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CAPITAL BUDGETING INAIR-INDIA

PROJECT REPORT SUBMITTED IN PARTIAL FULFILLMENT OFTHE REQUIREMENTS FOR THE AWARD OF THE DEGREE OF

MASTER OF MANAGEMENT STUDIES.

MUMBAI UNIVERSITY

SUBMITTED BY: -

Mr. VISHAL D. JADHAV

M.M.S 09-11 (Finance)

SUBMITTED TO: -

AIR- INDIA LTD.

UNDER THE GUIDANCE: -

Mr. SHOBHAN A. TALAVDEKAR


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DECLARATION

I HEREBY DECLARE THAT I HAVE COMPLETED THIS PROJECT ON CAPITAL

BUDGETING IN THE ACADEMIC YEAR 2010-2011. THIS INFORMATION IS TRUE AND

ORIGINAL TO THE BEST OF MY KNOWELEDGE.

ACKNOWLEDGMENT

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It is indeed a great pleasure to express my thanks & gratitude to all those people who helped me

during this summer training period. This project would not have been materialized without the

help from many quarters.

I express a deep sense of gratitude to Miss Pervin Choksey, Asst. General Manger-Finance and

all the members of Capital Budget & Property Control Section, Finance Department. Their

guidance suggestion & expertise have been a source of inspiration & were very helpful to me

during our project work.

I am deeply thankful to Mr. Shobhan Talavdekar, Dy. Manger-Finance and Mr. Bindoo M.

Katti Asst. Manager Finance for guiding me through general training and providing valuable

advice through out the project work.

INDEX

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Sr.

No

Topic Page no.

1 INTRODUCTION TO AIR INDIA 4

2 FINANCE DEPARTMENT IN AIR INDIA 14

3 CAPITAL BUDGETING SECTION 16

4 CAPITAL BUDGET PROCESS 20

5 PREPARATION OF CAPITAL BUDGET 23

6 PROJECT CLASSIFICATION 28

7 CAPITAL EXPENDITURE/INVESTMENT DECISIONS 29

8 ACCOUNTING OF CAPITAL EXPENDITURE 40

9 NACIL CAPITAL BUDGET 2010-11 44

10 CONCLUSION 48

11 RECOMMEDATION 49

12 BIBLIOGRAPHY 50

BRIEF HISTORY OF AIR INDIA

Air India is Indias national Airline. Air Indias history can be

traced to October 15, 1932. On this day J.R.D. Tata, the father ofCivil Aviation in India and founder of Air India, took off from

Drigh Road Airport, Karachi, in a tiny, light single-engine de

Havilland Puss Moth on his flight to Mumbai via Ahmadabad.

Air India was earlier known as Tata Airlines. At the time of its

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Commencement, Tata Airlines consisted of one Puss Moth, one Leopard Moth, one palm-

thatched shed, one whole time pilot, one part-time engineer, and two apprentice-mechanics. Tata

Airlines was converted into a Public Company under the name of Air India in August 1946. On

March 8, 1948, Air India International Limited was formed to start Air Indias international

operations. On June 8, 1948, Air India started its international services with a weekly flight from

Mumbai to London via Cairo and Geneva with a Lockheed Constellation aircraft.

In early 1950s due to deteriorating financial condition of various airlines, the Government

decided to nationalize air transport. On August 1, 1953 two autonomous corporations were

created. Indian Airlines was formed with merger of eight domestic airlines to operate domestic

services, while Air India International was established to operate the overseas services. The word

'International' was dropped in 1962. With effect from March 1, 1994 the airline has been

functioning as Air India Limited. Air India's worldwide network today covers 44 destinations by

operating services with its own aircraft and through code-shared flights. Important destinations

covered by Air India are Bangkok, Hong Kong, Jakarta, Kuala Lumpur, Osaka, Singapore,

Tokyo, Seoul, Dar-es-Salam, Nairobi, Frankfurt, London, Paris, Birmingham, Abu Dhabi, Al

Ain, Bahrain, Dammam, Doha, Dubai, Jeddah, Muscat, Riyadh, Kuwait, Los Angeles, Chicago,Newark, New York, and Toronto.

INCORPORATION

Established in 1953 under Air Corporations Act

Became Public Limited Company in 1994

Registered Office : New Delhi

Head Office : Mumbai

Authorized Capital : Rs 500.00 Crores

Paid-up Capital : Rs 153.84 Crores

SUBSIDIARY COMPANIES

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Air India has the following Subsidiary Companies with an Authorized / Paid-up Capital

(in Rs. Crores) as under:

Authorised Paid-up

(a) Hotel Corporation of India 41.00 40.00

(b) Air India Charters Ltd. 30.00 30.00

(c) Air India Air Transport Services Ltd. 100.00 0.05

(d) Air India Engineering Services Ltd. 10.00 0.05

Hotel Corporation of India Ltd (HCI)

Centaur Hotels at Juhu, Mumbai Airport and Rajgir Sold

Centaur Hotel at Delhi, Chefair-New Delhi and Chefair-Mumbai Under Disinvestment

Air India Charters Ltd (AICL)

New Airline Air India Express set-up under AICL in 2005. It is Air-Indias low-cost

subsidiary which was established during the aviation boom in India

All AI Express operations carried out on B-737-800 with a current

Fleet strength of 12.

Air India Air Transport Services Ltd (AIATSL )

Incorporated in June 2003

set up to undertake ground handling & other allied activities

being operational zed at all domestic airports

Air India Engineering Services Ltd (AIESL)

Incorporated to undertake engineering and other allied activities

To be operational zed

Cabinet approval required

INDIAN AIRLINES

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http://en.wikipedia.org/wiki/Air-India_Expresshttp://en.wikipedia.org/wiki/Low-cost_airlinehttp://en.wikipedia.org/wiki/Air-India_Expresshttp://en.wikipedia.org/wiki/Low-cost_airline


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Indian Airlines was Indias first state owned domestic airline. Indian Airlines was set up under

the aegis of federal Union Ministry of Civil Aviation and based in New Delhi. Its main bases

were the international airports in Chennai, Mumbai, Kolkata and New Delhi.

Indian Airlines came into being with the enactment of the Air Corporations Act, 1953. Indian

Airlines started its operations from 1st August, 1953, with a fleet of 99 aircraft and was the

outcome of the merger of seven former independent airlines, namely Deccan Airways, Airways-

India, Bharat Airways, Himalayan Aviation, Kalinga Air Lines, Indian National Airways and Air

Services of India. The year 1964 saw the Indian Airlines moving into the jet era with the

introduction of Caravelle aircraft into its fleet followed by Boeing 737-200 in the early 1970.

Along with its wholly owned subsidiary Alliance Air, it flies a fleet of 70 aircraft including

Airbus A300, Airbus A320, Airbus A319, Boeing 737, Dornier Do-228, ATR-4, Airbus A319,

A320 & A321. Along with Indian cities, it flies to many foreign destinations which include

Kuwait, Singapore, Oman, UAE, Qatar, Bahrain, Thailand, Singapore, Malaysia, and Myanmar

besides Pakistan, Afghanistan, Nepal, Bangladesh, Sri Lanka and Maldives.

The main base of the Indian airlines are Chatrapati Shivaji International Airport, Mumbai; Indira

Gandhi International Airport, Delhi; Netaji Subhash Chandra Bose International Airport,

Kolkata; Chennai International Airport, Chennai.

NATIONAL AVIATION COMPANY OF INDIA LIMITED (NACIL)

(Amalgamation of Air India Limited and Indian Airlines Limited)

The Government of India, on 1 March 2007, approved the merger of Air India and Indian

Airlines. Consequent to the above, a new Company viz National Aviation Company of

India Limited (NACIL) was incorporated under the Companies Act, 1956 on 30 March 2007

with its Registered Office at Airlines House, 113 Gurudwara Rakabganj Road, New Delhi.

The Certificate to Commence Business was obtained on 14 May 2007.

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The Scheme of Amalgamation of Air India Limited and Indian Airlines Limited with

National Aviation Company of India Limited was approved by the Board of Directors of all

the three Companies.

Thereafter, the Meetings of Secured and Unsecured Creditors of Air India and Indian Airlines

were held in New Delhi on 28 June 2007, in which the Scheme of Amalgamation was approved

by the Creditors. The final hearing of the merger petition was held on 31 July 2007 wherein

the last date of submissions of objections was fixed on 8 August 2007 and the Order Ministry

of Corporate Affairs is awaited.

The Authorized and Paid-Up Share Capital of the merged entity is Rs.1500,05,00,000/-

and Rs.145,00,00,000/-, respectively.

COMPANY PROFILE:

It has been decided that post merger, the new entity will be known as Air India while

Maharaja will be retained as its mascot. The logo of the new airline will be a red colored

flying swan with the Konark Chakra in orange placed inside it. The flying swan has been

morphed from Air Indias characteristic logo The Centaur whereas the Konark Chakra

was reminiscent of Indians logo. The Corporate Office of NACIL will be at Mumbai.

This new airline is also a member of the Star Alliance, the largest airline alliance.

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The Government has approved the appointment of Shri V Thulasidas and Dr V Trivedi as

Chairman & Managing Director and Joint Managing Director, respectively, of the merged entity,

with effect from the date of merger.

Presently, the Board of NACIL consists of:

Shri Raghu Menon, Addl Secretary & Financial Advisor, Ministry of Civil Aviation

Shri R K Singh, Jt Secretary, Ministry of Civil Aviation

Shri Rajiv Bansal, Director, Ministry of Civil Aviation

AIR INDIA (NACIL) CURRENT FLEET:

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Note:

* Includes 3 under Sale & Lease Back.

** All under Sale & Lease Back.

*** Includes 8 under Sale & Lease Back. and 11 more are under proposal for sale.**** Includes 2 under Sale & Lease Back.

% 2 A310 Freighters are under process of Lease Out.

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NACIL Fleet (As on 1st February 2010)

-

-

- *

-

-

- **

-

***

-

- ****

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OBJECTIVES

1. To provide safe, efficient, adequate, economical and properly co-ordinate international airservices, and develop such services to the best advantage.

2. To provide high standard of services to passengers and customers on ground and in the air.

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3. To achieve, maintain and improve its rightful place in the international air transport

industry.

4. To make an increasing contribution to the national economy and maximize revenues withefficient fleet utilization and route network.

5. To promote international tourism to India and improve the nations foreign exchangeresources.

6. To assist in the promotion of nations export trade.

7. To improve the national economy by encouraging local skills and technology to getequipment and materials other than air crafts, indigenously manufacture with the intention

to curtain imports steadily.

8. To promote healthy relations with the various employees unions for ensuring employees cooperation in the performance of companies activities.

9. To provide wider participation amongst its employees in management functions.

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SWOT ANALYSIS:

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STRENGTHS WEAKNESSES

Professionally qualified team contributingvital inputs on corporate decisions

Expertise in Treasure & currencyManagement in a multi currency Global

environment.

Effective compliance of Govt. auditobservation / suggestions resulted in NILaudit reports from comptroller and Auditor

General (CAG) during the last 4

consecutive years.

Active participation in international forumViz. IATA, ICAO etc relating to

Global Aviation financing issues.

Negotiating Skills-on financing relatedissues with International Banks, financial

institutions, Insurers, underwriters, Fuel

contractors, Export credit Agencies etc.

Effective monitoring on Repayment ofAircraft /Non Aircraft loans-resulting in

NO DEFAULT ever in Debt servicing.

Ban on recruitmenta) Time-bound promotion policy-inability to

reward talents

b) Ageing, non-qualified/professional staff

Lack of adequate IT systems and procedure toadapt to the enhanced level of corporate

surveillance being introduced by the Govt. atvarious levels in order to prevent corporate

delinquencies/ bankruptcies.


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FINANCE DEPARTMENT (AIR INDIA)

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OPPORTUNITIES THREATS

International Banks - Ready to offerglobal cash Management

System.

Swap Interest/currency- Reduce InterestBurden & cap the burden Due to

fluctuation in interest rate.

Fuel Hedging- RBI approval received andcounter party selection in process for

hedging in fuel prices for international

uplifts.

Arranging new Aircraft loans to financenetwork & introduction of real time /

online computerized based systems.

Introduction of the system of corporateGovernance & Accounting at various levels

including the establishment of Audit

committees following the implementation of

Naresh Chandra committee recommendation

by the Government, resulting in the

maintenance & administration of more string

stringent standards at various levels in theorganizational hierarchy.

Threats of Mergers, Amalgamation,Consolidation by Mega carriers and

Marginalization of small carriers, line with

practices followed by mega carriers for inter &

intra firm comparison.

Introduction of US GAAP by many companiesin India in order to provide greater transparency

to International Financial Institution and enable

funding by Export credit Agencies.

NACIL being an International company andbeing a Global player has to train a number of

staffs in the field of provide the cutting edge

financial technology.


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Manages interlinked settlement with different airlines.

Cargo and Mail Section

Manages revenues collected by the cargo.

Taxation

Calculates taxes like VAT, Income Tax, Sales Tax, Service Tax, Octri, Revenue Tax, etc.

Pay Accounts

Concerned with the salary calculation of the employees taking into consideration the

allowances granted to the staff, paid leave, leave without pay, increments, etc.

Internal Audit Section

This section deals with the internal audit of accounts prepared by the Financial

Accounting section.

3. Stores Accounts Section:

Stores are those products which are purchased by Air India to be provided on board to the

travelers or for sale. Purchasing of such products is dealt by this section.

4. Insurance Section:

Deals with aircraft insurance and also non-aircraft insurance like vehicles, machinery and

furniture.

ORGANISATIONAL STRUCTURE OF CAPITAL BUDGETING

SECTION:

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Capital budget is prepared on yearly basis for new & continuing projects. It is allocation of funds

category wise & department wise for the particular year. Subsequent years capital budget is

prepared by considering last year project cost addition & deletions/utilization during the year.

CONTINUING PROJECT

Each department may have some previous years project to be continues this year also.

NEW PROJECT

Each department may have some new project to be started this year.

SANCTION REQUEST FORM (SRF)

Approved SRf are sent by the Department for each project, partly or fully to property control

section. Same is sent to purchase Department for procurement action. Along with purchase

requisition form (PR). It is checked that SRFs risen by departments should not cross the

financial limits of the particular project.

PURCHASE ORDER (PO)These are prepared sent by stores & purchase department to property control section.

WORK ORDER (WO)

Work order are prepared & properties department & engineering department

VENDORS INVOICE:

Invoices are sent by purchase department for advance payments or full & final settlement.

As case may be along with authorization for making par et to property control section with GRN

or installation report.

BILL INTERIM PAYMENTS CERTIFICATE/FINAL FOR PAYMENT

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These are sent by civil work & engineering Department to property control section along with

authorization for making payment advance or full & final as case may be.

CASH VOUCHER (CV)

Cash voucher is prepared for all the invoices received & the amount is debited to respective

capital asset account (nearly 100) or advance account as the case may be. Payment register is

maintained for all cash/cheque payments for partys invoices received forms s & p as well as

civil work.

JOURNAL VOUCHER (JV)

In case GRN or installation report is received after some period, JV is passed for debiting

appropriate Capital Asset Account adjusting the Advance Account debited earlier. On half yearly

basis, C.W. & P. Engineering Department sends an ABC statement giving status of the various

projects. Referring to that statement for completed project a JV is passed for debiting appropriate

asset account/ work-in-progress account.

DETAIL COLLECTION FOLDER:These folders are written on the basis of cvs, jvs passed at property control section. These

folders are written monthly Account wise. Station wise property purchase Advices & property

receipt advances received from stations quarterly.

FIXED ASSETS REGISTER (NON AIRCRAFT)

Fixed asset register is written annually using the detail collection folder & maintained account

code wise, station wise, department wise.

FIXED ASSET REGISTER (AIR CRAFT)

This is written on the basis of Jv, prepared & sent by project control section.

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SCRAPPAGE ENTRY

Scrap page advices duly approved & received from various department & control section & JV is

passed for asset value, cumulative depreciation, written down value, sales proceeds, profit & loss

etc. scrapped is maintained account code wise.

CAPITAL BUDGET PROCESS

Capital Budgeting is a complex process which may be divided into the following phases:

Identification of potential investment opportunities.

Organizing proposed investment.

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Proposals are usually classified into various categories for facilitating decision making

budgeting, and control. An illustration classified is given below:

Replacement investment

Expansion investment

New product/service investment

Obligatory and welfare investment

(C) Decision making

A problem of rupee gateways usually characterizes capital investment decision making. Under

this system, executives are vested with the power to approve investment proposals up to certain

levels. For example, in one company the plant superintendent can approve investment outlays, up

to Rs. 2.00 crores, the works manager up to Rs. 1.00 crores. Investments requiring higher outlays

need the approval of the board of directors.

(D) Preparation of capital budgeting appropriations

Process involving smaller outlays and which can be decided by executives at lower levels are

covered by blanket appropriation for expeditious action. Projects involving larger capital are

included in the capital budget after necessary approvals. Before undertaking such project an

appropriation order is usually required. The purpose of this check is mainly to ensure that the

funds position of the firm is satisfactory at the time of implementation.

(E) Implementation

Implementing an investment proposal into a concrete project is a complex, time consuming, risk

fraught task. Delays in Implementation, can lead to substantial reduction in rate of return.For expeditious Implementation at a reasonable cost, the following are helpful.

i. Adequate formulation of project

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2. The capital budget is prepared and submitted to the board according to departments,

regions and SBUs (Strategic Business Unit). It is requested to all concerned directors,

executive directors and SBU heads to submit their proposals under New and Continuing

Schemes.

3. The capital budget requirment is to be submitted by the respective director, executive

directors and SBU heads relating to their departments/ unit under the different categories

for the both New and Continuing Schemes uneder the enclosed format specified for each

category.

There are certain guidelines given in the circular which are to be followed for preparing

and compiling the Capital Budget requirement of the department, unit and region.

1. The schemes which are not required to be implemented further are to be deleted.

Wherever additional provisions are required for continuing schemes, same is to be shown

separately with justification along with estimated amount of expenditure.

2. The departmental proposals regarding building/ workshops under new and continuing

schemes are to be routed through Properties and Facilities Department to weigh the

project by them and for obtaining project cost and estimated expenditure for the budgetedyear.

3. The requirement for replacement of vehicles for operational areas pertaining to the

department should be routed through Ground Service Department (GSD) with full details

of stations where GSD representatives are present. Similarly, the requirement for new

vehicle should be approved by head quarters. Without the HQs approval the requirement

will not be considered in the budget formation.

4. The Office Equipment, vehicles and miscellaneous items costing less than Rs. 10 lacks

will be budgeted under new schemes only. The balance from last years budget under

above categories will not be carried forward and will be lapsed.

5. The project report is to be submitted by departments for project/ schemes costing more

than Rs. 1 crore each giving cost benefit analysis as required by the Board.

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6. As per the Institute Of Chartered Accountant manual, Capital expenditure costing less

than rupees 5000 each, is not treated as Capital expenditure and not provided in the

capital budget. The details of such expenditure be included in the Departments Revenue

Expenditure Budget.

7. It is requested to exercise utmost economy in expenditure and submit the requirements

with full details in the prescribed format for continuing and new schemes under each

category latest by mid of December.

8. On compilation of the information by Capital Budget and Property Control Section, the

proposals will be discussed with the respective Departments/Units/Regions before

finalization and submission to the Board for approval.

9. Capital budget booklet is prepared by Property Control Section for Boards approval. The

proposal approved by the Board are entered in the system category wise and department

wise under new and continuing schemes, including block funds for unforeseen

circumstances.

STAGE-I: The proposals when received from various departments are categorized under one

of the following:a. Building and workshops -Budget category F

b. Ground Handling and Ramp Equipment - Budget category C

c. Workshop Equipment and Plant and Machinery -Budget category D

d. Computer facilities and Equipment - Budget category H

e. Office Equipment and Furniture including PCs - Budget category A

f. Vehicles - Budget category B

They are checked with reference to need/justification, details cost breakup etc and query list is

prepared (Time 15 days).

STAGE II: After scrutiny of proposals the query list is sent to respective departments for

further details-clarifications. On receipt of reply a summer for each department category wise is

prepared showing estimated payments of all proposals (time 10 days).

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STAGE-III: The section further scrutinizes the proposal in the light of justification, resources

position of the company (time 10 days).

STAGE-IV: They call departments representatives for discussions, for further information/

clarification in respect of major projects. Based on this an inclusion/deletion of proposals are

finalized and the budget is sized up. Operational requirement are to be considered first while

sizing up (time 7 days).

STAGE -V: The sized up budget is thereafter forwarded by finance department to Headquarters

for approval of MD/Chairman before it is finalized. For project costing above Rs. 1.00 crore

included in the budget are to be presented by respective department before MD/CMD or Board.

STAGE-VI: The budget proposals so cleared by MD/Chairman, is sent by section to printing

press for preparation of the capital budget booklets. These booklets are then forwarded to HQ

well in time for submitting to the Board members (time 15 days).

PROJECT CLASSIFICATION

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Project analysis entails time and effort. The cost incurred in this exercise must be justified by the

benefits from it, certain projects, given their complexity and magnitude, may warrant detailed

analysis. Hence firms normally classify projects into different categories. Each category is then

analyzed somewhat differently.

While the system of classification may vary from one firm to another, the following categories

are found in most classifications.

(A)Mandatory investments

These are expenditures required to comply with statutory requirements. Examples of such

investments are pollution control equipments, medical dispensary, fire fighting equipments,

crche in factory premises, and so on. These are often non revenue producing investments. In

analyzing such investments the focus is mainly on finding the most cost-effective way of

fulfilling a given statutory need.

(B) Replacement projects.

Firms routinely invest in equipments meant to replace obsolete inefficient equipments, eventhough they may be in serviceable condition. The objective of such investment is to reduce costs

(of labour, raw material and power), increased yield, and improve quality. Replacement projects

can be evaluated in a fairly straightforward manner, though at times the analysis may be quite

detailed.

(C) Expansion projects

These projects are meant to increase capacity and/or widen the distribution network. Such

investments call for explicit forecast of growth. Since this can be risky and complex, expansion

projects normally warrant more careful analysis than replacement projects. Decisions relating to

such projects are taken by the top management.

(D)Diversification projects

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These investments are aimed at producing new products and services or entering into nearly new

geographical areas. Often diversification projects entail substantial risks, involve large outlay,

and require considerable managerial effort and attention. Given their strategic importance, such

projects call for a very thorough evaluation, both quantitative and qualitative. Further, they

require a significant involvement of the board of directors.

(E) Research and development projects

Traditionally, R&D projects absorbed a very small proportion of capital budget in most Indian

Companies. Things, however, are changing. Companies are now allocating more funds to R&D

projects, more so in knowledge intensive industries. R&D projects are characterized by

numerous uncertainties and typically involve sequential decision making. Such projects are

decided on the basis of managerial judgment. Firms which rely more on quantitative methods use

decision tree analysis and option analysis to evaluate R&D projects

(F) Miscellaneous projects

This is a catch-all category that includes items like interior decoration, recreational facilities,

executive aircrafts, land spaced gardens, and so on. There is no standard approach for evaluatingthese projects and decisions regarding them are based on personal preferences of top

management.

ECONOMIC EVALUATION OF INVESTMENT PROPOSALS

The analysis stipulates a decision rule for:

I) accepting or II) rejecting investment projects

(A) Net present value (NPV)

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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

Io = the initial investment outlay

r = the discount rate/the required minimum rate of return on investment

n = the project/investment's duration in years.

The discount factor r can be calculated using:

Examples:

Decision rule:

If NPV is positive (+): accept the projectIf NPV is negative(-): reject the project

(B) The internal rate of return (IRR)

The IRR is the discount rate at which the NPV for a project equals zero. This rate 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.

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The IRR is found by trial and error.

wherer = IRR

IRR of an annuity:

where:

Q (n,r) is the discount factor

Io is the initial outlay

C is the uniform annual receipt (C1 = C2 =....= Cn).

Economic rationale for IRR:

If IRR exceeds cost of capital, project is worthwhile, i.e. it is profitable to undertake.

(C) The profitability index - PI

This is a variant of the NPV method.

Decision rule:

PI > 1; accept the project

PI < 1; reject the project

If NPV = 0, we have:

NPV = PV - Io = 0

PV = Io

Dividing both sides by Io we get:

PI of 1.2 means that the project's profitability is 20%. Example:

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PV of CF Io PIProject A 100 50 2.0

Project B 1,500 1,000 1.5

Decision:

Choose option B because it maximizes the firm's profitability by $1,500.

Disadvantage of PI:

Like IRR it is a percentage and therefore ignores the scale of investment.

(D)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 pay

back 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.

Example 1:

Years 0 1 2 3 4

Project B - 10,000 5,000 2,500 4,000 1,000

Payback period lies between year 2 and year 3. Sum of money recovered by the end of the

second year

= $7,500, i.e. ($5,000 + $2,500)

Sum of money to be recovered by end of 3rd year

= $10,000 - $7,500

= $2,500

= 2.625 years

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Disadvantages of the payback method:

It ignores the timing of cash flows within the payback period, the cash flows after the end of

payback period and therefore the total project return.

It ignores the time value of money. This means that it does not take into account the fact that

$1 today is worth more than $1 in one year's time. An investor who has $1 today can

consume it immediately or alternatively can invest it at the prevailing interest rate, say 30%,

to get a return of $1.30 in a year's time.

It is unable to distinguish between projects with the same payback period.

It may lead to excessive investment in short-term projects.

Advantages of the 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.

Allowing for inflation

So far, the effect of inflation has not been considered on the appraisal of capital investment

proposals. Inflation is particularly important in developing countries as the rate of inflation tends

to be rather high. As inflation rate increases, so will the minimum return required by an investor.

For example, one might be happy with a return of 10% with zero inflation, but if inflation was

20%, one would expect a much greater return.

Example:

Keymer Farm is considering investing in a project with the following cash flows:

TIME

ACTUAL CASH FLOWS

Z$

0 (100,000)

1 90,000

2 80,000

3 70,000

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Keymer Farm requires a minimum return of 40% under the present conditions. Inflation is

currently running at 30% a year, and this is expected to continue indefinitely. Should Keymer

Farm go ahead with the project?

Let us take a look at Keymer Farm's required rate of return. If it invested $10,000 for one year on

1 January, then on 31 December it would require a minimum return of $4,000. With the initial

investment of $10,000, the total value of the investment by 31 December must increase to

$14,000. During the year, the purchasing value of the dollar would fall due to inflation. We can

restate the amount received on 31 December in terms of the purchasing power of the dollar at 1

January as follows:

Amount received on 31 December in terms of the value of the dollar at 1 January:

= $10,769

In terms of the value of the dollar at 1 January, Keymer Farm would make a profit of $769 which

represents a rate of return of 7.69% in "today's money" terms. This is known as the real rate of

return. The required rate of 40% is a money rate of return (sometimes known as a nominal rate of

return). The money rate measures the return in terms of the dollar, which is falling in value. Thereal rate measures the return in constant price level terms.

The two rates of return and the inflation rate are linked by the equation:

(1 + money rate) = (1 + real rate) x (1 + inflation rate)

where all the rates are expressed as proportions.

In the example,

(1 + 0.40) = (1 + 0.0769) x (1 + 0.3)

= 1.40

So, which rate is used in discounting? As a rule of thumb:

a) If the cash flows are expressed in terms of actual dollars that will be received or paid in the

future, the money rate for discounting should be used.

b) If the cash flows are expressed in terms of the value of the dollar at time 0 (i.e. in constant

price level terms), the real rate of discounting should be used.

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In Keymer Farm's case, the cash flows are expressed in terms of the actual dollars that will be

received or paid at the relevant dates. Therefore, we should discount them using the money rate

of return.

TIME CASH FLOW DISCOUNT FACTOR PV

$ 40% $

0 (150,000) 1.000 (100,000)

1 90,000 0.714 64,260

2 80,000 0.510 40,800

3 70,000 0.364 25,480

30,540

The project has a positive net present value of $30,540, so Keymer Farm should go ahead with

the project.

The future cash flows can be re-expressed in terms of the value of the dollar at time 0 as follows,

given inflation at 30% a year:

TIME ACTUAL CASH FLOW CASH FLOW AT TIME 0 PRICE LEVEL

$ $

0 (100,000) (100,000)

1 90,000 69,231

2 80,000 47,337

3 70,000 31,862

The cash flows expressed in terms of the value of the dollar at time 0 can now be discounted

using the real value of 7.69%.

TIME CASH FLOW DISCOUNT FACTOR PV$ 7.69% $

0 (100,000) 1.000 (100,000)

1 69,231 64,246

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2 47,337 40,804

3 31,862 25,490

30,540

The NPV is the same as before.

Expectations of inflation and the effects of inflation

When a manager evaluates a project, or when a shareholder evaluates his/her investments, he/she

can only guess what the rate of inflation will be. These guesses will probably be wrong, at leastto some extent, as it is extremely difficult to forecast the rate of inflation accurately. The only

way in which uncertainty about inflation can be allowed for in project evaluation is by risk and

uncertainty analysis.

Inflation may begeneral, that is, affecting prices of all kinds, orspecific to particular prices.

Generalized inflation has the following effects:

a) Inflation will mean higher costs and higher selling prices. It is difficult to predict the effect of

higher selling prices on demand. A company that raises its prices by 30%, because the general

rate of inflation is 30%, might suffer a serious fall in demand.

b) Inflation, as it affects financing needs, is also going to affect gearing, and so the cost of

capital.

c) Since fixed assets and stocks will increase in money value, the same quantities of assets must

be financed by increasing amounts of capital. If the future rate of inflation can be predicted with

some degree of accuracy, management can work out how much extra finance the company will

need and take steps to obtain it, e.g. by increasing retention of earnings, or borrowing.

However, if the future rate of inflation cannot be predicted with a certain amount of accuracy,

then management should estimate what it will be and make plans to obtain the extra finance

accordingly. Provisions should also be made to have access to 'contingency funds' should the rate

of inflation exceed expectations, e.g. a higher bank overdraft facility might be arranged should

the need arise.

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(I) PURCHASE V/S LEASING

In many cases it may be found that leasing is economical and advantageous to the company as in

quite a number of countries tax benefits accruing to the lesser are passed on to the lessees.

Besides, leasing terms may provide full or partial maintenance which will save considerable

recurring expenditure incidental to outright purchase.

Further, in either leasing or outright purchase consideration could be given for TSC arrangement

whereby cash outgo can be avoided. The TSC arrangement is moreover advantageous to the

company as the carriage provided on the companys services is against normal applicable

fares/freight rates whereas in some parts of the world actual sale cost of such transportation may

be less.

Care should be taken that the expenditure proposal related to item of durable nature which can be

easily maintained/ service and also there is a commonality in usage so as to avoid maintenance

problem as well as stocking of excessive inventories of spares, etc, if different items/model are to

be procured.

In terms of delegation of financial power as explained above, financial concurrence is a must. In

case of abstention this requirement would have to be met not only at the station level but also at

the regional level whereby a proposal pertaining to a station requires to be vetted not only by the

Accounts Manager of the station but also by the Regional Director concerned in consultation

with the Regional Finance and Accounts Manager.

Why Should They Lease Equipment Instead of Buy?

Leasing is flexible

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Companies have different needs, different cash flow patterns and sometimes irregular-

streams of income. For example, start-up companies typically are characterized by little cash

and limited debt lines. Mature companies might have other needs: to keep debt lines free, to

comply with debt covenants, and avoid committing to equipment that may quickly become

obsolete. Therefore, your business conditions-cash flow, specific equipment needs, and tax

situation- may help define the terms of your lease.

Moreover, a lease provides the use of equipment for specific periods of time at fixed rental

payments. Therefore, leasing allows you to be more flexible in the management of your

equipment.

Leasing is practicalBy leasing, you transfer the uncertainties and risk of equipment ownership to the lesser,

which allows you to concentrate on using that equipment as a productive part of your

business.

Leasing is cost effectiveEquipment is costly and some of the costs are unexpected. When you lease, your risk of

getting caught with obsolete equipment is lower because you can upgrade or add equipment

to best meet your needs.

Further, your equipment needs can change over time due to change in your company, such as

diversification. Leasing allows you to stay on the cutting edge of technology. Sophisticated

business managers have learned that the primary benefits of higher productivity and profit

come from the use of equipment, not owing it.

Leasing has tax advantages

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Rather than deal with depreciation schedules and Alternative Minimum Tax (AMT)

problems, you, the lessee, simply make the lease payment and deduct it as a business

expense.

Leasing helps conserve your operating capitalLeasing keeps your lines of credit open. You dont tie up your cash in equity. Also, you

avoid costly down payments. With other advantages such as off balance sheet financing,

leasing helps you better manage your balance sheet.

CONTROLS

Capital expenditure budget itself is a system of controlling in advance, after assessing the

requirements of various operating units and which are duly vetted by the Finance Department.Boards approval is merely an administrative sanction as mentioned before, but before the

expenditure is actually committed and incurred, a process known as Executive Sanction or

Sanction Request Form has to be progressed. Delegation of powers to departmental/station heads

specify the powers of financial limits up to which the departmental/station heads can operate the

budget and accord Executive Sanction which thus provide an opportunity to have a second look

before committing funds on capital expenditure. Major items of expenditure, by this process

have always to be cleared by the Chief Executive, which means that expenditure on such items

cannot be simply committed merely for the reason that there is an administrative approval in

existence. This is a very useful and effective system of controlling capital expenditure and in fact

provides the organization with every opportunity of reviewing the expenditure on capital items

even right up to the time of actual procurement action .

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ACCOUNTING OF CAPITAL EXPENDITURE

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With executive sanction for incurring the capital expenditure having been obtained as stated

above, actual procurement action may be taken after following the usual store procedure abd

necessary purchase order issued. Payment of capital expenditure would be made on the strength

of the sanction request form (SRF), purchase order, and goods received not or in its absence

certification by the person responsible for the receipt of such capital items. Payments made in

this fashion world require to be debited to the respective asset account head as per the description

of the item and as given in the accounts code books.

1. Property control procedures:

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Property control i.e. accounting, recording, inventory and vouching is primarily accounts

responsibility. Tag no. Should be affixed to all assets of the corporation as per the tag no.

Indicated in the SRF. Each sanction is allotted a block of tag no. By the property control

division and metal tags duly embossed with the prefix and Sr. No. Is supplied from the

Santacruz, if required then the tag no are assigned. Motor vehicles are identified by their

registration no. And buildings are identified by their registration no. And buildings are

identified by the municipal door no.

2. Property purchase Advice

Stations are required to send a monthly list of capital asset purchased by the 10th of the

following month to the property control division, accounts department, santacruz as per

specimen enclosed (attachment C).

3. Asset/Inventory register

Wide format D encloses stations that may maintain an up to date record of capital assets

location-wise and category-wise, annually as per the directions issued in this regard every

year. Certified inventories of not only those items which are taken up for physically

verification but also of all assets held at the station are required to be forwarded to the

property control division by the 30 th may of every year. It may be noted that the furniture

in office premises need not be physically verified. Physical inventory of residential furniture

etc. Is compulsory, every year.

4. Need for proper asset inventory control

Maintenance of asset record location-wise and item-wise, apart from the necessity of

keeping a proper record of the fixed assets which largely represents the net worth of the

company vis-a-vis creditors and lending financial institutions, it is also an audit requirement

as usually the auditors have to satisfy themselves about the correctness and completeness of

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the asset records maintained by the company and record their remarks to this effect in the

published annual accounts and auditors report.

Asset inventory helps proper evaluation of capital expenditure proposals either for replacing

an existing item or procuring a new/additional item. It further helps retirement and write-off

of assets in a systematic way.

From our far-flung stations in the network, we usually ensure receipt of certified physical

inventories each year and biannually cover the physical verification of the considerably

large quantum of assets held at the headquarters base on a selective basis.

5. Retirement of property and scrap page

Before any asset is retired or disposed off, approval for scrap page of the same has to be

obtained from the departmental head concerned. After receipt of the scrap page approval

stations may arrange to dispose may arrange to dispose of the items after following the usual

stores property and not to asset account. When the disposal involves a huge lot of items upon

a closure of a station or off-line office or due to renovation or moving to new premises, and

in case of disposal of major equipments as well as motor vehicles, the bits received should be

put to controller of stores and purchases for his prior clearance before the sale is affected. In

such case usually it is advisable to have a local committee consisting of the managers,

accounts manager and representative of the user division to go into all aspect of sale and

make the appropriate tender noting. Scrap page advice worlds require to be issued as per

format E attached. It should also be noted that the disposal of an item would not

automatically entitle replacement of the same, as the normal process of budgeting, executive

sanction and other process would require to be gone through before items can be replaced.

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NATIONAL AVIATION COMPANY OF INDIA LIMITED

CAPITAL BUDGET OF 2010-2011

1. The Annual Plan Outlay for the year 2010-11 was framed at Rs 4434.80 crores.

However, approval of the Annual Plan 2010-11 from Ministry of Civil Aviation has been

received for Rs 5634.80 crores i.e. after adding Rs 1200 crores as Gross Budgetary

Support (GBS) in the form of Equity Infusion during the year by the Govt of India.

2. The Capital Budget for the year 2010-11 has accordingly been made within the

Annual Plan Outlay of Rs 4434.80 crores submitted to the Ministry of Civil Aviation.

The details of the Capital Budget 2010-11 are as follows:

(Rs in Crores)(A) Aircraft Projects

i) Payments to Aircraft Manufacturers for new Boeing Aircraft 3330.36

ii) Payments to Aircraft Manufacturers for new Airbus aircraft 204.97

iii) Interest to be capitalized for new Boeing Aircraft 251.52

iv) Payment for Spare Engines for new Boeing aircraft 261.22

v) Payment towards infrastructure for new Airbus aircraft 116.81 4164.88

(B) Non-Aircraft Projects

i) Other Capital Expenditure 269.92

TOTAL 4434.80

3. The total outgo under Aircraft Projects is estimated to be Rs 4164.88 crores as

detailed above. During the year, 5 new aircraft are to be received by the company

comprising of 1 A-321 aircraft from Airbus Industrie and 4 B 777-300 ER aircraft from

Boeing. The total payments to aircraft manufacturers during the year for these aircraft is

estimated to be Rs 3786.85 crores. In addition, 3 GE spare engines shall be received from

GE Aircraft Engines during 2010-11 at an estimated outgo of Rs 261.22 crores. The outgo

on account of infrastructural support payments for induction of new aircraft, which

includes payment for spare parts, ground handling, engineering workshop equipment etc,is estimated to be Rs 116.81 crores during the year.

4. The non aircraft projects include an outgo of Rs 269.92 crores under the head of

Other Capital Expenditure which includes Rs 82.73 crores for New Schemes and

Rs.187.19 crores for Continuing Schemes. The expenditure under this head represents the

payments to be made towards other capital projects such as Building Projects, Computer

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& Communication Equipment, IT Projects, Ground Support Equipment, Workshop

Equipment Plant & Machinery and Other Miscellaneous Assets etc.

5. Apart from the above outgo of Rs 4434.80 crores, the Miinistry of Civil

Aviation has made a provision of Rs 1200 crores as budgetary support in the form of

equity infusion in the company during the year 2010-11.

I) New Schemes Rs. 82.73 crores

The new projects to be undertaken and capital expenditure thereon required to be

incurred during the financial year 2010-11 are as under:

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Outgo

2010-11

1) Buildings & Workshopsa) Northern Region

i) Civil/Interior & allied works at Terminal 3 New Delhi 27.43 10.00

ii) Satellite Hangar/Workshop at Terminal 3 New Delhi 10.40 4.00

b) Eastern Region

i) Construction of GSE Complex Workshop at Kolkata. 3.80 0.10

c) SBU-Cargo

i) Drop Box Outlets at six metros 3.00 0.30

ii) Warehouse at Mumbai & Chennai 5.00 0.50

iii) Sales Offices at six metros 1.20 0.20

d) MRO-Engine & Components

i) Merging of APU Centre Module I & II at Kolkata 5.00 1.00

ii) Construction of 3rd & 4th Floor over Annexure Building in

New Hangar Complex at Kolkata

1.30 0.10

e) Other Departments/SBUs 4.85 2.06

Total of (1) 61.98 18.26

2) Ground Handling & Ramp Equipment

a) SBU Ground Handling

i) GH Equipment viz AC Unit, GPUs, Tractors etc 10.00 10.00

b) Other Departments(SBU-Cargo) 1.00 1.00

Total of (2) 11.00 11.00

3) Workshop Equipment, Plant & Machinery

a) Engine Overhaul

i) CNC Milling Machine at OAP 2.00 0.50

b) MRO-Engine & Components

i) Setting up of CFM 56-5B engine servicing facility at

JEOC New Delhi

41.00 10.00

ii) Test Bench for CIDS Director 5.04 1.00

iii) Universal Hydraulic Component Test Stand for

Accessory Overhaul Mumbai

9.00 2.00

iv) Renovation and upgradation of Hi-Flow facility 5.00 0.50v) APU Testing Facility Kolkata 21.32 3.00

vi) Setting up of servicing facility for A-320 Kolkata 4.55 2.00

c) Other Departments/SBUs 28.07 10.87

Total of (3) 115.98 29.87

4) Computer Facilities/Equipment

a) Information Technology

i) Centralized Oracle DB Server 1.00 0.10

ii) New SAN Box 1.20 0.10

iii) New PROS Project 6.00 0.50

b) Quality Management System (QMS)

i) Fuel & Operational Efficiency Management 10.00 5.00

c) Other Departments/SBUs 4.45 1.90

Total of (4) 22.65 7.60

5) Office Equipment - Block Provision 8.00 8.006) Vehicles - Block Provision 4.00 4.00

7) Unforeseen Expenditure - Block Provision 4.00 4.00

Total New Schemes-Non Aircraft 227.61 82.73

Particulars Project Cost

(Rs in Crores)

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II-a) Continuing Schemes Rs. 187.19 crores

The Capital Expenditure on Continuing Schemes for 2010-11 is placed at Rs. 187.19 crores.These Continuing Schemes also include an additional cost of Rs.32.62 crores due to

operational requirements as under, for which specific approval of the Board is required:

(Rs in Crores)Particulars Additional

Cost

1) Buildings & Workshops

a) Southern Region

i) Setting up of common booking offices at various stations 0.10

2) Workshop Equipment, Plant & Machinery

a) Materials Managementi) Automated Storage Retrieval System for aircraft spares 0.50

b) Engine Overhaul

i) Aviation Software Package for Maintenance including MRO

Management & Operations

25.00

ii) Video Boroscope 0.15

3) Computer Facilities/Equipment

a) Information Technology

i) Network Up gradation 0.37

b) Central Planning & Control Systems

i) Setting up of Central Planning & Control Systems (CPCS) 6.50

Total (1 to 3) 32.62

II-b) Under Continuing Schemes, certain old projects/schemes where there had been no

expenditure/outgo for two years or more have been dropped from Continuing Schemes and the

same can be reinstated as New Schemes in future as and when operational necessity arises. The

total Project Cost of such Continuing Schemes which have been dropped is Rs 40.16 crores.

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CONCLUSION

The Scope of our project was limited to capital budgeting for the Non-Aircraft section.

Air india like every other airlines has been making losses due to

Excess capacity

Lower yield

Drop in passenger numbers

An increase in fuel prices

The Effects of the global slowdown

Though It has shown good sign as its operating loss has decreased by 39 per cent from `5,672

crore in 2008-09 to `3,472 crore in 2009-10, while the net loss dipped by 23 per cent from `7,189

crore in 2008-09 to `5,551 crore in 2009-10. However still a lot needs to be done as the company

is struggling to cover even its total variable costs.

The role of capital budgeting section is very significant in such scenario as fixed assets and lease

expenses form major source of cash outflow in an airline industry. The expenditure for workshop

equipment, plant and machinery and Computer facilities/equipments has been increased over the

previous year. This indicates that the efforts are being made to improve the productivity of

existing business by the application of improved modern and technological applications.

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RECOMMENDATION

Equity of Air India should be restricted so that they can have a much wider equity on

which they can build up debt.

The government should immediately provide some amount as equity as per AI estimates,

for financial restructuring of Air India which would raise the paid-up share capital of Air

India.

A priority based capital budgeting with the cash inflows from one project be reinvestedinto another project will reduce its capital demand on long run.

Management information system (MIS) and Database management system needs to be in

place in order to increase efficiency and should be effectively enforced via capital

budgeting process.

As Voluntarily retirement schemes and very few recruitment, the workforce is likely to

decrease in the coming years and it will lead to decrease in expenses however to maintain

the productivity the employees need to be provided with additonal training in computers

and its cost vs beneefit needs to be considered.

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BIBLIOGRAPHY

http://www.air-india.com

Financial Management by Khan & Jain.

Nacil capital budget annual handbook.

Various magazines and reports published by Air-India

air_india_project rr

Documents