -10%,+10%, +20%, and +30%. Note that changes in these variables have multiperiodspillovereffects on depreciation, which affects taxes and future cash flows. Thus, the change in theICO not only affects the Year-0 cash flow, but it also affects the cash flows in thesubsequent years.Exhibit 5 compares the estimated NPVs for the different levels of ICOs.Exhibit 5.Sensitivity analysis for the equipment purchase showing the impact of individualchangesin two initial cash outlay components on the project’s net present value 37
  • 38. (NPV) in crore of Rs. CHANGE IN ORIGINAL INSTALLATION COST -30% -20% -10% Base +10% +20% +30%Resulting NPV 58.93 45.27 31.58 17.92 4.25 ( 9.43) (23.09) CHANGE IN ORIGINAL SHIPPING COST -30% -20% -10% Base +10% +20% +30%Resulting NPV 38.43 31.53 24.75 17.92 11.08 4.25 ( 2.59)From Exhibit 5, we can see that if estimated installation cost were to increase by roughly13percent or more from the base case, our project’s net present value turns negative. Forshipping cost, however, the increase would need to be roughly 28 percent or more beforethe project has a negative net present value.The data contained in Exhibit 5 can also be presented graphically in an NPV sensitivitygraph –see Exhibit 6. Notice the two “sensitivity lines” in the NPV sensitivity graph. The“installation cost” line has the steepest slope. Therefore, NPV is more sensitive to equalpercentage changes in that variable than in “shipping cost.” Based on this information,management may want to concentrate more control efforts on the seemingly more critical“installation cost” variable. It may even want to try and negotiate a fixed-cost pricecontract for installation from a third party. 38
  • 39. One potential problem with our sensitivity analysis, so far, is that it has looked atsensitivity “one variable at a time.” We can also judge the sensitivity of NPV tosimultaneous changes in two variables by constructing an NPV sensitivity matrix. Exhibit7 is one such sensitivity matrix that depicts NPV results for combinations of changes inour two input estimates – “shipping cost” and “installation cost.” Note that asimultaneous cost increase approaching 10 percent for both shipping and installationcosts would result in a negative net present value.Exhibit 7. 39
  • 40. Sensitivity matrix for the equipment purchase showing the impact of simultaneouschanges in two initial cash outlay components on the project’s net present value(NPV) CHANGE IN INSTALLATION COSTCHANGE INSHIPPING COST -30% -20% -10% Base +10% +20% +30% 30% 79.44 72.60 65.77 58.93 52.10 45.27 38.43-20% 65.77 58.93 52.10 45.27 38.43 31.58 24.75-10% 52.10 45.27 38.43 31.58 24.75 17.92 11.08Base 38.43 31.58 24.75 17.92 11.08 4.25 (2.59)+10% 24.75 17.92 11.08 4.25 (2.59) (9.43) (16.25)+20% 11.08 4.25 (2.59) (9.43) (16.25) (23.09) (29.93)+30% (2.59) (9.43) (16.25) (23.09) (29.93) (36.77) (43.60)Sensitivity analysis, as we have seen, provides a useful and easily understood insight intohow project’s NPV responds to a change in one (or more) uncertain ICO input variables.Thus, the analysis provides insights into the risk-return trade-off for the project. Giventhe risk-return profile in Exhibit 7, should the project be taken? In other words, is theexpected NPV of Rs 17,920 worth the risk of two simultaneous 30% cost overruns, whichwould result in Rs43, 600 losses? Although there is no theoretically definitive answer, ifthe possible loss is small relative to the size of the company, then the risk is probablyworth taking, given that the project has positive expected value. If the loss is so large thatit is a “bet the company” proposition, then the board of directors should make the finaldecision.Sensitivity analysis does not provide any absolute rules for deciding whether or not toaccept the project, but it does provide some clear guidelines regarding the need for aproject to be reevaluated. For the project in this example, a re-approval analysis should be 40
  • 41. triggered when the combined shipping and installation cost overrun is Rs 26,213 or more,since this leads to an expected negative NPV.10 In fact, if cost overruns approach Rs26,213, then the company’s managers should consider possible interventions that mighthelp salvage the value of the project.Cost of capital Determination of cost of capital HindalcoThe term cost of capital is referred to the discount rate that is used in determining thepresent value of the estimated future cash proceeds. The cost of capital is used as thediscount rate to calculate the NPV. It is the minimum rate of retrun that a firm must earnon its investment for the market value of the firm remain unchanged.The cost of capital of the firm is the composition of several factors, which means that hasits own cost firstly we calculate the specific cost of various components and then andthen we combine them to reach to the overall cost of capital of the firm, which is referredas weighted average cost of capital of the firm.Cost of DebenturesCost of debt is the after tax cost of long terms fund through borrowings. The funds raisedthough debts is in the form of loans and debentures. Hindalco has both short-term andlong-term. It also has current liabilities such has creditors.a. 6.39% Non convertible Debentures of rupees 1 crore each= 100 crore shares.Tax rate= 22.3%IP= Interest payable 41
  • 42. T=Tax rateNP= Net ProceedsIP=10000000 x 6.39/100=639000639000(1-0.223)/1000000x100=639000(.0777)/ 10000000 x100=496503/10000000 x100=0.0496503 x100=4.96503%b. 6.50% NON convertible Debentrues of rupees 0.1 crore each= 250 crore shares.Tax Rate= 22.3%IP= Interest payableT=Tax rateNP= Net ProceedsIP=10000000 x 6.50/100=65000 [65000(1-0.223)/10000000] x 100=65000(0.777)10000000 x 100=50505 /10000000 x 100= 5.0505%c. Loans and Borrowings Total loan taken by firm= 8324.29crore Total Interest = 669.65crore 42
  • 43. = [669.95(1-0.223)/8324.29] x 100= [669.95(0.777)/8324.29] x 100= 6.2534%d. Government of India Bonds Total GOI bonds= 2039crore Cost of Bonds= 8%Weighted Average cost of capital of Debt In CroresParticulars Total amt. Propotion Cost Weighted Cost 100 0.092 4.97% 0.45724Debentures(a) 250 0.0233 5.05% 0.118Debentures(b) 8324.29 0.777 6.25% 4.856Loans 2039 0.1903 8% 1.5224GOI Bonds 10713.29 100 6.954%TotalSo, the total weighted average cost of DEBT=6.954%COST OF PREFERRENCE SHARESThe cost of preference capital is the annual preference share dividend divided by the netproceeds from the sale of preference shares. Or we can say that it is the dividendexpected by the preference shareholders. Unlike interest payment on debt, dividendpayable to preference share is not tax deductible.Number of shares=2032734shares @2Rs.Interest Rate= 6% 43
  • 44. Dividend on preference share= 0.02croreDividend tax on preference shares=0.01crorePD= Payable DividendNP=net proceedst=dividend taxKp= cost of preference sharePD= 2032734 X 6/100 =0.02croreDividend on one share= 2 X 6/100 =0.12Rs/shareNP/Share= 2 RsDividend Tax= 50%Kp=[0.12(1+0.50)/2]X 100=0.18/2 X100=.09 X100= 9%Cost of equity sharesIt is the rate at which discount the expected dividends of the firm to determine its sharevalue. When equity shareholders invest their funds they also expect returns in the form ofdividends. The market value of the shares is the function of the return that theshareholders may be expected and get. If the company does not meet the requirement of 44
  • 45. the shareholders and pay dividends, it will adversely affect the market value of the sharesof the company.Cost of equity shares of firmYear Earnings per share1998-1999 7.161999-2000 7.742000-2001 8.572001-2002 8.672002-2003 5.922003-2004 8.532004-2005 5.922005-2006 8.672006-2007 8.572007-2008 7.742008-2009 7.16Dividend growth modelAccording to this approach the cost of equity capital is calculated on the basis of therequired rate of return in terms of future dividends to be paid on shares.The formula for calculating it is as follows:Estimation of growth rateThere exist different methods for the estimation of growth rate of the firmInternal growthThis approach may be used when the firm has the stable dividend policy. Hindalco’spayout ratio has fluctuated over the year. But if we see the past 10 years record of thefirm we can say that generally company distribute upto 20% of the total profit not morethan that. And retained 80% of the total profit. In 2006 company retained 85% of the totalprofit.Growth may be calculated by calculating the product of retention ratio and ROEg=Retention ratio X ROE (year2009) 45
  • 46. =0.88 X 0.094 =8.272%Cost of equity taking into consideration internal growth rate as gD1 =1.35Po=55.75(As on 31st march)Cost of equity = 1.35/55.75+8.272 =10.69%Past average growthIn practice the growth may be based on past EPS rather than DPS since companies do notchange their DPS frequently with changes in EPS. Thus DPS grows at a slower rate. Theaverage of EPS past growth rates may be used as a proxy for the future growth. There aretwo alternatives available for calculating the average.The arithmetic average: - The arithmetic average EPS growth rate for HINDALCO(1998-2009)= (7.74-7.16)/7.16+(8.57-7.74)/7.74+(8.67-8.57)/8.57+(5.92-8.67)/8.67+(8.53-5.92)/5.92+(13.48-8.53)/8.53+(16.79-13.48)/13.48+(25.52-16.79)/16.79+(22.23-25.520/25.52+(14.82-22.23)/22.23/10X100= (0.81+0.1072+0.012-0.317+0.441+0.58+0.25+0.5199-0.13-0.333)/10X100= 1.211/10X100= 12.11%Cost of equity taking into consideration arithmetic average rate as g (growth)Cost of equity= 1.35/55.75+12.11 = 14.53% 46
  • 47. The geometric average: - The geometric average will give a compound average and ispreferable when there is much variability in EPS data. The geometric average EPSgrowth for the past 10 years is a follows.Formula (1+g) n=EPSn / EPSoWheren= Number of yearsEPSn=EPS of current yearEPSo= EPS of base yearEPSn=14.82EPSo= 7.74n=10 1+g=10√14.82/7.74 X100 1+g=10√1.92 g=1.0674 – 1 g= .0674 x100 g= 6.74%Cost of equity taking into consideration geometric rate as g (growth)Cost of equity = 1.35/ 55.75+6.75 = 9.16%Estimate of growth rate and cost of equity according to that:Method Growth rate Cost of equityInternal growth 8.272% 10.69% 12.11% 14.53%Arithmetic average 6.74% 9.16%Geometric average 47
  • 48. Growth rate and cost of equity of firmFor different growth rate HINDALCO’s cost of equity is calculated. It varies from 15%to 10% so on an average we take 12% as the cost of equity of the firm.Cost of retained earningsThe companies do not generally the entire profits earned by them by way of dividendsamong their shareholders. They retain some profits for the future expansion of thebusiness. The amount retained by the company, if it had been distributed among theshareholders by way of dividends, would have given them some earnings. The companyhas deprived the shareholders of these earnings by retaining the part of profit with it.Thus the cost of retained earnings is the earnings forgone by the shareholders. Simplystated the opportunity cost of retained earnings may be taken as the cost of retainedearnings. It is equal to the income that the shareholders can earn by placing these funds inalternative investments.Weighted average cost of capital of HINDALCOPARTICULARS TOTAL PROPORTION COST WEIGHTE AMOUNT D COSTDebt 10713.29 0.310814 6.954% 2.1614%Preference 0.41 0.000012 9% 0.000108%Equity 170.027 0.0049 12% 0.0552%Retained earnings 235384.69 0.68424 12% 8.21088%Total 34468.417 1.00 10.427588%Interpretationso, the weighted average cost of capital of the firm is 10.427588% so, on the basis of thiswe can say that, if HINDALCO is considering an investment project of average risk that 48
  • 49. has a same capital budgeting as HINDALCO, then it can use 10.43% as discount rate tocompute the project’s NPV. Future investment decisions by HINDALCOThe expansion programme of hindalco industries ltd, the flagship company of the AdityaBirla Group, is on track, the company management said at a recent press conference inmumbai. The aluminium major has set a total capital expenditure programme of Rs25000 crore till 2012, by which time its aluminium production capacity would havesurged to 17 lakh tpa from around 5 lakh tpa now. Hindalco had acquried canadian aluminium product marker Novelisin 2007 for$ 5.9billion and has also announced investment of $4billion(Rs19800crore)over three years to expand capacity of India. Novelis has reported anet loss of $1.8 billion is the 3rd quarter ended 31 December 2008 on largely to a goodwillloss of $1.5 billion, fallout of the ongoing global meltdown.Now here as company had decided to raise 25000 crore rupees from the market. Theycan raise this money through any of the following options: #. Company can raise 25000crore from the market in the form of equity share of Re1 each. #. Company can raise money through debentures @6.50% of Rs 1000000 each i.e.company is issuing 25000 debentures.Now the present capital structure of the firms is:Total equity share capital 170.027 croreDividend on preference share = 0.02croreDividend tax on dividend of preference share=50%Total interest payment by the company to debt=669.65crore at the tax rate of 22.3%Now on the basis of this we can calculate the point of indifference of the firm. 49
  • 50. Total number of new+ old equity share= (170.027+25000)crore =25170.027croreTotal interest on debt (old+new)= (669.65+1625)crore =2294.65croreCalculation:PLAN 1(X-669.65)(1-0.223)-0.02(1+.0.50)÷25170.027PLAN 2(X-2294.65)(1-0.223)-0.02(1+0.50) 170.027= (X-669.65)(0.777)-0.03÷25170.027=(X-2294.65)(0.777)-0.03÷170.027= 0.777X- 52.31805-0.03÷25170.027=0.777x-1782.92-0.03÷170.027= 0.777X-520.35÷25170.027 =0.777X-1782.97-170.027= 0.777X-520.35÷0.777X-1782.97=25170.027÷170.027= 0.777X-520.35÷0.777X-1782.97=148.036= 0.777X-520.35= 115.027X-0.777X= 63423.20÷114.24=X= 2305.88crore= X InterpretationNow here this shows that at 2305.88crore of EBIT there exists indifference point. Meanat this point the EPS is same wither the company uses equity its uses just for raisingfunds from the market. If firm is expecting EBIT more than the level ofIndifference level them in such a case using plan 1 is more beneficial for the firm.Because the greater is the level of EBIT than the indifference point the stronger is thecause of using leveraged financial plan to maximize the EPS of the firm. 50
  • 51. Finding The study is basically done to have a deep knowledge aboutcapital budgeting of the hindalco industries limited. Hindalco industries limited is havingan appropriate capital budgeting of the organizations.EPS growth rate is 21.84%,it isshowing a high safety of the interest of the investors as well as it is increasing the profitof the organization by an average of 24%every year. The way it is helping theorganization in giving more and more benefits to the shareholders of the organization.The market price of the share is also increasing day by day. The EPS is getting high dayby day last year it was just Rs 25.25 and in 2008 it is Rs24.51 hindalco’s interestcoverage ratio is also increasing after FY04. The company raised a major part of its debt by issuing non-convertible debentrues. During my study I identify the approaches to establishappropriate strategic investment decision.1-Cost of capital and weighted average cost2Calculation of NPV and IRR ConclusionIn a typical capital budgeting analysis, a project’s initial cash outlay (ICO) is generallytreated as a single, certain cash outflow. However, upon closer inspection, one or more ofthe following conditions may hold true in “real life”: 51
  • 52. • The ICO may have several cash outflow components – e.g., land, land improvements,Buildings, machinery and equipment.• Some of the ICO components may be certain cash flows and some may beuncertain/risky cash flows.• Some ICO components may be capitalized, but not subject to tax depreciation (e.g.,Land) . An outflow like this is already “after-tax” and provides no depreciation tax-shieldBenefits that would affect future after-tax operating cash inflows.• Other ICO components may also be capitalized, but would be subject to taxdepreciation(E.g., land improvement, buildings, machinery and equipment). These outflows will haveSpillover effects on future operating cash inflows because of their depreciation tax shield.• Some ICO component flows may occur after time period zero.Given these “real life” complicating factors involving a project’s ICO, we recommendthat sensitivity testing be applied to uncertain ICO components at the project-evaluationstage. Based on this sensitivity testing, the firm can then better decide whether to: a)subject any ICO component estimates to further refining/review; b) remove any ICOcomponent uncertainty by negotiating a fixed price contract for some service; c)outsource some in-house, uncertain ICO cost item; or d) accept/reject the project basedon the currently available information. The firm can also identify the critical levels ofcost overruns that should trigger a formal re-approval of the project.As the conclusion the company has delivered record performance amidst challengingenvironment. The company is continuously confidence of delivering superior operatingperformance on the back of improving cost of improving cost competitiveness driven byestablishing an appropriate capital budgeting techniques like past average growth rate andfavorable demand condition in the domestic and regional market. The company haschalked out expansion in alumina and aggressive growth plans in aluminium. The effortwill be supported by robust current operations, a strong balance sheet which is supportedby an excellent proportionate relationship between investment and return. 52
  • 53. Therefore the company is confident of success of these efforts in transforming thecompany to the league of Global top-10 in the both the metal and deliver superior valueto stakeholders in future.Limitations of studyThe following were the limitations that were there during the course of the study: 1. Lack of awareness in concern to the topic amongst the people. 2. At some place approximate figures had been taken as per instruction of company officers. 3. Place for research is limited. 4. Funds available for the research is limited. 5. Financial Disclosures Company are not sharing more internal information either on internet or ready to give. 53
  • 54. The major objective of the study is the proper understanding of capital budgeting andfinancial position of HINDALCO and to suggest measures to overcome the shortfalls ifany.Among all the financial management decisions one of the important decisions is capitalbudgeting .Investment decision about debt- equity mix and capital techniques this projecthelps in analyzing the capital budgeting of HINDALCO. What is the relationshipbetween application and source of cash and weighted average cost of capital other thanthis the project also analysis the long-term solvency and short-term solvency of the firmtaking global and India market situations in mind with use of ratio analysis because toanalysis the financial position of a firm one of the method is ratio analysis which usesdata from the balance sheet and income statement to produce values that have been easilyinterpreted financial meaning.The firm results shows that the performance of the firm is better in 2008 than in 2009,and the major reason for this is economy down term during this financial year other thanthis the aluminium market is also affected severely due to sharp fall in the LME prices.But the performance of the company and the EBIT level of the company the highestrelative to domestic and global peers. The company recorded Highest ever-primaryaluminium production this year and become the first indian company to produce morethan 0.5mn tones in a year. 54
  • 55. In case of cost of capital of the firm company the debt proportion in the company is lowas compared to shareholders fund and the maximum out came from retained earnings.The major competitors of Hindalco also have low on loan & borrowing. Since aluniniumseeks is highly vulnerable to fluctuations in LME. So this is the main reason due to whichcompanies in this sector avoid using more debt financing. Company has also declared toraise 25000crore from market in the form of equity shares. So, decision of the firm itselfindicates that company is now trying to increase their equity proportion rather than usingmore of debt. Other than this in 2009 end companies 350 crores of debentures and goingto redeemed. so this leads to more increase in the proportion of equity in the totalfinancial position of the firm.The future predictions of aluminium industry are positive, as it indicates the increase inthe demand and consumption of aluminium at global level in other than this there arevarious emerging sectors also likes automobiles industry where the usage of alunimumincrease with very high pace.Hindalco provides better return to its shareholders and are having more equity than debt.Therefore, the company remains in the safety range and is maintaining the balance. 55
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  • 58. Business Performance ReviewThe company has recorded its best ever performance during the fiscal 2008-2009. Aluminium Copper Total Rs.Mn Rs.Mn Rs.MnNet sales and 7,600.54 10,619.11 18219.65operating 1530.35 627.41 2157.76EBIT 22728 10765 33493Capital employed 9.04%ROCE(%)Aluminium businessThe aluminium business demonstrated a stellar performance with # Highest ever alumina and primary aluminium production with over 100%capacityutilization at all operating units. # Highest ever turnover and business profit. # Highest ever EBIT margins at 50%. 58
  • 59. Financial Review and AnalysisHighlights (in Rs. Millions)Particulars FY 2008 FY 2009Net sales and operating revenues 192010 182200Total expenditure 157999 158140Operating profit 34011 30366Other income 4929 6369Interest 2806 3371Depreciation 5878 6454Profit before tax 30256 26903Extraordinary items --- ----Provision for current tax 6063 4781Provision for deferred tax 876 1214Provision for fringe benefits tax 114 113Profit after tax 28609 22303Operating margins 17.06% 16.66%Net Sales and Operating Revenues Net sales and operating revenues for the year 2008-09 in increasedby5% YOY on the back of higher aluminium volume, increased VAP tonnage andbuoyant prices for both the metals. A large increase in net sales and operating revenueswas though negated by a sharp decline in US dollar. Conslidated revenues jumped from Rs.19316 cores to Rs.60013cores, an increase of211%.This includes NOVELIS’ sale for the 10.5 months from 16th May, 07 to 31stMarch.FY09 will see incorporation of full-year NOVELIS results. Other income Other income at Rs 4929 million was higher by 33.2% over the last year largelydue to higher pre-tax treasury yield and higher average treasury. Interest The company’s working capital requirement increased significantly onaccount of. Higher copper prices driven by higher LME. Rising interest rates resulted inhigher average cost of borrowing which rose from 7.24% last year to 7.51% this year. 59
  • 60. Depreciation Depreciation charges were at Rs. 5878 in FY09 against Rs 6380 millions inFY08. Taxes Effective tax rate went up to 26.8% to 23%on account of increase in pre-taxprofit by 66% over last year and also proportion of income exempt from tax was lower incurrent year. Profit Net profit increased 12% to Rs 28609 million on account of tax adjustmentfor earlier year. Cash profit increased from Rs 32,024 million to Rs 34,487 million.Cash flow analysis (In Rs.million)Particulars FY 2008 FY2009 %Source of cashCash from operating 2140 3171 23%Non-Operating Income 619 691 5%Net debt Inflows 964Equity Raised 2424 4426 32%Other treasury investment(net) 5507 40%Total 6147 13795 100%Application of cashNet capital Expenditure 888 967 7%Investment in subsidiaries 2970 11004 84%Other treasury investment(net) 2124 193 2%Interest and finance charges 668 669 5%Dividend payout --- 266 2%Total 6650 13099 100%Increase/(decrease)in cash and cash (503) 696Equivalents.Source of cashCash from operations Lower realizations for aluminium and lower TcRc in copper impactedmargins, however cash profit was higher by 8%. This coupled with higher workingcapital resulted in lower cash flow from operation compared to last year.Non-operating income Cash from non-operating income increased to Rs.691crores ascompared to Rs 620crores a year earlier. The increase is on account of higher dividendincome and income earned on utilized lone funds which got capitalized.Equity Your company raised Rs4426crores(net of issue expenses) from rightsissue for take-out of the bridge loan taken for Novelis acquisition. 60
  • 61. Other treasury investment(net) Treasury investment were liquidated for take-out of the bridge loan takefor Noveils acquisition. Application of cashCapital expenditure The company spent Rs.967crores on various expansion andefficiency improvement projects. Going forwards,this amount is slated to riseconsiderably as per planned investment are made in planned drownfield and greenfieldprojects.Investment in subsidiaries Aggregate invesments, including loans and advances to subsidiaries,amounted to Rs11,004crores.your company infused Rs.10400.37crores into AVmineral(netherlands) BV a SPV created for acquisition of Noveils Inc. and this amountwas used by AVMinerals(Netherlands) BV for takeout of the bridge loan taken for Noveils acquisitionand servicing of debts on its balance sheet. Investment (Including loans and advances) inutkal alumina rose by rs.317crores.Interest Interest and finance charges paid for the year was almost same as in lastyear.interest charged to profit and loss account is only Rs.337crorenet of interestcapitalized.Dividend Dividend paid including tax on dividend is Rs266crores. We have put in place a permanent capital structure to support our strategicbusiness plan. We successfully took out the bridge of us$3.03billion in November 2008admist hostile and turbulent marco economic envirnoment. We managed to preserve ourbalance sheet strength to grow by reducing our leverage while doing so. 61
  • 62. BibiliographyBooks 1. Pandey, I. M. “Financial Management”, Vikas Publisher, New Delhi, 2003 2. Chandra Prasanna ,“Financial Management” , Tata McGraw-Hill, 2008. 3. Khan M.Y. and Jain P.K, “Management Accounting”, Tata McGraw-Hill, 2006Reports Annual report(2004-2009) Bonus issue bulletin 2006 Capital planning and policy manual Aditya management annual reportWebsites www.wikipedia.org www.adityakiran.com www.hindalco.comARTICLES: (Journal) Value creation other Aditya Birla publication Hindalco magazine 62
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