capital budgeting process

FINAL SEMESTER PROJECT

CAPITAL BUDGETING PROCESS

Investment Screening and selection

Capital Budget Proposal

Budgeting proposal and authorization

Project Tracking

Post Compilation Audit

Cement Industry Pakistan

Business Expansion

Establishing news Industry Capital Budgeting

STEP 1

INVESTMENT SCREENING

AND SELECTION

Investment Screening

Opportunities

Threats

Opportunities

•Existence of a cartel type arrangement of APCMA.•Expansion of operations to southern regions.•Greater budget allocations for PSDPs.•Reduced tariffs and taxes.•Pakistan is rich in coal reserves (Thar) whose exploitation can provide a cheap and continuous source of energy to cement industry.•Economy is improving (low inflation rate).•Improvement in infrastructure spending

Threats

•Political instability in the country.•Poor law and order conditions.•Governmental interference.•Price volatility•High circular debt•Severe power energy shortages

PORTER’S FIVE FORCES MODEL OF CEMENT SECTOR

1. Bargaining Power of Suppliers

2. Bargaining Power of Buyers

3. Barriers to Entry in the Market

4. Threat of Substitute Product

5. Rivalry among the Existing Competitors

1. BARGAINING POWER OF SUPPLIERS

the most significant industry among all industries of Pakistan

these raw materials are natural resources

Pakistan is abundant in limestone and gypsum resources

is coal or fuel which contributes approximately 40% cost.

2. BARGAINING POWER OF BUYERS

structure with more than 50 % share with top five companies

Secondly formation of cartels has maintained same prices in the region

Thirdly it’s difficult for a new company to enter in the market because of the barriers (but big companies can

However in winter due to low demand prices could be decrease but overall bargaining power is low

3. BARRIERS TO ENTRY IN THE MARKET

1. High Cost

2. Absence of Healthy Competition

3. Nature of Industry

4. THREAT OF SUBSTITUTE PRODUCT

threat of substitute product for cement is very low

steel as a substitute could prove very costly

timber, steel or gypsum which can replace cement we would come to know that they are best fitted to be used in the regions of extreme climate.

5. RIVALRY AMONG THE EXISTING COMPETITORS

29 small and large cement companies which are currently producing cement.

people can shift easily from one firm to another due to low switching cost which increases competition between firms.

Prices are not competitive advantage

Brand image would help determine higher prices due to cartel

SELECTION

Environmental Aspects

Legal Aspects

Technological Aspects

Social Aspects

Economic Aspect

Political Aspects

STEP 2

GENRATE THE PROPOSAL

CAPITAL BUDGET PROPOSAL

Methodolgy Expecte

d costs

Time required

PER UNIT COST ANALYSIS OF CEMENT SECTOR OF PAKISTAN

2008(000)Rs

2009(000)Rs

2010(000)Rs

2011(000)Rs

2012(000)Rs

2013(000)Rs

Sale Price/Ton 4.88 5.34 4.85 5.77 6.94 7.50

V.Cost/Ton 2.80 3.48 3.52 3.78 5.17 4.53

Contribution Margin/Ton

2.08 1.86 1.33 1.99 1.77 2.97

Fixed Cost/Ton 1.00 0.91 1.02 1.00 1.29 1.44

T.Cost/Ton 3.80 4.39 4.54 4.78 6.46 5.97

M.O.S 34% 61% 25% 39% 43% 53%

BREAK EVEN (A VIEW OF EXISTING INDUSTRY)

Cement companies Break-even in Rs. Break-even in units (ton)

Al-abbas cement 762,873 265,955

Attock cement 1,885,682 331,291

Bestway cement 2,694,403 448,737

Cherat cement 1,274,814 249,951

Dada bhoy cement 169,755 37,323

Dewan cement 2,232,315 364,814

Kohat cement 867,772 142,244

Lucky cement 4,996,686 936,576

Maple leaf cement 3,898,648 641,702

Lafarge Pak cement 3,394,987 635,968

Pioneer cement 1,441,959 226,362

Thatta cement 370,535 55,950

Leiner Pak Gelatine cement 327,917 10,499

D.G. Khan cement 7,428,762 1,811,695

Fauji cement 1,895,289 347,654

Flying cement 5,271 (19,027)

Ghareeb Wall cement 1,207,317 232,730

JVDC 203,726 35,991

Average 1,947,706 375,356

ABOVE AVERAGE BREAK EVEN COMPANIES

1. Bestway cement

2. Dewan cement

3. Lucky cement

4. Maple Leaf cement

5. Lafarge Pak cement

6. D.G. Khan Cement

The Real compititon

SALES PRICE PER UNIT

S.P/Unit 2008(000)Rs

2009(000)Rs

2010(000)Rs

2011(000)Rs

2012(000)Rs

2013(000)Rs

Industry Average

4.88 5.34 4.85 5.77 6.94 7.50

Rate of Change of S.P/Unit

2008 2009 2010 2011 2012

Industry Average 0.15 0.45 0.20 0.21 0.15

Rate of change of sales Price

VARIABLE COSTS PER UNIT

V.C/Unit 2008(000)Rs

2009(000)Rs

2010(000)Rs

2011(000)Rs

2012(000)Rs

2013(000)Rs

Industry Average 2.81 3.48 3.52 3.78 5.17 4.53

FIXED COST PER UNIT

F.Cost/Unit 2008(000)Rs

2009(000)Rs

2010(000)Rs

2011(000)Rs

2012(000)Rs

2013(000)Rs

Industry Average

1.00 0.91 1.02 1.00 1.29 1.44

COST OF SALE PER UNIT

T.Cost/Unit 2008(000)Rs

2009(000)Rs

2010(000)Rs

2011(000)Rs

2012(000)Rs

2013(000)Rs

Industry Average

3.80 4.39 4.54 4.78 6.46 5.97

MARGIN OF SAFETY

Margin of Safety

2008 2009 2010 2011 2012 2013

Industry Averages

34% 61% 25% 39% 43% 53%

CONCLUSION

The cost analysis has concluded that sales per unit in 2013 has increased, cost per unit has decreased resulting in high profitability so that’s a positive sign for the sector.

Total variable cost of the sector has decreased in 2013, hence increasing the contribution margin. This will not only decrease the break-even point but also increase the profit margin on each unit after achieving break-even. The sector has a high contribution margin of 2970 Rs in 2013. This means that after achieving break-even each ton will give a profit of this amount.

Margin of safety is 53% in 2013 which means that if industry loses half of its sales even then it would be safe from going into loss. So that shows a very good performance of the sector. High Margin of safety and high contribution margin in 2013 proved very good for the sector.

Table 62: Overview of Cement Sector in F.Y. 2013

Overview of cement sector Financial year 2013

Average total assets1.68 Billions

Average total liabilities8.27 Billions

Average total equity1.04 Billions

Average sales1.01 Billions

Average EPS8.14

Average installed cement capacity1.62 M-Tons

Average actual cement production1.47 M-Tons

Average installed clinker capacity1.77 M-Tons

Average actual clinker production5.96 M-Tons

Average capacity utilization-cement90.9%

Total assets Total liabilities Total equity Sales0

2

4

6

8

10

12

14

16

18

Averages in FY 2013 (Billions-Rs.)

Averages (Billions-Rs.)

Installed capacity-cemnt Actual production-cement Installed capacity-clinker Actual production-clinker0

0.2

0.4

0.6

0.8

1

1.2

1.4

1.6

1.8

Averages in FY 2013-M.Ton

Averages-M.Ton

PROPOSAL

Average total assets of the sector are increasing in recent years which show positive growth prospective (i.e. sector is growing).

Cement sector is moving long financing to short term financing. Cement sector increased emphasis on cost cutting has enhanced profitability Currently net profit in the sector has turned positive in recent years because

of increased sales and cost control measures therefore the sector has become attractive.

Currently sector is utilizing their assets efficiently to generate revenues. Cement sector has enough resources to pay short term obligations but also

facing short term liquidity and cash flow problems.

PROPOSAL

Currently cement sector is more solvent and debt financing is decreasing.

Cement sector has less chance of loss and efficient assets management in earning profits (High net profits) now.

The total variable cost per unit for the sector has decreased and the portion of fixed cost in total cost has increased which has resulted in low breakeven and high contribution margin.

Sale price per ton of cement sector has increased and total cost per ton has decreased resulting in high profitability in 2013.

Margin of safety of cement sector has increased.

CEMENT SECTOR HAS SHOWN GOOD FINANCIAL

POSITION, PERFORMANCE, PROFITABILITY, EPS

AND GROWTH IN CURRENT YEARS DUE TO

WHICH IT HAS BECOME ATTRACTIVE FOR

INVESTORS

STEP

3

Budgeting Approval and Authorization

LEGAL REQUIREMENTS

Reserve a company name online via the Securities and Exchange Commission of Pakistan (SECP) E-services website 

Pay the name reservation and company incorporation fees at the MCB Bank

Obtain a digital signature from the National Institutional Facilitation Technologies (NIFT) system of SECP

Complete online registration on the Securities & Exchange Commission of Pakistan (SECP) e-portal 

Apply for a national tax number (NTN) and register for income tax 

Apply for a Sales Tax Number (STN) at the tax facilitation center of the Regional Tax Office (RTO) of the Federal Board of Revenue (FBR) in Lahore

Register for Professional Tax with the Excise & Taxation Department of the District

Register with the Sind Employees Social Security Institution (SESSI) 

Register with Employees Old-Age Benefits Institution (EOBI) 

Register under the West Pakistan Shops and Establishment Ordinance 1969 with the Labor Department of the District

AUTHORIZATION

Finance department

HR DEPARTMENT

MARKETING DEPARTMENT

Other RELATED DEPARTMENT

APPROVAL

THE PROPOSAL AFTER BEING PREPARED AND AUTHORIZED WILL BE PRESENTED IN A MEETING AND CEO WILL APPROVE IT FOR FURTHER PROCESSING

STEP 4

PROJECT TRACKING

EXPENDITURES

Fixed cost

Variable cost

VARIABLE COST

Raw material, direct labor, variable FOH and variable selling and distributive expensesVariable FOH:Fuel and powerStores and spares consumedRepair and maintenanceVehicle running and maintenanceIndirect materialCommunicationTransportationTraveling and conveyancePrinting and stationaryOther manufacturing cost

Variable Selling andDistributive Cost: Salaries and wages Logistic and related chargesLoading and othersCommunicationTraveling and conveyanceFreightPrinting and stationaryUtilitiesVehicles and maintenanceRepair and maintenanceOthers selling expense

FIXED COST

Depreciation and amortization

Insurance

Provision for slow moving spare parts

Earthmoving machinery

Inspection for electrical installment

Rent, rates and taxes

Mess subsidy

Technical assistance

Legal and professional charges

Fixed Selling and Distributive Expenses:

Insurance

Rent, rates and taxes

DepreciationSecurity charges InsuranceFee subscription and periodicalsAdvertisement and sales promotionEntertainmentOffice canteen Meetings and conferences

ESTIMATING CASH FLOWS

Year 0 1 2 3 4

Sales - 3750000 1680000 1380000 1320000

Advertisement Cost - 650000 100000 - -

Material   810000 378000 324000 324000

Fixed Cost   600000 600000 600000 600000

OH   900000 420000 360000 360000

operating cash flows   790000 182000 96000 36000

Tax @30%   237000 54600 28800 10800

Net cash flows   613000 187400 127200 85200

In dollars

BREAK EVENS

Cement companies Break-even in Rs. Break-even in units (ton)

Al-abbas cement 762,873 265,955

Attock cement 1,885,682 331,291

Bestway cement 2,694,403 448,737

Cherat cement 1,274,814 249,951

Dada bhoy cement 169,755 37,323

Dewan cement 2,232,315 364,814

Kohat cement 867,772 142,244

Lucky cement 4,996,686 936,576

Maple leaf cement 3,898,648 641,702

Lafarge Pak cement 3,394,987 635,968

Pioneer cement 1,441,959 226,362

Thatta cement 370,535 55,950

Leiner Pak Gelatine cement 327,917 10,499

D.G. Khan cement 7,428,762 1,811,695

Fauji cement 1,895,289 347,654

Flying cement 5,271 (19,027)

Ghareeb Wall cement 1,207,317 232,730

JVDC 203,726 35,991

Average 1,947,706 375,356

PRESENT VALUE

Year Cash Flows   PV@ 10%

0 800000  800000

1 613000 0.909 557217

2 187400 0.826 154792.4

3 127200 0.751 95527.2

4 85200 0.683 58191.6

NPV     65728.2

In dollars

IRR

Year Cash Flows Dis @10% PV@ 10%

Dis.@15%

PV @15%

0 800000  800000  800000

1 613000 0.909 557217 0.833 510629

2 187400 0.826 154792.4 0.694 130055.6

3 127200 0.751 95527.2 0.578 73521.6

4 85200 0.683 58191.6 0.482 41066.4

NPV     65728.2  -44727.4

16%

In dollars

STEP 5

POST COMPLITION AUDIT

Ratios analysisHorizontal analysisVertical analysis

Overview of cement sector Financial year 2013

Average total assets 1.68 Billions

Average total liabilities 8.27 Billions

Average total equity 1.04 Billions

Average sales 1.01 Billions

Average EPS 8.14

Average installed cement capacity 1.62 M-Tons

Average actual cement production 1.47 M-Tons

Average installed clinker capacity 1.77 M-Tons

Average actual clinker production 5.96 M-Tons

Average capacity utilization-cement 90.9%

THAN

K YO

U..

Saman Khurshid