project on capital budgeting

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 a
financial Growth of ours we need complete knowledge of transaction required. We not
need to know how money grows but also need to know instant gratification and live the
universal principles of austerity and hard work all of which form the basis of achieving
financial freedom.
We all know that “A Rupee today is more valuable than a Rupee tomorrow” the
entire would of the investment decision revolve around the “Time value concept of
money.”
All of us are aware, the companies prepare capital investment decision and they
follow that budget and they follow that budget throughout of the year in order to make
profit and to reduce cost but most of us don’t know how actually things work. The
objective of the study is to know how to take decisions and how a budget is prepared in
big organizations like Hindalco industries limited. During training of six weeks, I came to
know about how capital decision is prepared in Hindalco industries limited and how
budget is prepared in Hindalco industries limited and how to take investment decision
and analysis expenditure, how these expenditure are controlled. Every organization has
its own method to prepare budget so as to work efficiently and effectively. I also came to
know about how decision process start with the estimation and determination of cost and
benefits associated with different proposals.
In this project, I have performed about decision making and
understanding 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 capital
By using Net Present Value
By using interest Rate of Return
1

2. Title of the project
“Capital Budgeting Tools and analysis of Capital Expenditures in Hindalco Industries
limited”.
Scope of study
After doing this project, while preparing the project analysis was on how to prepare a
capital budget and how to take investment decision and analysis of capital expenditure
and how expenditure can be controlled. The different department prepare budget with the
using of tools and then finally finance manager take investment decision.
And be aware the concept of cost of capital has been used quite
often without providing a good deal of explanation about, how it is obtained and learn
about the method of calculation component cost of capital and the weighted average cost
of capital.
Objective of the study
The main objective of the study is to understand how and from where an organization
arranged 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 metals
flagship company of the Aditya Birla Group is the world's largest aluminium rolling
company and one of the biggest producers of primary aluminium in Asia. A metals
powerhouse with a turnover Rs18856.30 crore. Its copper smelter is the world’s largest
custom smelter at a single location.
Established in 1958, we commissioned our aluminium facility at Renukoot in eastern
Uttar Pradesh, India in 1962. Later acquisitions and mergers, with Indal, Birla Copper
and the Nifty and Mt. Gordon copper mines in Australia, strengthened our position in
value-added alumina, aluminium and copper products.
The growth story for Aditya Birla Group’s flagship company, Hindalco, will remain
inherently Indian. After posting impressive numbers, that saw its consolidated net profit
soaring eight-fold to Rs. 485 crore for the year ended March 31, Hindalco’s management
said they expect domestic demand to post a double-digit growth in the current financial
year. 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 hit
demand — 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, as
China and India see rapid expansion in their economies.
Aluminium demand in India is very positive because of auto, construction and power
sectors. Even globally, I would be very surprised if aluminium prices come down from
the current levels,” managing director Debu Bhattacharya told reporters. “Copper
demand, 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 in
India to 1.9 million tones by 2013 at a cost of about $5 billion. “Financial closures of all
the three Greenfield projects are on track. In fact, we have invested Rs.5, 000crore
already on the projects, as we are strongly committed to them. We raised Rs.2, 700crore
from our QIP to meet any shortfall in equity funding. As of now, I see no requirement for
any more equity funding,” said Sunirmal Talukdar, group executive president & chief
financial officer, Hindalco.
Novelis, has seen a remarkable turnaround with its adjusted Ebitda (earnings before
interest, depreciation, tax and amortisation) up 55 per cent in FY10 compared to the
previous year. The improved numbers and profitability have been a result of right sizing
operations and higher efficiency management and exploring new applications for
Aluminium rolled product maker Novelis, which Hindalco acquired in 2007, will
primarily 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 going
into expanding rolling operations in Brazil, which is likely to get completed by late
2012.Aluminium in sectors like auto. Cost-saving exercises also helped. Novelis for
example recycled 40 billion tonnes of used beverage cans (UBCs) in 2009, saving
significant energy costs.
Hindalco overview
History of our company and other corporate matters Our company is a flagship company
of the Aditya Birla Group and was incorpation on December 15, 1958 as Hindustan
Aluminium Corporation Limited under the provisions of the Act. We changed our name
from Hindustan Aluminium corporation Limited to Hindalco Industries Limited on
October 9,1989, as we had expanded our line of products and also proposed to diversify
into allied fields including aluminium foils, steel plant etc. The Equity shares of our
company 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 value
of 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 capacity
of 20,000 MTPA. It has since grown to become the largest integrated aluminium
producer 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. Kumar
Mangalam Birla as the chairman of the board of Directors. Day to day affairs of the
company is managed by professional executives headed by Mr Ratan K. Shah as the chief
Operating Officer.
The dream of the visionary GD Birla to locate an aluminium plant near Rihand
powerhouse comes true. The late Prime Minister, PT. JAWHERLAL NEHRU formally
inaugurated
the plant in January 1963. Going round the extensive work, Pandit ji saw his dream of a
brighter feature of India take shape before his eyes.From the modest beginning giant with
a capacity to produce 345000 tons of aluminium per annum.
Aluminium and Power (Renukoot, U.P.) the company has sales and distribution
network 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 aluminium
units across the country encompass the entire gamut of operations from bauxite mining
alumina refining, aluminium smelting to downstream rolling, extrusion, foils and alloy
wheels , along with captive power plants and coal mines.
The company has significant market share in the entire segment in which it operates. It
enjoys 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. Hindalco
has launched sevelar brands in recent years, which include Aura for Alloy wheel, fresh
rapper for kitchen foil and ever last for roofing sheets. Our exclusive showroom, the
aluminium gallery, seeks to promote Hindalco products to its customers. It is a platform
for the company to showcase quality audience in an appropriate ambience. The exhibits
include products to a quality audience in an appropriate ambience. The exhibits include
products like windows, doors, furniture, ladder, roofing sheets and ceiling and cladding
panels.
Hindalco products are well received not only in the domestic markets, but also in the
international market. The company’s metal is accepted for delivery under the high grade
aluminium contract on the London Metal Exchange (LME). The company export about
17% of its total sales volume of aluminum. The company’s alumina chemical business is
a leader in manufacturing and marketing of specialty alumina and alumina hydrate
products in the country. It has a market share of 90% in the country. These specialty
products find wide usage in diversified industries including water treatment chemicals,
refractory, ceramics, cryolite, glass, filler and plastic, conveyor belts and cables among
others. The company also exports these alumna chemical to over 30 country covering
North 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/TS
16949 certification to meet the stringent standard in specialty alumina, primary
aluminium and downstream products. A part from being a dominant player in the
domestic market, Hindalco’s products as well accepted in international markets. Exports
account 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 alloys
wheels. Hindalco is the world’s largest aluminium rolling company and one of the
biggest producers of primary aluminium in Asia. In India, Hindalco enjoys a ledership
position in specialty alumina, primary aluminium and downstream products.
Hindalco’s major products include standard and specialty grade alumina and hydrates
aluminium ingots, billets, wire rods, flat rolled products, extrusions, foil and alloy
wheels.
The integrated facility at Renukoot (uttar pradesh) houses an alumina refinery and an
aluminium 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 and
consistent supply of power for smelter and other operations.
# UTKAL ALUMINA INTERNATIONAL LIMITED, ORISSA
A Rs 44 billion( $1 billion) greenfield joint venture with Alcan Inc, of canada in which
Hindalco holds 55% equity. The proposed 1.5 million tonne alumina refinery is to be set
up in Doragurha, Rayagada district of Orissa, sourcing bauxite from the rich reserves of
Baplimali Rayagada.
# MADHYA PRADESH
7

8. A Rs.77 billion($1.7 billion) project for a smelter-power complex in the siddhi district of
madhya pradesh Aluminium smelter capacity of 325,000 tpa supported by a 750 mw coal
based captive power plant. The coal for the power plant will be sourced from Mahan coal
company Ltd., a joint venture between Hindalco and Essar Group for mining of coal from
the Mahan coal block.
# JHARKHAND
A 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 750
mw.
Globally the aditya birla group is :
A metals powerhouse, among the world’s most cost- efficient aluminium and copper
producers. Hindalco-Novelis is the largest aluminium rolling company. It is one of the
three biggest poducers of primary aluminium in Asia, with the largest single location
copper 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
E
Copper
Aluminu
smelter 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 units
across the globe encompass the entire gamut of operations, from bauxite mining, alumina
refining and aluminium smelting to downstream rolling, extrusions, foils, along with
captive power plants and coal mines.
Our copper unit, Birla Copper, produces copper cathodes, continuous cast copper rods
and other by-products, such as gold, silver and DAP fertilisers.
Our units are ISO 9001:2000, ISO 14001:2004 and OHSAS 18001 certified. Several units
have gone a step further with an integrated management system (IMS), combining ISO
9001, ISO 14001 and OHSAS 18001 into one business excellence model. We have been
accorded the Star Trading House status in India. Hindalco's aluminium metal is accepted
for delivery under the High Grade Aluminium Contract on the London Metal Exchange
(LME). Our copper quality standards are also internationally recognised and registered on
the LME with Grade A accreditation.
Aluminium
Hindalco's major products include standard and
speciality grade aluminas and hydrates, aluminium ingots, billets, wire rods, flat rolled
products, extrusions and foil. The integrated facility at Renukoot houses an alumina
refinery 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 is
backed by a co-generation power unit and a 742 MW captive power plant at Renusagar to
ensure the continuous supply of power for smelter and other operations. A strong
presence across the value chain and synergies between operations has given us a
dominant share in the value-added products market. As a step towards expanding the
market for value-added products and services, we have launched various brands in recent
years — Everlast roofing sheets, Freshwrapp kitchen foil and Freshpakk semi-rigid
containers.
COPPER
Birla Copper, Hindalco’s copper unit, is located at Dahej
in Gujarat, India. The unit has the unique distinction of being the largest single-location
copper smelter in the world. The smelter uses state-of-the-art technology and has a
capacity of 500,000 tpa. Birla Copper also produces precious metals, fertilizers and
sulphuric and phosphoric acid. The unit has captive power plants for continuous power
generation and a captive jetty to facilitate logistics and transportation. Birla Copper
upholds its longstanding reputation for quality copper cathodes and continuous cast
copper rods by assuring its management processes meet the highest standards. It has
acquired certifications such as ISO-9001:2000 (Quality Management Systems),
ISO-14001:2004
12

13. (Environmental Management System) and OHSAS-18001:2007 (Occupational Health
and 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, heap
leach pads and a solvent extraction and electrowinning (SXEW) processing plant, which
produces copper cathode. The Mt. Gordon copper operation consists of an underground
mine and a copper concentrate plant. Until recently, the operation produced copper
cathode through the ferric leach process.
In 2004, a copper concentrator was commissioned to provide concentrate for use at
Hindalco's operations in Dahej. During FY2009, Mt. Gordon produced 17,815 tonnes of
copper in concentrate. Both Nifty and Mt. Gordon have a long-term life of mine off-take
agreement 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 cost
competitiveness, quality and global reach. We are also committed to the triple bottom
line accountability of economic, environment and social factors. Care for the community
around 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 downstream
activities. 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 the
lowest cost in India.
The production of Aluminium is done in different stages.Normally the stage consists of
conversion of bauxite to alumina. Then alumina is converted into aluminium. The
refineries at Hindalco are well established and cost worthly.They are very efficient and
wastage is very low.
Hindalco refines bauxites primarily obtained from capative mines, to extract
alumina,which is smelted into alumina ingots and are called billets.Hindalco smelts its
entire 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 - Renukoot
Indal 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 Mines
Co-Generation Alumina refinery caustic soda
from joint
ventrue
Renusagar Aluminium smelter Aluminium
Fluoride
(power plant) from j.v.
Semi fabrication plant
Redrow Rod Mills Rolling Mills Extrusion
presses
Foils At. Wheel Plant
19

20. Production Capacities
Division Capacity Location
Alumina 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 Silvassa
Power 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 it
And it would continue to be my focus”
Kumar Mangalam Birla
Vision
To be a premium metals major, global in size and reach, excelling in everything we do,
and creating value for its stakeholders.
Mission
To relentlessly pursue the creation of superior shareholder value, by exceeding customer
expectation profitably, unleashing employee potential, while being a responsible
corporate 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, as
promised.
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 other
single metal can do so many jobs, so well and so economically. Aluminium’s growth rate
is the highest amongst the major basic metals today. Hindalco ranks is the largest
Aluminium producer in India, whose more than 58% sale is in value added product and
has more than 40% in total market share. The company’s fully integrated aluminium
operations consists of the mining of Bauxite, conversion of Bauxite, into alumina,
production of primary aluminium from alumina by electrolysis and production of
properzi redraw rods, rolled products, extrusions and value added products like foil and
wheels at silvassa.
Hindalco’s integrated operation and operational efficiency have enabled the company to
be one of the world’s lowest cost producers of aluminium. The company’s cost efficiency
has helped it to record an outstanding performance in the face of adverse market
conditions. Hindalco also owns a large captive thermal power plant at Renusagar that
meets the power requirement of the company very effectively. Hindalco currently has
aluminium capacity of 3,45,000 MTPA.
Ever last, a hindalco brand for aluminium-roofing sheets, offers ideal and economical
solutions for all roofing and cladding needs. Hindalco also offers colors-coated and tiled
roofing profiles.
Conclusion of company
The company has recorded a strong performance despite the challenging conditions in
copper business posed by the falling tariffs as well as production related issues. The
success of its cost optimization initiatives at its power plant in hirakud as well as higher
operating margins that the company has achieved.
The company has also made good progress on the strategic growth projects that will
propel it into the league of global majors. Efforts towards obtaining relevant approvals
for the expansions are moving at a fast pace.
There have been significant developments during the year towards meeting the funding
objectives of the same. The strong balance sheet, prudent financial practices as well as
expectations of improved operations give the confidence that your company will be able
to economically finance its growth plans. On the whole the companyis poised to deliver
superior value to its stakeholders on a continuing basis.
OBJECTIVE
This above report outlines the detailed guidelines,process flows and work
steps related to the capital expenditure investment analysis process at HINDALCO
INDUSTRIES LIMITED.
22

23. Capital budgeting
Capital budgeting is a financial procedure to ensure that capital is allocated to value
adding opportunities. A capital budgeting/investment proposal should be accepted/
rejected depending on whether it generates, over the life of investment, returns more than
its cost of capital.
Capital expenditure
Whenever we make expenditure that generates a cash flow benefit for more than one
Year, this is a capital expenditure. Capital expenditures often involve large cash outlays
with major implications on the future values of the company.
Additionally, once we commit to making a capital expenditure it is sometimes difficult to
backout. Therefore, we need to carefully analyze and evaluate proposed capital
expenditures.
Investment decisions equire special attention because of the
following reasons
Growth: The effects of investment decisions extend into the future and have to be
endured for a longer period than the consequences of the current operating expenditure. A
firm’s decision to invest in long-term assets has a decisive influence on the rate and
direction 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 in
its earnings, the firm will become more risky. Thus, investment decisions shape the basis
character of a firm.
Funding: Investment decisions generally involve large amount of funds,which make it
imperative for the firm to plan its investment programmes very carefully and make an
advance arrangement for procuring finances internally or externally.
23

24. Irreversibility: Most investment decisions are irreversible. it is difficult to find a market
for such capital items once they have been acquired. The firm will incur heavy losses if
such assets are scrapped.
Complexity: Investment decisions are among the firm’s most difficult decisions. They
are an assessment of future events, which are difficult to predict. It is really a complex
problem to correctly estimate the future cash flows of an investment. Economic, political,
social, and technological forces cause the uncertainly in cash flow estimation
Types of investment decisions
# Expansion of existing business
# Expansion of new business
# Replacement and Modernization
The Three stages of capital budgeting analysis
Capital 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 the
following question:
Will the future benefits of this project be large enough to justify the investment given the
risk involved?
It has been said that how we spend our money today determines what our value will be
tomorrow. Therefore, we will focus much of our attention on present values so that we
can understand how expenditures today influence values in the future. A very popular
approach 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 Analysis
Decision-making is increasingly more complex today because of uncertainty.
Additionally, most capital projects will involve numerous variables and possible
outcomes. For example, estimating cash flows associated with a project involves working
capital requirements, project risk, tax considerations, expected rates of inflation, and
disposal 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. If
our capital project involves production, we have to understand operating costs, additional
overheads, capacity utilization, and startup costs. Consequently, we cannot manage
capital projects by simply looking at the numbers; i.e. discounted cash flows. We must
look at the entire decision and assess all relevant variables and outcomes within an
analytical hierarchy. In financial management, we refer to this analytical hierarchy as the
Multiple Attribute Decision Model (MADM). Multiple attributes are involved in capital
projects and each attribute in the decision needs to be weighed differently. We will use an
analytical hierarchy to structure the decision and derive the importance of attributes in
relation to one another. We can think of MADM as a decision tree, which breaks down a
complex decision into component parts. This decision tree approach offers several
advantages:
! We systematically consider both financial and non-financial criteria.
! Judgments and assumptions are included within the decision based on expected
Values.
! 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 project
and organize this knowledge into a decision tree. We can use software programs such as
Expert Choice or Decision Pro to help us build a decision tree.
25

26. Option Pricing
The uncertainty about our project is first reduced by obtaining knowledge and working
the decision through a decision tree. The second stage in this process is to consider all
options or choices we have or should have for the project. Therefore, before we proceed
to discounted cash flows we need to build a set of options into our project for managing
unexpected changes. In financial management, consideration of options within capital
budgeting is called contingent claims analysis or option pricing. For example, suppose
you have a choice between two boiler units for your factory. Boiler A uses oil and Boiler
B 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 we
consider option pricing Boiler B maybe the best choice because we have a choice or
option 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 second
fuel to better control operating costs. Consequently, we want to assess the options of
capital projects. Options can take many forms; ability to delay, defer, postpone, alter,
change, etc. These options give us more opportunities for creating value within capital
projects. We need to think of capital projects as a bundle of options. Three common
sources 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 negative
Values. For example, a new research program may appear negative, but it might lead to
New product innovations and market growth. We need to consider the growth options of
Projects. Option pricing is the additional value that we recognize within a project because
it has flexibilities over similar projects. These flexibilities help us manage capital projects
and therefore, failure to recognize option values can result in an under-valuation of a
project.
Discounted Cash Flow
So 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 within
our capital projects. We can now make an investment decision based on Discounted Cash
Flows or DCF. Unlike accounting, financial management is concerned with the values of
assets today; i.e. present values. Since capital projects provide benefits into the future and
since we want to determine the present value of the project, we will discount the future
cash flows of a project to the present. Discounting refers to taking a future amount and
finding its value today. Future values differ from present values because of the time value
of 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 Brealey
Capital Budgeting Techniques: A variety of measures have evolved over
time to analyze capital budgeting requests. The newer methods use time value of money
concepts. Older methods, like the payback period, have the deficiency of not using time
value techniques and will eventually fall by the wayside and be replaced in companies by
the 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 investment
is the present value of the cash inflows minus the present value of the cash outflows. A
more common way of expressing this is to say that the net present value (NPV) is the
present 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 project
is expected to earn our minimum desired rate of return. Here are our decision rules:
Should we expect to earn at
least Accept the
If the NPV is: Benefits vs. Costs
our minimum rate of investment?
return?
Positive Benefits > Costs Yes, more than Accept
Zero Benefits = Costs Exactly equal to Indifferent
Negative Benefits < Costs No, less than Reject
Remember that we said above that the purpose of the capital budgeting analysis is to see
if the project's benefits are large enough to repay the company for (1) the asset's 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.
Therefore, if the NPV is:
• Positive, the benefits are more than large enough to repay the company for (1) the
asset's 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 earn
on the investment. Technically, it is the discount rate that causes the present value of the
benefits to equal the present value of the costs. According to surveys of businesses, the
IRR method is actually the most commonly used method for evaluating capital budgeting
proposals. This is probably because the IRR is a very easy number to understand because
it can be compared easily to the expected return on other types of investments (savings
accounts, bonds, etc.).
Test Interpretation of Results Next percentage
Results to be tested?
PVB > PVC The project is expected to A higher rate
earn more
than the percentage rate
used for the test
PVB < PVC The project is expected to A lower rate
earn less
than the percentage rate
used for the test
Which 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 project's cash inflows
are reinvested to earn the hurdle rate; the IRR assumes that the cash inflows are
reinvested to earn the IRR. Of the two, the NPV's assumption is more realistic in most
situations 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 one
solution. 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 Period
Since it does not use the time value of money principle, the Payback Period is the
weakest of the capital budgeting methods discussed here. By definition, the payback
period is the length of time that it takes to recover your investment
Capital Budgeting Analysis
Whenever we analyze a capital project, we must consider unique factors. A discussion of
all of these factors are beyond the scope of this course. However, three common factors
to 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 results
Risk analysis
We previously learned that we could manage uncertainty by initiating decision analysis
and building options into our projects. We now want to turn our attention to managing
risks. It is worth noting that uncertainty and risk is not the same thing. Uncertainty is
where 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 on
outcomes. Sensitivity Analysis and Simulation can be used to measure how changes to a
project affect the outcome. Sensitivity analysis is used to determine the change in Net
Present 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 relevant
variables associated with the project. It should be noted that sensitivity analysis is much
easier to implement since sophisticated computer models are usually required for
simulation.
31

32. Type of the project
The project is descriptive and analytical in nature
Sampling Plan:
There has been no sampling plan as such as the study involves understanding the various
processes and analyzing them. The study involves the detailed analysis of secondary data
collected 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 finance
department and my project guide.
Secondary source
Annual reports
Manuals of finance department
Internal circulation booklets
Internet sites like www.google.com., www.solidconey or @indiatimes.com
Data has been collected through literature survey includes the collection of data from
various sources like handbooks. Study materials etc.
Study Conduct
The study has been conducted from information over a period of 3 years from financial
year2006-2007 to 2008-2009
32

33. Duration
Period of study during 25th may to 4th August2010.
Assumptions
Year is taken of 360 days
All purchases have been taken as credit purchases and all sales have been taken as credit
sales. In the absence of relevant data the data from Internet site is taken as the relevant
information.
Methods of Quantative analysis
Capital budgeting techniques
Calculation of weighted average Cost of capital
Analysis
For the analysis data were used along with charts and necessary tables. Other than these
different models are used to access the true financial position of the firm. The current
year i.e. 2010 has not been taken into calculation because, at that time of preparation of
this report annual closing accounting of the company was going on.
Interpretation and recommendation
After completion of the entire analysis, interpretation and recommendation were made on
the basis of figures and diagrams. Statistical tools like tables, charts are used for
representation of data.
33

34. Business decisions that require capital budgeting analysis are decisions that involve in
outlay now in order to obtain some return in the future.This return may be in the form of
increased revenue or reduced costs. Typical capital budgeting decisions include:
Cost reduction decisions
Should new equipment be purchased to reduce costs?
Expansion decisions
Should a new plan, warehouse, or other facility be acquired to increase capacity and
sales?
Equipment selection decision
Which of several available machines should be the most cost effective to purchase?
Lease or buy decisions
Should new equipment be leased or purchased?
Equipment replacement decisions
Should old equipment be replaced now or later? The use of modified sensitivity analysis
as it applies to ICO uncertainty in a capital budgeting analysis, consider the potential
purchase of some equipment to be used in a project. The purchase price is known with
certainty to be Rs.60,00,000. The equipment has a useful life of five years and is in the
three-year property class for MACRS tax-depreciation purposes. Shipping and
installation costs are "estimated" to be Rs.10,00,000 and Rs.20,00,000, respectively, and
the equipment has a zero expected final salvage value, five years from now. No
additional "net" working capital is needed. The new equipment will generate estimated
additional 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 equals
40 percent, we can estimate the project's relevant incremental cash flows for the "base
case."
IV.A. The Base Case: Net Present Value
Exhibit 2 shows the project's 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) = 10,00,000
Installation cost (estimate) = 20,00,000
_______________
= Initial cash outlay (ICO) = 90,00,000 = depreciable
basis for tax purposes
Exhibit 3
shows the expected the incremental future cash flows.
Exhibit 3
Expected Incremental Future Cash Flows
35

36. END OF YEAR (in x10,000s)
__________________________________________
1 2 3 4 5
Net change in operating
revenue, 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 from
Exhibit 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 5
Period ( 900.00) 299.99 340.02 233.32 206.68 180.00
Net cash flows
For an estimated initial cash outlay of 90,00,000, the firm expects to generate net cash
flows 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, the
net present value is 17,920. The typical capital budgeting response to the project's
positive net present value would be to signal project acceptance. However, given the
uncertain 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 until
those uncertain estimates and their multi-year spillover effects are subjected to sensitivity
analysis.
IV.B. Sensitivity Analysis
Sensitivity analysis can be applied to our equipment purchase's uncertain ICO
components to answer a few “what if” questions. What if, for example, our Rs10,00,000
estimate for shipping cost turns out to be higher/lower? And, what if installation is
higher/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 variables
of concern (shipping and installation) individually by, for example,-30%, -20%, -10%,
+10%, +20%, and +30%. Note that changes in these variables have multiperiodspillover
effects on depreciation, which affects taxes and future cash flows. Thus, the change in the
ICO not only affects the Year-0 cash flow, but it also affects the cash flows in the
subsequent 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 individual
changesin 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 roughly
13percent or more from the base case, our project’s net present value turns negative. For
shipping cost, however, the increase would need to be roughly 28 percent or more before
the project has a negative net present value.
The data contained in Exhibit 5 can also be presented graphically in an NPV sensitivity
graph –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 equal
percentage 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 price
contract for installation from a third party.
38

39. One potential problem with our sensitivity analysis, so far, is that it has looked at
sensitivity “one variable at a time.” We can also judge the sensitivity of NPV to
simultaneous changes in two variables by constructing an NPV sensitivity matrix. Exhibit
7 is one such sensitivity matrix that depicts NPV results for combinations of changes in
our two input estimates – “shipping cost” and “installation cost.” Note that a
simultaneous cost increase approaching 10 percent for both shipping and installation
costs would result in a negative net present value.
Exhibit 7.
39

40. Sensitivity matrix for the equipment purchase showing the impact of simultaneous
changes in two initial cash outlay components on the project’s net present value
(NPV)
CHANGE IN INSTALLATION COST
CHANGE IN
SHIPPING 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 11.08
Base 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 into
how 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. Given
the risk-return profile in Exhibit 7, should the project be taken? In other words, is the
expected NPV of Rs 17,920 worth the risk of two simultaneous 30% cost overruns, which
would result in Rs43, 600 losses? Although there is no theoretically definitive answer, if
the possible loss is small relative to the size of the company, then the risk is probably
worth taking, given that the project has positive expected value. If the loss is so large that
it is a “bet the company” proposition, then the board of directors should make the final
decision.
Sensitivity analysis does not provide any absolute rules for deciding whether or not to
accept the project, but it does provide some clear guidelines regarding the need for a
project 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 Rs
26,213, then the company’s managers should consider possible interventions that might
help salvage the value of the project.
Cost of capital
Determination of cost of capital Hindalco
The term cost of capital is referred to the discount rate that is used in determining the
present value of the estimated future cash proceeds. The cost of capital is used as the
discount rate to calculate the NPV. It is the minimum rate of retrun that a firm must earn
on 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 has
its own cost firstly we calculate the specific cost of various components and then and
then we combine them to reach to the overall cost of capital of the firm, which is referred
as weighted average cost of capital of the firm.
Cost of Debentures
Cost of debt is the after tax cost of long terms fund through borrowings. The funds raised
though debts is in the form of loans and debentures. Hindalco has both short-term and
long-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 rate
NP= Net Proceeds
IP=10000000 x 6.39/100=639000
639000(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 payable
T=Tax rate
NP= Net Proceeds
IP=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 Crores
Particulars Total amt. Propotion Cost Weighted
Cost
100 0.092 4.97% 0.45724
Debentures(a)
250 0.0233 5.05% 0.118
Debentures(b)
8324.29 0.777 6.25% 4.856
Loans
2039 0.1903 8% 1.5224
GOI Bonds
10713.29 100 6.954%
Total
So, the total weighted average cost of DEBT=6.954%
COST OF PREFERRENCE SHARES
The cost of preference capital is the annual preference share dividend divided by the net
proceeds from the sale of preference shares. Or we can say that it is the dividend
expected by the preference shareholders. Unlike interest payment on debt, dividend
payable to preference share is not tax deductible.
Number of shares=2032734shares @2Rs.
Interest Rate= 6%
43

44. Dividend on preference share= 0.02crore
Dividend tax on preference shares=0.01crore
PD= Payable Dividend
NP=net proceeds
t=dividend tax
Kp= cost of preference share
PD= 2032734 X 6/100
=0.02crore
Dividend on one share= 2 X 6/100
=0.12Rs/share
NP/Share= 2 Rs
Dividend Tax= 50%
Kp=[0.12(1+0.50)/2]X 100
=0.18/2 X100
=.09 X100
= 9%
Cost of equity shares
It is the rate at which discount the expected dividends of the firm to determine its share
value. When equity shareholders invest their funds they also expect returns in the form of
dividends. The market value of the shares is the function of the return that the
shareholders 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 shares
of the company.
Cost of equity shares of firm
Year Earnings per share
1998-1999 7.16
1999-2000 7.74
2000-2001 8.57
2001-2002 8.67
2002-2003 5.92
2003-2004 8.53
2004-2005 5.92
2005-2006 8.67
2006-2007 8.57
2007-2008 7.74
2008-2009 7.16
Dividend growth model
According to this approach the cost of equity capital is calculated on the basis of the
required rate of return in terms of future dividends to be paid on shares.
The formula for calculating it is as follows:
Estimation of growth rate
There exist different methods for the estimation of growth rate of the firm
Internal growth
This approach may be used when the firm has the stable dividend policy. Hindalco’s
payout ratio has fluctuated over the year. But if we see the past 10 years record of the
firm we can say that generally company distribute upto 20% of the total profit not more
than that. And retained 80% of the total profit. In 2006 company retained 85% of the total
profit.
Growth may be calculated by calculating the product of retention ratio and ROE
g=Retention ratio X ROE (year2009)
45

46. =0.88 X 0.094
=8.272%
Cost of equity taking into consideration internal growth rate as g
D1 =1.35
Po=55.75(As on 31st march)
Cost of equity = 1.35/55.75+8.272
=10.69%
Past average growth
In practice the growth may be based on past EPS rather than DPS since companies do not
change their DPS frequently with changes in EPS. Thus DPS grows at a slower rate. The
average of EPS past growth rates may be used as a proxy for the future growth. There are
two 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 is
preferable when there is much variability in EPS data. The geometric average EPS
growth for the past 10 years is a follows.
Formula (1+g) n=EPSn / EPSo
Where
n= Number of years
EPSn=EPS of current year
EPSo= EPS of base year
EPSn=14.82
EPSo= 7.74
n=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 equity
Internal 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 firm
For 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 earnings
The companies do not generally the entire profits earned by them by way of dividends
among their shareholders. They retain some profits for the future expansion of the
business. The amount retained by the company, if it had been distributed among the
shareholders by way of dividends, would have given them some earnings. The company
has 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. Simply
stated the opportunity cost of retained earnings may be taken as the cost of retained
earnings. It is equal to the income that the shareholders can earn by placing these funds in
alternative investments.
Weighted average cost of capital of HINDALCO
PARTICULARS TOTAL PROPORTION COST WEIGHTE
AMOUNT D COST
Debt 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%
Interpretation
so, the weighted average cost of capital of the firm is 10.427588% so, on the basis of this
we 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 to
compute the project’s NPV.
Future investment decisions by HINDALCO
The expansion programme of hindalco industries ltd, the flagship company of the Aditya
Birla Group, is on track, the company management said at a recent press conference in
mumbai. The aluminium major has set a total capital expenditure programme of Rs
25000 crore till 2012, by which time its aluminium production capacity would have
surged to 17 lakh tpa from around 5 lakh tpa now.
Hindalco had acquried canadian aluminium product marker Novelis
in 2007 for$ 5.9billion and has also announced investment of $4
billion(Rs19800crore)over three years to expand capacity of India. Novelis has reported a
net loss of $1.8 billion is the 3rd quarter ended 31 December 2008 on largely to a goodwill
loss of $1.5 billion, fallout of the ongoing global meltdown.
Now here as company had decided to raise 25000 crore rupees from the market. They
can raise this money through any of the following options:
#. Company can raise 25000crore from the market in the form of equity share of Re
1 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 crore
Dividend on preference share = 0.02crore
Dividend 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
=25170.027crore
Total interest on debt (old+new)= (669.65+1625)crore
=2294.65crore
Calculation:
PLAN 1
(X-669.65)(1-0.223)-0.02(1+.0.50)÷25170.027
PLAN 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
Interpretation
Now here this shows that at 2305.88crore of EBIT there exists indifference point. Mean
at this point the EPS is same wither the company uses equity its uses just for raising
funds from the market. If firm is expecting EBIT more than the level of
Indifference 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 the
cause 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 about
capital budgeting of the hindalco industries limited. Hindalco industries limited is having
an appropriate capital budgeting of the organizations.EPS growth rate is 21.84%,it is
showing a high safety of the interest of the investors as well as it is increasing the profit
of the organization by an average of 24%every year. The way it is helping the
organization 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 day
by day last year it was just Rs 25.25 and in 2008 it is Rs24.51 hindalco’s interest
coverage 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 establish
appropriate strategic investment decision.
1-Cost of capital and weighted average cost
2Calculation of NPV and IRR
Conclusion
In a typical capital budgeting analysis, a project’s initial cash outlay (ICO) is generally
treated as a single, certain cash outflow. However, upon closer inspection, one or more of
the 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 be
uncertain/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-shield
Benefits that would affect future after-tax operating cash inflows.
• Other ICO components may also be capitalized, but would be subject to tax
depreciation
(E.g., land improvement, buildings, machinery and equipment). These outflows will have
Spillover 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 recommend
that sensitivity testing be applied to uncertain ICO components at the project-evaluation
stage. 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 ICO
component 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 based
on the currently available information. The firm can also identify the critical levels of
cost overruns that should trigger a formal re-approval of the project.
As the conclusion the company has delivered record performance amidst challenging
environment. The company is continuously confidence of delivering superior operating
performance on the back of improving cost of improving cost competitiveness driven by
establishing an appropriate capital budgeting techniques like past average growth rate and
favorable demand condition in the domestic and regional market. The company has
chalked out expansion in alumina and aggressive growth plans in aluminium. The effort
will be supported by robust current operations, a strong balance sheet which is supported
by an excellent proportionate relationship between investment and return.
52

53. Therefore the company is confident of success of these efforts in transforming the
company to the league of Global top-10 in the both the metal and deliver superior value
to stakeholders in future.
Limitations of study
The 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 and
financial position of HINDALCO and to suggest measures to overcome the shortfalls if
any.
Among all the financial management decisions one of the important decisions is capital
budgeting .Investment decision about debt- equity mix and capital techniques this project
helps in analyzing the capital budgeting of HINDALCO. What is the relationship
between application and source of cash and weighted average cost of capital other than
this the project also analysis the long-term solvency and short-term solvency of the firm
taking global and India market situations in mind with use of ratio analysis because to
analysis the financial position of a firm one of the method is ratio analysis which uses
data from the balance sheet and income statement to produce values that have been easily
interpreted 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 than
this 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 highest
relative to domestic and global peers. The company recorded Highest ever-primary
aluminium production this year and become the first indian company to produce more
than 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 low
as compared to shareholders fund and the maximum out came from retained earnings.
The major competitors of Hindalco also have low on loan & borrowing. Since aluninium
seeks is highly vulnerable to fluctuations in LME. So this is the main reason due to which
companies in this sector avoid using more debt financing. Company has also declared to
raise 25000crore from market in the form of equity shares. So, decision of the firm itself
indicates that company is now trying to increase their equity proportion rather than using
more of debt. Other than this in 2009 end companies 350 crores of debentures and going
to redeemed. so this leads to more increase in the proportion of equity in the total
financial position of the firm.
The future predictions of aluminium industry are positive, as it indicates the increase in
the demand and consumption of aluminium at global level in other than this there are
various emerging sectors also likes automobiles industry where the usage of alunimum
increase 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

56. 56

57. 57

58. Business Performance Review
The company has recorded its best ever performance during the fiscal 2008-2009.
Aluminium Copper Total
Rs.Mn Rs.Mn Rs.Mn
Net sales and 7,600.54 10,619.11 18219.65
operating
1530.35 627.41 2157.76
EBIT 22728 10765 33493
Capital employed
9.04%
ROCE(%)
Aluminium business
The aluminium business demonstrated a stellar performance with
# Highest ever alumina and primary aluminium production with over 100%capacity
utilization at all operating units.
# Highest ever turnover and business profit.
# Highest ever EBIT margins at 50%.
58

59. Financial Review and Analysis
Highlights (in Rs. Millions)
Particulars FY 2008 FY 2009
Net sales and operating revenues 192010 182200
Total expenditure 157999 158140
Operating profit 34011 30366
Other income 4929 6369
Interest 2806 3371
Depreciation 5878 6454
Profit before tax 30256 26903
Extraordinary items --- ----
Provision for current tax 6063 4781
Provision for deferred tax 876 1214
Provision for fringe benefits tax 114 113
Profit after tax 28609 22303
Operating margins 17.06% 16.66%
Net Sales and Operating Revenues
Net sales and operating revenues for the year 2008-09 in increased
by5% YOY on the back of higher aluminium volume, increased VAP tonnage and
buoyant prices for both the metals. A large increase in net sales and operating revenues
was though negated by a sharp decline in US dollar.
Conslidated revenues jumped from Rs.19316 cores to Rs.60013cores, an increase of
211%.This includes NOVELIS’ sale for the 10.5 months from 16th May, 07 to 31st
March.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 largely
due to higher pre-tax treasury yield and higher average treasury.
Interest
The company’s working capital requirement increased significantly on
account of. Higher copper prices driven by higher LME. Rising interest rates resulted in
higher 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 in
FY08.
Taxes
Effective tax rate went up to 26.8% to 23%on account of increase in pre-tax
profit by 66% over last year and also proportion of income exempt from tax was lower in
current year.
Profit
Net profit increased 12% to Rs 28609 million on account of tax adjustment
for 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 cash
Cash from operating 2140 3171 23%
Non-Operating Income 619 691 5%
Net debt Inflows 964
Equity Raised 2424 4426 32%
Other treasury investment(net) 5507 40%
Total 6147 13795 100%
Application of cash
Net 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) 696
Equivalents.
Source of cash
Cash from operations
Lower realizations for aluminium and lower TcRc in copper impacted
margins, however cash profit was higher by 8%. This coupled with higher working
capital resulted in lower cash flow from operation compared to last year.
Non-operating income
Cash from non-operating income increased to Rs.691crores as
compared to Rs 620crores a year earlier. The increase is on account of higher dividend
income and income earned on utilized lone funds which got capitalized.
Equity
Your company raised Rs4426crores(net of issue expenses) from rights
issue 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 take
for Noveils acquisition.
Application of cash
Capital expenditure
The company spent Rs.967crores on various expansion and
efficiency improvement projects. Going forwards,this amount is slated to rise
considerably as per planned investment are made in planned drownfield and greenfield
projects.
Investment in subsidiaries
Aggregate invesments, including loans and advances to subsidiaries,
amounted to Rs11,004crores.your company infused Rs.10400.37crores into AV
mineral(netherlands) BV a SPV created for acquisition of Noveils Inc. and this amount
was used by AV
Minerals(Netherlands) BV for takeout of the bridge loan taken for Noveils acquisition
and servicing of debts on its balance sheet. Investment (Including loans and advances) in
utkal alumina rose by rs.317crores.
Interest
Interest and finance charges paid for the year was almost same as in last
year.interest charged to profit and loss account is only Rs.337crorenet of interest
capitalized.
Dividend
Dividend paid including tax on dividend is Rs266crores.
We have put in place a permanent capital structure to support our strategic
business plan. We successfully took out the bridge of us$3.03billion in November 2008
admist hostile and turbulent marco economic envirnoment. We managed to preserve our
balance sheet strength to grow by reducing our leverage while doing so.
61

62. Bibiliography
Books
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, 2006
Reports
Annual report(2004-2009)
Bonus issue bulletin 2006
Capital planning and policy manual
Aditya management annual report
Websites
www.wikipedia.org
www.adityakiran.com
www.hindalco.com
ARTICLES: (Journal)
Value creation
other Aditya Birla publication
Hindalco magazine
62

63. 63

64. 64

65. 65