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AProject ReportOn“CAPITAL BUDGETING”AtDR. REDDY’S LABORATORIES LIMITEDDissertation SubmittedIn The Partial Fulfillment for the Award of the DegreeIn FinanceSubmitted ByUnder the guidance ofFinanceManagerAt Dr. Reddy’s, FTO-III, BachupallyCERTIFICATEThis is to certify that the Project Work entitled “CAPITAL BUDGETING” at Dr. Reddy’s, FTO – III, Bachupally , is a bonafied work of submitted in partial fulfillment of the requirements for the award of the degree of “Masters Programme In International Business” for the academic year Mr. T. Koteshwar Rao(Internal Project Guide)(External Examination)(Department of Management Studies)DECLARATIONI hereby declare that the project report titled “CAPITAL BUDGETING” submitted in partial fulfillment of the requirements for the Post Graduation of “Masters Programme In International Business”, from a bonafide work carried out by me under the guidance of Mr. T. Koteshwar Rao, Managing Director of Finance, Dr. Reddy’s Laboratories Limited, FTO – III, Bachupally Hyderabad.I also declare that this is the result of my own effort and is not submitted to any other University for the award of any other Degree, Diploma, Fellowship or prizes. Place: ACKNOWLEDGEMENTI take this opportunity to acknowledge, all the people who rendered their valuable advice in bringing the project to function.As part of curriculum at college. The project enables us to enhance our skills, expand our knowledge by applying various theories, concepts and laws to real life scenario which would further prepare us to face the extremely “Competitive Corporate World” in the near future.I express my sincere gratitude to the staff of COLLEGE Hyderabad. I specially thank “the management and staff of Dr. Reddy’s” for creating out the study and for their guidance and encouragement that made the project very effective and easy.I sincerely express my gratitude to Mr. Koteshwar Rao, Finance, Manager Dr. Reddy’s, for his valuable guidance and cooperation throughout my project work.I would like to thank Mr. Koteshwar Rao, Mr. Kalyan Kumar and Mr. Doki Srinivas , for guiding and directing me in the process of making this project report and for all the support and encouragement.I am grateful to our Internal Faculty, faculty in MPIB Department for his support and assistance in my project work. I have tried my level best to put my experience and analysis in writing this report. I am grateful to Dr. Reddy’s as an organization and its various employees for helping me to learn and explore many fields.INDEXIntroductionPage No.Definition of Capital BudgetingScope of the studyObjective of the studyNeed for the studyLimitations of the studyMethodologyIndustry ProfileHistory of the Pharmaceuticals IndustryMajor players of the World Pharmaceuticals IndustryThe Indian Pharmaceuticals IndustryCompany ProfileAbout the CompanyBoard of DirectorsStrategic Business UnitsKey MilestonesDepartmentCapital BudgetingFindings and SuggestionsBibliographyINTRODUCTIONDefinition of Capital BudgetingCapital budgeting (or investment appraisal) is the planning process used to determine whether a firm's long term investments such as new machinery, replacement machinery, new plants, new products, and research development projects are worth pursuing. It is budget for major capital, or investment, expendituresNEED and IMPORTANCE FOR CAPITAL BUDGETINGCapital budgeting means planning for capital assets. The importance of capital budgeting can be well understood from the fact that an unsound investment decision may prove fatal to the very existence of the concern. The need, significance or importance of capital budgeting arises mainly due to the following:Large Investments: Capital budgeting decisions involves large investment of funds but the funds available with the firm are always limited and demand for funds far exceeds the resources. Hence, it is very important for the firm to plan and control its capital expenditure.Long – Term Commitment of Funds: It increases the financial risk involved in the investment decision.Irreversible Nature: The capital expenditure decisions are of irreversible in nature . Once the decision for acquiring a permanent asset is taken, it becomes very difficult to dispose of these assets without incurring heavy losses.Long – Term Effect on Profitability: Capital budgeting decisions have a long - term and significant effect on the profitability of a concern. Not only are the present earnings of the firm affected by the investments in capital assets.Difficulties of Investment Decision: The long term investment decisions are difficult to be taken because decision extends to a series of years beyond the current accounting period.SCOPE OF THE STUDYThe study is done on capital budgeting held by Generics division of Dr. Reddy’s Laboratories Limited. The scope of the study includes the Payback period method.OBJECTIVES OF THE STUDYMain Objective: - The main Objective of the project is to understand why Payback period is better than other capital budgeting techniques from the company’s point of view. Sub – Objectives: - To know the investment criteria done by Dr. Reddy’s lab while evaluating a project. a) To study the financial feasibility of the proposal. b) To find out the benefits that the company is going to get from the new projects. c) To critically evaluate a project using different types of capital budgeting techniques. and to arrive at the right conclusion. d) To understand advantages and disadvantages of various techniques. e) Estimating of assets & tools required for this new project. NEED FOR THE STUDYCapital budgeting means planning for capital assets. The need of capital budgeting can be well understood from the fact that an unsound investment decision may prove fatal to the very existence of the concern. It is used to determine whether Dr. Reddy’s long term investments such as new machinery, replacement machinery, new plants, new products, and research development projects are worth pursuing. It is budget for major capital, or investment, expenditures.LIMITATIONS OF THE STUDYSince the study covers only Generics division of Dr. Reddy’s Laboratories Limited, it does not represent the overall scenario of the industry.Few values taken are on facts basis.The project is constraint to only one proposal.This is a study conducted within a period of 45 days.During this limited period of study, the study may not be a detailed, fully fledged and utilitarian one in all aspects.The study contains some assumption based on the demands of the analysis done by the company executives.INDUSTRYPROFILEPROFILE OF THE INDUSTRYHistory of the pharmaceutical industryThe earliest drugstores date back to the middle Ages. The first known drugstore was opened by Arabian pharmacists in Baghdad in 755 A.D., and many more soon began operating throughout the medieval Islamic world and eventually medieval Europe. By the 19th century, many of the drug stores in Europe and North America had eventually developed into larger pharmaceutical companies.Most of today's major pharmaceutical companies were founded in the late 19th and early 20th centuries. Key discoveries of the 1920s and 1930s, such as insulin and penicillin, became mass-manufactured and distributed. Switzerland, Germany and Italy had particularly strong industries, with the UK, US, Belgium and the Netherlands following suit.Cancer drugs were a feature of the 1970s. From 1978, India took over as the primary center of pharmaceutical production without patent protectionThe pharmaceutical industry entered the 1980s pressured by economics and a host of new regulations, both safety and environmental, but also transformed by new DNA chemistries and new technologies for analysis and computation. Drugs for heart disease and for AIDS were a feature of the 1980s, involving challenges to regulatory bodies and a faster approval process.Diagram 1: The Core of Pharmaceutical BusinessIntermediatesDrug Discovery&DevelopmentFinished DosagesAPIBrandedGenerics(source: ) THE INDIAN PHARMACEUTICAL INDUSTRY “The Indian pharmaceutical industry is a success story providing employment for millions and ensuring that essential drugs at affordable prices are available to the vast population of this sub-continent.”The pharmaceutical industry plays a crucial role in building a country’s human capital. In India, it is among the top science based industries with a wide range of capabilities in the complex field of Drug Technology and Manufacture.Achievements of the industry during the last three decades have been spectacular by any standards, from a mere processing industry it has grown into a sophisticated sector with advanced manufacturing technology, modern equipment and stringent quality control.A highly organized sector, the Indian Pharmacy Industry is estimated to be worth $ 4.5 billion, growing at about 8 to 9 percent annually. It ranks very high in the third world, in terms of technology, quality and range of medicines manufactured. From simple headache pills to sophisticated antibiotics and complex cardiac compounds, almost every type of medicine is now made indigenously.The Indian Pharmaceutical sector is highly fragmented with more than 20,000 registered units. It has expanded drastically in the last two decades. The leading 250 pharmaceutical companies control 70% of the market with market leader holding nearly 7% of the market share. It is an extremely fragmented market with severe price competition and government price control.The “organized” sector of India's pharmaceutical industry consists of 250 to 300 companies, which account for 70 percent of products on the market, with the top 10 firms representing 30 percent. However, the total sector is estimated at nearly 20,000 businesses, some of which are extremely small approximately 75 percent of India's demand for medicines is met by local manufacturing. In 2008, India's top 10 pharmaceutical companies were Ranbaxy, Dr. Reddy's Laboratories, Cipla, Sun Pharma Industries, Lupin Labs, Aurobindo Pharma, GlaxoSmithKline Pharma, Cadila Healthcare, Aventis Pharma and Ipca Laboratories Indian-owned firms currently account for 70 percent of the domestic market, up from less than 20 percent in1970. In 2008, nine of the top 10 companies in India were domestically owned, compared with just four in 1994. RankCompanyRevenue 2008 (Rs in crore)1Ranbaxy LaboratoriesRs. 25,196.482Dr. Reddy’s LaboratoriesRs. 4,162.253CiplaRs, 3,763.724Sun Pharma IndustriesRs. 2,463.595Lupin LaboratoriesRs. 2.215,526Aurobindo PharmaRs. 2,080.197Glaxo SmithKline PharmaRs. 1,773.418Cadila HealthcareRs. 1,613.009Aventis PharmaRs. 983.8010Ipca LaboratoriesRs. 980.44 Source: 1:Top 10 Indian Pharmaceuticals Companies, 2008India's potential to further boost its already-leading role in global generics production, as well as an offshore location of choice for multinational drug manufacturers seeking to curb the increasing costs of their manufacturing, R&D and other support services, presents an opportunity worth an estimated $48 billion in 2008. India's US$ 3.1 billion pharmaceutical industry is growing at the rate of 14 percent per year. It is one of the largest and most advanced among the developing countries. Over 20,000 registered pharmaceutical manufacturers exist in the country. Indian Pharmaceutical EvolutionPhase IIGovernment ControlIndian Patent Act –1970Drug prices cappedLocal companies begin to make an impactPhase III Development PhaseProcess developmentProduction infrastructure creationExport initiativesPhase IVGrowth PhaseRapid expansion of domestic marketInternational market developmentResearch orientationPhase VInnovation and ResearchNew IP lawDiscovery Research ConvergencePhase IEarly YearsMarket share domination by foreign companiesRelative absence of organized Indian companiesOver-the-Counter Medicines The Indian market for over-the-counter medicines (OTCs) is worth about $940 million and is growing 20 percent a year, or double the rate for prescription medicines. the government is keen to widen the availability of OTCs to outlets other than pharmacies, and the Organization of Pharmaceutical Producers of India (OPPI) has called for them to be sold in post offices. Developing an innovative new drug, from discovery to worldwide marketing, now involves investments of around $1 billion, and the global industry's profitability is under constant attack as costs continue to rise and prices come under pressure. Pharmaceutical production costs are almost 50 percent lower in India than in Western nations, while overall R&D costs are about one-eighth and clinical trial expenses around one-tenth of Western levels. “India's largest-selling drug products are antibiotics, but the fastest growing are Diabetes, cardiovascular and central nervous system treatments”. The industry's exports were worth more than $3.75 billion in 2005-06 and they have been growing at a compound annual rate of 22.7 percent over the last few years, according to the government's draft National Pharmaceuticals Policy for 2007, published in January 2007. The Policy estimates that, by the year 2010, the industry has the potential to achieve $22.40 billion in formulations, with bulk drug production going up from $1.79 billion to $5.60 billion: “India's rich human capital is believed to be the strongest asset for this knowledge-led industry. Various studies show that the scientific talent pool of 4 million Indians is the second-largest English-speaking group worldwide, after the USA.” VAT :In April 2005, the government introduced value-added tax for the first time and abolished all other taxes derived from sales of goods. So far, 22 states have implemented VAT, which is set at 4 percent for medicines. This led to pharmaceutical wholesalers and retailers cutting their stocks dramatically, which severely affected drug manufacturers' sales for several months. Opportunities The main opportunities for the Indian pharmaceutical industry are in the areas of: Generics (including biotechnology generics) Biotechnology Outsource and R&D (outsourcing).Pricing (including contract manufacturing, information technology (IT) COMPANY PROFILEOVERVIEW OF DR.REDDY’S LABORATORIES LIMITEDABOUT THE COMPANYDr. Reddy’s Laboratories Limited (Dr. Reddy’s) together with its subsidiaries (collectively, the company) is a leading India- based pharmaceutical company head quarter in Hyderabad, India. The company’s principal areas of operation are formulations, active pharmaceutical ingredients and intermediates, generics, custom pharmaceutical services, critical care and biotechnology and drug discovery. The company’s principal reached and developed and manufacturing facilities are located in Andhra Pradesh, India and Cuernavaca cuautla, Mexico with principal marketing facilities in India, Russia, United States, United Kingdom, Brazil, and Germany. The company’s shares trade on several stock exchanges in India and, since April 11, 2001, on the NYSE and in the US as of March 31, 2007. Since Dr. Reddy’s Laboratories inception in 1984, it has chosen to walk the path of discovery and innovation in health science. Dr. Reddy’s has been a quest to sustain and improve the quality of life and Dr. Reddy’s had more than three decades of creating safe pharmaceutical solution with the ultimate purpose of making the world a healthier place. Dr. Reddy’s competencies cover the entire pharmaceutical value chain – API and Intermediates, Finished Dosages (Branded and Generic) and NCE research. Dr. Reddy’s research centre uses cutting-edge technology and has discovered breakthrough pharmaceutical solutions in select therapeutic areas. In a short span of operations, Dr. Reddy’s have filed for more than 75 patents. Dr. Reddy’s is the first Indian company to out-license an NCE molecule for clinical trials. To strengthen their research arm, it has set up a research subsidiary, Reddy US Therapeutics Inc., in Atlanta, USADr. Reddy’s export API, branded formulations and generic formulations to over 60 countries.The company exports API, branded formulations and generic formulations to over 60 countries. The inherent strength lies in identifying relevant API and formulations, and selling them at affordable prices across the world. A few of our API such as Norfloxacin, Ciprofloxacin and Enrofloxacin enjoy a large customer base. The finished dosages have an enviable track record. Some of them such as Nise, Omez, Enam, Stamlo, Stamlo Beta, Gaiety and Ciprolet?are among the top brands in India, and many have become household names in near-regulated countries too. The generic formulations have also become very popular in quality-conscious regulated markets such as the US and?Europe. All this has been possible because of our innovative and sustained marketing efforts. “The company set to spread our wings further and touch more lives across the globe.Dr. Reddy’s is having six manufacturing facilities (Formulations Technical Operations Plants) across India.Bolaram (Hyderabad) - FTOIBachupally (Hyderabad) – FTO II and FTO IIIYanam ( Near Kakinada) – FTO IVBaddi (Himachal Pradesh) – FTO VIVishakhapatnam (Andhra Pradesh) – FTO VIIBUSINESS DIVISIONS OF DR REDDY’S LABORATORIES Dr Reddy's is a global pharmaceutical powerhouse committed to protecting and improving health and well-being. The Dr. Reddy’s 5 Strategic Business Units. (SBU): For management purposes, the Group is organized on a worldwide basis into five strategic business units (SBUs), which are the reportable segments:? Formulations (including Critical care and Biotechnology);? Active Pharmaceutical Ingredients and Intermediates (API);? Generics;? Drug Discovery and? Custom Pharmaceutical Services (CPS).BOARD AND MANAGEMENTWhole-Time DirectorsDr. Anji ReddyChairmanG V PrasadExecutive Vice Chairman and Chief Executive OfficerSatish ReddyManaging Director & Chief Operating OfficerIndependent & Non Whole Time DirectorsDr. Omkar GoswamiRavi BhoothalingamDr. Bruce LA CarterAnupam PuriMs.Kalpana MorpariaJ.P. Moreau.The present CFO of Dr. Reddy’s is Mr. Umang BohraAuditorsBSR & Co. audited the financial statements of 2008 – 2009 prepared under the Indian GAAP.The Company had also appointed KPMG as independent auditors for the purpose of issuingopinion on the financial statements prepared under the US GAAP.INERNATIONAL MARKET AREAS OF DR. REDDY’S LABORATORIESAlbaniaBelarusCambodiaCayman islandsChinaDmpr GhanaGuyanaHaitiIraqJamaica KazakhstanKenyaKyrgyzstanMalaysiaMauritiusMyanmarOmanRomaniaRussiaSingaporeSri LankaSt.KittsSt.luciaSudanTanzaniaTrinidadUgandaUkraineUzbekistanVenezuelaVietnamYemenSHARE CAPTIAL: (Rs in Thousands)PARTICULARS2004-052005-062006-20072007-08Equity4798275011149646921176665Debt-long Term576 471085414604321604Total Share Capital48040397219913792961498269Graph 1:Source CURRENT FINANCIAL POSITION OF DR.REDDY’S LABShareholding Pattern on May 29, 2009Promoters Holding:No. Of Shares% of SharesIndividual Holding4,489,4842.66Companies39,978,32823.73Sub Total44,467,812Indian Financial Institutions22,524,56813.37Banks312,7460.19Mutual Funds10,764,2936.39Sub Total33,601,60719.95Foreign Holding:Foreign Institutional Investors38,985,96423.14NRIs3,097,4321.84ADRs / Foreign National24,903,19314.78Sub Total66,986,58939.76Indian Public & Corporates23,412,76913.90Total168,468,777100.00Table 3:Source 2008 - 2009, the company launched 116 new generic products, filed 110 new generic product registrations and filed 55 DMFs globally. The Board of Directors of the Company have recommended a final dividend of Rs. 6.25 (125%) per equity share of Rs. 5/- face value, subject to the approval of shareholders at the ensuing Annual General Meeting.Revenues in India increase to Rs. 8.5 billion ($167 million) in FY09 from Rs.8.1billions($158 million), representing a growth of 5%. 36 new products launched during the year. New products launched in the last 36 months contribute 14% to total revenues in FY09Dr. Reddy’sExtracted from the Audited Income Statement for the year ended March 31, 2009?FY 09?FY 08??Particulars($)(Rs.)%($)(Rs.)(%)Growth % Revenues 1,36569,44110098350,00610039Cost of revenues 64832,9414748424,5984934Gross profit 71836,5005349925,4085144Operating Expenses???????Selling, General & Administrative Expenses(a) 41321,0203033116,8353425Research & Development Expenses, net794,0376693,533714Write down of intangible assets623,1675593,01165Write down of goodwill21310,856162900-Other (income)/expenses, net52530(8)(402)(1)-Total Operating Expenses77339,3335745323,0674671Results from operating activities(56)(2,833)(4)462,3415-Finance Income(b)(9)(482)(1)(31)(1,601)(3)(70)Finance expenses(c)331,6682211,080254Finance expenses, net231,1862(10)(521)(1)-Share of profit/ (loss) of equity accounted investees02400201,100Profit before income tax(79)(3,995)(6)562,8646-Income tax expense(23)(1,173)(2)199722-Profit for the period(102)(5,168)(7)753,8368-Attributable to:???????Equity holders of the company(102)(5,168)(7)763,8468-Minority interest000(0)(10)(0)-Profit for the period(102)(5,168)(7)753,8368-?Weighted average no. of shares o/s ?169???169?Diluted EPS(0.6)(30.7)??0.422.8?Exchange rate?50.87???50.87?Notes:?(a) Includes amortization charges of Rs. 1,503 million in FY09 and Rs. 1,588 million in FY08(b) Includes forex gain of Rs. 739 million in FY08(c)Includes forex loss of Rs. 634 million in FY09.(In millions)Key Balance Sheet Items ParticularsAs on 31st Mar 09As on 31st Mar 08($)(Rs.)($)(Rs.)Cash and cash equivalents1105,6031467,421Investments (current & non-current)10530934,753Trade and other receivables28214,3681346,823Inventories26013,22621911,133Property, plant and equipment41020,88133016,765Loans and borrowings (current & non-current)38719,70138019,352Trade accounts payable1185,9871075,427Total Equity82742,04593147,350Dr. Reddy’s Award and Recognition :Best Workplaces 2008 In Biotech/ Pharma Industry Sector-The Economic TimesBest Performing CFO in the Pharma Sector for 2007 CNBC-TV18's CFO Award Saumen Chakroborty – Ex. CFONDTV Profit Business Leadership Awards 2007 Business Leader in the Pharmaceutical SectorAmity Leadership AwardBest Practices in HR in Pharmaceutical Sector. 4th HR Summit '08Dun & Bradstreet American Express Corporate Awards 2007Best Corporate Social Responsibility Initiative 2007 BSE – IndiaPharma Excellence Awards 2006-07Category : Corporate Social Responsibility The Indian ExpressBest Employers in India 2007 AwardHewitt Associates & The Economic TimesSouth Asian Federation of Accountants (SAFA) Award 20072nd Best Annual Report in the South Asian RegionFinance Asia Achievement Awards 2006 Best India Deal - Acquisition of betapharm for $570 millionAsia-Pacific HRM Congress 2007 Global HR Excellence Award for Innovative HR PracticesAnd many more.CAPITAL BUDGETINGIn modern times, the efficient allocation of capital resources is a most crucial function of financial management. This function involves organization’s decision to invest its resources in long-term assets like land, building facilities, equipment, vehicles, etc. The future development of a firm hinges on the capital investment projects, the replacement of existing capital assets, and/or the decision to abandon previously accepted undertakings which turns out to be less attractive to the organization than was originally thought, and diverting the resources to the contemplation of new ideas and planning. For new projects such as investment decisions of a firm fall within the definition of capital budgeting or capital expenditure decisions.Capital budgeting refers to long-term planning for proposed capital outlays and their financing. Thus, it includes both rising of long-term funds as well as their utilization. It may, thus, be defined the “firm’s formal process for acquisition and investment of capital”. To be more precise, capital budgeting decision may be defined as “the firms’ decision to invest its current find more efficiently in long-term activities in anticipation of an expected flow of future benefit over a series of years.” The long-term activities are those activities which affect firms operation beyond the one year period. Capital budgeting is a many sided activity. It contains searching for new and more profitable investment proposals, investigating, engineering and marketing considerations to predict the consequences of accepting the investment and making economic analysis to determine the profit potential of investment proposal. The basic features of capital budgeting decisions are:1. Current funds are exchanged for future benefits.2. There is an investment in long term activities.3. The future benefits will occur to the firm over series of yearsCapital budgeting (or investment appraisal) is the planning process used to determine whether a firm's long term investments such as new machinery, replacement machinery, new plants, new products, and research development projects are worth pursuing. It is budget for major capital, or investment, expenditures.Capital budgeting processThe capital budget process is usually a multi-step process, including:Identification of potential investment opportunitiesAssembling of proposed investments Inventory of Capital Assets; Developing a Capital Investment Plan (CIP); Developing a Multi-Year CIP; Developing the Financing Plan; and, Implementing the Capital Budget.Types Of Capital Budgeting Projects:Independent Projects - Projects unrelated to each other where a decision to accept one project will not affect the decision to accept another Mutually Exclusive Projects - The decision to choose only one project from the many being considered.Types Of Capital Budgeting Decisions:Capital Budgeting Decision for Expansion purposes orFor replacement of existing assets.Importance of Capital Budgeting:Proper decision on capital budget will increase a firm’s value as well as shareholders’ wealthCapital budgeting is critical to a firm as it helps the firm to stay competitive as it is expanding its business like proposing to purchase equipments to produce additional or new products, renting or owning premises for opening new branches, etc.Guidelines In Capital Budgeting AnalysisAs capital budgeting involves substantial initial outlay and years( at least more than one year) to reap the benefits, it is critically important to understand some of the cardinal principles or rules or guidelines when performing this capital budgeting exercise.Append below in brief pertaining to:GUIDELINES/PRINCIPLES ON THE CAPITAL BUDGETING ANALYSISGuideline No1: Use Cash Flows And Not Accounting Profit. You need to adjust accounting profit to arrive at the relevant cash flows?.Guideline No 2: Focus on Incremental Cash flows. Simply it means that you should compare the total cash flows of the company with and without the project. After determining the incremental cash flows, you need to consider the tax implication on these cash flows viz focus only on “after-tax incremental cash flows” in the capital budgeting analysis.Guideline No.3: Consider any synergistic effect on the project. For example, when this new product, the firm is going to introduce, will the sales of the existing products also increase- are they complementary to each other. In financial terms, therefore we need to consider the sales of the new products plus the increase in sales of the existing products.Guideline No.4: Consider the opposite of rule no 3 re: the existing sales might reduce with the introduction of the new products. Factored the loss of revenue from such existing products into the capital budgeting analysis.Guideline No.5:Ignore sunk costs and consider only those costs which are relevant to the projects.?Guideline No.6:Incorporate any NET additional working capital requirements into the capital budgeting analysis for example the need to have additional inventories, accounts receivables and or cash (increase in current assets) minus additional financing from accounts payable, bank borrowings (current liabilities)?.Guideline No.7: Excludes Interest Payments as this is already reflected in the discount rate (this rate implicitly accounts for the cost of raising the financing).APPRAISAL CRITERIAA number of criteria have been evolved for evaluating the financial desirability of a project. The important investment criteria, classified into two broad categories—non-discounting criteria and discounting criteria—are shown in exhibit subsequent sections describe and evaluate these criteria in some detail:These criteria can be classifies as follows:Evaluation Criteria Non- Discounting Criteria Discounting CriteriaPaybackAccounting RateProfitability InternalNet PresentAnnual Period of ReturnIndexRate of ValueCapital (ARR)(PI)Return(NPV)Charge(IRR)Comparing Methods of Valuation under Various ScenariosMethodIndependentProjectsMutually ExclusiveProjects*CapitalRationing*Scale DifferencesIRRAcceptableNot AcceptableNot AcceptableNot AcceptableMIRRAcceptableNot AcceptableNot AcceptableNot AcceptableNPVAcceptableAcceptableAcceptableAcceptablePaybackNot AcceptableNot AcceptableNot AcceptableNot AcceptableDiscountedNot AcceptableNot AcceptableNot AcceptableNot AcceptableMany formal methods are used in capital budgeting, including the techniques such asDiscounting CriteriaNet Present Value Profitability Index or Benefit Cost RatioInternal Rate of Return Modified Internal Rate of Return Equivalent Annuity or Annual Capital ChargeThese methods use the incremental cash flows from each potential investment, or project. Techniques based on accounting earnings and accounting rules are sometimes used - though economists consider this to be improper - such as the accounting rate of return, and "return on investment." Non-Discounting CriteriaSimplified and hybrid methods are used as well, such as Payback PeriodDiscounted Payback PeriodAverage rate of ReturnDiscounting CriteriaNet Present ValueEach potential project's value should be estimated using a discounted cash flow (DCF) valuation, to find its net present value (NPV). (First applied to Corporate Finance by Joel Dean in 1951). This valuation requires estimating the size and timing of all of the incremental cash flows from the project. These future cash flows are then discounted to determine their present value. These present values are then summed, to get the NPV. See also Time value of money. The NPV decision rule is to accept all positive NPV projects in an unconstrained environment, or if projects are mutually exclusive, accept the one with the highest NPV (GE).The NPV is greatly affected by the discount rate, so selecting the proper rate - sometimes called the hurdle rate - is critical to making the right decision. The hurdle rate is the minimum acceptable return on an investment. It should reflect the riskiness of the investment, typically measured by the volatility of cash flows, and must take into account the financing mix. Managers may use models such as the CAPM or the APT to estimate a discount rate appropriate for each particular project, and use the weighted average cost of capital (WACC) to reflect the financing mix selected. A common practice in choosing a discount rate for a project is to apply a WACC that applies to the entire firm, but a higher discount rate may be more appropriate when a project's risk is higher than the risk of the firm as a whole. The formula is as follows:PV = 1(1+r)nWhere PV = Present Valuer = rate of interest / discount raten = number of yearsDecision Rules A. "Capital Rationing" situation Select projects whose NPV is positive or equivalent to zero. Arrange in the descending order of NPVs. Select Projects starting from the list till the capital budget allows. B. "No capital Rationing" Situation Select every project whose NPV >= 0 C. Mutually Exclusive Projects Select the one with a higher NPV. ExampleAssuming that the cost of capital is 6% for a project involving a lumpsum cash outflow of Rs.8,200 and cash inflow of Rs.2,000 per annum for 5 years, the Net Present Value calculations are as follows: Present value of cash outflows Rs.8200Present value of cash inflows Present value of an annuity of Rs.1 at 6% for 5 years=4.212Present value of Rs.2000 annuity for 5 years = 4.212 * 2000 = Rs.8424Net present value = present value of cash inflows - present value of cash outflows = 8424 -8200 = Rs.224Since the net present value of the project is positive (Rs.224), the project is accepted.Profitability IndexProfitability index identifies the relationship of investment to payoff of a proposed project. The ratio is calculated as follows:Profitability Index = PV of Future Cash Flow / PV of Initial InvestmentProfitability Index is also known as Profit Investment Ratio, abbreviated to P.I. and Value Investment Ratio (V.I.R.). Profitability index is a good tool for ranking projects because it allows you to clearly identify the amount of value created per unit of investment.A ratio of 1 is logically the lowest acceptable measure on the index. Any value lower than one would indicate that the project's PV is less than the initial investment. As values on the profitability index increase, so does the financial attractiveness of the proposed project.Rules for selection or rejection of a project:If PI > 1 then accept the project If PI < 1 then reject the project Decision Rule A. "Capital Rationing" Situation Select all projects whose profitability index is greater than or equal to 1.Rank them in descending order of their profitability indices.Select projects starting from the top of the list till the capital budget B. "No Capital Rationing" SituationSelect every project whose PI >= 1. C. Mutually Exclusive ProjectSelect the project with higher PI. ExampleA new machine costs Rs.8,200 and generates cash inflow (after tax)per annum of Rs.2,000 during its life of 5 years. Let us assume that the cost of capital for the company is 6%.The present value of the cash inflows at 6% discount rate is 2000 * 4.212 = 8424. The present value of outflow is 8,200. The profitability index is (8424/8200) = 1.027.The profitability index of 1.027 leads to an acceptance decision of the project, since it is greater than 1. Internal Rate of ReturnThe internal rate of return (IRR) is defined as the discount rate that gives a net present value (NPV) of zero. It is a commonly used measure of investment efficiency.The IRR method will result in the same decision as the NPV method for (non-mutually exclusive) projects in an unconstrained environment, in the usual cases where a negative cash flow occurs at the start of the project, followed by all positive cash flows. In most realistic cases, all independent projects that have an IRR higher than the hurdle rate should be accepted. Nevertheless, for mutually exclusive projects, the decision rule of taking the project with the highest IRR - which is often used - may select a project with a lower NPV.One shortcoming of the IRR method is that it is commonly misunderstood to convey the actual annual profitability of an investment. However, this is not the case because intermediate cash flows are almost never reinvested at the project's IRR; and, therefore, the actual rate of return is almost certainly going to be lower. Accordingly, a measure called Modified Internal Rate of Return (MIRR) is often used.Decision Rules A. "Capital Rationing" Situation Select those projects whose IRR (r) = k, where k is the cost of capital. Arrange all the projects in the descending order of their Internal Rate of Return. Select projects from the top till the capital budget allows. B. "No Capital Rationing" Situation Accept every project whose IRR (r) = k, where k is the cost of capital. C. Mutually Exclusive Projects Select the one with higher IRR. ExampleIn the present case this is 8200 divided by 2000 = 4.1The interest factor 4.1 for a 5 year project corresponds to a discount rate of 7%. So the IRR of the project is 7%. An interest factor of 4.100 indicates that the present value of one Rupee annuity for 5 years at 7% is equivalent to 4 rupees and ten paise .The present value of Rs.2,000 annuity is 4.100 * 2000 = 8200The present value of cash inflows = Rs.8200 and the present value of cash outflow = Rs.8200.At 7% the present value of cash inflows is equivale to the present value of cash outflows. Hence 7% is the IRR of the project. Modified Internal Rate of ReturnMIRR is the discount rate that makes the future value of the project equal to its initial cost. MIRR requires a reinvestment rate.There are 3 basic steps of the MIRR:Estimate all cash flows as in IRR.Calculate the future value of all cash inflows at the last year of the project’s life.Determine the discount rate that causes the future value of all cash inflows determined in step 2, to be equal to the firm’s investment at time zero. This discount rate is known as the MIRR.Decision ruleTake the project if MIRR is larger than the required rate.DisadvantagesMIRR cannot rank mutually exclusive projects.Equivalent Annuity MethodThe equivalent annuity method expresses the NPV as an annualized cash flow by dividing it by the present value of the annuity factor. It is often used when assessing only the costs of specific projects that have the same cash inflows. In this form it is known as the equivalent annual cost (EAC) method and is the cost per year of owning and operating an asset over its entire lifespan.It is often used when comparing investment projects of unequal lifespan. For example if project A has an expected lifetime of 7 years, and project B has an expected lifetime of 11 years it would be improper to simply compare the net present values (NPVs) of the two projects, unless the projects could not be repeated.The use of the EAC method implies that the project will be replaced by an identical project. Real OptionsReal options analysis has become important since the 1970s as option pricing models have gotten more sophisticated. The discounted cash flow methods essentially value projects as if they were risky bonds, with the promised cash flows known. But managers will have many choices of how to increase future cash inflows, or to decrease future cash outflows. In other words, managers get to manage the projects - not simply accept or reject them. Real options analyses try to value the choices - the option value - that the managers will have in the future and adds these values to the NPV.Ranked ProjectsThe real value of capital budgeting is to rank projects. Most organizations have many projects that could potentially be financially rewarding. Once it has been determined that a particular project has exceeded its hurdle, then it should be ranked against peer projects (e.g. - highest Profitability index to lowest Profitability index). The highest ranking projects should be implemented until the budgeted capital has been expended.Non-Discounting CriteriaPayback Period Payback period is the time duration required to recoup the investment committed to a project. Business enterprises following payback period use "stipulated payback period", which acts as a standard for screening the project. Of Technology MadrasComputation of Payback PeriodWhen the cash inflows are uniform the formula for payback period is Cash Outlay of the Project or Original Cost of the AssetAnnual Cash InflowWhen the cash inflows are uneven, the cumulative cash inflows are to be arrived at and then the payback period has to be calculated through interpolation.Here payback period is the time when cumulative cash inflows are equal to the outflows. i.e.,∑ Inflows = OutflowsPayback Reciprocal Rate The payback period is stated in terms of years. This can be stated in terms of percentage also. This is the payback reciprocal rate. Reciprocal of payback period = [1/payback period] x 100 Capital Rationing Situation Select the projects which have payback periods lower than or equivalent to the stipulated payback period. Arrange these selected projects in increasing order of their respective payback periods.Select those projects from the top of the list till the capital budget is exhausted.Decision Rules Mutually Exclusive Projects In the case of two mutually exclusive projects, the one with a lower payback period is accepted, when the respective payback periods are less than or equivalent to the stipulated payback period.Determination of Stipulated Payback Period Stipulated payback period, broadly, depends on the nature of the business/industry with respect to the product, technology used and speed at which technological changes occur, rate of product obsolescence etc. Stipulated payback period is, thus, determined by the management's capacity to evaluate the environment via-a-via the enterprise's products, markets and distribution channels and identify the ideal-business design and specify the time target. Advantages of Payback Period It is easy to understand and apply. The concept of recovery is familiar to every decision-maker.It is cost effective. It can be used even by a small firms having limited manpower that is not trained in any other sophisticated techniques.The payback period measures the direct relationship between annual cash inflows from a proposal and the net investment required.The payback period also deals with risk. The project with shorter payback period will be usually less riskyBusiness enterprises facing uncertainty - both of product and technology - will benefit by the use of payback period method since the stress in this technique is on early recovery of investment. So enterprises facing technological obsolescence and product obsolescence - as in electronics/computer industry - prefer payback period method. Liquidity requirement requires earlier cash flows. Hence, enterprises having high liquidity requirement prefer this tool since it involves minimal waiting time for recovery of cash outflows as the emphasis is on early recoupment of investment. Disadvantages of Payback Period The time value of money is ignored. But this drawback can be set right by using the discounted payback period method. The discounted payback period method looks at recovery of initial investment after considering the time value of inflows. It ignores the cash inflows received beyond the payback period. In its emphasis on early recovery, it often rejects projects offering higher total cash inflow. Investment decision is essentially concerned with a comparison of rate of return promised by a project with the cost of acquiring funds required by that project. Payback period is essentially a time concept; it does not consider the rate of return. Example There are two projects (project a and b) available for a Company, with a life of 6 years each and requiring a capital outlay of rs.9,000/- each; and additional working capital of rs.1000/- each.The cash inflows comprise of profit after tax + Depreciation + Interest (Tax adjusted) for five years and salvage value of Rs.500/- for each project plus working capital released in the 6th year. This company has prescribed a hurdle payback period of 3 years. Which of the two projects should be selected?Example - DataProject ACumulative Cash Inflows of Project AProject BCumulative Cash Inflows of Project BYear 13,0003,0002,0002,000Year 23,5006,5002,5004,500Year 33,50010,0002,5007,000Year 41,50011,0002,5009,500Year 51,50013,0003,00012,500Year 63,00016,0005,50018,000Payback Period3 years4 years & 2 monthsExample ? Payback period for Project A = 3 years (cumulative cash inflows = outflows) ? Payback period for Project B = 4 years + 500/3000 = 4 years and 2 months. (Note: Interpolation technique is used here to identify the exact period at which cumulative cash inflows will be equal to outflows. The amount required to equate is Rs.500, while the returns from the 5th year is 3,000. Hence the addition time duration required to compute the payback period is (500/3000) x 12 which is 2 months. The interpolation technique is used based on the assumption that cash inflows accrue uniformly throughout the year.) The investment decision will be to choose Project A with a payback period of 3 years and reject Project B with a payback period of 4 years and 2 months. Discounted Payback PeriodIn investment decisions, the number of years it takes for an investment to recover its initial cost after accounting for inflation, interest, and other matters affected by the time value of money, in order to be worthwhile to the investor. It differs slightly from the payback period rule, which only accounts for cash flows resulting from an investment and does not take into account the time value of money. Each investor determines his/her own discounted payback period rule and, as such, it is a highly subjective rule. In general, however, short-term investors use a short number of years — or even months — for their discounted payback period rules, while long-term investors measure their rules in years or even decades.Accounting Rate of Return Accounting rate of return is the rate arrived at by expressing the average annual net profit (after tax) as given in the income statement as a percentage of the total investment or average investment. The accounting rate of return is based on accounting profits. Accounting profits are different from the cash flows from a project and hence, in many instances, accounting rate of return might not be used as a project evaluation decision. Accounting rate of return does find a place in business decision making when the returns expected are accounting profits and not merely the cash flows. Computation of Accounting Rate of Return The accounting rate of return using total investment. orSometimes average rate of return is calculated by using the following formula:= Net Profit After Tax Average InvestmentWhere average investment = total investment divided by 2 Decision Rules A. Capital Rationing Situation ? Select the projects whose rates of return are higher than the cut-off rate. ? Arrange them in the declining order of their rate of return. ? Select projects starting from the top of the list till the capital available is exhausted. B. No Capital Rationing Situation Select all projects whose rate of return are higher than the cut-off rate. C. Mutually Exclusive Projects Select the one that offers highest rate of return. Accounting Rate of Return – Advantages It Is Easy To Calculate. The Percentage Return Is More Familiar To The Executives. Accounting Rate of Return – Disadvantages The definition of cash inflows is erroneous; it takes into account profit after tax only. It, therefore, fails to present the true return. Definition of investment is ambiguous and fluctuating. The decision could be biased towards a specific project, could use average investment to double the rate of return and thereby multiply the chances of its acceptances. Time value of money is not considered here. Example There are two projects (Project A and B) available for a business enterprise, with a life of 6 years each and requiring a capital outlay of Rs.9,000/- each and additional working capital of Rs.1000/ each. The cash inflows comprise of profit after tax + depreciation + interest (Tax adjusted) for five years and salvage value of Rs.500/- for each project at year 6 plus working capital released also in the 6th year. Net Profit After TaxYearProject AProject B11,58028022,0801,08032,0801,0804801,0805802,5806801,880Total Net Profit After Tax5,9807,980Average Annual Net Profit5,980/6 = 996.67,980/6 = 1330Taking into account the working capital released in the 6th year and salvage value of the investment, the total investment will be (10,000- 1,500) Rs.8500 and the average investment will be (8500/2) Rs.4250 for each project.The rate of return calculations are: Net profit after tax as a percentage of total investmentProject A Project B1330 * 100 = 15.6% 8500The investment decision will be to select Project B since its rate of return is higher than that of Project A if they are mutually exclusive. If they are independent projects both can be accepted if the minimum required rate of return is 11.7% or less.Difficulties in Capital BudgetingGeneral difficulties: Ensuring that forecasts are consistent (across departments)Eliminating (reducing) conflicts of interestReducing forecast bias: the proportion of proposed projects that have a positive NPV is independent of the estimated opportunity cost of capital.Bottom-up and top-down planning is necessary.Control projects in progress, Post-audit afterwardsTry hard to measure incremental cash flows--when you canEvaluate performance: actual versus projected; actual versus absolute standard of the true cost of capitalMeasurement problem:While calculating the NPV, IRR, PAY BACK PERIOD, AND PROFITABILITY INDEX, we have to be very much careful with the calculations values throw it is a very difficult job to remember many values at a time but we have to be care full because it will effect on the total output of project in decision making.Risk and Uncertainty: Different capital investment proposals have different degrees of risk and uncertainly there is a slight difference between risk and uncertainty risk involves situations in which the probabilities of a particular event occurring are known where as in uncertainty these probabilities are unknown. In many cases these two terms are used inter changeably. Risk in capital investments may be due to the general economic conditions competition, technological developments, consumer preferences etc. One to these reasons the revenues costs and economic life of a particular investment are not certain. While evaluating capital investment proposals a proper adjustment should therefore be made for risk and uncertaintyAnalysis of a New Project with the help of Capital Budgeting Process.Proposed capital: 653.1 millionsDivided in 2 phasesPhase 1 is proposed from 2009 and is assumed to be capitalized on 2011 and Phase 2 is proposed from 2012 and is assumed to be capitalized on 2013. - about Rs. 570.7 millions splited in 2 years for the phase 1 ( 285.37 million per year). - about Rs. 82.4 millions in the phase 2.With an expected rate of return of 14% starting after 2 years.Production plant is at Baddi (Himachal Pradesh) The project is about the producing 2 products - Vials and - Syringes. The capital is divided between both the product - Rs.578.1 millions in vials and - Rs.75 millions in syringes. Expecting annual average production is: 18,000,000 (from FY 11 to FY 17).Sales and volumes are taken as per the BFROW strategic plan.Quotations from Gland, for the following products: (Indian manufacturing charges)Liquid Vial (Zoledronic Acid)$0.75 Lypo Vial (Amifostin)$1.00 PFS (Enoxaparin Na)$0.50 Royalties will be ignored in case of development of the product. The cost includes the purchase of assets for the production purpose and the depreciation is on the straight line method.Freight cost taken at 50 g per pack of 10 vials at Rs 200/per kg to US weight. SG&A costs taken in P&L as 20% on sales.Effective Tax rate is considered at 8.8%. First let us see if the product is given on contract then what is the cost that Dr. Reddy’s is going to incur:Contract Manufacturing???(Rs. Per Unit)Type of VialEquivalent InjectionUSD CCCC (In Rs)FreightRoyalty (Rs)Non LyophilisedZoledronic Acid – Liq0.7530.0010.00 - LyophilisedAmifostin – Lyo1.0040.0010.00 - Prefilled SyringesEnoxaparin Na0.5020.0010.00 - CC = Conversion CostTotal cost incurred would be: Rs. 120 And if the product is manufactured at Dr. Reddy’s, then what is the cost the organization is going to incur:Estimated in New Project(Rs. per Unit)Type of VialEquivalent InjectionCCDepreciation FreightTotal CCSavingsNon LyophilisedZoledronic Acid – Liq5.18-10.0015.1824.82LyophilisedAmifostin – Lyo5.18-10.0015.1834.82Prefilled SyringesEnoxaparin Na5.18-10.0015.1814.82 Cost incurred would be: Rs. 45.54From the above table, we can observe that if Dr. Reddy’s go for manufacturing the product then they have a total savings of Rs.74.46.So its beneficial for the company to go for manufacturing the product.For manufacturing the product the following assets are required:Project Cost of Non Cyto Injectables & Prefilled Syringes(Rs. In Lakhs)Description Amount (Ph 1)Amount (Ph 2)Class of Asset????Civil 1,112 100 BuildingsPartitions 500 - BuildingsHVAC 400 - Plant & MachEquipments 2,410 654 Plant & MachMechanical 200 - Plant & MachElectrical 270 - Electrical EquipUtility 125 30 Plant & MachValidation 70 10 Plant & MachInstruments - QC 100 ?Lab EquipRevenue 100 - BuildingsRevenue – QC 20 - Lab EquipConsultant Fees 150 ?BuildingsContingency 250 30 Plant & Mach????Total 5,707 824 ? Depreciation of Non Cyto InjectablesDepreciation is calculated on Straight Line Method(Rs. In Millions)Phase 1Phase 2ClassPolicy (Life in Years)LifeAmountDep per yearAmountDep per yearBuildings20 to 5035? 186.24 5.32 10.00 0.29 Plant & Mach3 to 159? 345.50 38.39 72.40 8.04 Electrical Equip5 to 1510? 27.00 2.70 - - Lab Equip5 to 1510? 12.00 1.20 - - Total? 570.74 47.61 82.40 8.33 Total Depreciation for the assets as per their phases:YearFY 09FY 10FY 11FY 12FY 13FY 14FY 15FY 16FY 17TotalDep. in Year (Phase 1)?? 47.61 47.61 47.61 47.61 47.61 47.61 47.61 333.27 Dep. in Year (Phase 2)???? 8.33 8.33 8.33 8.33 8.33 41.65 Total Dep. ( in Mln Rs) - - 47.61 47.61 55.94 55.94 55.94 55.94 55.94 374.92 Conversion Cost at Manufacture is as follows:( The Actual Total cost of the product i.e, The Cost Sheet)Actual Material – Imported0.07?Actual Material – India?1.53?Actual Packing – Imported?2.45?Actual Packing – India?3.57?Actual Input Taxes?0.33?Actual Landed cost0.20Actual Subcontractor0.00Actual Material8.15Actual Direct Depreciation0.94Actual Direct Manpower0.59Actual ETF0.08Actual HVAC0.13Actual Maintenance0.85Actual Other Direct0.28Actual Other Utility0.14Actual Power0.08Actual Quantity0.12Actual Steams0.00Actual Overhead3.21Actual Total Cost11.36 Non Cyto Injectables Project – CC ProjectionManpower Cost Computation?No. Of people10050 per shift * 2 Shifts?Average salary per head250,000Payroll Cost p.a.25,000,000Production18,000,000Average annual production from fy 11 to fy 17Manpower cost per unit1.39Summary of Conversion CostCost Component FY 11 FY 12 FY 13 FY 14 FY 15 FY 16 FY 17 Manpower Cost1.391.501.621.751.892.042.20Utility cost1.561.641.721.811.901.992.09Depreciation 2.322.322.322.322.322.322.32Others-------QC/QA4.202.731.150.950.720.710.69Conversion Cost (per Vial)9.468.196.816.836.827.067.30CC (per Vial) excl dep7.145.874.494.514.504.744.98Manpower Cost – 8% increment year over yearUtility Cost – 5% inflation year over year Cost of freight per Vial?Weight per vial?Fill Liquid Weight15GramsBottle weight20GramsShippers weight15GramsTotal weight per vial50Grams???Cost per kg by air to US200Rs. Per kg???Freight cost per vial10Rs. Per bottleComputation of the project:A Comparison of Capital Budgeting Techniques (Rs. in Millions)Vial Facility - Payback period computation?OutflowInflowTax????YearOutflowLiquid VialsLypo VialsPFSSEZNet In Flow DCF @ 0%Discounted In flowCum Discntd In flow1 260.37 ??? - (260.37) 1.00 (260.37) (260.37)2 260.37 - - ? - (260.37) 1.00 (260.37) (520.74)3? - - ? - - 1.00 - (520.74)4? 143.88 2.45 ? 11.75 158.09 1.00 158.09 (362.65)5 57.40 183.42 7.50 ? 15.93 149.46 1.00 149.46 (213.19)6? 225.06 18.95 ? 26.94 270.95 1.00 270.95 57.76 7? 258.27 24.12 ? 33.25 315.65 1.00 315.65 373.41 8? 397.02 66.60 ? 53.43 517.05 1.00 517.05 890.45 9? 416.89 70.72 ? 28.03 515.64 1.00 515.64 1,406.09 10? 437.36 74.24 ? 29.35 540.95 1.00 540.95 1,947.04 Payback Period is 5 years 8 monthsPre Filled Syringes Facility - Payback period computationYearOutflow Rs. MnIn flow Rs. Mn on NonLypoIn flow Rs. Mn on LypoIn flow Rs. Mn on PFS?Net In Flow DCF @ 0%Discntd In flowCum Discntd In flow025.00(25.00)1.00(25.00)(25.00)125.00-(25.00)1.00(25.00)(50.00)2--1.00-(50.00)31.001.001.001.00(49.00)425.009.20(15.80)1.00(15.80)(64.80)5100.04100.041.00100.0435.246143.67143.671.00143.67178.917219.42219.421.00219.42398.338228.88228.881.00228.88627.219 238.58 238.58 1.00 238.58 865.79 Payback is 5 Years 2 Months Total Project - Payback period computation?OutflowInflowTax????YearProject CostLiquid VialsLypo VialsPFSSEZNet In Flow DCF @ 0%Discntd In flowCum Discntd In flow1 285.37 - - - - (285.37) 1.00 (285.37) (285.37)2 285.37 - - - - (285.37) 1.00 (285.37) (570.74)3? - - - - - 1.00 - (570.74)4? 143.88 2.45 1.00 11.75 159.09 1.00 159.09 (411.65)5 82.40 183.42 7.50 9.20 15.93 133.66 1.00 133.66 (277.99)6? 225.06 18.95 100.04 26.94 370.98 1.00 370.98 93.00 7? 258.27 24.12 143.67 33.25 459.32 1.00 459.32 552.31 8? 397.02 66.60 219.42 53.43 736.47 1.00 736.47 1,288.78 9? 416.89 70.72 228.88 28.03 744.51 1.00 744.51 2,033.30 10? 437.36 74.24 238.58 29.35 779.54 1.00 779.54 2,812.83 Payback period: The Cash Outflow is the project cost i.e., the investment done by the company.Calculation of Inflows:The company has made a market research and has given the estimated volumes for the product from US, EU and RoW (Rest Of World).And then has multiplied it with the savings of each product to get the inflows.For example:Volumes of US (liquid vials) :5.8Savings for liquid vials : 24.82Cash inflow for liquid vials:143.88CC Savings - Total Project - NPV computationOutflowInflowsTaxYearProject CostLiquid VialsLypo VialsPFSSEZNet InflowsDCF @ 14%DiscountedInflow1 285.37 - - - - (285.37) 1.00 (285.37)2 285.37 - - - - (285.37) 0.88 (250.32)3 - - - - - - 0.77 - 4 - 143.88 2.45 1.00 11.75 159.09 0.67 107.38 5 82.40 183.42 7.50 9.20 15.93 133.66 0.59 79.14 6 - 225.06 18.95 100.04 26.94 370.98 0.52 192.68 7 - 258.27 24.12 143.67 33.25 459.32 0.46 209.26 8 - 397.02 66.60 219.42 53.43 736.47 0.40 294.32 9 - 416.89 70.72 228.88 28.03 744.51 0.35 261.00 10 - 437.36 74.24 238.58 29.35 779.54 0.31 239.71 NPV of the CC Savings194.65CC Savings - Total Project - IRR computation?OutflowInflows?Tax?YearProject CostLiquid VialsLypo VialsPFSSEZNet In Flow DCFDiscntd In flow1 285.37 - - - - (285.37) 1.00 (285.37)2 285.37 - - - - (285.37) 0.75 (213.19)3 - - - - - - 0.56 - 4 - 143.88 2.45 1.00 11.75 159.09 0.42 66.33 5 82.40 183.42 7.50 9.20 15.93 133.66 0.31 41.64 6 - 225.06 18.95 100.04 26.94 370.98 0.23 86.33 7 - 258.27 24.12 143.67 33.25 459.32 0.17 79.85 8 - 397.02 66.60 219.42 53.43 736.47 0.13 95.65 9 - 416.89 70.72 228.88 28.03 744.51 0.10 72.24 10 - 437.36 74.24 238.58 29.35 779.54 0.07 56.51 NPV of CC savings0%IRR of CC savings34%Procedure followed by Dr. Reddy’s while selecting a Project: When a new proposal comes to Dr. Reddy’s then it goes through several important decisions before selecting the proposal. Let’s us assume that a proposal has come to Dr. Reddy’s First the proposal goes to the Business Development team.Business Development team with the help of market research team, does the necessary market survey about the project such as How many alternative products are already in the market?About the product and its prices.About its demand.About its competitors.which they disclose it in their annual report. Once the project is evaluated then they decide from their organization’s point of view.Investment required in the project.Time of the proposalThen they prepare a strategic report with all the details such as profits, cost, etc., based on it they decide whether to manufacture the product or get it don’t on the contract basis.If the product is to be manufactured then the manufacturing team decides the cost of materials required, machines, power, buildings, etc., which help them to arrive at the project cost.Now the project comes to the finance department, where payback period, taxes, depreciation, etc., is found out with the coordination with IPDO (Integrated Product Development Operations) team.Generally 2 years payback period is considered ideal at Dr. Reddy’s because as these are fast moving products and chances are there that may be your competitors may go a step ahead in producing the product.Now after all the figures and facts are found out, the proposal goes to Managing Director. Presentation is made to him with all the details which shows the pros and cons of the proposal..Then suggestions are given by the management, budget is decided and a final decision is taken by the management whether to consider the proposal or reject it.CONCLUSION & SUGGESTIONSDecision and review of projectCompany is getting its payback after 4 years (approximately 4.33 years) Project can be approved such that company can get back its profit with in a limited pany is getting its “Discounted Pay Back” within 5.75 years even after discounting cost of capital.NPV (Net Present Value) of the company is positive “194.65” so project the project can be approved.PI (Profitability Index) is good because company is making money. Hence, the project can be approved.IRR (Internal Rate of Return) is more than the cost of capital “34% so approve the project.Decision MethodResultApprove?Why?Payback4.33 yearsYesWell, cause we get our money backDiscounted Payback5.75 yearsYesBecause we get our money back, even after discounting our cost of capital. NPV194.65YesBecause NPV is positive (reject the project if NPV is negative)Profitability Index1.2980YesCause we make moneyIRR34%YesBecause the IRR is more than the cost of capitalDr. Reddy’s takes Payback period method only into consideration because they want their returns at the earliest as Pharmacy industry is a fasting moving industry with lot of innovative ideas year after year. BibliographyThe information required for successful completion of the project has been collected through primary and secondary sources.Primary Source DataThe data has been gathered through interactions with the various officials and employees working in the division. Some important information has been gathered through couple of instructed interviews.Secondary Source DataReferred text books for collecting the information regarding the theoretical aspects of the topic.Financial Management - I .M PandeyManagement Accounting – R. P. TrivediAnnual Report of Dr. Reddy’s – 2007-2008Annual reports, magazines published by the company are used for collecting the required information. Even help is taken from internet. ................
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