Indian Streams Research Journal

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1 Vol 5 Issue 1 Feb 2015 ISSN No : ORIGINAL ARTICLE International Multidisciplinary Research Journal Indian Streams Research Journal Executive Editor Ashok Yakkaldevi Editor-in-Chief H.N.Jagtap

2 Welcome to ISRJ RNI MAHMUL/2011/38595 ISSN No Indian Streams Research Journal is a multidisciplinary research journal, published monthly in English, Hindi & Marathi Language. All research papers submitted to the journal will be double - blind peer reviewed referred by members of the editorial board.readers will include investigator in universities, research institutes government and industry with research interest in the general subjects. International Advisory Board Flávio de São Pedro Filho Federal University of Rondonia, Brazil Kamani Perera Regional Center For Strategic Studies, Sri Lanka Janaki Sinnasamy Librarian, University of Malaya Romona Mihaila Spiru Haret University, Romania Delia Serbescu Spiru Haret University, Bucharest, Romania Anurag Misra DBS College, Kanpur Titus PopPhD, Partium Christian University, Oradea,Romania Mohammad Hailat Dept. of Mathematical Sciences, University of South Carolina Aiken Abdullah Sabbagh Engineering Studies, Sydney Ecaterina Patrascu Spiru Haret University, Bucharest Loredana Bosca Spiru Haret University, Romania Fabricio Moraes de Almeida Federal University of Rondonia, Brazil George - Calin SERITAN Faculty of Philosophy and Socio-Political Sciences Al. I. Cuza University, Iasi Editorial Board Hasan Baktir English Language and Literature Department, Kayseri Ghayoor Abbas Chotana Dept of Chemistry, Lahore University of Management Sciences[PK] Anna Maria Constantinovici AL. I. Cuza University, Romania Ilie Pintea, Spiru Haret University, Romania Xiaohua Yang PhD, USA...More Pratap Vyamktrao Naikwade Iresh Swami ASP College Devrukh,Ratnagiri,MS India Ex - VC. Solapur University, Solapur R. R. Patil Head Geology Department Solapur University,Solapur Rama Bhosale Prin. and Jt. Director Higher Education, Panvel Salve R. N. Department of Sociology, Shivaji University,Kolhapur N.S. Dhaygude Ex. Prin. Dayanand College, Solapur Narendra Kadu Jt. Director Higher Education, Pune K. M. Bhandarkar Praful Patel College of Education, Gondia Sonal Singh Vikram University, Ujjain Rajendra Shendge Director, B.C.U.D. Solapur University, Solapur R. R. Yalikar Director Managment Institute, Solapur Umesh Rajderkar Head Humanities & Social Science YCMOU,Nashik S. R. Pandya Head Education Dept. Mumbai University, Mumbai Govind P. Shinde Bharati Vidyapeeth School of Distance Education Center, Navi Mumbai Chakane Sanjay Dnyaneshwar Arts, Science & Commerce College, Indapur, Pune Awadhesh Kumar Shirotriya Secretary,Play India Play,Meerut(U.P.) G. P. Patankar Alka Darshan Shrivastava S. D. M. Degree College, Honavar, Karnataka Shaskiya Snatkottar Mahavidyalaya, Dhar Maj. S. Bakhtiar Choudhary Director,Hyderabad AP India. S.Parvathi Devi Ph.D.-University of Allahabad Sonal Singh, Vikram University, Ujjain Rahul Shriram Sudke Devi Ahilya Vishwavidyalaya, Indore S.KANNAN Annamalai University,TN Satish Kumar Kalhotra Maulana Azad National Urdu University Address:-Ashok Yakkaldevi 258/34, Raviwar Peth, Solapur Maharashtra, India Cell : , Ph No: ayisrj@yahoo.in Website:

3 Indian Streams Research Journal ISSN Impact Factor : (UIF) Volume-5 Issue-1 Feb-2015 Available online at CASE STUDY ON CAPITAL BUDGETING WITH SPECIAL REFERENCE TO HOTEL MADHUVAN INTERNAL PRIVATE LIMITED 1 2 Pooja K. Jahagirdar and Pradeep K. Gupta 1 Student, BLDEA's, A. S. Patil College of Commerce, (BBA Programme), Vijayapur, Karnataka. 2 Asst. Professor, BLDEA's, A. S. Patil College of Commerce, (MBA Programme), Vijayapur, Karnataka. Abstract:-Capital investment refers to the investment in projects whose results would be available after year for the maximization profit of the company, the company should take right investment decision or accept right investment proposal which will help in achieving expected flow of benefits at the right time. Secondary data was collected through various media like fact sheets, internet, business magazines, newspapers, books of various authors etc. This research paper is based on Capital Budgeting with special reference to Hotel Madhuvan International Private Limited, Vijayapur. It s a service firm with hotel and lodging facilities. The firm has decided to modernize its lodging department investing 2.5 lakh on each room; there are 36 rooms and require a investments of Rs.90,00,000. This research paper is an attempt to analyze the viability of the new proposal by using different capital budgeting techniques. Keywords: Capital budgeting, investment proposal. INTRODUCTION: Capital Budgeting is the planning of long-term financial projects relating to investments funded through long term sources of capital. Capital budgeting is a decision-making process that facilitates managers to evaluate and identify projects that are beneficial to the company. It is the most important task for managers for the following reasons. Firstly, capital budgeting helps the company to take its strategic decisions and directs the company in undertaking new product, new service, new technology. Second, capital budgeting decisions are less flexible and have long lasting effect on the company. Third, serious consequences may arise from poor capital budgeting decisions. For example, if a company devoted too much capital to one project, the company s capital would be unnecessarily spent on excess production capacity. On the other hand, investment of inadequate capital by the company results in low productivity and would suffer by the simple fact that its equipment, computer hardware and software might not be cutting-edge to improve production. These poor capital budgeting decisions may provide the rival companies an opportunity to steal market share by taking advantage of a lower cost structure or production capabilities matching demand. The goal with capital budgeting is to select the projects that bring the most value to the firm. Ideally, one would like to select all of the projects that add value, and avoid those that lose value. Making optimal capital budgeting decisions requires recognizing and correctly accounting the flexibilities associated with the project. The Capital Budget reflects the continuing need to replace existing infrastructure along with making investments to achieve efficient, effective and sustainable utilization of available resources. REVIEW OF LITERATURE Chandra, P(1975): conducted a study on 20 companies and his observations were payback period method 1 2 Pooja K. Jahagirdar and Pradeep K. Gupta, CASE STUDY ON CAPITAL BUDGETING WITH SPECIAL REFERENCE TO HOTEL MADHUVAN INTERNAL PRIVATE LIMITED Online & Print 1

4 was used for evaluating the investments of small size and accounting rate of return method was used as primary criterion and payback period method as supplementary criterion for evaluating the investments of large size. Discounted cash flow technique though not commonly used, are gaining importance, particularly in the evaluation of large investments. Porwal L.S. (1976): An empirical study was conducted by Porwal L.S. on the organizational, quantitative, qualitative, behavioural and control aspects of capital budgeting. He had selected 118 companies out of which 52 companies (44%) provided usable responses. He states 44% of the respondents ranked first preference for DCF techniques, however, most companies were using combination of traditional and theoretically correct economic evaluation techniques of capital expenditure proposals. New product line preferred IRR and existing product line preferred ARR and PBP continues to be the next preferred technique. Competitive position is the main non-financial factor that is given due consideration for the capital budgeting decision. Most companies in India are using one or more methods for incorporating risk. The shorter payback period and higher cut-off rate are the popular techniques used by companies in India. Wong, K. A., Farragher, E. J., and Leung, R. K. C. (1987) conducted a survey of large corporations in Hong Kong, Malaysia and Singapore in They found that in Malaysia, payback period was the most popular primary technique for evaluating and ranking projects. In Hong Kong, payback period and accounting rate of return are equally popular. They concluded that, in contrast to US companies where discounted cash flow techniques are significantly more popular than non-discounted cash flow techniques as primary evaluation measures, companies in Hong Kong, Malaysia and Singapore prefer to use several methods as primary measures in evaluating and ranking proposed investment projects. Pandey, I. M. (1989):In his survey and found that all companies, except one, used payback period method and payback period method gained importance because of its simplicity to use and understand, its emphasis on the early recovery of the investment, its focus on risk. DCF techniques in India plays secondary role because of its difficulty in understanding and using these techniques, lack of qualified professionals and unwillingness of top management to use DCF techniques. Ken, L. K., and Cherukuri, U. R.(1991): In their study on US companies observed "Internal rate of return is the number one choice of 66%, while 33% selected net present value as their most preferred (Primary) method." Pike Richard(1992): had conducted a longitudinal capital budgeting study based on surveys between 1975 and 1992 on 100 large United Kingdom s companies and observed firms size influenced the usage of DCF methods but not the traditional methods of capital budgeting techniques ( PBP & ARR). Large organizations ranked Internal Rate of Return (IRR) first, followed by Net Present Valueand Pay Back Period whereas smaller organizations ranked PBP first, Accounting Rate of Returnsecond and adjusted PBP and IRR third. Dhankar R. S.(1995): examined methods of evaluating investments and uncertainty in Indian companies. He selected a sample of 75 firms. His findings revealed that non-discounted methods like PBP and ARR were used by 33% of firms whereas 16% of firms used modern DCF techniques. Moreover, almost 50% of the companies incorporated risk by Adjusting the Discount Rate and Capital Asset Pricing Model Gupta, S., Batra, R.,and Sharma, M.(2007): they made an attempt to explore which capital budgeting techniques is used by industries in Punjab and they found non-discounted cash flow techniques like PBP and ARR were used by majority of the sample companies. Only a few companies used DCF, and among them very negligible number use NPV technique to evaluate a new project OBJECTIVES OF STUDY To study & understand the capital budgeting process. To study and understand on what basis investment decision are taken. To analyse the investment proposal of Hotel Madhuvan International Private Limited using capital budgeting techniques. SCOPE OF THE STUDY This research paper is based on Capital Budgeting with special reference to Hotel Madhuvan International Private Limited, Vijayapur. It s a service firm with hotel and lodging facilities. Madhuvan hotel has decided to modernize its lodging department investing 2.5 lakh on each room; there are 36 rooms i.e., Rs. 90,00,000 investments. This research paper will analyze the viability of the new proposal by using different capital budgeting techniques and suggest the Hotel Madhuvan International Private Limited to undertake the project or not. 2

5 RESEARCH METHODOLOGY For the purpose of the study secondary data was collected from the books of Hotel Madhuvanand capital budgeting techniques have been used to achieve the objective. The capital budgeting can be categorised as given below: Traditional techniques Payback period Accounting rate of return Modern techniques Discounted payback period Net present value Profitability index Internal rate of return Formula used Payback period= No. of years + Amount to recover/ total cash inflow of next year ARR = Average Profits After Tax/ Net investment x 100 NPV= Present value of cash inflows Initial investment Profitability index = Present value of cash inflows/ Initial investment DATA ANALYSIS AND INTERPRETATION Existing project Note: It is assumed that 70% of capacity is utilized. Hence 70% of Rs. 1,20,45,000 is Rs. 84,31,500. Expenses incurred are assumed to be around 25% of computed receipts i.e., 25% of 84,31,500 are 21,07,875 Proposed project Note: TYPE OF ROOM TARIFF TOTAL NO. OF ROOMS TOTAL INCOME (PER DAY) TOTAL INCOME (PER YEAR) 1 Executive deluxe A/C 1, ,000 43,80,000 2 Deluxe A/C 1, ,000 32,85,000 3 Deluxe non A/C ,200 26,28,000 4 Standard ,800 17,52,000 Total 36 33,000 1,20,45,000 TYPE OF ROOM TARIFF TOTAL NO. OF ROOMS TOTAL INCOME (PER DAY) TOTAL INCOME (PER YEAR) 1 Executive deluxe A/C 2, ,600 78,84,000 2 Deluxe A/C 1, ,200 59,13,000 3 Deluxe non A/C 1, ,960 47,30,400 4 Standard 1, ,640 31,53,600 Total 36 59,400 2,16,81,000 Booking of the rooms in a year is approximately 70%. Hence 70% of 2, 16, 81,000 are1, 51, 76,700. Expenses incurred are assumed to be increased to 40% of total income i.e.,40% of 1,51,76,700 are 60,70,680 Net income 3

6 =Total income - total expenses =1, 51, 76,700-60, 70,680 =91, 06,020 Hence, incremental cash flow is RS.27, 82,395. (Net cash flow of proposed project Net cash flow of existing project) (91, 06,020-63, 23,625) Other Details of the Proposed Project The project is about Hotel Madhuvan International Private Limited who has undertaken modernization and the details are as follows: 2.5 lakh is invested on each room for its modernization. Total investment RS. 90,00,000 Own investment RS.40,00,000 Loan from bank RS.50,00,000 Interest on loan 14 % Calculations: Depreciation ASSET DEPRECIATION RATE(WDV) Building 10% Plant and machinery 13.91% Furniture and fixture 18.10% Computer and peripherals 40% Office equipment 13.91% Electrical installation 13.91% ASSET Building (10% depreciation) SHARE IN TOTAL INVESTMENT AMOUNT Building 36% 32,40,000 Plant and machinery 13% 11,70,000 Furniture and fixture 32% 28,80,000 Computer and peripherals 2% 1,80,000 Office equipment 9% 8,10,000 Electrical installation 8% 7,20,000 Total 100% 90,00,000 YEAR AMOUNT DEPRECIATION BALANCE 1 32,40,000 3,24,000 29,16, ,16,000 2,91,600 26,24, ,24,400 2,62,440 23,61, ,61,960 2,36,196 21,25, ,25,764 2,12, ,13,

7 Plant and machinery (13.91% depreciation) YEAR AMOUNT DEPRECIATION BALANCE 1 11,70,000 1,62,747 10,07, ,07,253 1,40, ,67, ,67, ,20, ,46, ,46, ,03, ,42, ,42, , ,53, Furniture and fixture (18.10% depreciation) YEAR AMOUNT DEPRECIATION BALANCE 1 28,80,000 52,128 28,27, ,27,872 51, ,76, ,76, , ,26, ,26, , ,77, ,77, , ,28, Computer and peripherals (40% depreciation) YEAR AMOUNT DEPRECIATION BALANCE 1 1,80,000 72,000 1,08, ,08,000 43,200 64, ,800 25,920 38, ,880 15,552 23, ,328 9, ,996.8 Office equipment (13.91% depreciation) YEAR AMOUNT DEPRECIATION BALANCE 1 8,10,000 1,12,671 6,97, ,97,329 96, ,00, ,00, , ,16, ,16, , ,44, ,44, , ,83, Electrical installation (13.91% depreciation) YEAR AMOUNT DEPRECIATION BALANCE 1 7,20,000 1,00,152 6,19, ,19,848 86, ,33, ,33, , ,59, ,59, , ,95, ,95, , ,40, DEPRECIATION Year Building Plant Furniture Computer & Office Electric Total &machinery & fixture peripherals equipment installation 1 3,24,000 1,62,747 52,128 72,000 1,12,671 1,00,152 8,23, ,91,600 1,40, , ,200 96, , ,09, ,62,440 1,20, , ,920 83, , ,16, ,36,196 1,03, , ,552 71, , ,40, ,2, , , , , , ,76,

8 NET PRESENT VALUE YEAR INCREMENTAL CASH FLOW DEPRECIATION PADBT TAX PADAT PATNBD 1 27,82,395 8,23,698 19,58,697 98, ,59, ,83, ,82,395 7,09, ,73, ,10, ,62, ,71, ,82,395 6,16, ,65, ,20, ,45, ,62, ,82,395 5,40, ,41, ,27, ,13, ,54, ,82,395 4,76, ,05, ,34, ,71, ,47,904.7 NPV= Present value of cash inflows Initial investment 26,83, ,71, ,62, ,54, ,47,904.7 NPV = ,00, ^2 1.14^3 1.14^4 1.14^5 NPV = 91,53, ,00,000 NPV 1=,53,926.2 PROFITABILITY INDEX Profitability index = Present value of cash inflows/ Initial investment 91,53, PI = 90,00,000 PI 1=.02 ACCOUNTING RATE OF RETURN ARR = Average Profits After Tax/ Net investment x ,59, ,62, ,45, ,13, ,71, APAT = 5 APAT 1,01,52, = 5 6

9 APAT 20=,30, ,30, ARR = *100 90,00,000 ARR 22=.5% INTERNAL RATE OF RETURN Calculate the NPV of two closest rate of return. 14% = 1,53, % -= 61, Find the absolute sum of the NPV obtained in step1. 1,53, , = 2,51, Calculate the ratio of NPV of smallest rate and sum obtained in step 2 1,53, ,15, =.71 Add the number obtained in step 3 to smallest NPV = 14.71% Hence, IRR is % PAY BACK PERIOD Payback period= No. of years + Amount to recover/ total cash of next year s 9,82, = 26,54, =.37 years YEAR CASH FLOW CUMULATIVE CASH FLOW 1 26,83, ,83, ,71, ,55, ,62, ,17, ,54, DISCOUNTED PAY BACK PERIOD YEAR CASH FLOW DISCOUNTED CASH FLOW CUMULATIVE DISCOUNTED CASH FLOW

10 DPBP= No. of years + Amount to recover/ total cash of next year s 12,21, = 19,30, =.63years FINDINGS The points observed from the capital budgeting process are as follows: Net present value is Rs.1,53,926.2 Profitability index is 1.02 Accounting rate of return is 22.5% Internal rate of return is 14.72% Payback period is 3.37years Discounted payback period is 4.63 years CONCLUSION The capital budgeting helps management to choose the most profitable alternative for long term investment. The existing capital budgeting proposal is found to be clear and comprehensive.capital budgeting influences managerial action for long-term implications and it effects the growth and profitability of the firm. Since, Net present value is greater than 0, Profitability index is greater than 1, Accounting rate of return is higher than the target rate, Internal rate of return is greater than cost of capital, Payback period is less than target period, the proposed project has to be considered for investment. BIBLIOGRAPHY Chandra, P., (1975), Capital Expenditure Analysis in Practice, Indian Management, July, p Porwal, L. S., (1976), Capital Budgeting in India, Sultan Chand and Sons, New Delhi. 8.Wong, K. A., Farragher, E. J., and Leung, R. K. C.,(1987), Capital Investment Practices: A Survey of Large Corporations in Malaysia, Singapore and Hong Kong, Asia Pacific Journal of Management, January, pp Pandey, I. M.,(1989), Capital Budgeting Practices of Indian Companies,MDI Management Journal, January, Vol. 2, No.1 10.Ken, L. K., and Cherukuri, U. R., (1991), CurrentPractices in Capital Budgeting, Cost of Capital and Risk Adjustment, ASCI Journal of Management, June, Vol. 2 1, (1). 11.Pike Richard,(1996), A longitudinal survey on capital budgeting practices, Journal of Business Finance & Accounting, 23(1), January, X, pp Dhankar, R. S., (1995), An Appraisal of Capital Budgeting Decision Mechanism in Indian Corporates, Management Review, July-December, pp Gupta, S., Batra, R.,and Sharma, M.,( 2007 ), Capital Budgeting Practices in Punjab-based Companies, The Icfai Journal of APPLIED FINANCE, February, Vol. 13, No.2, pp Pooja K. Jahagirdar Student, BLDEA's, A. S. Patil College of Commerce, (BBA Programme), Vijayapur, Karnataka. Pradeep K. Gupta 2 Asst. Professor, BLDEA's, A. S. Patil College of Commerce, (MBA Programme), Vijayapur, Karnataka. 8

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