CAPITAL BUDGETING

CHAPTER-I

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INTRODUCTION

The field of capital budgeting is both comprehensive and challenging. It is clearly

plays a vital role in assigning most business firms to achieve there various goals (e.g.,
profitability, growth, stability, risk reduction, social goals, etc) it has been closely
allied to the economic problem. This is rather broadly defined as the allocation of
scarcer resources among competing alternatives.

Capital budgeting may be defined as the planning, evaluation and selection of capital
expenditure proposal as distinguished from operating year, capital expenditures
represent outlay whose principal benefits will be recognized over longer period of
time. Decision relating to capital expenditures as opposed to those for operating
expenditures, are generally irreversible and they require careful selection techniques
and procedures.

Capital budgeting is commonly referred to as fixed asset management, when

integrated with the financial manager’s goal of attending proper combination of assets
( i.e., optimal asset mix), fixed asset assume a great deal of significance. Fixed assets
are also frequently termed as the ‘earning asset’ of the firm since they usually
generate large returns. Since assets are the sources of revenue generation for the firm
and fixed asset its principal sources, it appears logical that future sales growth is
heavily correlated with the expansion of capital expenditures.

WHAT IS CAPITAL BUDGETING?

Capital budgeting is a required managerial tool. One duty of a financial manager is to

choose investments with satisfactory cash flows and rates of return. Therefore, a
financial manager must be able to decide whether an investment is worth undertaking
and be able to choose intelligently between two or more alternatives. To do this, a
sound procedure to evaluate, compare, and select projects is needed. This procedure is
called capital budgeting.

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Capital is a limited resource

In the form of either debt or equity, capital is a very limited resource. There is a limit
to the volume of credit that the banking system can create in the economy.
Commercial banks and the other lending institutions have limited deposits from which
they can lend money to individuals, corporations and governments. In addition, the
Federal Reserve System requires each bank to maintain part of its deposits as
reserves. Having limited resources to lend, lending institutions are selective in
extending loans to their customers. But even if a bank were to extend unlimited loans
to a company, the management of that company would need to consider the impact
that increasing loans would have on the overall cost of financing.

In reality, any firm has limited borrowing resources that should be allocated among
the best investment alternatives. One might argue that a company can issue an almost
unlimited amount of common stock to raise capital. Increasing the number of shares
of company stock, however, will serve only to distribute the same amount of equity
among a greater number of share holders. In other words, as the number of shares of a
company increases, the company ownership of the individual stock holder may
proportionally decrease.

DEFINITION

Capital budgeting is defined as “the firm decision to invest its current funds
most effectively in long term activities in anticipation of an expected flow of future
benefit over a serious of year.

Capital budgeting includes are those expenditure which are expected to

produce benefits to the firm over more than one year, and encompasses both tangible
and intangible assets. Many companies follow the traditional benefits occurring only
the expenditure on tangible fixed assets.

“Capital budgeting involves the process of planning expenditure whose returns

are expected to extend beyond one year”.
-Weston & Brigham

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“Capital budgeting is long term planning for making and financing proposed
capital outlay”.
-Charles T.Horngeren

FEATURES OF CAPITAL BUDGETING DECISION:

 Potentially large anticipated benefits.

 A relatively high degree of risk.
A relatively long time period between the initial outlay and the anticipated returns.

NATURE OF CAPITAL BUDGETING DECISIONS:

The investment decision of a firm are generally know as the capital budgeting or
capital expenditure decisions. A capital budgeting decision may be defined as the
firm’s decision to invest its current funds most effectively in the long term assets in
anticipation of an expanded flow of benefits over a series of years. The long term
asset are those that affect the firm’s operational beyond the one year period.

Investment decisions generally include expansion, acquisition modernization and

replacement of the long term asset sale of a division or business (divestment) is also
an investment decision. Decision like the change in the method of sales distribution or
an advertisement campaign or a research and developing program have long term
implication for the firm’s expenditures and benefits and therefore they should also be
evaluated as investment decision.

The argument that capital is a limited resource is true of any form of capital, whether
debt or equity (short-term or long-term, common stock) or retained earnings, accounts
payable or notes payable, and so on. Even the best known firm in an industry or a
community can increase its borrowing up to a certain limit. Once this pint has been
reached, the firm will either be denied more credit or be charged a higher interest rate,
making borrowing a less desirable way to raise capital.

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CAPITAL BUDGETING PROCESS:

Capital budgeting is a complex process as it involves decisions relating to the

investment of current funds for the benefits to be achieved in future and the future is
always uncertain. However, the following procedure may be adapted in the process of
capital budgeting. There are five stages in the capital budgeting.

Identification Assembling of Decision

of investment investments making
opportunities

Performance Implement Preparation of

review action capital
budgeting

 Identification of investment opportunities:

The capital budgeting process begins with the identification of potential
investment opportunities. Typically, the planning body (it may be an individual or
committee organized formally or informally) develops estimates of future sales which
identifying required investment in plant and equipment.

Identification of investment ideas it is helpful to:

 Monitor external environment regularly to scout investment opportunities.

 Formulate a well defined corporate strategy based on through analysis of

strengths, weaknesses, opportunities and threats.

 Share corporate strategy and respective with persons.

 Motivate employees to make suggestions.

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 Assembling of investments

Investment proposal identified by the production department and other department are
usually submitted in a standardized capital investment proposal form. Generally, most
of the proposal, before they reach the capital budgeting committee or viewed from
different angle. It also helps in creating a climate for bringing about co-ordinations of
inter related activities.

Investment proposals are usually classified into various categories for facilitating
decision making, budgeting and control.

 Replacement investments
 Expansion investment
 New product investment
 Obligatory and welfare investment

 Decision making:

A system of rupee gateways usually characterized capital investment decision

making. Under this system executive are vested with the power to pay investment
proposals up to certain limits.

 Preparation of capital budgeting:

Projects involving smaller outlays and which can be decided by executives at lower
levels are often covered by a blanket appropriation for expenditures action. Projects
involving larger outlays are included in the capital budget after necessary approvals.
Before under facing such projects an appropriation order is usually required. The
purpose of this check is mainly to ensure that the funds position of the firm
satisfactory at the time of implementation.

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 Implementation action:

Translating an investment proposal into a concert project is a complex, time

consuming and risk fraught task.

 Adequate formulation of projects

The major reasons for delay is insinuate formulation of projects but differently,
if necessary home work in terms of preliminary comprehensive and detailed
formulation of the project.

 Use of the principal of responsibility accounting:

Assigning specific responsibility to project managers for completing the

project within the defined time frame and cost limits is helpful for expeditious
execution and cost control.

 Use of network techniques:

For project planning and control several network techniques like PERT
(Programmed evolution review techniques) and CPM (Critical path method) is
available.
 Performance review:

Performance review or post completion is a feed back device. It is a means for

comparing actual performance with projected performance. It may be conducted, most
appropriately. When the operation of the project have been stabilized. It is useful in
several ways

 It throws light on how realistic were the assumption underlying the project.

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 It provided a documented log of experience that is highly valuable for

decisional making.

Components of capital budgeting:

Initial investment outlay:

It includes the cash required to acquire the new equipment or build the new plant less
any net cash proceeds from the disposal of the replaced equipment. The initial outlay
also includes any additional working capital related to the new equipment. Only
changes that occur at the beginning of the project are included as part of the initial
investment outlay. Any additional working capital needed or no longer needed in a
future period is accounted for as a cash outflow or cash inflow during the period.

Net cash benefits or savings from the operations:

This component is calculated as under:

(The incremental change in operating revenues minus the incremental change in the
operating cost=incremental net revenue) minus (taxes) plus or minus (Changes in the
working capital and other adjustments).

Terminal cash flow:

It includes the net cash generated from the sale of the assets, tax effects from the
termination of the asset and the release of networking capital.

The net present value techniques:

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Although there are several methods used in capital budgeting, the net present value
technique is more commonly used. Under this method a project with a positive NPV
implies that it is worth investing in.

Basic steps of capital budgeting:

1. Estimate the cash flows.

2. Assess the risk ness of the cash flows.

3. Determine the appropriate discount rate.

4. Find the PV of the expected cash flows.

5. Accept the project if PV of inflows> costs. IRR> Hurdle Rate and/or

payback<policy.

Faced with limited sources of capital, management should carefully decide whether a
particular project is economically acceptable. In the case of more than one project,
management must identify the projects that will contribute most to profits and,
consequently, to the value (or worth) of the firm. This, in essence, is the basis of
capital budgeting.

Investment decisions- capital budgeting

Capital budgeting is vital in marketing decisions. Decisions on investment, which take

time to measure, have to be based on the returns which that investment will make.
Unless the project is for social reasons only, if the investment is unprofitable in the
long run, it is unwise to invest in it now.

Often, it would be good to know the present value of the future investment is, or how
long it will take to mature (give returns). It could be much more profitable putting the
planned investment money in the bank and earning interest, or investing in an
alternative project.

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Typical investment decisions include the decision to build another grain silo, cotton
gin or cold store or invest in a new distribution depot. At a lower level, marketers may
wish to evaluate whether to spend more on advertising or increasing the sales force,
although it is difficult to measure the sales to advertising ratio.

Chapter objective:
This chapter is intended to provide:

• An understanding of the importance of capital budgeting in marketing decision

making.
• An explanation of the different types of investment project.
• An introduction to the economic evaluation of investment proposals.
• The importance of the concept and calculation of net present value and
internal rate of return in decision making.
• The advantages and disadvantages of the payback method as a technique for
initial screening of two or more competing projects.

Structure of the chapter:

Capital budgeting is very obviously a vital activity in business. Vast sums of money
can be easily wasted if the investment turns out to be wrong or uneconomic. The
subject matter is difficult to grasp by nature of the topic covered and also because of
the mathematical content involved. However, it seeks to build on the concept of the
future value of money which may be spent now. It does this by examining the
techniques of net present value, internal rate of return and annuities. The timing of
cash flows are important in new investment decisions and so the chapter looks at this
“payback” concept. One problem which plagues developing countries is “inflation
rates” which can, in some cases, exceed 100% per annum.

Capital budgeting versus current expenditures:

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A capital investment project can be distinguished from current expenditures by two

features:
a) Such projects are relatively large.
b) A significant period of time (more than one year) elapses between the
investment outlay and the receipt of the benefits.
As a result, most medium sized and large organizations have developed special
procedures and methods for dealing with these decisions. A systematic approach to
capital budgeting implies:

a) The formulation of long term goals.

b) The creative search for and identification of new investment opportunities.

c) Classification of projects and recognition of economically and/or statistically

dependent proposals.

d) The estimation and forecasting of current and future cash flows.

e) A suitable administrative framework capable of transferring the required

information to the decision level.

f) The controlling of expenditures and careful monitoring of crucial aspects of

project execution.

g) A set of decision rules which can differentiate acceptable from unacceptable

alternatives is required.

The last point (g) is crucial and this is the subject of later sections of the chapter.

The classification of investment projects:

a) By project size:

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Small projects may be approved by departmental managers. More careful

analysis and board of directors approval is needed for large projects of say, half a
million dollars or more.

b) By type of benefit to the firm:

• An increase in cash flow.

• A decrease in risk
• An indirect benefit (showers for workers, etc).

c) By degree of dependence:

• Mutually exclusive projects (can execute project A or B, but not both)

• Complementary projects: taking project A increases the cash flow of
project B
• Substitute projects: taking project A decreases the cash flow of project
B

d) By degree of statistical dependence:

• Positive dependence
• Negative dependence
• Statistical dependence

e) By type of cash flow:

• Conventional cash flow: Only one change in the cash flow sign.
e.g. -/++++ or +/----, etc

• Non- Conventional cash flow: More than one change in the cash flow
sign.

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e.g. +/-/+++ or -/+/-/++++, etc

The economic evaluation of investment proposals:

The analysis stipulates a decision rule for:
I) Accepting or
II) Rejecting

Investment projects:
The time value of money:

Recall that the interaction of lenders with borrowers sets an equilibrium rate of
interest. Borrowing is only worthwhile if the return on the loan exceeds the cost of the
borrowed funds. Lending is only worthwhile if the return is at least equal to that
which can be obtained from alternative opportunities in the same risk class.

The interest rate received by the lender is made up of:

I) the time value of money: The receipt of money is preferred sooner rather than later.
Money can be used to earn more money. The earlier the money is received, the
greater the potential for increasing wealth. Thus, to forego the use of money, you
must get some compensation.

II) The risk of the capital sum not being repaid: This uncertainty requires a premium
as a hedge against the risk; hence the return must be commensurate with the risk
being undertaken.

III) Inflation: Money may lose its purchasing power over time. The lender must be
compensated for the declining spending/purchasing power of money. If the lender
receives no compensation, he/she will be worse off when the loan is repaid than at the
time of lending the money.

Future values/compound interest:

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Future value (FV) is the value in dollars at some point in the future of one or more
investments.
The general formula for computing future value is as follows:
FVn = V0 (1+r)n
Where
V0 is the initial sum invested,r is the interest rate ,n is the number of periods for which
the investment is to receive interest.
Thus we can compute the future value of what V0 will accumulate to in n years when
it is compounded annually at the same rate of r by using the above formula.

We can derive the present value(PV) by using the formula:

FVn = V0 (1+r)n
By denoting Vo by PV we obtain:
FVn = PV (1+r)n

Rationale for the formula:

As you will see from the following exercise, given the alternative of earning 10% on
his money, an individual (or firm) should never offer (invest) more than $10.00 to
obtain $11.00 with certainty at the end of the year.

Net Present Value (NPV):

The NPV method is used for evaluating the desirability of investments or projects.
Where
Ct = the net cash receipt at the end of year t
I0 = the initial investment outlay
r = the discount rate/the required minimum rate of return on investment
n = the project/investment’s duration in years

Decision rule:

If NPV is positive(+): accept the project

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If NPV is negative(-): reject the project

d) Perpetuities:

Perpetuities in an annuity with an infinite life. It is an equal sum of money to be paid

in each period forever.

e) The internal rate of return(IRR):

Refer students to the tables in any recognized published source.

• The IRR is the discount rate at which the NPV for a project equals zero. This
means that the present value of the cash inflows for the project would equal the
present value of its outflows.
• The IRR is the break even discount rate.
• The IRR is found by trail and error

Net Present Value vs Interal Rate of Return:

Independent vs dependent projects

NPV and IRR methods are closely related because:

I. Both are time-adjustment measures of profitability.

II. Their mathematical formulas are almost identical.

So, which leads to an optimal decision: IRR or NPV?

a) NPV vs IRR: Independent projects:

Independent project: Selecting one project does not preclude the choosing of the
other.

With conventional cash flows (-|+|+) no conflict in decision arises; in this case
both NPV and IRR lead to the same accept/reject decisions.

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NPV vs IRR independent projects

If cash flows are discounted at k1, NPV is positive and IRR> k1: accept project

If cash flows are discounted at k2, NPV is negative and IRR< k1: reject project

Mathematical proof: for a project to be acceptable, the NPV must be positive,

i.e.,where R is the IRR.

Since the numerators Ct are identical and positive in both instances:

• Implicitly/intuitively R must be greater than k (R>k).

• If NPV=0 then R=K: the company is indifferent to such a project.
• Hence, IRR and NPV lead to the same decision in this case.

b) NPV vs IRR: Dependent projects:

NPV clashes with IRR where mutually exclusive projects exist.

Up to a discount rate of k0: project B is superior to project A, therefore project B is

referred to project B.

Beyond the point k0: project A is superior to project B, there project is preferred to
project B.

The two methods do not rank the projects the same.

Differences in the scale of investment

NPV and IRR may give conflicting decisions where projects differ in their scale of
investment.

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The payback period (PP):

The CIMA defines payback as ‘the time it takes the cash inflows from a capital
investment project to equal the cash outflows, usually expressed in years’. When
deciding between two or more competing projects, the usual decision is to accept the
one with the shortest payback.

Payback is often used as a “first screening method”. By this, we mean that when a
capital investment project is being considered, the first question to ask is: ‘How long
will it take to payback its cost?’ The company might have a target payback, and so it
would reject a capital project unless its payback period was less than a certain number
of years.

Advantages of payback method:

Payback can be important: long payback means capital tied up and high investment
risk. The method also has the advantage that it involves a quick, simple calculation
and an easily understood concept.

The accounting rate of return- (ARR):

The ARR method (also called the return on capital employed(ROCE) or the return on
investment (ROI) method) of appraising a capital project is to estimate the accounting
rate of return that the project should yield. If it exceeds a target rate of return, the
project will be undertaken.
The payback and ARR methods in practice:

Despite the limitations of the payback method, it is the method most widely used in
practice. There are a number of reasons for this:

• It is particularly useful approach for ranking projects where a firm faces

liquidity constraints and requires fast repayment of investments.

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• It is appropriate in situations where risky investments are made in uncertain

markets that are subject to fast design and product changes or where future
cash flows are particularly difficult to predict.
• The method is often used in conjunction with NPV or IRR methods and act as
a first screening device to identify projects which are worthy of further
investigation.
• It is easily understood by levels of management.
• It provides an important summary method: how quickly will the initial
investment be recouped?

TYPES OF CAPITAL BUDGETING DECISIONS:

Capital budgeting decisions are of paramount importance in financial decision

making. In first place they affect the profitability of the firm. They also have a bearing
on the competitive position of the firm because they relate to fixed assets. The fixed
assets are true goods than can ultimately be sold for profit. Generally the capital
budgeting of investment decision includes addition, deposition, modification and
replacement of fixed assets

EXPANSION

DIVERSIFICATION

Types of capital
budgeting
decisions
REPLACEMENT

RESEARCH AND
DEVELOPMENT

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PROPOSAL
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Expansion:

The company may have to expand its production capacities on accounts of high
demand for its products or inadequate production capacity. This will need additional
capital equipment.

Diversification:

A company may intend to reduce it risk by operating in several activities. In such a

case capital investment may become necessary for purchases of new machinery and
facilities to handle the new product.

Replacement:

The replacement of fixed assets in place of existing assets, either being worn out or
become out dated on account of new technology.

Research and Development:

Large sums of money may have to be spent for research and development, in case
those industries where technology is rapidly changing. In such cases large sums of
money are needed for research and development activities. So these are also included
in the proposal so Capital Budgeting.

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Miscellaneous Proposals:

A company may have to invest money in projects, which do not directly helping
achieving profit-oriented goals. For example, installation of pollution control
equipment may be necessary on account of legal requirements. Therefore, funds are
required for such proposal also.

TECHNIQUES OF CAPITAL BUDGETING DECISIONS:

There are many methods of evaluating profitability of capital investment proposals.

The various commonly used methods are as follows.

Traditional methods or non-discounted Techniques:

1. Payback Period Method or Pay out or Pay off Method.

2. Improvement of traditional Approach to Pay Back Period Method.

3. Rate of Return Method or Accounting Method.

Time-adjusted method or discounted Techniques:

4. Net present Value Method.

5. Internal Rate of Return Method.

6. Profitability index Method.

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Capital
Budgeting
Techniques

Non- DCF DCF criteria

criteria

Net Present value

Pay Back Period (NPV)
(PBP)

Internal Rate of
Accounting Rate return(IRR)
of Return(ARR)

Profitability
Index
(PI)

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TYPES OF CAPITAL BUDGETING DECISIONS:

Capital budgeting decisions are of paramount importance in financial decision

making. In first place they affect the profitability of the firm. They also have a bearing
on the competitive position of the firm because they relate to fixed assets. The fixed
assets are true goods than can ultimately be sold for profit. Generally the capital
budgeting of investment decision includes addition, deposition, modification and
replacement of fixed assets.

Types of Capital Budgeting Decisions:

• Cost reduction program

• Undertaking an advertising campaign
• Replacement of assets
• Obtaining new facilities or expanding existing ones
• Merger analysis
• Refinancing an outstanding debt issue
• New and existing product evaluation
• No profit investments(e.g., health and safety)

IMPORTANCE OF CAPITAL BUDGETING:

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Capital budgeting decisions are among the most crucial and critical decisions and they
have significant impact on the future profitability of the firm. A special care should
taken while making capital decisions, because it influences all the branches of a
company such as production, marketing, personnel, etc. the other reasons for keeping
more attention on capital budgeting decisions include the following:
1. Long term implications:
2. Investment of large funds:
3. Irreversible decisions:
4. Most difficult to make:
5. Rising of fund

CHAPTER-II

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OBJECTIVES & METHODOLOGY

A capital budgeting decision may be defined as the firm’s to investing its current
funds most efficiency in the long term assets in anticipation of expected flows of
benefits over a serious of years.

The firm’s investment decision would generally expiation. Acquisition modernization

and replacement of the long – term assets. Thus the system of capital budgeting is
employed to evaluate expenditure decisions, which involve current outlays but are
likely to produce benefits over a period of time longer than one year. These benefits
may be either in the form of increased costs or reduced revenues.

The overall development of a firm depends on market development, entry in new

product line, termination of ma product, which is in declining stage, expansion of the
plant change of location etc.

OBJECTIVES OF THE STUDY

 To present theoretical framework relating to capital budgeting

 To evaluate the effectiveness of capital expenditure decisions of company.

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 To provide support in order to accomplished the over all goal of the capital

budgeting system of the company

 To evaluate the elements consider by the of the company expansion project.

 To offer findings, suggestions & conclusion based on the study.

RESEARCH METHODOLOGY

Methodology is a systematic process of collecting information in order to analyze and

verifies a phenomenon. The collection of data is two principle sources. They are
discussed as

I. Primary data

II. Secondary data

PRIMARY DATA

The primary data needed for the study is gathered through interview with concerned
officers and staff, either individually or collectively, sum of the information has been
verified or supplemented with personal observation conducting personal interviews
with concerned officers of finance department of “TIRUMALA MILK PRODUCTS
PRIVATE LTD”.

SECONDARY DATA

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The secondary data needed for the study was collected from published sources such
as, pamphlets of annual reports, returns and internal records, reference from text
books and journal management.

Further data needed for the study was collected from:-

 Collection of required data from annual records of the company.

Reference from text books and journals relating to financial management.

SCOPE OF THE STUDY

The study of capital budgeting in TIRUMALA MILK PRODUCTS PRIVATE LTS

includes analyzing the investment decision of the firm. As substantial amounts are
tied up in such decision, it needs careful analysis and proper management in order to
minimize the manufacturing costs and maximize its profits. As the information
available is limited and the subject is vast the study is combined to overall capital
budgeting techniques followed at the firm.

NEED FOR THE STUDY

A project is an activity sufficiently self-contained to permit financial and commercial

analysis. In most cases projects represent expenditure of capital funds by pre-existing
which want to expand or improve their operation.

In general a project is an activity in which, we will spend money in expansion of

returns in which logically seems to lead itself planning. Financing and

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implementations as a unit, is a specific activity with a specific point and a specific

ending point intended to a accomplish a specific objective of the study.

An efficient allocation of capital is the most important finance function in the modern
times. It involves decisions to commit the firm’s funds to the long-term assets.
Capitals budgeting for investment decisions are of considerable importance to the
firm since they tend to determine its value by influencing its growth, evaluation of
capital budgeting decisions.

A capital budgeting decisions may be defined as the firm’s decision to invest is

current funds most effectively & efficiently in the long term assets in anticipation of
an expected flow of benefits over a series of years. The long-term assets are those that
affect the firm’s operations beyond the one year period. The firm’s investment
decisions would generally includes expansion, acquisition modernization and
replacement of long term assets. Sale of a division or business is also an investment
decision. Decision like the change in the methods of sales distribution or an
advertisement campaign or research and development program have long—term
implications for the firm’s expenditure and benefits, and therefore they should also be
evaluated as investment decisions.

The rationale underlying the capital budgeting decisions efficiency. Thus, a firm must
replace worn and obsolete plant and machinery, acquire fixed assets for current and
new products and make strategic investment decisions. This will enable the firm to
achieve its objective of maximizing profits either by way of increased revenues or
cost reductions. The quality of these decisions is improved by capital budgeting.
Capital budgeting decision can be of two types:

1) To those which expand revenues, and

2) To those which reduce costs.

IMPORTANCE OF THE STUDY

Capital investments, representing the growing edge of a business, are deemed

to be very important “THREE” inter – related factors.

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1) The influence firm growth in the long term consequences capital

investment decisions have considerable impact on what the firm can do in future.

2) They affect the risk of the firm; it is difficult to reverse capital investment
decisions because the market for used capital investment in ill organized or most of
the capital equipments bought by a firm to meet its specific requirements.

3) Capital investment decisions involve substantial outlays.

TIRUMALA MILK PRODUCTS PRIVATE LTD, capital budgeting is more or less a

continuous process and it is carried out by different functional areas of management
such as production, marketing, financial management etc., all the relevant functional
departments play a crucial role in the capital budgeting decision process.

DIAGRAMATIC REPRESENTATION OF RESEARCH METHODOLOGY

Diagram 1.4:

DATA
SOURCES

PRIMARY SECONDARY
SOURCES SOURCES

INSIDE OUT SIDE

MANAGEMENT RESPONDENTS THE THE
COMPANY COMPANY

PERSONAL TEXT
ANNUAL
OBSERVA NCE BOOKS
REPORTS
JOURNALS
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LIMITATIONS OF THE STUDY

The following the limitations of the study:

 The project has to be completed with the available data given to us.

 The period of study that is 4 weeks is not enough to conduct study of the

project

 The study is carried basing on the information and documents provided by the

organization

 There was no scope of gathering current information, as the auditing has not

been done by time of project work.

 The procedure has to be completed with the available data with us.

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CHAPTER-III

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BRIEF INTRODUCTION ABOUT COMPANY

We have established a dairy unit named Tirumala Milk products (P) Limited, at
Kadivedu Village, Chillakur Mandal, Nellore District, Andhra Pradesh and
commissionered for commercial production for mareting during sepetember 1999 to
handle 2,25,000 litres of milk per day. The plant is located on Calcutta-Chennai
National High way, 9kms from Gudur town towards Chennai, in an are of 13.00 acres.

1. Inception
2. Vision
3. Mission
4. Policies

(1) INCEPTION:

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The unit is registered under S.S.I. The milk is bulk is being purchased from other
dairies processed, homogenized, packed and marketed mainly in Chennai, Bangalore
and Mysore cites. The milk is being also sold in Guduru, Tirupathi and Nellore towns
basing on consumers’ demand. By marketing the milk in various towns, assured
market. Out let is provided to large number of village milk producers for their surplus
are applied before machinery is installed in the dairy. Strict quality standards are
applied before marketing the milk for which well equipped laboratory is established.
In order to deliver quality milk to the consumers insulted trucks are used to transport
milk from the dairy to various destinations.

(2) VISION:

Tirumala Milk Products (P) Limited is a dream come true to the dynamic young
entrepreneurs who have jointly efforted to convert their skills, knowledge and
experience in the field of processing and producing milk and milk products.

Realizing the Milk Product Potentialities of the inversion track of the Government of
Andhra Pradesh and Government of India, with self managed financial resources and
established the Tirumala Dairy in the year 1995 at Narasaraopet, Guntur District and
erected new plant at Kadivedu in the year 1999. Today, the dairy has posd to equate
major dairies int eh southern region which has not only captured the market but also
has mode “Thirumala” an accepted Brand and preference of the consumers.

(3) MISSION:

Tirumala Milk Product (P) Limited is a dream come true to the dynamic young
entrepreneurs who have jointly efforted to convert their skills, knowledge and
experience in the field of processing and producing milk products.

(4) POLICIES:

Realizing the milk product potentialities of the inversion track of the Government of
Andhra Pradesh and Government of India, with self managed financial resources and
established the Tirumala Dairy in the year 1995, at Narasaraopet District, Guntur and

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erected new plant at Kadivedu in the year 1999. today, the dairy has posed to equate
major dairies in the southern region which has not only captured the market but also
has mode “ TIRUMALA” an accepted Brand and preference of the consumers.

II. HISTORY AND MILE STONES OF COMPANY:

Tirumala Milk Product (P) Ltd., Handles 6.5 Lakhs litres of milk per day in all their
pacing stations and main dairy plant. TMPPL having good infrastructure and well
equipped with all latest machinery to process 6.5 lakhs liter of milk per day, which is
the highest in the state of Andhra Pradesh has developed in a decade.

TMPPL handles milk in the following locations

S.No Packing Locations Handling capacity per
day
1 Gudur (Main plant) 4.0 lakhs litre
2 Vellala Cheruvu 1.0 lakhs litre
3 Bhimadolu 1.0 lakhs litre
4 Palamaner 1.5 lakhs litre

PROCUREMENT OF MILK

TMPPL established 32 chilling centers in Andhra Pradesh and 11 chilling centers in

Tamilnadu and one in Karnataka procure both buffalo milk. Good quality milk is
being procured and chilled with in short time at chilling centers, to retain freshness of
milk. The strength of the TMPPL is to procure 6.0 lakh liters of milk directly from
agents / farmers, by having fully equipped machinery and professionally trained staff.
TMPPL have full control on its systems. So that pure quality of milk products can be
supplied to customers.

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Butter: Is made from pure cow & buffalos fat under hygienically processed through
continues butter making machine with a capacity.

Ghee: Is made from pure cow & Buffalos butter under supervision 30 years
granulation, color and aroma of ghee with a capacity of 8 tones per day. Ghee is
packed in a wide range of 7ml to 15 kgs.

Milk powder: Is made from fresh cow & buffalo milk, plant is capable of marketing
all type of milk powders with a capacity of 15 tones per day.

By – products: Like Sterilized Flavored Milk, Lassi, Khava, Milk cake, Mysore Pak,
Panner.

ORGANIZATIONAL STRUCTURE

(a) Company C.M.D

TMPPL has its main dairy plant at kadivedu with handling and local procurement.
TMPPL has well maintained laboratories in all their dairies. Technically qualified

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staff are looking after testing of milk and milk products. Quality assurance
programmes are implemented at every stage to ensure quality of milk and products.

(b) Marketing Manager:

Main plant is processing 2.5 lakhs liter of milk per day in automatic sachet filling
machines to supply and distribution of milk to Chennai, Tirupathi, Nellore etc., in
insulated pubs.

(c) Roles:

The main dairy has powder plant of 15 tons capacity per day. The plant has been
designed to product 15000 kgs of milk power on a 20hours/ day. Evaporation is done
in multiple effect falling film evaporators and powder is manufactured with high
pressure nozzles pray dryer. The water evaporation capacity of the evaporator is
9400kg/hr and spray dryer is designed to 753 kg/hr. Fluid dbe dryer is also provided.

III. FUNCTIONAL ACTIVITIES

Marketing :-

TMPPL is having good marketing of milk and milk products, arketing offices at
Chennai, Bangalore & Hyderabad is having good distribution system. All the
marketing Executives are professionally trained and having good skills and
experience in marketing products. To maintain cold chain there are about 35 insulated
puff vehicles to trans port milk to various towns. There is tremendous in crease in
sales of milk card milk products due to best quality, there are about 3000 out tets in
AP, Tamilanadu and Karanataka. The dairy is catering need of 10 lakh customers
daily in southern region.
Finance :-

Your directors have pleasure is submitting they 10th annual report and audited
accounts for the financial year 2008-2009.

Financial Results

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The Consolidated Financial Results for the year ended 31th March, 2009 are
summarized below (Rs. In lacs)

PARTICULARS 31-03-2009 31.03.2008

CURRENTYEAR PREVIOUS YEAR
1. SALES 37380.24 28527.34
2. PROFIT BEFORE INTEREST 2221.87 1247.78
3. DEPRECIATION 526.75 403.69
4. INTEREST 371.11 235.99
5. PFROFIT BEFORE TAX 1324.01 608.10
6. CURRENT YEAR TAX 329.87 137.95
7. F B T 6.28 5.48
8. EARLIER YEARS TAX 1.78 10.22
9. PROFIT AFTER TAX 989.98 454.45
10. BROUGHT FORWARD BALANCE 1211.27 756.82
11. BALANCE CARRIED TO BALANCE SHEET 2201.25 1211.27

REVIEW OF OPERATION

During the year under review the following companies are amalgamated.

1) Tirumala Milk Product Pvt.Ltd. – Amalgamated Company

2) Tirumala Dairy Pvt.Ltd – Amalgamating Company
3) Janaki Rama Dairy Pvt. Ltd – Amalgamating Company
4) Pragathi Milk Products Pvt.Ltd – Amalgamating Company
5) Bhaktanjaneya Milk Foods Pv. Ltd - Amalgamating Company

As the share holders are aware of the amalgamation is to carry out the business more
economically and profitably by expanding the activities of the company. The scheme
of amalgamation is approved by the Honorable High Court of A.P as under Tirumala
Dairy Pvt Ltd. For 20 shares 1 share of Tirumala Milk Products (P) Ltd.,The share
application money with amalgamating shall be transferred to amalgamated company
and will treat accordingly.

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Review of Financial Statements:

The company has achieved a turnover of Rs.28527 lakhs as against 22202 lakhs for
previous year recording increase of 28.49% over the previous year. And the net profit
margin was increased to 2.13% from 1.40% i.e Rs.608.10 lakhs 311.80 lakhs of
previous year.

Fixed deposits:
Your company has not accepted deposits during the year under review

.Production:
The main plant has capacities with equipment to manufacture milk products like
butter, ghee and milk powder.

HUMAN RESOURCE:
The primary functions of the personnel department are responsible for initiating
evolving general policies procedure with practiced common with the future objectives
of the company. Responsible for leaving uniform service conditions for all
employees. Responsible for recruitment and promotion of officers and respect of
posting various groups users.

PRODUCTION:
TMPPL has its main dairy plant at Kadiveedu with handing capacity of 4.0 lakhs. Lts.
Of milk per day from various chilling centers and local procurement.

Market Milk:
Main plant is processing 2.5 lakhs liter of milk per day in automatic sachet filling
machines to supply and distribution of milk to Chennai, Tirupathi, Nellore etc, and
insulated pubs.

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 There is continuous growth is sales of milk from 5000 lts to 2,50,000. Its with in a
span of one decade. TMPPL maintaining consistency in quality and its standards
consumers have much confidence.
 TMPPL having its own supply chain management, which makes ease in timely
distribution and assured supply, which gains customers satisfaction.
 At our palamer unit process and supply of 1.00 lakh liters of milk and 2000 liters
of cured to Bangalore city.
 At our Vellachervu & Bhimadolu packing stations processing and packing 2.00
lakhs liters of milk to Hyderabad, Warangal, Vijayawada, Eluru, Guntur and
Rajahmundry.

IV. Research & Development:

Quality Assurance:

• TMPPL has well maintained laboratories in all their dairies. Technically qualified
staff are looking after of milk and products. Quality assurance programmes are
implemented at every stage to ensure quality of milk and milk products.

• This dairy is am ISO 9001:2000 and an ISO 22000:2005 certified company. The
dairy is following quality management system and food safety standards.

• TMPPL is having ISI License and Agmark License and all other statutory standards
as per requirements.

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• There is continuous growth in procurement and sales the capacities of the plant are
also increased to handle the milk to manufacture milk products.

• To meet the demand in market there is also plant to introduce products like cup
curd, lussey in retail markets.

• From time to time consumer are identified and producing the new products to
satisfy the customer, continual surveys are conducted to get feedback information
for analysis.

Sales:

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V. RATIONALITY OF TAB THE TOPIC SELECTED IN THE COMPANY:

“Capital Budgeting” decisions are paramount importance in financial decision

making. In the first place, such decisions affect the profitability of a firm. They also
have a bearing on the competitive position of they enterprise mainly because of the
fact that they relate of fixed assets. The fixed assets represent in a services. The true
earning assets of the firm. They enable the firm the generate finished goods that can
ultimately be sold from profit. The rather they precede a buffer that allows the if firms
to make sales and setend. True current assets are important the operating. That with
out fixed assets to generate finished products that can be converted into current assets
it firm involve a relatively small amount of funds therefore, such capital investment
decision may results in a major departive from what the company has been departive
from what the company has been doing in the past capital bodgoty decision determine
the future desty of it company.

The study in “A STUDY ON CAPITAL BUDGETING IN TIRUMALA MILK

PRODUCT PVT LTD” can to know that they are two sider of the project that the
investment side. The soeparetion principle says that the cash flows associated with
these sides should be separate while extrimating the cash inflowing an investment side
do not consider it formal charge like interest or dividend and fixed long term assets by
the company. It is suggested to hold the company in the same level. It also reveals that
cases blows having ups and downs due to expansions of assets simultaneously
depreciation.

INDIAN DAIRY INDUSTRY PROFILE

Today, India is ‘The Oyster” of the global dairy industry. It offers opportunities
galore to entrepreneur’s world wide, who wish to capitalize on one of the world’s
largest and fastest growing markets for milk and milk products. A bagful of ‘pearls’
awaits the international dairy processor in India. The Indian dairy industry is rapidly

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growing, trying to keep pace with the galloping progress around the world. As he
expands his overseas operation to India many profitable options await him. He may
transfer technology, sign joint ventures or use India as a sourcing center for regional
exports. The liberalization of the Indian economy beckons to MNC’s and foreign
investors alike.

India’s dairy sector is expected to triple its production in the next 10 years in view of
expanding potential for export to Europe and the West. Moreover with WTO
regulations expected to come into force in coming years all the developed countries
which are among big exporters today would have to withdraw the support and subsidy
to their domestic milk products sector. Also India today is the lowest cost producer of
per liter of milk in the world, at 27 cents, compared with the U.S’s 63 cents, and
Japan’s $2.8 dollars. Also to take advantage of this lowest cost of milk production and
increasing production in the country multinational companies are planning to expand
their activities here. Some of these milk producers have already obtained quality
standard certificates from the authorities. This will help them in marketing their
products in foreign countries in processed form.

The urban market for milk products is expected to grow at an accelerated pace of
around 33% per annum to around Rs.43,500 Crores by year 2005. This growth is
going to come from the greater emphasis on the processed foods sector and also by
increase in the conversion of milk into milk products. By 2005, the value of Indian
dairy produce is expected to be Rs.10,00,000 Million. Presently, the market is valued
at around Rs.7,00,000 Million.

Background:

India with 134mn cows and 125mn buffaloes has the largest population of cattle in the
world. Total cattle population in the country as on October’00 stood at 313mn. More
than fifty percent of the buffaloes and twenty percent of the cattle in the world are
found in India and most of these are milk cows and milk buffaloes.

Indian dairy sector contributes the large share in agricultural gross domestic products.
Presently there are around 70,000 village dairy cooperatives across the country. The

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co-operative societies are federated into 170 district milk producers unions, which is
turn has 22-state co-operative dairy federation. Milk production gives employment to
more than 72mn dairy farmers. In terms of total production, India is the leading
producer of milk in the world followed by USA. The milk production in 1999-00 is
estimated at 78mn MTas compared to 74.5mn MT in the previous year. This
production is expected to increase to 81mn MT by 2000-01 of this total produce of
78mn cows’ milk constitute 36mn MT while rest is from other cattle.

While world milk production declined by 2 percent in the last three years, according
to FAO estimates, Indian production has increased by 4 percent. The milk production
in India accounts for more than 13% of the total world output and 57% of total Asia’s
production. The top five milk producing nations in the world are India, Russia,
Germany and France.

Although milk production has grown at a fast pace during the last three decades
(Courtesy: Operation Flood), milk yield per animal is very low. The main reasons for
the low yield are

 Lack of use of scientific practices in milching

 Inadequate availability of fodder in all seasons.
 Unavailability of veterinary health service

Milk yield comparision:

Country Milk Yield

(Kgs per year)
USA 7002
UK 5417
Canada 5348
New Zealand 2976
Pakistan 1052
India 795
World (Average) 2021

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Source: Export prospects for agro-based industries, World Trade Centre, Mumbai.

Production of Milk in India:

year Production in MT

1998-99 48.4

1999-00 51.4

2000-01 53.7

2001-02 56.3

2002-03 58.6

2003-04 61.2

2004-05 63.5

2005-06 65.0

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2006-07 68.5

2007-08 70.8

2008-09 74.7

2009-2010(E) 78.1

2010-11(T) 81.0

E = Estimated T = Target/ Expected

Source: DEPI, Annual Report – 2009-2010

World’s major milk producers:

(Million MTS)
country 2007-08 2008-09 (Approx.)
India 71 74.5
USA 71 71
Russia 34 33
Germany 27 27
France 24 24
Pakistan 21 22
Brazil 21 27
UK 14 14
Ukraine 15 14
Poland 12 12
New Zealand 11 12
Netherlands 11 11
Italy 10 10
Australia 9 10

Operation Flood:

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The transition of the Indian milk industry from a situation of net import to that of
surplus has been led by the efforts of National Dairy Development Board’s Operation
Flood. Program under the aegis of the former Chairman of the board Dr.Kurien.

Launched in 1970, Operation Flood has led to the modernization of India’s dairy
sector and created a strong network for procurement processing and distribution of
milk by the co-operative sector. Per capita availability of milk has increased from 132
gm per day in 1950 to over 220 gm per day in 2007. The main thrust of Operation
Flood was to organize dairy cooperatives in the milk shed areas of the village, and to
link them to the fourth Metro cities, which are the main markets for milk. The efforts
undertaken by NDDB have not only led to enhanced production, improvement in
methods of processing and income generation in the rural areas. It has also led to an
improvement in yields, longer lactation periods, shorter calving intervals, etc through
the use of modern breeding techniques. Establishment of milk collection centers and
chilling centers has enhanced life of raw milk and enabled minimization of wastage
due to dairy development programmed and looking at the success achieved in India
by adopting the co-operative route, a few other countries have also replicated the
model of India’s White Revolution.

Per Capita availability of milk:

Gm / day
Year
1950 132
1960 127
1968 113
1973 111
1980* 128
1990 178
1992 192
2005 198
2006 200
2007 202
2008 203
2009 212
2010 E 225
2011 P 250

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E = Estimated
P = Provisional

Fresh milk:

Over 50% of the milk produced in India is buffalo milk. And 45% is cow milk. The
buffalo milk contribution to total milk produce is expected to be 54% in 2000. buffalo
milk 3.6% protein, 7.4% fat, 5.5% sugar, 0.8% ash and 82.7% water where as cow
milk has 3.5 protein, 3.7% fat, 4.9% milk sugar, 0.7% ash and 87% water. While
presently (for the year 2000) the price of buffalo milk is ruling at $261 – 313 per MT
that of cow is ruling $170-267 per MT. fresh pasteurized milk is available in
packaged from. However, a large part of milk consumed in India is not pasteurized,
and is sold in loose form by vendors. Sterilized milk is scarcely available in India.

Packaged milk can be divided according to fat content as follows.

Whole (full cream) Milk – 6% fat

Standardized (toned) milk -4.5% fat
Doubled toned (low fat) Milk – 3 % fat
Another category of milk, which has a small market is flavored milk.

1. THE INDIAN MARKET – A PYRAMID:

Consumer Habits and Practices

Milk has been an integral pat of Indian food for centuries. The par capital availability
of milk in India has grown from 172 gm per person per day in 1972 to 182 gm in
1992 and 203 gm in 1988-2008. This is expected to increase to 212 gms for 2008-09.
However, a large part of the population cannot afford milk. At this per capita
consumption it is below the world average of 285 gm and even less than 220 gm

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recommended by the Nutritional Advisory Committee of the Indian Council of

Medical Research.

There are regional disparities in production and consumption also. The per capita
availability in the north is 278gm, west 174gm, south 148gm and in the east only 93
gm per person per day. This disparity is due to concentration of milk production in
some pockets and high cost of transportation. Also the output of milk in cereal
growing areas is much higher than elsewhere which can be attributed to abundant
availability of fodder, crop residues, etc which have a high food value for milk
animals.

In India about 46% of the total milk produced is consumed in liquid form and 47% us
converted into traditional products like cottage butter, ghee, punier, khoya, curd,
Malay, etc. only 7% of the milk goes into the production of western products like
milk powders, processed butter and processed cheese. The remaining 54% is utilized
for conversion to milk products. Among the milk products manufactured by the
organized sector some of the prominent ones are ghee, butter, cheese, ice creams,
milk powders, malted milk food, condensed milk infant’s foods etc of these ghee
alone accounts for 85%.

It is estimated that around 20% of the total milk produced in the country is consumed
at producer-household level and remaining is marketed through various cooperatives,
private dairies and vendors. Also of the total produce more than 50% is produced by
cooperatives and other private dairies.

While for cooperatives of the total milk produced 60% is consumed in fluid form and
rest is used for manufacturing processed value added dairy products; for private
dairies only 45% is marketed in fluid form and rest is processed into value added
products like ghee, makhan etc.

Still, several consumers in urban areas prefer to buy loose milk from vendors due to
the strong perception that loose milk is fresh. Also a current level of processing and
packaging capacity limits the availability of packaged milk.

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The preferred dairy animal in India is buffalo unlike the majority of the world market,
which is dominated by cow milk. As high as 98% of milk is produced in rural India,
which caters to 72% of the total population, whereas the urban sector with 28%
population consumes 56% of total milk produced. Even in urban India, as high as
83% of the consumed milk comes from the unorganized traditional sector.

Presently, only 12% of the milk market is represented by packaged and branded
pasteurized milk, valued at about Rs.8,000 crores. Quality of milk sold by
unorganized sector however is inconsistent and o is the price across the season in
local areas. Also these vendors add water and caustic soda, which makes the milk
unhygienic.

India’s dairy market is multi-layered. It’s shaped like a pyramid with the base made
up of a vast market for low-cost milk. The bulk of the demand for milk is among the
poor in urban areas whose individual requirement is small, may be a glassful for use

as whitener for their tea and coffee. Nevertheless, it adds up to a sizable volume –
millions of liters per day. In the major cities lies an immense growth potential for the
modern sector. Presently, barely 778 out of 3,700 cities and towns are served by its
milk distribution network, dispensing hygienically packed wholesome, quality
pasteurized milk. According to one estimate, the packed milk segment would double
in the next five years, giving both strength and volume to the modern sector. The
narrow tip at the top is a small but affluent market for western type milk products.

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