Fouji

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CAPITAL BUDGETING OF FAUJI CEMENT

2013

FAUJI CEMENT

SUMITTED TO: CH. MAZHAR HUSSAIN

SUBMITTED BY:

AMIR UR RAHMAN 5280

TARIQ FAROOQ

SYED KHURRUM SHAHZAD 5276

SYED AHMAD BLAL 5275

F A U J I C E M E N T L T D

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ACKNOWLEDGEMENTS

All Praise to Allah. First and foremost I thank Allah, the Generous, for having finally made this

effort a reality. I praise Him because if it were not for His Graciousness, it would never

materialize.

I’m extremely grateful to SIR CH. MAZHAR HUSSAIN who spent a lot of valuable time with us

and gave all the related information and expertise very generously about related course.

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TABLE OF CONTENTS

Chapter No. 1

Executive Summary…………………………………..…………………..……..6

Introduction……………………………………………….……………….……7

Company History………………………………………………..……………....8

Business……………………………………………………...……….………...9

Vision………………………...…………..………………………….……….…9

Mission…………...……………………………………………………. .............9

Product…………...……………………………………………….…………….9

Code of conduct……...…………………………………………….…………..10

Core responsibilities………………………………...……………………….…10

Our values…………………………………………..…….……………………10

Statement of corporate governance………………………...…………………..11

Chapter No. 2

Capital Budgeting………………………….………………..……………….…………15

Independent Project…….……………………….………...…….………..……...15

Mutually Exclusive Project……...………………….…………………..………..15

Capital Budgeting Method………………….………….…………..…………….16

Payback ………………………………………………………………………….16 Net Present Value…………………………………..……………….………...…17

Profitability Index…………………………….……………………….………...18

Internal Rate of Return………………………………………………….……….18

Interpolation…………………………………….………………………..……..18

Chapter No. 3

Project Introduction………………………………………………..……………….…20

Introductions ……………..…………………...……………….…………..........27

Capital structure of the project…………………………………………………..27

Assumption…………………………………………..………………..................28

Initial investment………………………………………...…..…………………..29

Cash flows………………………………………………….…………………....30

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Terminal cash flow…………………………………………………………...35

Chapter No. 4

Cost of capital ………………………………………………..……………..37

Structure of the project……………………………..………………………..38

Cost of Debt ……….……………………………………..…….……………39

Cost of Equity…………………………………………………….……..……39

Calculation of WAAC…………………………..……………………....……40

Chapter 5

Payback ……………………………………………………..………………….42

Discounted pay back ……………………………………….…………………..44

NPV…………………………………………………………………………….45

IRR …………………………………………………………..…………………46

Selection………………………………………………….…………………….50

Chapter 6

Risk and capital budgeting…………………….……………………………………….51

Break even analysis…………….……………………………………………….51

Sensitivity analysis……………………………………………………………...52

Risk adjusted discounted rate…………………..………………………………53

Chapter 7

Leverage and capital structure

Leverage…….…………………………………………………………………..55

Degree of Operating leverage……………………………………….………….56

Degree of debts leverage ……………………………………………………….57

Degree of total leverage…………………………..…………………………….58

Expected EPS and coefficient of EPS……………………..……………………59

Conclusion …………………………………………………..…………………………60

References ………………………………………………………...................................61

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Executive summary

This project is about the selection of investment project using capital budgeting

techniques. We selected Fauji Cement Company to choose its production plant project.This project has assigned to us as a complete course to provide opportunity of gaining

practical knowledge & using different techniques. The nature of project is capital

expenditure, we will use different methods of predicting future cash flows and also use

selection procedure method of capital budgeting.

After studying the capital budgeting process for cement industry, we have concluded that

almost all the objective and purpose of the report have been performed and a much

practical project has been presented. We have understood the capital budgeting process

and its application in the perspective of cement industry & Fauji Cement. We have

calculated the NPV, IRR, PI & PBP of this project, due to some drawbacks in

profitability index and payback period we selected the project on the basis of Net present

value & internal rate of return techniques.

We suggest Fauji Cement Company is to definitely accept the project which cost is

22000M.It is cost effective and reliable plant.

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CHAPTER NO. 1

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CHAPTER # 1 COMPANY INTRODUCTION

COMPANY PROFILE:

Since 19 years, they are giving the services for the Pakistan and its nation. its a long time

leader in the cement manufacturing industry, Fouji cement company, main branch is located

at Rawalpindi, and it is a headquartered, they operates a cement plant jhang Bahterm,

Tehsil Fateh Jhang & district Attock in the provinces of Punjab. More than 13 years

company is producing valuable products in which we can reliable and they are producing

quality products for their consumer and long standing traditions of services.

Fouji cement plant is one of the most efficient plants than all cements company. This plant

is best maintained in the country that is why they are producing 1.170 million tons of

cement. By producing the high quality of cement, government also preferred to use fouji

cement in construction of Highways, Bridges, commercial & Industrial complexes,

Residential homes & other structures.

COMPANY HISTORY

Fauji Cement Company Limited was sponsored by Fauji Foundation and incorporated as a

public limited company on 23 November 1992. It obtained the Certificate ofCommencement of Business on 22 May 1993. A longtime leader in the cement

manufacturing industry, Fauji Cement Company, headquartered in Islamabad, operates a

cement plant at Jhang Bahtar, Tehsil Fateh Jang, and District Attock in the province of

Punjab.

Fauji Cement is operating two lines of Cement Plants, one each from FLS Denmark &

POLYSIUS Germany. The plants are well renowned for their high efficiencies, best quality

production and are well maintained with annual total production capacity of 3.3 million tons

of cement. FAUJI Cement enjoys the reputation of being the Best Quality Cement in theCountry and is preferred in the construction of Mega Projects like Dams, Bridges,

Highways & Motorways, Commercial & Industrial complexes, Residential Housing Societies,

and a myriad of other structures needing speedy strengthening bond, fundamental to

Pakistan's economic vitality and quality of life.

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Ingredients:

- Clinker 95%

- Gypsum 5%

28 days compressive strength up to 10000 psi

OUR CODE OF CONDUCT:

It has been said that the essence of a successful and visionary company is the ability to

preserve its core values and to stimulate progress. Corporate ethics is the practice of our

shared values. These shared values define who we are and what we can expect from each

other. It is a code which applies to all employees and consists of standards decided by

Allah and His Messenger (PBUH).

CORPORATE RESPONSIBILITY: 1.1. The key to corporate integrity lies with all of us. Everyone has a

responsibility to uphold dedication to corporate ethics on daily basis. We allmust:-

•Know and follow this code in letter and spirit.

•Know and comply with our professional obligations.

•Take responsibility of own conduct.

•Report violations of this code to management appropriately.

1.2. This statement defines following broad corporate values that shape our

business practices.

OUR VALUES We listen to our customers and improve our product to meet their present and

future needs.

Our success depends upon high performing people working together in a safe and

healthy work place where diversity, development and team work are valued and

recognized.

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We expect superior performance and results. Our leaders set clear goals and

expectations, are supportive and provide and seek frequent feedback.

We support the communities where we do business, hold ourselves to the highest

standards of ethical conduct and environment responsibility, and communicate

openly with public and FCCL employees.

STATEMENT OF CORPORATE

VERNANCE

1. The company always encourages representation of independent non-executive

directors and directors representing less interest on its board of directors.

2. All of the directors have confirmed already that no one is serving as a director in

more than ten listed companies including this company.

3. All the directors have confirmed that they are registered as tax payers & none of

them has defaulted in payment of loan to bank.4. All the directors & employees have been signed on " statement of Ethics & business

Practices" which is prepared by the company.

5. All the powers of the board have been duly exercised & decision on meterial

transactions.

6. The meetings of the board are fully conversant with their duties & responsibilities

as directors.

7. All the directors of the board are fully conversant with their duties and

responsibilities as directors.

8. The directors, CEO & executives do not hold any interest in the shares of the

company, other than that disclosed in pattern of share holding.

9. The company has setup an effective internal audit function.

10. The statutory auditors or the persons associated with them have not been

appointed to provide other services.

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CHAPTER # 2 CAPITAL BUDGETING

CAPITAL BUDGETING:

The process in which a business determines whether projects such as building a new plantor investing in a long-term venture are worth pursuing. Oftentimes, a prospective project's

lifetime cash inflows and outflows are assessed in order to determine whether the returns

generated meet a sufficient target benchmark. Also known as "investment appraisal.

Ideally, businesses should pursue all projects and opportunities that enhance shareholder

value. However, because the amount of capital available at any given time for new projects

is limited, management needs to use capital budgeting techniques to determine which

projects will yield the most return over an applicable period of time.

Popular methods of capital budgeting include net present value (NPV), internal rate of

return (IRR), discounted cash flow (DCF) and payback period.

Steps in capital budgeting decision:

Proposal (feasibility report)

Financial analysis

Decision making

Follow up/ monitoring

PROJECT CLASSIFICATIONSCapital Budgeting projects are classified as either Independent Projects or Mutually

Exclusive Projects.

1. Independent Project:An Independent Project is a project whose cash flows are not affected by the

accept/reject decision for other projects. Thus, all Independent Projects which meet the

Capital Budgeting criterion should be accepted.

2. Mutually Exclusive Projects:

Mutually Exclusive Projects are a set of projects from which at most one will be accepted.

For example a set of projects which are to accomplish the same task. Thus, when choosing

between "Mutually Exclusive Projects" more than one project may satisfy the Capital

Budgeting criterion. However, only one, i.e., the best project can be accepted.

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Following are the cash flows from projects:

These project A and B are mutually exclusive but project have initial investment of 10000000

and the pattern of cash inflow is different so by the IRR project is accepted while through NPV

method shows B project is better than A.

Unlimited Funds Vs. Capital Rationing:

The company may have unlimited access to capital in which case it can execute all

profitable projects simultaneously. However, in reality firms will have constraints on how

much funds they have to invest. If there are more capital projects then the funds

available, the firm will have to exercise capital rationing and prioritize the projects and

first execute those that have the highest impact on shareholder’s value.

CAPITAL BUDGETING METHODSMany formal methods are used in capital budgeting, including the techniques

as followed:

Payback period Discounted payback period

Net present value

Profitability index

Internal rate of return

Equivalent annuity

http://www.capitalbudgetingtechniques.com/wp-content/uploads/2010/12/IRR-Example21.jpg




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Real options analysis

1) Payback periodPayback period in capital budgeting refers to the period of time required for the return on

an investment to "repay" the sum of the original investment. Payback period intuitively

measures how long something takes to "pay for itself." All else being equal, shorter

payback periods are preferable to longer payback periods.

The payback period is considered a method of analysis with serious limitations and

qualifications for its use, because it does not account for the time value of money, risk,

financing, or other important considerations, such as the opportunity cost.

Following formula can be used to calculate Payback period

2) Net Present Value:

The Net Present Value (NPV) of a Capital Budgeting project indicates the expected impact

of the project on the value of the firm. Projects with a positive NPV are expected to

increase the value of the firm. Thus, the NPV decision rule specifies thatall independent projects with a positive NPV should be accepted. When choosing

among mutually exclusive projects, the project with the largest (positive) NPV should be

selected.

The NPV is calculated as the present value of the project's cash inflows minus the present

value of the project's cash outflows. This relationship is expressed by the following

formula:

where

CFt = the cash flow at time t and

r = the cost of capital

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The example below illustrates the calculation of Net Present Value. Consider Capital

Budgeting projects A and B which yield the following cash flows over their five year lives.

The cost of capital for the project is 10%.

Project AYear Cash F low

0 $-1000

1 500

2 400

3 200

4 200

5 100

Net Present Value Project A:

3) Profitability Index:Profitability index (PI), also known as profit investment ratio (PIR) and value investment

ratio (VIR), is the ratio of payoff to investment of a proposed project. It is a useful tool

for ranking projects, because it allows you to quantify the amount of value created perunit of investment.

Following is the formula which is used for profitability index.

PROFITABILITY INDEX = PRESENT VALUE OF FUTURE CASH FLOW

INITIAL INVESTMENT

Rules for selection & rejection of projects.

If Profitability Index is greater than 1 so project will be accepted. If Profitability Index

is less than 1 so project will be rejected.

4) Internal rate of return:The Internal Rate of Return (IRR) of a Capital Budgeting project is the discount rate at

which the Net Present Value (NPV) of a project equals zero. The IRR decision rule

specifies that all independent projects with an IRR greater than the cost of capital should


http://www.prenhall.com/divisions/bp/app/cfl/CB/NetPresentValue.html

http://www.prenhall.com/divisions/bp/app/cfl/CB/NetPresentValue.html


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than the cost of capital. On the other hand, if they are mutually exclusive projects then

Project A should be chosen since it has the higher IRR.

Interpolation:

Interpolation relies on simple proportionality arguments as follows. If items a, b, c, d, and fare known, then e can be found by noticing that e is, in a proportion sense, at the same

relative position between d and f as b is between a and c. Thus, even if the scale for the

items below the line differs from the items above the line, the fractions of the distances will

be the same.

The interpolation process is only a close approximation of the true IRR. A more accurate

numeric search produces a resulting IRR The relationship between the discount rate and

the NPV is not linear, and thus the linear approximation provided by the interpolation will

not be exact. Of course, the wider the range of values over which you interpolate the

greater the potential degree of inaccuracy in your answer. And, surprisingly, the error isusually greatest when the IRR is approximately evenly bracketed by the end points; with

the approximation improving the closer the sought value is to one of the endpoints. Thus, it

is more important to get at least one of the endpoints to have an NPV near zero than to find

similar sized positive and negative values.

Interpolated Discount Rate = iL + (iH – iL)(PV1 )

PVl -PVH

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CHAPTER NO. 3

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CHAPTER # 3 PROJECT INTRODUCTION

PROJECT INTRODUCTION

The cement plant operating in the Fauji Cement is one of the most efficient and bestmaintained in the Country and has an annual production capacity of 1.165 million tons of

cement. The quality portland cement produced at this plant is the best in the Country and is

preferred in the construction of highways, bridges, commercial and industrial complexes,

residential homes, and a myriad of other structures, fundamental to Pakistan’s economic

vitality and quality of life.

Erection & Commissioning of New Line with a Production capacity of 7200 TPD has been

completed and Plant has started its production on 30th May 2011. The Plant is equipped

with latest and state of the art equipment and is a great value addition in Pakistan Cement

Industry. Major Equipment Suppliers are;

a. POLYSIUS Germany

b. LOESCHE GmBH Germany (Vertical Cement Mills)

c. Havor & Boecker Germany (Packing Plant)

d. ABB Switzerland (Electrical Equipment & PLC)

In pursuance of its commitment to produce cement under stringent environment friendly

conditions, the Company has taken the lead by installing first ever Refuse Derived Fuel

(RDF) Processing Plant at a cost of Rs. 320 Million. This project acts as a beacon to the

entire industrial sector of the Country towards an environment friendly production; RDF isnot only providing economical fuel to the Company but also contributing towards solving

the problem of Municipal Garbage Disposal. Minimum 300-400 tons of garbage is being

lifted from each garbage dump located at Rawalpindi and Islamabad. In addition, the other

important advantages include reduced use of fossil fuel, lowering of green house gases in

the atmosphere and availability of compost fertilizer as a byproduct.

For the new line production of 7200 TPD we have to evaluate two projects.

One Project has 22000 million initial cash outflow.

Second project have Cost of project cash outflow

CAPITAL STRUCTURE OF THE PROJECT

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Capital sources Amount Weight

common equity 9,900,000,000 0.45

Debt 12,100,000,000 0.55Total 22,000,000,000 0.1

Other relevant data of the two projects is given as below:

Cost of project A 22000 million

Cost of project B Cost of project

Project time period is 25 years

Rate = 35%

Debt to Equity Ratio = 0.55

Depreciation = 4%

Average Sale Increase = 12%

Average Price Per Ton = 3645

Average Capacity Utilization = 80%

ASSUMPTIONS

Due to new technology company sale will increase up to 12% in first 10 years of the

expansion. Then 9% increment will be made to the company sale to next five years

and at the end of last 10 years the company sale will increase to 6%. Due to new technology company sale will increase up to 10% in first 10 years of the

expansion. Then 8% increment will be made to the company sale to next five years

and at the end of last 10 years the company sale will increase to 6%.

Project time period is 24 years

Gross profit is 30% of the sales.

Expenses include cost of goods sold and operating expenses excluding depreciation

that is total 73.9% of the sale.

Depreciation rate is assumed 4% on original over the whole file of machinery

It is assumed that prevailing interest rate in Pakistan is 14% on average.

Tax must be applied at the rate of 35%.

It is assume that the plant with be scrape value equal to 880 at the end of 24 and

this scrape is sold for the 1200.

Company is financing with the combination of debt and common stock. The cost of

debt before adjusting tax factor is 14% as interest is 14% too

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Average Price Per Ton = 3645

INITIANAL INVESTMENT OF PROJECT A

Amount in million (Rs.)Cost of Asset 20,000

Installation Cost 2,000

Total cost of asset 22,000

Net working capital 0

Initial investment 22,000

INITIANAL INVESTMENT OF PROJECT B

Amount in million (Rs.)

Cost of Asset 15,000

Installation Cost 1,100Total cost of asset 16,100

Net working capital 0

Initial investment 16,100

OPERATIOAL CASH FLOWS OF

OJECT A

Financial year 2012 2013 2014 2015 2016 2017 2018

Revenue 6620.32 7414.758 8304.529 9301.073 10417.2 11667.27 13067.34

Expenses -4892.416 -5479.51 -6137.05 -6873.49 -7698.31 -8622.11 -9656.76

EBDIT 1727.9035 1935.252 2167.482 2427.58 2718.89 3045.156 3410.575

Depreciation -880 -880 -880 -880 -880 -880 -880

Earnings before interest

& Tax847.90352 1055.252 1287.482 1547.58 1838.89 2165.156 2530.575

Interest -1694 -1694 -1694 -1694 -1694 -1694 -1694

Earnings before Tax -846.0965 -638.748 -406.518 -146.42 144.8896 471.1564 836.5752

Tax 296.13377 223.5618 142.2812 51.24699 -50.7114 -164.905 -292.801

Earnings After Tax -549.9627 -415.186 -264.237 -95.173 94.17827 306.2517 543.7739

Depreciation 880 880 880 880 880 880 880

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Net operating Cash inflow 330.03729 464.8138 615.7634 784.827 974.1783 1186.252 1423.774

Financial year 2019 2020 2021 2022 2023 2024 2025

Revenue 14635.42 16391.67 18358.67 20561.71 22412.26 24429.37 26628.01

Expenses -10815.6 -12113.4 -13567.1 -15195.1 -16562.7 -18053.3 -19678.1

EBDIT 3819.844 4278.225 4791.613 5366.606 5849.601 6376.065 6949.91

Depreciation -880 -880 -880 -880 -880 -880 -880

Earnings before interest

& Tax 2939.844 3398.225 3911.613 4486.606 4969.601 5496.065 6069.91

Interest -1694 -1694 -1694 -1694 -1694 -1694 -1694

Earnings before Tax 1245.844 1704.225 2217.613 2792.606 3275.601 3802.065 4375.91Tax -436.045 -596.479 -776.164 -977.412 -1146.46 -1330.72 -1531.57

Earnings After Tax 809.7987 1107.747 1441.448 1815.194 2129.14 2471.342 2844.342

Depreciation 880 880 880 880 880 880 880


Financial year 2026 2027 2028 2029 2030 2031 2032Revenue 29024.53 31636.74 33534.94 35547.04 37679.86 39940.65 42337.09

Expenses -21449.1 -23379.5 -24782.3 -26269.3 -27845.4 -29516.1 -31287.1

EBDIT 7575.402 8257.189 8752.62 9277.777 9834.444 10424.51 11049.98

Depreciation -880 -880 -880 -880 -880 -880 -880

Earnings before interest &

Tax 6695.402 7377.189 7872.62 8397.777 8954.444 9544.51 10169.98

Interest -1694 -1694 -1694 -1694 -1694 -1694 -1694

Earnings before Tax 5001.402 5683.189 6178.62 6703.777 7260.444 7850.51 8475.981

Tax-1750.49 -1989.12 -2162.52 -2346.32 -2541.16 -2747.68 -2966.59


Depreciation 880 880 880 880 880 880 880


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Financial year 2019 2020 2021 2022 2023 2024 2025

Revenue 11289.34 12418.27 13660.1 15026.11 16228.2 17526.46 18928.57

Expenses

-8342.82 -9177.1 -10094.8 -11104.3 -11992.6 -12952.1 -13988.2EBDIT 2946.518 3241.17 3565.286 3921.815 4235.56 4574.405 4940.358

Depreciation -644 -644 -644 -644 -644 -644 -644


Tax 2302.518 2597.17 2921.286 3277.815 3591.56 3930.405 4296.358

Interest -1239.7 -1239.7 -1239.7 -1239.7 -1239.7 -1239.7 -1239.7


Tax-371.986 -475.114 -588.555 -713.34 -823.151 -941.747 -1069.83


Depreciation 644 644 644 644 644 644 644Net operating Cash inflow

1334.832 1526.355 1737.031 1968.775 2172.709 2392.958 2630.827

Financial year 2026 2027 2028 2029 2030 2031 2032

Revenue 20442.86 22078.29 23402.98 24807.16 26295.59 27873.33 29545.7

Expenses -15107.3 -16315.9 -17294.8 -18332.5 -19432.4 -20598.4 -21834.

EBDIT 5335.586 5762.433 6108.179 6474.67 6863.15 7274.939 7711.43

Depreciation -644 -644 -644 -644 -644 -644 -64


Tax 4691.586 5118.433 5464.179 5830.67 6219.15 6630.939 7067.43

Interest -1239.7 -1239.7 -1239.7 -1239.7 -1239.7 -1239.7 -1239.


Tax -1208.16 -1357.56 -1478.57 -1606.84 -1742.81 -1886.93 -2039.7


Depreciation 644 644 644 644 644 644 64


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Financial year 2033 2034 2035 2036

Revenue 31318.47 33197.58 35189.44 37300.

Expenses -23144.4 -24533 -26005 -27565.

EBDIT 8174.121 8664.569 9184.443 9735.50

Depreciation -644 -644 -644 -64

Earnings before interest & Tax7530.121 8020.569 8540.443 9091.50

Interest -1239.7 -1239.7 -1239.7 -1239.

Earnings before Tax 6290.421 6780.869 7300.743 7851.80

Tax -2201.65 -2373.3 -2555.26 -2748.1

Earnings After Tax 4088.774 4407.565 4745.483 5103.67

Depreciation 644 644 644 64

Net operating Cash inflow 4732.774 5051.565 5389.483 5747.67

OPERATING CASH FLOW OF A & B

GRAPHICAL PRESENTATION

0

1000

2000

3000

4000

5000

6000

7000

8000

9000

2 0 1 2

2 0 1 3

2 0 1 4

2 0 1 5

2 0 1 6

2 0 1 7

2 0 1 8

2 0 1 9

2 0 2 0

2 0 2 1

2 0 2 2

2 0 2 3

2 0 2 4

2 0 2 5

2 0 2 6

2 0 2 7

2 0 2 8

2 0 2 9

2 0 3 0

2 0 3 1

2 0 3 2

2 0 3 3

2 0 3 4

2 0 3 5

2 0 3 6

Project A Operating Cash Flows

Cash Flows A

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TERMINAL CASHFLOWS

Project A:

After tax sale proceed from the plant:

sale proceed from new plant 1,200

Tax 112

Net sale proceeds 1,088

After tax sale proceed from old Assets 0

working capital 0

Net terminal Cash flow 1,088

Calculation of tax

Sale proceed of the plant 1200

Book value 880

Re-capturing depreciation 320

Tax payment 112

Project B:

After tax sale proceed from the plant:

sale proceed from new plant 900

0

1000

2000

3000

4000

5000

6000

7000

Project B Operating CashFlows

Project B OperatingCashFlows

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Tax 89.6

Net sale proceeds 810.4

After tax sale proceed from old Assets 0

working capital 0

Net terminal Cash flow 810.4

Calculation of tax

Sale proceed of the plant 900

Book value 644

Re-capturing depreciation 256

Tax payment 89.6

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CHAPTER NO. 4

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CHAPTER # 4 COST OF CAPITAL

COST OF CAPITAL

The cost of funds used for financing a business. Cost of capital depends on the mode of

financing used – it refers to the cost of equity if the business is financed solely through

equity or to the cost of debt if it is financed solely through debt. Many companies use a

combination of debt and equity to finance their businesses, and for such companies, their

overall cost of capital is derived from a weighted average of all capital sources, widely

known as the weighted average cost of capital (WACC). Since the cost of capital represents

a hurdle rate that a company must overcome before it can generate value, it is extensively

used in the capital budgeting process to determine whether the company should proceed

with a project.

Sources of financing:

Debts

Common Stock

Preferred Stock

Retain earning

CAPITAL STRUCTURE OF THE

OJECT

Capital sources Amount Weight

common equity 9,900,000,000 0.45

Debt 12,100,000,000 0.55

Total 22,000,000,000 0.1

Cost of debts:

The effective rate that a company pays on its current debt. This can be measured in either

before- or after-tax returns; however, because interest expense is deductible, the after-tax

cost is seen most often. This is one part of the company's capital structure, which also

includes the cost of equity.

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A company will use various bonds, loans and other forms of debt, so this measure is

useful for giving an idea as to the overall rate being paid by the company to use debt

financing. The measure can also give investors an idea as to the riskiness of the company

compared to others, because riskier companies generally have a higher cost of debt.

To get the after-tax rate, you simply multiply the before-tax rate by one minus the marginal

tax rate (before-tax rate x (1-marginal tax)). If a company's only debt were a single bond in

which it paid 5%, the before-tax cost of debt would simply be 5%. If, however, the

company's marginal tax rate were 40%, the company's after-tax cost of debt would be only

3% (5% x (1-40%)).

In this project we assume that the company is paying 14% interest rate for the debt

portion. So the cost of debts of the can determine as:

Kd= Ki (1-Tax Rate)

Kd= 0.135(1-0.35)

Kd = .0.135(0.65)

k d =0.087

Cost of Equity:

Cost of equity means cost which is beard by firm for getting finance through equity. We

calculate the cost of equity of Pakistan Tobacco Company by using Dividend Discount

Model. Reason for selecting this model is negative return in market. CAPM is applied when

Return in market is greater than Risk free rate.

A return which is company pays to the equity investor for compensating investor because

he is taking risk in company capital. There are various methods for calculating the cost of

equity.

Dividend discount model

Capital Asset Pricing Model

Bond Yield Model

Dividend discount model:

A procedure for valuing the price of a stock by using predicted dividends and discounting

them back to present value. The idea is that if the value obtained from the DDM is higher

than what the shares are currently trading at, then the stock is undervalued.

Equation of Cost of Common Stock

Kc =D1/ P0 + g

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'Capital Asset Pricing Model - CAPM':

CAPM (capital asset pricing model) is used to evaluate investment risk and rates of return

compared to the overall market. You can use CAPM to price an individual asset, or aportfolio of assets, using a linear model defined as:

We assumed that:

Risk free Rate=0.1180

Market Rate=0.001

Beta=1.08

CAPM=RF+β (Rm-Rf)

CAPM=0.1180+1.08(0.001-0.1180)

CAPM=0.1180+ (-0.1263)

CAPM= -0.0083

COST OF CAPITAL BY USING

“WACC”

Weighted average cost of capital is what overall firm beard in capturing the total finance

for firm. You may call it as the calculation of the discount rate. The simple method to

calculate the WACC is cost of debt multiplied with weight of debt plus cost of equity

multiplied with weight of equity.

WACC= (Cost of debt)*(weight of debt) + (Cost of proffered stock)*(weight of preferred

stock) + (cost of equity)*(weight of equity)

For calculation of weighted average cost of capital we first have to determine the

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CHAPTER NO. 5

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CHAPTER # 5 CAPITAL BUDGETING

PAYBACK PERIOD OF PROJECT AFinancial year Cash Flow Cumulated Cash Flows

0 -22000 -22000

1 330.03729 -21669.96271

2 464.8138 -21205.14891

3 615.7634 -20589.38551

4 784.827 -19804.55851

5 974.1783 -18830.38021

6 1186.252 -17644.12821

7 1423.774 -16220.35421

8 1689.799 -14530.55521

9 1987.747 -12542.80821

10 2321.448 -10221.36021

11 2695.194 -7526.16621

12 3009.14 -4517.02621

13 3351.342 -1165.68421

14 3724.342 2558.65779

15 4130.912 6689.56979

16 4574.073 11263.64279

17 4896.103 16159.74579

18 5237.455 21397.20079

19 5599.288 26996.48879

20 5982.832 32979.32079

21 6389.388 39368.70879

22 6820.337 46189.04579

23 7277.143 53466.18879

24 7761.358 61227.54679

25 8274.625 69502.17179

Pay Back Period = a + (b – c)

D

Pay Back Period= 13+1165.6842/ 3724.342 = 13.31 years

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PAYBACK PERIOD OF PROJECT B

Pay Back Period = a + (b – c)

D

Pay Back Period= 12+2101.21898/2392.958= 12.88 years

Financial year Cash flows Cumulated Cash Flows

0 -16100 -16100

1 400.15482 -15699.84518

2 500.6961 -15199.149083 608.8062 -14590.34288

4 727.7273 -13862.61558

5 858.5406 -13004.07498

6 1002.435 -12001.63998

7 1160.719 -10840.92098

8 1334.832 -9506.08898

9 1526.355 -7979.73398

10 1737.031 -6242.70298

11 1968.775 -4273.92798

12 2172.709 -2101.21898

13 2392.958 291.73902

14 2630.827 2922.56602

15 2887.726 5810.29202

16 3165.176 8975.46802

17 3389.911 12365.37902

18 3628.13 15993.50902

19 3880.642 19874.15102

20 4148.305 24022.45602

21 4432.028 28454.4840222 4732.774 33187.25802

23 5051.565 38238.82302

24 5389.483 43628.30602

25 5747.676 49375.98202

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DISCOUNTED PAYBACK PERIOD

PROJECT A

Financial year Cash Flow Discount rate (4.4%) Present

Value

cumulative discounted

cash flow

0 -22000 -22000 -220001 330.03729 0.95785441 316.1276724 -21683.87233

2 464.8138 0.91748506 426.4597187 -21257.41261

3 615.7634 0.87881711 541.1434119 -20716.2692

4 784.827 0.84177884 660.6507628 -20055.61843

5 974.1783 0.80630157 785.481495 -19270.13694

6 1186.252 0.77231951 916.1655677 -18353.97137

7 1423.774 0.73976965 1053.264792 -17300.70658

8 1689.799 0.70859162 1197.377407 -16103.32917

9 1987.747 0.6787276 1349.138757 -14754.19041

10 2321.448 0.65012223 1509.22494 -13244.9654711 2695.194 0.62272244 1678.357779 -11566.6077

12 3009.14 0.59647743 1794.884097 -9771.723598

13 3351.342 0.57133854 1914.750831 -7856.972767

14 3724.342 0.54725913 2038.180177 -5818.79259

15 4130.912 0.52419457 2165.40165 -3653.39094

16 4574.073 0.50210208 2296.651572 -1356.739368

17 4896.103 0.48094069 2354.735158 997.9957898

18 5237.455 0.46067116 2412.744468 3410.740258

19 5599.288 0.4412559 2470.718866 5881.459124

20 5982.832 0.42265891 2528.69724 8410.15636421 6389.388 0.4048457 2586.716241 10996.8726

22 6820.337 0.38778324 2644.812346 13641.68495

23 7277.143 0.37143988 2703.021125 16344.70607

24 7761.358 0.35578533 2761.377286 19106.08336

25 8274.625 0.34079054 2819.913939 21925.9973

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DISCOUNTED PAYBACK PERIOD

PROJECT B

Financial year Cash Flows Discount rate (4.4%) Present Value cumulative discountedcash flow

0 -16100 -16100 -16100

1 400.15482 0.95785441 383.2900575 -15716.70994

2 500.6961 0.91748506 459.381193 -15257.32875

3 608.8062 0.87881711 535.0293055 -14722.29944

4 727.7273 0.84177884 612.5854435 -14109.714

5 858.5406 0.80630157 692.2426356 -13417.47136

6 1002.435 0.77231951 774.2001117 -12643.27125

7 1160.719 0.73976965 858.6646874 -11784.60657

8 1334.832 0.70859162 945.8507665 -10838.75589 1526.355 0.6787276 1035.979271 -9802.776528

10 1737.031 0.65012223 1129.282459 -8673.494069

11 1968.775 0.62272244 1226.000368 -7447.493701

12 2172.709 0.59647743 1295.971883 -6151.521818

13 2392.958 0.57133854 1367.18912 -4784.332698

14 2630.827 0.54725913 1439.744105 -3344.588593

15 2887.726 0.52419457 1513.730296 -1830.858297

16 3165.176 0.50210208 1589.241456 -241.6168403

17 3389.911 0.48094069 1630.346137 1388.729297

18 3628.13 0.46067116 1671.374854 3060.10415119 3880.642 0.4412559 1712.356178 4772.46033

20 4148.305 0.42265891 1753.318061 6525.778391

21 4432.028 0.4048457 1794.287466 8320.065857

22 4732.774 0.38778324 1835.290412 10155.35627

23 5051.565 0.37143988 1876.352699 12031.70897

24 5389.483 0.35578533 1917.498966 13949.20793

25 5747.676 0.34079054 1958.75362 15907.96155

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Graphical presentation of discounted payback:

-18000-16000

-14000

-12000

-10000

-8000

-6000

-4000

-2000

0

2000

4000

0 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 192021 22232425

Discounted payback B

Project A

-25000

-20000

-15000

-10000

-5000

0

5000

0 2 4 6 8 10 12 14 16 18 20 22 24

Discounted payback A

Discounted payback A

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NET PRESENT VALUE:

NPV Of Project A NPV Of Project B

Financial

year

Present Value Financial

year

Present Value

0 -22000 0 -161001 316.1276724 1 383.2900575

2 426.4597187 2 459.381193

3 541.1434119 3 535.0293055

4 660.6507628 4 612.5854435

5 785.481495 5 692.2426356

6 916.1655677 6 774.2001117

7 1053.264792 7 858.6646874

8 1197.377407 8 945.8507665

9 1349.138757 9 1035.97927110 1509.22494 10 1129.282459

11 1678.357779 11 1226.000368

12 1794.884097 12 1295.971883

13 1914.750831 13 1367.18912

14 2038.180177 14 1439.744105

15 2165.40165 15 1513.730296

16 2296.651572 16 1589.241456

17 2354.735158 17 1630.346137

18 2412.744468 18 1671.37485419 2470.718866 19 1712.356178

20 2528.69724 20 1753.318061

21 2586.716241 21 1794.287466

22 2644.812346 22 1835.290412

23 2703.021125 23 1876.352699

24 2761.377286 24 1917.498966

25 2819.913939 25 1958.75362

Total 43925.9973 Total 32007.96155

NPV 43925.9973-22000 NPV 32007.96155-16100

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Secondly we are calculating at higher discount rate which is 8%

Financial

Year

Cash Flow of Project A Discount Rate

(Assume 5%)

NPV (Millions)

0

1 330.0373 0.925925926 305.59012 464.8138 0.85733882 398.5029

3 615.7634 0.793832241 488.8128

4 784.827 0.735029853 576.8713

5 974.1783 0.680583197 663.0094

6 1186.252 0.630169627 747.54

7 1423.774 0.583490395 830.7585

8 1689.799 0.540268885 912.9458

9 1987.747 0.500248967 994.3684

10 2321.448 0.463193488 1075.28

11 2695.194 0.428882859 1155.923

12 3009.14 0.397113759 1194.971

13 3351.342 0.367697925 1232.281

14 3724.342 0.340461041 1267.993

15 4130.912 0.315241705 1302.236

16 4574.073 0.291890468 1335.128

17 4896.103 0.270268951 1323.265

18 5237.455 0.250249029 1310.668

19 5599.288 0.231712064 1297.423

20 5982.832 0.214548207 1283.60621 6389.388 0.198655748 1269.289

22 6820.337 0.183940507 1254.536

23 7277.143 0.170315284 1239.409

24 7761.358 0.157699337 1223.961

25 8274.625 0.146017905 1208.243

Total 25892.61

Investment 22000

NPV 3892.61

INTERPOLATION:

Interpolated Discount Rate = iL + (iH – iL)(PV1 )

PVl -PVH

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Interpolated Discount Rate = 0.03 + (0.08 – 0.03) (32895.29)

(32895.29-3892.61)

Interpolated Discount Rate = 0.03 + 1.134217

IIR= 1.164217

Project B: Firstly we are calculating at lower discount rate which is 3%

Financial

Year

Cash Flow of Project A Discount Rate (Assume

5%)

NPV (Millions)

0

1 400.1548 0.970873786 388.4998

2 500.6961 0.942595909 471.9541

3 608.8062 0.915141659 557.1439

4 727.7273 0.888487048 646.57635 858.5406 0.862608784 740.5847

6 1002.435 0.837484257 839.5235

7 1160.719 0.813091511 943.7708

8 1334.832 0.789409234 1053.729

9 1526.355 0.766416732 1169.824

10 1737.031 0.744093915 1292.514

11 1968.775 0.722421277 1422.285

12 2172.709 0.70137988 1523.894

13 2392.958 0.68095134 1629.488

14 2630.827 0.661117806 1739.287

15 2887.726 0.641861947 1853.521

16 3165.176 0.623166939 1972.433

17 3389.911 0.605016446 2050.952

18 3628.13 0.587394608 2131.144

19 3880.642 0.570286027 2213.076

20 4148.305 0.553675754 2296.816

21 4432.028 0.537549276 2382.433

22 4732.774 0.521892501 2469.999

23 5051.565 0.506691748 2559.58624 5389.483 0.491933736 2651.269

25 5747.676 0.477605569 2745.122

Total 39745.43

Investment 16100

NPV 23645.43

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Secondly we are calculating at higher discount rate which is 8%

Financial

Year

Cash Flow of Project A Discount Rate

(Assume 5%)

NPV (Millions)

0

1 400.1548 0.925925926 370.51372 500.6961 0.85733882 429.2662

3 608.8062 0.793832241 483.29

4 727.7273 0.735029853 534.9013

5 858.5406 0.680583197 584.3083

6 1002.435 0.630169627 631.7041

7 1160.719 0.583490395 677.2684

8 1334.832 0.540268885 721.1682

9 1526.355 0.500248967 763.5575

10 1737.031 0.463193488 804.5814

11 1968.775 0.428882859 844.3739

12 2172.709 0.397113759 862.8126

13 2392.958 0.367697925 879.8857

14 2630.827 0.340461041 895.6941

15 2887.726 0.315241705 910.3317

16 3165.176 0.291890468 923.8847

17 3389.911 0.270268951 916.1877

18 3628.13 0.250249029 907.936

19 3880.642 0.231712064 899.1916

20 4148.305 0.214548207 890.011421 4432.028 0.198655748 880.4478

22 4732.774 0.183940507 870.5488

23 5051.565 0.170315284 860.3587

24 5389.483 0.157699337 849.9179

25 5747.676 0.146017905 839.2636

Total 19231.41

Investment 16100

NPV 3131.405

Interpolation:

Interpolated Discount Rate = 0.03 + (0.08 – 0.03) (23645.43)

(23645.43-3131.405)

Interpolated Discount Rate = 0.03 + 0.057632

IIR= 0.107632

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PROJECT SELECTION

Capital Budgeting Techniques Project A Project B

payback 13 years 12 years

discount payback 17 years 16 years

NPV 43926 32008

IRR 11.64% 10.70%

payback 13 years 12 years

Through the analysis of capital budgeting we predict project A should be selected. We

selected the project on the basis of two capital budgeting techniques NPV and IRR.As

shown in the above table that NPV and IRR of project A is higher than project B. So project

A is more reliable for production.

Moreover project A plant which has a cost of 22000M Which they are going to buy from

Germany. They are the major supplier to manufacturing of cement .Fauji cement has

another option to buy Project B plant from China. This plant is not reliable because there

may be of chance that cash outflows will incur during the life of plant.

By comparing these two projects we found that Project NPV and IRR is much greater than

Project B so under taking this project will certainly generate huge profits for the fauji

cement.

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CHAPTER NO. 6

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CHAPTER # 6 RISK AND CAPITAL BUDGETING

RISK ANALYSIS IN CAPITAL

DGETINGCapital budgeting is used to ascertain the requirements of the long-term investments of a

company. The different types of risks that are faced by entrepreneurs regarding capital

budgeting are the following:

Corporate risk

International risk

Stand-alone risk

Competitive risk

Market risk

Project specific risk Industry specific risk

The following methods are used for Risk Analysis in Capital Budgeting:

Break Even Analysis

RISK ADJUSTED DISCOUNTED RATE

Sensitivity Analysis

BREAK EVEN ANALYSIS:

Break even cash inflow is the minimum level of cash inlow necessary for a project to be

acceptable that is NPV>0

Break even cash flow = initial investment /(PVIFAk,n)

Break Even of the project A:

Initial investment = 22000 (millions)

K (Rate) = 4.4%

N (time) = 25

Break even cash flow = 22000/ (PVIFA4.4%, 25) = 1468.43

Break Even of the project A:

Initial investment = 16100 (millions)

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K (Rate) = 4.4%

N (time) = 25

Break even cash flow = 16100/ (PVIFA4.4%, 25) = 1074.766 (millions)

If the company purpose is to minimize cost then must follow project B but if company is

looking for high profit then company must keep project A as project A takes time to gain

Break even.

SENSITIVITY ANALYSIS

A technique used to determine how different values of an independent variable will impact

a particular dependent variable under a given set of assumptions. This technique is used

within specific boundaries that will depend on one or more input variables, such as the

effect that changes in interest rates will have on a bond's price.

Sensitivity analysis is a way to predict the outcome of a decision if a situation turns out to

be different compared to the key prediction

Project A (millions) Project B(millions)

Initial investment 22000 22000

Outcomes Annual cash flows (millions)

Pessimistic 330 400

Most likely 3000 2000

Optimistic 8300 5800

Range of Project A = 8300 – 330 = 7970

Range of Project B = 5800 – 400 = 5400

By comparing range we again conclude that Project A is a better option as it is given more

return than Project B

Calculation of Range by NPV method:

Outcomes of Project A Outcomes of Project B

PVIFAn,k NPV PVIFAn,k NPV

Pessimistic 330 14.98203 -17056 400 14.98203 -16007

Most likely 3000 14.98203 22946 2000 14.98203 7970

Optimistic 8300 14.98203 102334 5800 14.98203 64900

Range 119390 Range 80907

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Project A is more risky than Project B but also has the possibility of a greater return as it is

shown in the above calculation.

RISK ADJUSTED DISCOUNTED RATE

An estimation of the present value of cash for high risk investments is known as risk-adjusted discount rate. A very common example of risky investment is the real estate. Risk

adjusted discount rate is representing required periodical returns by investors for pulling

funds to the specific property. It is generally calculated as a sum of risk free rate and risk

premium. The variation of risk premium is depending on the risk aversion of investor and

the perception of investor about the size of property’s investment risk.

Risk-adjusted discount rate = Risk free rate + Risk premium

Under CAPM or capital asset pricing model

Under RACR NPV is calculated as

NPV = PV – initial investment

Let’s suppose that the initial cost of the project is same as discuss above that is 22000 and

16100. And other relevant information is given as below:

Year Project A (22000 millions) Project B (16100 millions)

1 8000 12000

2 12000 12000

3 18000 12000

4 30000 12000

Market risk (Rm) = 12

Risk free Rate (Rf)= 7

Beta (A) = 1.2

Beta (B) = 1.4

http://www.readyratios.com/reference/analysis/capital_asset_pricing_model_capm.html

http://www.readyratios.com/reference/analysis/capital_asset_pricing_model_capm.html

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Ka= 7%+1.2(12%-7%)

Ka= 13%

Kb= 7%+1.4(12%-7%)

Kb= 14%

NPVa= 8000(PVIF14,1)+12000(PVIF14,2)+18000(PVIF14,3)+30000(PVI

F14,4) - 22000

NPVa= 7018+9234+12150+17765 = 55267-22000= 33267 Millions

NPVb= 12000(PVIFA13,4)-16100 = 35694-16100=19594 millions

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CHAPTER NO. 7

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CHAPTER # 5 LEVERAGE AND CAPITALSTRUCTURE

LEVERAGELeverage results from the use of fixed-cost assets or funds to magnify returns to the firm’s

owners. Generally, increases in leverage result in increased return and risk where as

decreases in leverage result in decreased return and risk.

There three basic types of leverages are used in finance

Operating leverage

Financial leverage

Total leverage

OPERATING LEVERAGEA type of leverage ratio summarizing the effect a particular amount of operating leverage

has on a company's earnings before interest and taxes (EBIT). Operating leverage involves

using a large proportion of fixed costs to variable costs in the operations of the firm. The

higher the degree of operating leverage, the more volatile the EBIT figure will be relative to

a given change in sales, all other things remaining the same. The formula is as follows:

Formula method to calculate degree of operations:

DOL= TR- TVC

TR-TVC-FC

FINANCIAL LEVERAGE

A ratio that measures the sensitivity of a company’s earnings per share (EPS) to

fluctuations in its operating income, as a result of changes in its capital structure. Degree of

Financial Leverage (DFL) measures the percentage change in EPS for a unit change in

earnings before interest and taxes (EBIT), and can be mathematically represented as

follows:

Formula method to calculate degree of Financial leavrage:

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DOFL = EBIT________________

EBIT – I(PD*1/1-T)

TOTAL LEVERAGE

A leverage ratio that summarizes the combined effect the degree of operating leverage

(DOL), and the degree of financial leverage has on earnings per share (EPS), given a

particular change in sales. This ratio can be used to help determine the most optimal level

of financial and operating leverage to use in any firm. For illustration, the formula is:

Calculation of the these degrees is given as below:

OPERATING LEVERAGE

Let’s suppose the company price per cement packet 3000. Whereas the company fix cost is

380000 and variable cost is 1000 per packet. The company made three different level of

sale 9000, 10000, 11000. We assumed further that the company is keeping 10000 sale

volumes as base and interest payment is 50000 so the calculation of financial leverage is as

given as below:

Base 9000 Base 10000 Base 11000Sale 27000000 30000000 33000000

Variable cost 9000000 10000000 11000000

Fix cost 380000 380000 380000

Earnings Before Interest and tax 17620000 19620000 21620000

% change in EBIT -0.1019368 0.1019368

& change in sale -0.1 0.1

Degree of operation leverage 1.019367992 1.01936799When DOL > 1 it means that degree of operation is existing. In above case DOL exist in both

situations as DOL is greater than 1.

Calculation of DOL by using formula method for 10000 volume.

DOL= TR- TVC

TR-TVC-FC

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DOL= 30000000 - 10000000

30000000-10000000-380000

DOL 1.019

FINANCIAL LEVERAGE

base 9000 base 10000 base 11000

Sale 27000000 30000000 33000000

Variable cost 9000000 10000000 11000000

Fix cost 380000 380000 380000

Earnings Before Interest and tax 17620000 19620000 21620000

less: interest 50000 50000 50000Earnings Before Tax 17570000 19570000 21570000

Less: Taxes -6149500 -6849500 -7549500

Earrings 11420500 26419500 14020500

No. of shares (supposed) 100000 100000 100000

Earnings Per Share 114.205 264.195 140.205

DOFL % change in EPS/% change in EBIT

% change in EPS -0.5677246 -0.46931244

%change In EBIT -0.1019368 0.1019368

DOFL 5.5693783 -4.60395503

Calculation by using formula method:

DOFL = EBIT________________

EBIT – I(PD*1/1-T)

DOFL= 19620000

19620000-50000

DOFL= 1.002

The degree of financial leverage calculation shows that there financial leverage is existing

in both of the situations as the never in both case is more than or equal to 1.

TOTAL LEVERAGE

Degree of total leverage is the combination of DOL and DOFL so the degree of total

leverage can determine as

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S.D = under root of (114-209)^2+(264-209)^2+(140-209)^2

S.D= under root of (9025+3025+4761) = 130

CVeps= 130/209= 0.622

BREAK EVEN

The break-even level or break-even point (BEP) represents the sales amount —in either

unit or revenue terms—that is required to cover total costs (both fixed and variable). Profit

at break-even is zero. Break-even is only possible if a firm’s prices are higher than its

variable costs per unit. If so, then each unit of the product sold will generate some

“contribution” toward covering fixed costs.

BEunits = 380000/3000-1000 = 190 units

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CHAPTER # 6

CONCLUSION

CONCLUSION

We have completed the capital budgeting analysis of Fauji Cement for the selection

of the production plant project. We used required rate of return based on the

weighted average cost of capital used by Fauji Cement to make its investment

decisions. After going through the whole project we have been able to analyze how

companies make investment decision using capital budgeting techniques. We also

analyze how mutually exclusive projects affects the cash flows of each other. From

the capital budgeting project we learned how every activity of business affect the

investment decision of the company and without the clear analysis of statement wecannot make effective investment decision .It is not possible for any investment

decision that cash flows receives is according to the estimated cash flows there may

be difference in it. But capital budgeting techniques provides some indication about

the investment future cash flows on the basis of previous performance of business.

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REFERENCES

www.fauji cement.com

www.investor pedia.com

Wikipedia

Fundamental of Financial Management by Brigham

Financial Reporting and Management Accounting by William J.B

Annual Reports of Fauji Cement

Nasir khan Finance executive of FFC

Fouji

Documents

Transcript of Fouji