BHARAT HEAVY ELECTRICALS LIMITED

A project report submitted in partial fulfillment of the requirements for

the

award of degree of

MASTER OF BUSINESS ADMINISTRATION

AMITY GLOBAL BUSINESS SCHOOL, NOIDA

AMITY UNIVERSITY – UTTAR PRADESH
 A PROJECT REPORT ON :

BUSINESS VALUATION,

LEASING Vs BUYING DECISION

AND

PROJECT FINANCING

IN

BHARAT HEAVY ELECTRICALS LIMITED

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 EXECUTIVE SUMMARY

Bharat Heavy Electricals Limited (BHEL) is in the business of capital goods for past many
years & has become the back born of power in India for the same reason it’s been given the
status of NAVARATNAS.

But, in the present world of globalization & labialization and growing demand for power its
market share is in danger. This project report is on the Strategic Analysis of BHEL. The
main purpose of the project is to analyse the Environment in which BHEL is operating. The
inter relationship of Heavy Engineering Industry and Power Sector and Company analysis is
done thoroughly to understand both external and internal factors influencing the company.

All various ratios are calculated and analyzed in length to appreciate their impact on
company performance. DuPont analysis is done to check the credibility of company as per
shareholders, financial analysts and other mutual funds along with Common Size Analysis.

In the light of understanding of power sector need & demand & supply condition and on the
basic of all the analysis, this report laid down various strategic option for the each operational
unit of BHEL.

Main Manufacturing Units:

Headquarters of BHEL is situated in New Delhi.
Bhopal (Madhya Pradesh)

Bharat Heavy Electrical Limited, Ranipur, Haridwar (Uttarakhand)

Hyderabad (Andhra Pradesh)

Jhansi (Uttar Pradesh)

Tiruchirapalli(Tamil Nadu)

Ranipet (Tamil Nadu)

Bangalore (Karnataka)

Jagdishpur (Uttar Pradesh)

Goindwal (Punjab)
Bharat Heavy Plates and Vessels Limited (Vizag)

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 TABLE OF CONTENTS

1. Company Profile

 Bharat Heavy Electricals Ltd. – Introduction

 Recent History
 Business Segments
 Products Offered
 Research and Development
 Human Resources
 Salary Grades
 Exports
 Technology Sourcing
 Company Financials
 SWOT Analysis of BHEL
 Corporate Functional Structure
 Recommendation strategic option for BHEL-Finance
2. Objectives of the Project
3. Business Valuation
 The Value Concept
 Business Valuation Services
 Accepted Valuation Approaches and Methods
 The Approach Applied
 Business Valuation of BHEL

4. Leasing Vs Buying Decision

 Financing Decision
 Factors Effecting Cost of Financing Options (Specifying BHEL
Practices)
 The Decision Platform – Net Cash Outflows
 The Standardized Formats

5. Project Financing
 The Financing Concept
 Parties to Project Financing
 Project Financing in BHEL – Selection of Bank / Financial
Institution
 The Decision Platform – NPV & IRR
 The Standardized Formats

6. Conclusion

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7. Bibliography

Bharat Heavy Electricals Limited

INTRODUCTION

Bharat Heavy Electricals Limited is a largest engineering and manufacturing enterprise in

India. It is one of India’s nine largest Public Sector Undertaking, known as NAVARATNAS.
BHEL is the largest engineering and manufacturing enterprise of its kind in India and is one
of the leading international companies in the field of power equipment manufacture. The first
plant of BHEL, set up at Bhopal in 1956, signaled the dawn of the Heavy Electrical Industry
in India. In the sixties, three more major plants were set up at Haridwar, Hyderabad and
Tiruchirapalli that form the core of the diversified product range, systems and services that
BHEL offers today. BHEL's range of services extends from project feasibility studies to
after-sales-service, successfully meeting diverse needs through turnkey capability.
The company has 14 manufacturing units, 4 power sector regions, 8 service centers and 15
regional offices, besides project sites spread all over India and abroad. BHEL has a well
recognized track record of performance, making profits continuously since 1971-72 and
paying dividendssince-1976-77.
BHEL manufactures over 180 products under 30 major product groups and caters to core
sectors of the Indian economy viz., Power Generation and Transmission, Industry,
Transportation, Renewable Energy etc. The quality and reliability of its products is due to the
emphasis on design, engineering and manufacturing to international standards by acquiring
and adapting some of the best technologies from leading companies in the world, together
with technologies developed in its own R&D centers. The Company has been constantly
adapting itself to face the challenges thrown-up by the business environment.
Over 65 percent of power generated in India comes from BHEL-supplied equipment. Overall
it has installed power equipment with a total capacity of over 90,000 MW.

Quality & Awards: -

BHEL has attained ISO 9001 certification for quality management and all the manufacturing
units/divisions of BHEL have been upgraded to the latest ISO-9001: 2000 version. All the
major units/divisions of BHEL have been awarded ISO-14001 certification for
Environmental Management Systems and OHSAS-18001 certification for Occupational
Health and Safety Management Systems. BHEL was the first Public Sector Company in the
country to win the coveted ‘PRIZE’ for its Haridwar unit under the CII Exim Award for
business excellence, as per the globally recognized model of European Foundation for
Quality Management. The company received EEPC’s Top Export Award for Project Exports
for the seventeenth year in succession. It has also won the SCOPE Meritorious Award for
R&D and Innovation 2005-06 for commendable contribution in the area of R&D and
Innovation.

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 THE RECENT HISTORY

In the 1970s and the 1980s, power sector projects were either funded by the Government
through budgetary resources or through central government undertakings like the NTPC,
which largely relied on multilateral organizations like the World Bank. Both sources of
funding ensured a steady stream of orders for BHEL, which won these contracts in spite of
international competition. The World Bank’s insistence on a 15 percent price preference for
local equipment combined with the low cost of BHEL equipment ensured that BHEL won 29
out of the 31 projects that were funded by multilateral institutions during the 1980s.

By the late 1990s BHEL has emerged as a company whose products were competitive
internationally, in terms of price and quality.

In 1998, BHEL gave a renewed thrust to the Total Quality Management (TQM) drive that it
had initiated at its plants by following the European Foundation for Quality Management
(EFQM) Excellence Model. The company also finalized a Corporate Environment
Management Policy, which included a plan of action for various units to qualify for ISO
14001 Environment management System certification in a phased manner.

BUSINESS SEGMENTS

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BHEL’s business could be broadly classified into two categories – Power Equipment
Business and Industry Equipment Business. Power equipment business was BHEL’s core
business and generated about 52 percent of BHEL’s revenue during 1998. Its range of
services included systems design, engineering, manufacturing and project management.

Industry equipment business was set up to facilitate BHEL’s entry into growing areas like
process industries, telecommunications, non-conventional energy, transmission equipment
industry, etc.

Business Divisions

This enables BHEL to have a strong customer orientation and respond quickly to the changes
in the market.

Lets deal with them segment wise:

POWER SECTOR
This sector comprises of thermal, gas, hydro and nuclear power plant business. As of 31-3-
2002, BHEL-supplied sets account for nearly 67,232 MW or 64 per cent of the total installed
capacity of 1,04,917 MW in the country, as against Nil till 1969-70.

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BHEL has proven turnkey capabilities for executing power projects from concept to
commissioning. It possesses the technology and capability to produce thermal sets with super
critical parameters up to 1000 MW unit rating and gas turbine-generator sets of up to 250
MW unit rating. Co-generation and combined-cycle plants have been introduced to achieve
higher plant efficiencies. To make efficient use of the high-ash-content coal available in
India, BHEL supplies circulating fluidized bed combustion boilers to both thermal and
combined-cycle power plants.

The company has proven expertise in Plant Performance Improvement through renovation,
modernization and up rating of a variety of power plant equipment, besides specialized
know-how of residual, health diagnostics and life extension of plants.

TRANSMISSION AND DISTRIBUTION (T&D)

BHEL offers wide-ranging products and systems for T&D applications. Products
manufactured include: power transformers, instrument transformers, dry type transformers,
series & shunt-reactors, capacitors banks, vacuum & SF6 circuit breakers, gas-insulated
switchgears and insulators.

A strong engineering base enables the company to undertake turnkey delivery of electric
substations up to 400 kV level, series compensation systems (for increasing power transfer
capability of transmission line and improving system stability and voltage regulation), shunt
compensation system (for power factor and voltage improvement) and HVDC systems (for
economic transfer of bulk power). BHEL has indigenously developed the state-of-the-art
controlled shunt reactor (for reactive power management on long transmission lines).
Presently, a 400 kV FACTS (Flexible AC Transmission System) project is under execution.

INDUSTRY SECTOR
BHEL is a major contributor of equipment and systems to industries: cement, sugar,
fertilizer, refineries, petrochemicals, paper, oil and gas, metallurgical and other process
industries. The range of systems and equipment supplied includes: captive power plant, co-
generation plants, DG power plants, industrial steam turbines, industrial boilers and
auxiliaries, waste heat recovery boilers, gas turbines, heat exchangers and pressure vessels,

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centrifugal compressors, electrical machines, pumps, valves, seamless steel tubes,
electrostatic precipitators, fabric filters, reactors, fluidized bed combustion boilers, chemical
recovery boilers and process controls.

The company is a major producer of large-size thyristor devices. It also supplies digital
distributed control systems for process industries and control & instrumentation systems for
power plant and industrial applications. BHEL is the only company in India with the
capability to make simulators for power plants, defense and other applications. The company
has commenced manufacture of large desalination plants to help augment the supply of
drinking water to people.
TRANSPORTATION
BHEL is involved in the development, design, engineering, marketing, production, installation,
maintenance and after-sales service of rolling stock and traction propulsion systems. In the area
of rolling stock, BHEL manufactures electric locomotives up to 5000 HP, diesel electric
locomotives from 350 HP to 3100 HP, both for mainline and shunting duty applications. BHEL
is also producing rolling stock for special applications viz., overhead equipment cars, special
well wagons, Rail-cum-road vehicle etc. Besides traction propulsion systems for in-house use,
BHEL manufactures traction propulsion systems for other rolling stock producers of electric
locomotives, diesel – electric locomotive, electrical multiple units and metro cars. The electric
and diesel traction equipment of Indian Railways are largely powered by electrical propulsion
systems produced by BHEL. BHEL also undertakes retrofitting and overhauling of rolling
stock. In the area of urban transportation systems, BHEL is geared up to turnkey execution of
electric trolley bus systems, light rail systems, etc. BHEL is also diversifying in the area of port
handling equipment and pipelines transportation system.

TELECOMMUNICATION
BHEL provided total turnkey solution with extensive customer support. BHEL was the first
company in India to have installed electronic Private Automatic Branch Exchange (PABX)
system, and Rural Automatic Exchange (RAX) system based on indigenous technology from
C-DOT.
Renewable Energy: technologies that can be offered by BHEL for exploiting non-
conventional and renewable sources of energy include: wind electric generators, solar
photovoltaic systems, solar heating systems, solar lanterns and battery-powered road

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vehicles. The company has taken up R&D efforts for development of multi-junction
amorphous silicon solar cells and fuel cells based systems.

OIL AND GAS

BHEL is a major contributor to the Oil and Gas sector industry in the country. BHEL’s
product range includes Deep Drilling Oil Rigs, Mobile Rigs, Work Over Rigs, Well Heads
and X-Mas Trees (of up to 10,000 psi ratings), Choke and Kill Manifolds, Full Bore Gate
Valves, Mud Valves, Mudline Suspension System, Casing Support System, Sub-Sea Well
Heads, Block Valves, Seamless pipes, Motors, Compressors, Heat Exchangers, etc. BHEL is
the single largest supplier of Well Heads, X-Mass Trees and Oil Rigs to ONGC and OIL.

INTERNATIONAL SECTOR
BHEL is one of the largest exporters of engineering products and services from India,
ranking among the major power plant equipment suppliers in the world.
Over the years, BHEL has established its references in around 60 countries of the world,
ranging from the United States in the West to New Zealand in the Far East. These references
encompass almost the entire product range of BHEL, covering turnkey power projects of
thermal, hydro and gas-based types, substation projects, rehabilitation projects, besides a
wide variety of products, like transformers, insulators, switchgears, heat exchangers, castings
and forgings, valves, well-head equipment, centrifugal compressors, photovoltaic equipment,
etc. Apart from over 1100 MW of capacity contributed in Malaysia, and execution of four
prestigious power projects in Oman, the major successes achieved by the company have
been in China, Saudi Arabia, Libya, Greece, Cyprus, Egypt, Bangladesh, Azerbaijan, Sri
Lanka, Iraq, Kazakhstan, Indonesia, etc.

The company has been successful in meeting demanding customers’ requirements in terms of
complexity of the works as well as technological, quality and other requirements viz.,

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associated O&M, financing packages, extended warranties etc. BHEL has proved its
capability to undertake projects on fast-track basis. The company has been successful in
meeting varying needs of the industry, be it captive power plants, utility power generation or
for the oil sector requirements. Execution of overseas projects has also provided BHEL the
experience of working with world renowned Consulting Organizations and Inspection
Agencies.

In addition to demonstrated capability to undertake turnkey projects on its own, BHEL

possesses the requisite flexibility to interface and complement with international companies
for large projects by supplying complementary equipment and meeting their production
needs for intermediate as well as finished products.

BHEL PLANT PERFORMANCE

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The operational plant performance of BHEL as a whole is outstanding as compare to all India
basic. If we look at units individually all the 500MW, 250 MW & 200/210MW is performing
better then BHEL as a whole. This also shows the dominance of BHEL in thermal set
category. BHEL Thermal sets contributed 77.07 % of country’s installed thermal capacity of
77629.48 MW

PRODUCTS OFFERED

 THERMAL POWER PLANTS

 GAS BASED POWER PLANTS
 HYDRO POWER PLANTS
 DG POWER PLANTS
 INDUSTRIAL SETS
 BOILERS
 HEAT EXCHANGERS AND PRESSURE VESSELS
 PUMPS
 POWER STATION CONTROL EQUIPMENT
 BUS DUCTS
 SWITCHGEAR
 COMPRESSORS
 SILICON RECTIFIERS

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 CONTROL GEAR
 OIL FIELD EQUIPMENT
 TRANSPORTATION EQUIPMENT
 POWER DEVICES
 THYRISTOR EQUIPMENT
 INDUSTRIAL ELECTRICAL MACHINES
 ENERGY METERS
 CAPACITORS
 SYSTEMS AND SERVICES
 TELECOMMUNICATION
 NON-CONVENTIONAL ENERGY SYSTEMS
 SEAMLESS STEEL TUBES
 CASTINGS AND FORGINGS
 INSULATORS
 TRANSFORMERS

RESEARCH AND DEVELOPMENT

Over the years, BHEL had successfully adapted many global technologies to suit Indian
conditions. BHEL had modified boiler designs suitably to accommodate Indian coal, which
had high ash contents. It had also indigenized many components for power plants. During the
1960s, R&D activities at BHEL were conducted separately at its various units.

During 1997, BHEL’s research wing achieved two major breakthroughs. BHEL succeeded in
the development, manufacture and testing of India’s first 200 KVA (kilo volt-ampere)
superconducting generator. The company was also successful in developing ‘fuel cell
technology.’ Company sources explained that ‘phosphoric acid fuel cells,’ would emerge as a
major source of pollution-free electric power in the 21st century.

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To remain competitive and meet customers’ expectations, BHEL lays great emphasis on the
continuous up gradation of products and related technologies, and development of new
products. BHEL’s commitment to advancement of technology is reflected in its involvement
in the development of futuristic technologies like fuel cells and super conducting generators.
BHEL’s investment in R&D is amongst the largest in the corporate sector in India. Products
developed in-house during the last five years contributed about 7% to the revenues in 2002-
03.

HUMAN RESOURCE

BHEL has envisioned to becoming “A world-class innovative, competitive and profitable

engineering enterprise, providing total business solutions.” For realizing this vision,
continuous development and growth of the 48,000 strong highly skilled and motivated people
making the Organization, is the only ‘mantra’.

BHEL was perceived as a company where the promotions were fast, jobs were challenging,
and people enjoyed a great degree of freedom to operate and function. Employees at all
levels of BHEL received extensive training in different facets of management, technology
and operations. The Human Resource Development Institute (HRDI) at Noida and the
company’s other training institutes along with professional management institutes conducted
various programs to upgrade the skills of BHEL employees.

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BHEL sources felt that the strong emphasis on training had resulted in a positive work
culture. This had led to the development of a committed and motivated workforce and
enhanced productivity and quality. It launched various initiatives to encourage participative
management.
During 1999, BHEL introduced a Voluntary Retirement Scheme (VRS) for its employees.
The VRS aimed to correct imbalances that had crept in due to the government’s decision to
extend the retirement age from 58 to 60 years. The response for the VRS was overwhelming.
BHEL received applications from 8,600 workers (about 13 percent of its workforce).

To formulate strategies for growth and harmonious labor relations in a changing business
environment, the company organized a specially designed workshop fro unit level trade
union representatives and central trade union leaders.

SALARY GRADES

Executive Salary Grades with effect from 1.1.1997:

CMD Rs.27750-750-31500
Director Rs.25750-650-30950
Executive Director Rs.23750-950-28550
E-8 - General Manager Rs.20500-820-26500
E-7 - Addl. General Manager Rs.20000-800-25700
E-6A - Sr. Deputy Gen. Manager Rs.19500-780-25350
E-6 – Deputy General. Manager Rs.18500-740-23900 *
E-5 - Senior Manager Rs.17500-700-22300 *
E-4 - Manager Rs.16000-640-20800 *
E-3 – Deputy Manager Rs.14500-580-18700 *
E-2 - Sr. Engineer/Officer /Sr. Executive Rs.12500-500-18100 *

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E-1A - Engineer/Officer/Executive Rs.10750-430-16750 *
E-1 - Executive Trainee Rs.8600-350-14600 *

These scales are replaced with effect from 1.1.2000 as below:

E-6 – Deputy General Manager Rs19000-760-25300

E-5 - Senior Manager Rs.18500-740-23900

E-4 - Manager Rs.17500-700-22300

E-3 – Deputy Manager Rs.16000-640-20800

E-2 - Sr. Engineer/Officer /Sr. Executive Rs.13750-550-18300

E-1A -Engineer/Officer /Executive Rs.11225-450-17525

E-1 - Executive Trainee Rs.10750-430-16750

Supervisor Salary Grades with effect from 1.1.1997:

GRADE SCALE 01-01-1997 SCALE 01-01-2000

SA VII Rs.14500-580-18700 * Rs. 16000-640-20800

SA VI Rs.13000-520-18250 * Rs. 14500-580-18700
SA V Rs.12500-500-18100 * Rs. 13750-550-18300

SA IV Rs.10750-430-16750 * Rs. 11225-450-17525

SA III Rs.7000-245-7735 Rs. 7900-260-12000

SA II Rs.6500-230-7190 Rs. 7350-245-10640
SAI Rs.6000-210-6630 Rs. 6780-230-10160
S0 Rs.5600-150-8600

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Worker Salary Grades with effect from 1.1.1997:

GRADE SCALE 01-01-1997 SCALE 01-01-2000

AXI Rs.11580-460-18020
AX Rs.10335-415-17390
AIX Rs.7000-245-7735 Rs. 7900-260-12000
AVIII Rs.6500-230-7190 Rs. 7350-245-10640
AVII Rs.6000-210-6630 Rs. 6780-230-10160
AVI Rs.5750-190-6320 Rs. 6415-205-9285
AV Rs.5350-175-5875 Rs. 5965-190-8815
AIV Rs.5000-150-5450 Rs. 5525-175-7975
AIII Rs.4800-130-5190 Rs. 5255-150-7805
AII Rs.4400-110-4730 Rs. 4785-130-7125
AI Rs.4200-100-4500 Rs. 4550-110-6530

EXPORTS

Over the years, BHEL had emerged as one of India’s leading exporters. BHEL’s exports
turnover during 1997-98 touched an all time high of Rs.1783.85crore, for which it was
conferred the ‘National Export Award.’ Recently it has also crossed that mark in 2001-02
(Rs.2501.95). BHEL received orders from multinational companies like Siemens, Schneider,
Toa, GEC, Dresser and Pasau for a variety of products like ceramics, condensers, valves,
motors, transformers, castings and forgings, ceralin and insulators. BHEL’s export orders
during 1998-99 increased by over two and a half times to Rs.250crore as against Rs.91crore
in the previous year. This performance was achieved despite a highly competitive
international market affected by the currency crisis in South-East Asia.

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 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006
YEAR -98 -99 -00 -01 -02 -03 -04 -05 -06 -07

DEEMED 621 612 659 727 1138 1570 1902 1395 1425 1523
PHYSICAL 165 238 138 115 156 213 69 355 247 987
TOTAL 786 850 797 842 1294 1783 1971 1750 1673 2510

TECHNOLOGY SOURCING

Over the years, BHEL had successfully adapted many global technologies to remain
competitive and meet customers’ expectations, it lays great emphasis on the continuous up
gradation of products and related technologies, and development of new products. The
company has up graded its products to contemporary levels through continuous in-house
efforts as well as through acquisition of new technologies from leading engineering
organizations of the world.

BHEL had modified boiler designs suitably to accommodate Indian coal, which had high ash
contents. It has also indigenized many components for power plants.

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In its early years, BHEL did not have much choice while selecting its technology suppliers.
By the mid-1970s, BHEL had established its credibility and suppliers from the Western
countries were vying with each other to provide technology. These agreements enabled
BHEL to gain access to the latest technology and products of its collaborators.

In 1996, BHEL formed strategic alliances with Siemens and GE to set up two separate 50:50
joint venture companies. The joint venture between Siemens and BHEL, set up with a capital
of Rs.6crore, was named Power Plant Improvement Private Ltd. (PPIPL). The joint venture
between BHEL and GE, set up with a capital of Rs.7crore, was named BHEL-GE Gas
Turbine Services Pvt. Ltd. which would carry out after sales repair and services.

COMPANY FINANCIALS

BHEL completed a successful year in 1997-98, despite a highly competitive environment, a

decline in industrial growth from 7.9 percent to 4.15 percent, and a negative growth in the
capital goods sector. The company managed an order inflow of Rs.5853crore during 1997-
98. the year ended with outstanding orders in excess of Rs.10000crore.

In 1998, the Government on India, which held a 77 percent equity stake in BHEL, announced
that the company had been identified for further disinvestment in line with its policy of
giving Navaratnas more autonomy. The Government intended to reduce its stake to 51
percent.

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BHEL’s share price had appreciated considerably from Rs.100 in April, 1995 to Rs.223 in
May, 2003. In 1997-98, BHEL achieved the highest ever earnings per share (EPS) of 29.4. In
comparison, the EPS in 1996-97 was only 18.9. Since then it has kept fluctuating. BHEL’s
earnings had constantly grown till now, it is a growing company.

Defying the downward trend it has constantly grown and another successful year was
completed and has registered a net profit of Rs.4679 million. Net worth of the company has
gone up from Rs.36018 million in 2000-2001 to Rs.42203 million in 2001-2002 registering
an increase of 17.17%. NAV per share has increased by 17.17% from Rs.147.16 in 2000-
2001 to Rs.172.43 in 2001-2002.

Order inflow during 2001-2002 stood at Rs.98553 million. The year ended with an
outstanding order book of around Rs.1,25,000 million available for execution 2002-2003 and
beyond.

FINANCIAL RESULTS for the year 2007-2008:

(Rs. in Crore) 2007-08 2006-07

(a)Turnover 21401 18739

(b) Profit before depreciation,

interest & tax 4763 4052
(c) Less: Depreciation 297 273
(d) Less: Interest & Finance charges 36 43

(e) Profit before tax 4430 3736

(f) Less: Provision for Taxes 1571 1321
(including deferred tax &
Fringe benefit tax)

(g) Profit after Tax 2859 2415

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(h) Add:/(less) Statutory
appropriation 1 1

(i) Distributable Profit 2860 2416

(j) Add: Balance brought forward
from the previous year 443 219

k) Balance available for

appropriation 3303 2635
i) Dividend (including interim 746 600
dividend)
ii) Corporate Dividend tax
(incl. on interim dividend) 127 92
iii) Amount transferred to
General Reserve 2000 1500

l) Balance in P&L account to be

carried forward 430 443
(m) Earnings per Share based
on enhanced Share capital (Rs.) 58.4 49.3
(n) NAV per share based
on enhanced Share capital (Rs.) 220.1 179.5
(o) Economic Value Added (Rs. crore) 1810 1657

FOURS YEARS SUMMARY( for the year 2004-2008):

2007-08 2006-07 2005-06 2004-05

EARNINGS

Turnover (Gross) 21401 18739 14525 10336

Other Income 1445 824 547 656
Total Earnings 23673 19744 15458 11532
Materials, Erection & 11821 10018 8147 5871
Engineering Expenses
Personnel Payments 2608 2369 1879 1650
Other mfg., admn. & selling
expenses 4482 3305 2564 2128
Outgoings before interest & depr. 18911 15692 12589 9650
Profit before depreciation, interest
& tax 4762 4052 2869 1882
Depreciation 297 273 246 219

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Gross Profit 4465 3779 2623 1663
Interest 35 43 59 81
Profit before tax 4430 3736 2564 1582
Provision for tax 1571 1321 885 628
Profit after tax 2859 2415 1679 953
Dividend 746 600 355 196
Corporate Dividend Tax 127 93 50 27
Retained Profit 1986 1722 1275 731

II WHAT THE COMPANY OWNED

Gross Block 4443 4135 3822 3629

Less: Accumulated 3462 3146 2840 2585
Depreciation & Lease Adj.
Net Block 981 989 982 1044
Capital WIP 658 303 185 95
Investments 8 8 8 9
Current Assets, Loans & Advances 27705 20980 16331 13343
Total assets 29352 22280 17506 14491

III WHAT THE COMPANY OWED

Borrowings (incl. Credits for 95 89 558 537

assets taken on lease)
Current liabilities & provisions 19821 14337 10320 8446
Total liabilities 19916 14426 10873 8983

NET WORTH OF THE COMPANY

Share Capital 490 245 245 245
Reserves & Surplus 10285 8544 7057 5782
Less : Deferred Revenue
Expenditure 0 0 0 0
Net Worth 10775 8789 7302 6027

2007-08 2006-07 2005-06 2004-05

V CAPITAL EMPLOYED 7362 5571 5517 4557

VI VALUE ADDED 8323 7182 5683 4254

VII RATIOS
PBDIT to total assets # 18.4% 20.4% 17.9% 14.4%
Gross profit to capital employed # 69.0% 68.2% 52.1% 40.2%
Turnover/ gross block 4.8 4.5 3.8 2.8
Earnings per share Rs. 58.4## 98.7 68.6 39.0 26.9
Net worth per share Rs. 220.1## 359.1 298.3 246.2 215.6
Current Ratio 1.4 1.5 1.6 1.6
Total Debt / Equity 0.01 0.01 0.08 0.09
Return on Net Worth 26.5% 27.5% 23.0% 15.8%
Gross profit margin 20.9% 20.2% 18.1% 16.1%

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Net profit margin 13.4% 12.9% 11.6% 9.2%

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ANALYSIS
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THE earnings performance of BHEL for the quarter ended March 2008 has been fairly good.
Sales revenues during the period rose around 11 per cent to Rs 3,374.2 crore, compared to
the corresponding previous period. Of this, close to 68 per cent of the sales were generated
by the power division and the rest from the industrial division.

BHEL’s power equipment segment is the undisputed market leader in this segment. Its huge
capacity, ability to offer contemporary technologies and competitive prices, make it among
the preferred suppliers of power equipment in the country. This is evidenced by the order
book position, way ahead of its closest competitors. This trend is likely to continue and be in
favour of BHEL’s near-to-medium-term prospects.

INVESTMENT OUTLOOK

Trading at around Rs 167, the BHEL stock may be a good investment option for a moderate-
to-high-risk portfolio. It trades at a price earnings multiple of around 12 times its latest
quarter’s earnings per share. Its earnings performance for the quarter ended March 2008 has
been fairly impressive.

Despite tough industry conditions, the company has managed a sedate growth rate in both
profits and revenues. Gains have come mainly on account of the company’s dominant
position in the industry and also good management of resources. In this backdrop, the
valuation of the stock over the next three months should improve. Fresh positions can be
considered at current levels.

However, investors should also look out for exit opportunities once the stock breaches the Rs
200-210 levels. Risk-averse investors may consider taking an exposure if the stock declines
to Rs 150-155, and sell if it crosses Rs 200.

GENERAL OUTLOOK

25
While the Indian Economy is continuing to grow at slow pace, there are positive impulses
like on-going Restructuring and Reforms in the Power Sector, enhanced focus on
Distribution, increased outlay for Accelerated Power Development and Reforms Program,
creating regulatory system, new Electricity Bill etc. Government’s commitment to enhance
private and public investments in the infrastructure is a positive aspect that will spur
Industrial Growth and enhance market prospects for industrial products in the coming years.
BHEL has put in place a number of initiatives, as follows, for furthering future growth
prospects:
 Strengthening company’s core businesses of Power Generation, Transmission and
Distribution, Transportation and Industrial Systems and Products, through accelerated
project completion and consequent benefits to customers, along with new initiatives in
marketing, technology, facility up gradation and modernization, enhancing operational
effectiveness etc.
 Business Development efforts in related and allied areas utilizing the organizational
strengths and former customer focused specialized business groups e.g. formation of Oil
Sector R&M Business Group to address business in Renovation and modernization of
off-shore and on-shore oil platforms, down streams petroleum refining areas and Power
Plant Operational Services Group to provide Operation and Maintenance (O&M)
Services for Power Plants.
 After Market Services being the areas for future growth, spares and R&M services
business have been integrated into one focused group. R&M for hydro sets is an area
having major growth opportunity, which BHEL is poised to tap.
 Exploring Business Opportunities in areas like Energy Conservation, Water
Management, Pollution Control and Waste Management, Ports, LNG terminal etc.
 Positioning for Information Technology Business leveraging the domain knowledge in
Power Sector and Engineering field to provide IT enabled services for Power Sector and
software services for Engineering Industry.
 Sustain and Enhance Exports for products and services through multi-prolonged
approaches.

BHEL is also taking steps to re-position itself to meet the demands of the new market
economy through suitable strategies keeping in view the ultimate objective of enhancing
value for its stakeholders.

26
 SWOT ANALYSIS OF BHEL
SWOT analysis is a tool for auditing an organization and its environment. It is the first stage
of planning and helps marketers to focus on key issues. SWOT stands for strengths,
weaknesses, opportunities, and threats. The aim of any SWOT analysis is to identify the key
internal and external factors that are important to achieving the objective. These come from
within the company's unique value chain. SWOT analysis groups key pieces of information
into two main categories:

 Internal factors – The strengths and weaknesses internal to the organization.

 External factors – The opportunities and threats presented by the external

environment to the organization

SWOT analysis is a flexible concept that can be used in various scenarios from assessing
projects or business ventures, making decisions, solving problems, evaluating candidates for
a position to marketing strategy formulation.
It provides information that is helpful in matching the firm's resources and capabilities to the
competitive environment in which it operates. As such, it is instrumental in strategy
formulation and selection.




 STRENGTHS

• Low labor cost except china.

• Ability to set up power plants on turnkey basis, complete know- how for
manufacture of entire equipment is available with the company.
• Relatively stable industrial relationship
• The company has 180 products under 30 major product groups that cater to the
needs of the core sector like power, industry, transmission, transportation,
defense, telecommunications and oil business.
• BHEL's ability to acquire modern technology and make it suitable to Indian
conditions has been an exceptional strength of the company.

27
 • Strong relationship with NTPC is a strength as NTPC is planning a capacity
expansion of Rs. 52 bn and based on the past, 85% of NTPC projects have been
bagged by BHEL. The company also enjoys purchase price preference.

 WEAKNESSES

• PSU status is a big weakness for BHEL as it is subject to their rules and regulations
and is forced to carry a huge amount of labor force, which it is not able to retrench.
• The company offers very stringent credit facilities to the customers and this is a
weakness when compared in the face of rising competition. On the other hand their
customers in the power segment, SEBs, have a huge amount of receivables standing
against their name in the company's balance sheet. This is a major weakness for the
company.
• The company is vertically integrated, which could have been avoided by outsourcing
its components for power generation and transmission. This could have reduced the
cost.
• Difficulty in keeping up the commitments on the product delivery and desired
sequence of supplies.
• Larger delivery cycles in comparison with international suppliers of similar
equipment
• Lack of effective marketing infrastructure.
• Due to poor financial position of state electricity boards, which are the major
customers of BHEL in India, liquidity position of BHEL is not satisfactory.

 OPPORTUNITIES

• Demand for power and hence plant equipment is expected to grow

28
 • Easy processing of joint ventures/ collaboration/import/ acquisition of new
technology)
• Private sector power plants to offer expanded market as utilities suffers resource
crunch.
•
• The power sector reforms are expected to pick up in the near future in India, which
would directly benefit BHEL.
• Increase in defence budget will increase the topline for the company.

• NTPC is planning additional capacities to the tune of 2,800 MW, at a cost of Rs 52

bn. BHEL could benefit a lot as it has happened in the past that significant portion of
the project of NTPC is handled by BHEL. Nearly 85% of the NTPC projects were
assigned to BHEL only.
• The business of modernization and renovations of power plants is expected to grow in
India.
• The disinvestment plans of the government would bring in new resources and
experience into the company.
• Joint Venture with Siemens in the name of Powerplant Performance Improvement
Ltd. (PPIL), is a major strength for the company. This tie-up will be beneficial as
there is a lot of scope for business. During FY00 the PPIL received orders worth Rs.
320 crore.

 THREATS

• The global trend of consolidation has already resulted in a fall in turnover of the
company and this will prove to be a major threat in the years to come as well.
• The company is dependent on NTPC to a great extent.

29
 • Recently, the government has permitted the import of second hand capital goods that
are 10 years old without the need for a license. This move will definitely increase
competitive pressures for BHEL.
• Level playing ground not available, foreign companies spending much more on
business.
Increased competition both national and international.

CORPORATE FUNCTIONAL STRUCTURE

At the top most level are the Board of Directors under whom is Chairman and Managing
Directors. Under this level are corporate functions, business sectors and management
committee. Under Corporate functions there are four directors. They are:-
• Director Engineering Research and Development
• Director Human Resources
• Director Finance
• Chief Vigilance Officer

Under Director Finance comes Executive Director Finance under whom there are following
departments:-
 Finance Administration
 Cash Management
 Financial Services
 Budgeting
 Corporate books
 Internal Audit
 Provident Fund Trust

30
 Establishment
 Taxation
Direct Taxes
Indirect Taxes

RECOMMENDATION STRATEGIC OPTION FOR BHEL-FINANCE

In the light of BHEL’s Strategic Plan to achieve the following Turnover, ROCE & PBT by
2012 following Finance Action Plan is prepared.
Turnover: Rs.45000 Cr ROCE: Above 30% PBT: Rs.9440 Cr

FINANCE ACTION PLAN

OBJECTIVE

Finance as an active business partner:

• Provide analytical and innovative solutions to financial and accounting issues,

• Ensure integrity and independence,

• Imbibe synergy through team work and

• Build stronger and integrated financial systems.

FOCUS AREA

31
 • Policies & procedures

• Working capital management

• Tax management

• Financial risk management

• Accounts & annual report

• Audit & MIP

• Budgeting & monitoring

REQUIREMENTS

1. Compliance to various policies & procedures.

2. Reduction in material and other input costs to have better value addition.

3. Reduction in collectible debtors.

4. Reduction in inventory.

5. Improve ROCE.

6. Benchmarking operational parameters with the best in engineering industry.

32
 7. Improving Annual Report to international standards.

8. Following Corporate Governance practices.

9. Introduction of financial risk management.

10. Upgrading the skills of finance personnel.

11. Effective tax planning initiatives.

SUGGESTED APPROACH FOR BHEL FINANCE

A. Working Capital:

1) Re-orient cash management practices which ensure cash surplus from the
beginning of the year.

2) Use surplus funds for prudent capital investments to generate returns over and
above the cost of capital.

3) Aggressively support inorganic growth forays, viz. M&A, JVs for efficient
deployment of funds.

4) To act as a catalyst in expediting contract closing and for release of money

locked up in final payments.

B. Policies & Procedures:

1) Initiate updating of policies (purchase policy, sales policy, works policy,

delegation of powers) and manuals of finance function to maintain congruence
with business needs.

2) Concurrent updating of accounting policies and practices in line with the

mandatory accounting standards.

33
 3) Modernize financial systems & procedures so as to operate an effective
decision support system.

C. Tax Management:

Adopt best direct and indirect tax management policies & practices for optimizing
cash flows.
1) Carry out review to improve the tax payout ratio.

2) Ensure full availment of all benefits under Indirect tax and reduce the
impact of excise and service tax on the operations of the company.

3) To derive maximum tax advantage in M&A forays.

4) Maximum tax benefits out of capital investments for expansion coupled

with critical review of creating provisions.

D. Financial Risk Management Policy:

Documenting the process of identification, assessment and developing strategies to

manage risks
Steps:
1) Identification of potential risks.

2) Assessment of risks.

3) Risk treatment (avoidance, reduction, retention, transfer).

4) Creation of a plan & implementation.

E. Audit and Management improvement process (MIP):

34
 Enable the audit and Management information process functions to provide
appropriate feedback to management on compliance to various policies and
procedures.
1) A detailed action plan relating to modality of taking up improvement
initiatives has been formulated.

F. Budgeting & Monitoring:

1) To target reduction in material and other input costs, to have better value
addition.

2) To target for reduction in collectible debtors from the present level of 117
days to around 110 days of turnover.

3) To target for reduction in inventory from the present level of 95 days to 90

days of turnover.

4) To target ROCE of minimum 30%.

5) To benchmark the operational parameters with the best in the engineering

industry

G. Accounts & Audit

Re-orient current Annual report to international standards, in content, presentation and

disclosures.

H. Corporate Governance:

Ensure implementation of the principles of ‘Corporate Governance’ in letter & spirit, in the
finance function

35
 OBJECTIVES OF THE PROJECT:

• To Carry out Valuation of BHEL

• To develop standard formats for Leasing Vs. Buying decisions

• To standardize Purchase of Asset using Own Vs Borrowed funds decision formats

• To develop standard formats for Project Financing Decisions

36
THE VALUE CONCEPT

37
“The fundamental goal of all business is to maximize shareholder value” This statement is
now universally accepted as a guide to enhancing shareholder value. In United States, top
management is traditionally expected to seek shareholder value maximization. Failure to do
so results in pressure from board of directors and activist shareholders or even hostile
takeover bids. Elsewhere in the world, companies make different implicit tradeoffs among
their various stakeholders.

Earlier, maximizing shareholder value was often seen as short sighted, inefficient, simplistic
and even antisocial. But the evidences against these arguments and in favor of Shareholder
wealth maximization—are mounting. Winning companies have higher productivity, greater
increase in shareholder wealth and greater employment gains than their competitors. There is
no evidence of any conflict between shareholders and other stakeholders.

A value-based system grows in importance as capital becomes mobile. In wake of economic

liberalization, companies are relying more on capital market, acquisitions and restructuring
are becoming commonplace, strategic alliances are gaining popularity, employee stock
options are proliferating, and regulatory bodies are struggling with tariff determination. In
these exercises a crucial issue is: How should the value of a company or division thereof
be appraised ?

For the purpose of finding out a firm’s value, various methods are used and many a times, an
indepth appraisal of the company and it’s assets and liabilities has to be carried out. The goal
of such an appraisal is essentially to estimate a fair market value of a company. The most
widely accepted definition of fair market value was laid down by Internal Revenue Services
of the US. It defined fair market value as “the price as which the property would change
hands between a willing buyer and a willing seller when the former is not under any
compulsion to buy and the latter is not under any compulsion to sell , both parties have
reasonable knowledge of relevant facts.” When the asset being appraised is “a company”, the
property the buyer and the seller are trading consists of the claims of all the investors of the
company. This includes outstanding equity shares, preference shares, debentures, and loans.

BUSINESS VALUATION SERVICES

38
Business valuations provides the information necessary to make sound business decisions in
regards to assessing the value of assets owned by businesses or individuals. Business
valuation helps to meet individual and business needs in many situations of need or
adversity, including:
Adequacy of Life Insurance
Allocation of Acquisition Price
Buy/Sell Agreements
Bankruptcy and Foreclosures
Charitable Contributions
Eminent Domain
Employee Stock Ownership Plans (ESOPs)
Estate and Gift Taxes
Fairness Opinions
Insurance Claims
Financial Statements for a Business Loan
Financing
Franchise Valuation or Evaluation
Gifting Programs
Incentive Stock Option Programs
Initial Public Offerings (IPOs)
Lease vs. Buy
Disruption of Business
Dissenting Shareholder Actions
Economic Loss Analysis
Liquidation or Reorganization
Mediation and Arbitration
Mergers and Acquisitions
Sale of a Business
Split-ups/Spin-offs
Succession Planning

ACCEPTED VALUATION APPROACHES AND METHODS

39
Valuing a company is hardly a precise science and can vary depending on the type of
business and the reason for coming up with a valuation. There are a wide range of factors that
go into the process -- from the book value to a host of tangible and intangible elements. In
general, the value of the business will rely on an analysis of the company's cash flow. In
other words, it's ability to generate consistent profits will ultimately determine its worth in
the marketplace.

A company’s value can be examined using 16 different methods in order to arrive at a

supportable conclusion of value:

 Asset Valuation Methods:

• Book Value
• Adjusted Asset Value
• Liquidation Value

 Income Valuation Methods:

• Capitalization of Earnings
• Discounted Future Earnings

When determining discount and capitalization rates, you have the option to use either the
Build-Up method or the Capital Asset Pricing Model (CAPM) method. If you are valuing the
company on a debt-free basis, you can convert the discount and capitalization rates to their
debt-free equivalents based on the company’s weighted average cost of capital.
In valuing the company’s historic and/or future earnings, you can use any of the following:
Normalized Net Income, EBT, EBIT, EBITDA, Net Cash Flow and Free Cash Flow.

 Market and Comparable Company Approaches:

• Price to Earnings
1. From Mergerstat database (uses Net Income)
2. From Done Deals/Completed Transactions database (uses Net Income)
3. Other selected data source (you select earning base)
• Price to Revenue

40
 • Price to Cash Flow from Operations
• Price to Gross Cash Flow
• Price to Dividends
• Price to Total Assets
• Price to Equity / Book Value
1. From Done Deals/Completed Transactions database
2. Other selected data source

 Other Valuation Methods:

• Capitalization of Excess Earnings
• Rule of Thumb

 Preferred Stock Valuation:

• Market yield of the preferred stocks of comparable companies

The most commonly used approaches are :

ADJUSTED BOOK VALUE APPROACH

The simplest approach to valuing a firm is to rely on the information found on its balance
sheet. There are two equivalent ways of using the balance sheet information to appraise the
value of the firm. First the book value of investor’s claims may be summed directly. Second,

41
the assets of the firm may be totaled and from this total non-investor claims (like accounts
payable and provisions) may be deducted.

The accuracy of the book value approach depends on how well the net book values of the
assets reflect their fair market values. There are three reasons why book values may diverge
from market values.

• Inflation drives a wedge between the book value of an asset and it’s current value. The
book value of an asset is it’s historical cost less depreciation. Hence it does not consider
inflation which is definitely a factor influencing market value.
• Thanks to technological changes some assets become obsolete and worthless even before
they are fully depreciated in the books.
• Organizational capital, a very valuable asset is not shown on the balance sheet, is not
shown on the balance sheet. Organizational capital is created by bringing together
employees, customers, suppliers and managers in a mutually beneficial and productive
relationship. An important characteristic of organizational capital is that it cannot be
easily separated from the firm as a going entity.
Hence, their values are adjusted to reflect either Replacement cost or Liquidation values.
Using any of these methods was out of the purview of this project.

CAPITALIZATION OF INCOME METHOD

This method places no value on fixed assets such as equipment, and takes into account a
greater number of intangibles. Capitalization refers to the return on investment that is
expected by an investor. There may be many variations in how this method is applied.

42
In one method, factors effecting income of the business are listed, rated and then averaged to
get capitalization rates which are multiplied with buyer’s discretionary cash to determine the
market value of business.
Another method compares risk free returns or income of business are compared with same
level of returns being generated by other risk free investments. The business is then valued
equal to those investments.

EXCESS EARNING METHOD

This method is similar to the capitalization method. The difference is that it splits off return
on assets from other earning (the excess earnings). The financially rational reason for owning
business assets is to produce a financial return. A reasonable return here should be based on
industry averages for return on assets adjusted to current economic conditions.
This excess earning is typically multiplied by a factor of 2 to 5 based on such factors as the
level of risk involved in the business, the attractiveness of the business and the industry,
competitiveness, and growth potential. The higher the factor used, the higher the estimate of
the business will be. A typical number is 3 for a solid, profitable company. That is, a good
business that is judged to be average in terms of the level of risk involved, the attractiveness
of the business, the industry, competitiveness, and growth potential would use three as a
multiplier. The actual factor used is a mix of opinion, comparison to others in the industry,
and industry outlook.

These Capitalization methods is best used in non asset intensive businesses and ones that
derive their income primarily from tangible assets such as a utility (such as gas or electric
companies) like service companies, hence was not put to use in this project
MULTIPLIER OR MARKET VALUATION
This approach finds the value of a business by using an "industry average" sales figure as a
multiplier. This industry average number is based on what comparable businesses have sold
for recently. As a result, an industry-specific formula is devised, usually based on a multiple
of gross sales. This is the trouble point with these formulas, because they often don't focus on
bottom line profits or cash flow. Also, they don't take into account how different two
businesses in the same industry can be.

43
Here are a few industry multiplier examples, as mentioned in "The Complete Guide to
Buying a Business" by Richard Snowden (Amacom, 1994):
Travel agencies - .05 to .1 X annual gross sales
Ad agencies - .75 X annual gross sales
Retail businesses - .75 to 1.5 X annual net profit + inventory + equipment

To find the right multiplier for an industry, their trade associations may be contacted.
Another option is to utilize the services of a broker or appraiser who specializes in similar
businesses.

RULE OF THUMB METHOD

One of the most common approaches to small business valuation is the use of industry rules
of thumb. While most financial analysts cringe at the use of these approaches, they do have
their place as adjuncts to other methods.

One industry rule of thumb says an Internet Service Provider company is worth $75 to $125
per subscriber plus equipment at fair market value. Another says that small weekly
newspapers are worth 100% of one year's gross income.

The problem with these and all rule of thumb formulas is that they are statistically derived
from the sale of many businesses of each type. The rule of thumb averages may be accurate
for those businesses whose performances are right about at the average. The business with
expenses and profits that are right on target with industry averages may well sell for a price
in

line with the rule of thumb formula. Others will vary. To apply the rule of thumb to a
business that varies significantly from the average is not appropriate.

44
 THE APPROACH APPLIED

Making good decisions usually depends on having good information and value is the
performance metric that uses the best and most complete information. For understanding
value creation, a long term approach needs to be adopted, managing all cash flows across
both income statement and balance sheet and understanding how to compare cash flows from
different periods on a risk adjusted basis. It is this dependence on full picture that makes
value the best metric.

No other measure of corporate performance is as comprehensive or as well correlated with a

company’s market value. Earnings per share or market value tend to be used myopically,
looking only a few years ahead at best. Furthermore the earnings measure generally focuses
on managing the income statement and plays down actual amount and timing of cash flows.
Even the difference between return on invested capital (ROIC) and cost of capital can be a
bad metric. If it is used only in the short term it tends to encourage under investment in or the
harvesting of – a business to increase ROIC.

The Discounted Free Cash Flow approach is ideally suited when fairly credible business
plans are available for the explicit forecast period and the firm is expected to reach a
steady state at the end of the explicit period. Also this approach considers the cash

45
 flows and growth of invested capital in the forecasted period as well as beyond it.
With the nature data available at BHEL, this was the most suitable approach to carry
our Business Valuation.

DISCOUNTED FREE CASH FLOW FORECAST APPROACH

Valuing a firm using discounted cash flow approach is conceptually identical to valuing a
capital using present value method. However, there are two important differences:
While a capital project is deemed to have a definite life, a firm is considered as an entity that
has an indefinite life. This means that when we value a capital project we define it’s
economic life and impute a salvage value to the assets of the project at the end of
it’s economic life; however, for a firm we do not define an economic life and impute
a salvage value to it’s assets at the end of such a period.
A capital project is typically valued as a ‘one-off ‘ investment. We do not ordinarily look at
the follow on investments on the assumption that these will be evaluated separately
as and when they crystallize. A firm, however, is viewed as a growing entity and for
valuing a firm we take into account all the investments in fixed assets and net
working capital that are expected to be made over time to sustain the growth of the
firm.

Thus, Valuing a firm using the discounted cash flow approach calls for forecasting cash
flows over an indefinite period of time for an entity that is expected to grow. To
carry out this task, in practice the value of firm is separated into two time periods:

Value of the firm = Present Value of cash flow + Present value of cash flow
During an explicit forecast after the explicit forecast
Period period

During the explicit forecast period – which is often a period of 5 to 15 years – the firm is
expected to evolve rather than rapidly and hence a great deal of effort is expended to
forecast it’s cash flow on an annual basis. At the end of the forecast period, the firm

46
 is expected to reach a ‘steady state’ and hence a simplified procedure is used to
estimate the continuing value at the end of the explicit forecast period.
Thus, the discounted cash flow approach to valuing a firm involves the following steps:
Forecast the cash flow during the explicit forecast period.
Establish the Weighted Average cost of capital.
Determine the continuing value at the end of the explicit forecast period.
Calculate the firm value.

A Forecast the cash flow during the explicit forecast period.

i) Select the explicit forecast period – as in case of BHEL taken to be of four
financial years from 2003-04 to 2006-07.

ii) Define Free Cash Flow to firm.

FCFF = NOPLAT – Net Investment + Non-Operating Cash Flow

 NOPLAT (Net Operating Profit Less Adjusted Tax)

= EBIT – Adjusted Tax on EBIT
• EBIT (Earnings Before Interest and Tax)
= Profit Before Tax (PBT)
+ Interest expense
- Interest Income
- Non-operating income
• Adjusted Tax on EBIT
= Tax provision from income statement
+ Tax shield on interest expense
- Tax on interest income
- Tax on non operating income

 Net Investment
= Gross Investment - Depreciation

 Adjusted Non-Operating Income

= Interest / Dividend Income - Tax on Non-Operating Income

47
B. Establish the Weighted Average Cost of Capital (WACC)
WACC = [Cost of Debt (Cd) * Avg. Debts / (Avg Debts + Avg Net Worth) ]
+ [Cost of Equity (Ce) * Avg. Net Worth / (Avg Debts + Avg Net Worth) ]

 Cost of Debt
= Total Interest Cost / Avg Borrowings * 100
 Cost of Equity
= Risk Free Rate of Return + Risk Premium * Beta
• Risk Premium
= Market Expected Rate of Return
- Risk Free Rate

C. Determine the Continuing Value at the end of the explicit forecast period.
Continuing Value (CV) = [ Free Cash Flow n+1 (1 + Growth Rate of last year of
Explicit Period) ] / ( WACC – Growth Rate )
 Growth Rate (g) = (Net Investment / Invested capital ) * 100
D. Calculate the firm value
Firm Value = Present Value of Free Cash Flow in Explicit Forecast Period
+ Present Value of Continuing Value.

48
FINANCING DECISIONS

49
The lease-versus purchase (or lease-versus-buy) decision is one that commonly confronts
firms contemplating the acquisition of new long-term assets. Ultimately, a company or
business must pay for new equipment either from its own accumulated capital resources
'equity financing' or by using borrowed funds 'debt financing' or have another party acquire
the desired equipment and lease it to the company or business. In most cases, equipment
acquisition becomes a choice between purchase (either by equity or debt financing) and
lease.

The main feature distinguishing leasing from other forms of financing like loans or
mortgages is the separation of usage from ownership. Throughout the term of the lease, the
lessor retains legal ownership while the lessee has possession and use. The lease will not
normally confer on the lessee either the right or the obligation to acquire the leased
equipment from the lessor during the lease term but may do so at its expiry.

BUYING

If the business has excess cash to pay for an asset, purchasing it with that cash will be the
least expensive option since interest will be charged on any loan or lease option.
Consideration though would be that if cash that will be needed for day-to- day operations is
used to purchase a long-term asset, cash flow difficulties might arise.

Even if the company is doing well in terms of sales when purchase of asset is being
considered buying the asset, what is the likelihood of the situation changing over the next 3
years? This is what is called Opportunity Cost. Opportunity Cost is defined simply as that
cost incurred by investing (utilizing cash) in one item over another.

BORROWING

50
If the interest rates in the market are dipping and the company hasn’t got a flush of resources
to invest in asset purchase, borrowing is the best option. It helps avoid large initial
expenditure as well as blocking of internal funds. Moreover since the repayment is spread
over a long time period, it helps to capture the Time Value advantage.

LEASING

A Lease represents a contractual arrangement whereby the lessor grants the lessee the right to
use the asset in return of periodic leases rental payments. While Leasing of land, Buildings,
and animals has been known from times immemorial, the leasing of industrial equipment is a
relatively recent phenomenon especially on the Indian Scene.

Leasing and Hire-Purchase have emerged as a supplementary source of intermediate to long

term finance, provided mainly by Non-Banking financial companies, financial institutions,
and other organizations.

An equipment lease transaction can vary along many dimensions such as – extent to which
the risks and rewards of ownership are transferred, number of parties to the transaction,
domicilies of the equipment manufacturer, the lessor and the lessee, etc.

Lease transaction are primarily classified as :

 Financial Lease
 Operating Lease

A finance lease, or Capital Lease, is essentially a form of borrowing. Its Salient features are:

 It is an intermediate term to long term non-cancelable arrangement. During the initial

lease period, referred to as ‘primary lease period’, which is usually 3yrs, 5yrs or 8yrs, the
lease cannot be cancelled.
 The Lease is more or less fully amortized during the primary lease period. This means
that during this period, the lessor recovers through the lease rentals his investment in the
equipment with an acceptable rate of return.

51
 The Lessee is responsible for maintenance, Insurance and Taxes.
 The Lessee usually enjoys the option for renewing the lease for further periods at
substantially reduced rentals

An Operating Lease can be defined as any lease other than financial lease. The salient
features of an operating lease are:
 The lease term is significantly less than the economic life of the equipment.
 The Lessee enjoys the right to terminate the lease at short notice without any significant
penalty.
 The lessor usually provides the operating know-how and the related services and
undertakes the responsibility of insuring and maintaining the equipment.
Such an Operating lease is called a ‘Wet Lease’. An Operating Lease where the Lessee bears
the cost of insuring and maintaining the leased equipment is called a ‘Dry Lease’.
From the above features of an Operating Lease, it is evident that this form of a lease does not
result in substantial transfer of the risks and rewards of ownership from the lessor to the
lessee. The Lessor structuring an operating lease transaction has to depend upon multiple
leases or on the realization of a substantial resale value (on expiry of the first lease) to
recover the investment cost and a reasonable rate of return thereon. Therefore specializing in
operating Lease calls for an in-depth knowledge of the equipments per-se and the secondary
(re-sale) market of such equipments.

FACTORS EFFECTING COSTS OF THE FINANCING

OPTIONS (Specifying BHEL’s practices) :

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 Nature of Asset

 Nature of Lease

 Insurance, Annual Maintenance and Other Expenses

 Timing of Cash Outflows and the Repayment Schedule

 Rate of Depreciation

 Opportunity Cost

 Interest on Borrowed Funds

 Tax Considerations

 Expected end of the lease Contract

 Salvage Value

 Organization’s asset management capabilities

NATURE OF ASSET

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Leasing or buying—which is better? Isn’t it always better to be an owner? The answer:
sometimes. According to oil baron Paul Getty, “If it appreciates, buy it. If it depreciates,
lease it.” There are many benefits to both buying and leasing, depending on the type of
property involved.

Businesses have two property types— real and personal. Real property encompasses
buildings and other permanent structures, and the land on which they stand. Personal
property includes furniture, fixtures, and equipment—everything from shelving to desks.
Buying is often most beneficial when financing real property, because it will appreciate and
gain value over time. Owning real estate—and the structures on it—is almost always a good
investment for the long haul. Property owners build equity and reap the benefits of the
property’s increasing value. However, shops are heavily comprised of machinery—which is
in the category of personal property and, therefore, depreciates in value over time. What’s
more, technology is always changing, systems are always improving, and the equipment
needs to be updated and replaced every few years. For everything that needs to be replaced
every few years, therefore, leasing is very often the best option.

Nature of asset determines the rate of depreciation of the asset and thus it’s worth at the end
of the lease period. The amount of lease rental bears an effect of the residual value since that
would be the amount that the lessor would be recovering at the end of Lease period and thus
wouldn’t recover it through Lease rentals, thereby bringing down the overall cost of Leasing
the asset i.e. the lease rentals.

NATURE OF LEASE
The kind of lease contract i.e. Financial or Operating brings up differences in many aspects
since the treatment of several items is done in different manners according the rules and
provisions of various laws applicable in this context, such as:

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 Accounting Standards of India
Operating Lease are capitalized in the books of the lessor. Lease payments are treated
as income of the lessor and expense of the lessee. The depreciation of leased assets
should be on a basis consistent with the normal depreciation policy of the lessor for
similar assets.

Financial Lease according to recent accounting standards of ICAI, must be capitalized in

the books of lessee. This means that:
a) At, the time of inception the leased equipment is shown as an asset on the balance
sheet of the lessee. It’s Value is equated to the present value of committed lease
rentals. The leased asset is matched by a corresponding liability called the ‘Lease
Payable’
b) Lease payments are split into two parts : Finance Charge and Principal Amount.
The Finance Charge (Interest payment) is treated as an expense on the profit and
loss account and the principal amount is deducted from the liability ‘lease
payable’.
c) The leased asset is depreciated in the books of lessee as per its depreciation
policy.
 Income Tax Provisions

a) The depreciation is claimed by the person in whose books, the asset has been
capitalized.
b) Tax benefit on maintenance and insurance to be claimed by the person who bears
them.
c) The Lease rentals paid by lessee are tax deductible expenses for the lessee.

 Sales Tax provisions

a) The lessor is not entitled for the concessional rate of Central Sales Tax
because the asset purchased for leasing is meant neither for resale nor for
use in manufacture
b) The 46th Amendment Act has brought lease transactions under the purview
of ‘sale’ and has empowered the central and state governments to levy sales
tax on lease transactions. While the central sales tax has yet to be amended,

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 in this respect, several state govt. have amended their sales tax laws in this
respect.

As of yet, the Sales Tax provision is not applicable on the transactions entered into by BHEL.
Nature of lease

In Financial Lease, since the Lessor has to recover whole of the asset cost within one Lease
period (primary lease period) only, the rentals are expected to be higher than those
in Operating Lease, in which, Lessor may re-let the asset at for another lease period.
But due to the Insurance and Maintenance charges, the Operating Lease Rentals
tends to rise.
If the nature of your industry demands that you have the latest technology, a short-term
operating lease can help you get the equipment and keep your cash. Lease equipment that
you expect to depreciate quickly. Your risk of getting caught with obsolete equipment is
lower because you can upgrade or add equipment to meet your ever-changing needs.

INSURANCE, ANNUAL MAINTENANCE AND OTHER EXPENSES

In the options of Buying ( using own or borrowed funds) and Financial Leasing, since
the asset is capitalized in the hands of the person using it i.e. Lessee , he has to bear the
Insurance and maintenance charges and he only gets the Tax Benefits on them. But in
Operating Lease, the Lessor bears the Insurance and maintenance expenses, therefore he
includes them in the Lease Rentals.

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These two elements shall be common to all the options. If purchased or taken on financial
Lease, the business shall have to bear these expenses itself and if taken on Operating Lease,
the Lessor will load these expenses in the Lease Rentals.
The nature of asset also has a hand in determining

TIMING OF CASH OUTFLOWS AND THE REPAYMENT SCHEDULE

In case of buying using own funds, substantial cash outlays have to be made in the initial
phase for acquisition of the asset, which renders this option costlier than buying using
borrowed funds and leasing. While in case of buying using borrowed funds, monthly EMI
payments have to be made according to the repayment schedule, periodic payment of lease
rentals is spread over the lease tenure. The repayment schedule has a bearing on the Present
Value of outflows. The longer the spread of Lease rentals, the lesser will be it’s present
value. Thus the impact of timing of cash outflows shows up in the NPV of outflows of these
options.

RATE OF DEPRECIATION
The Rate of Depreciation that BHEL uses for it’s calculation is according to the IT
provisions, whereas the Lessors use the depreciation rate prevalent in market depending upon
the nature of asset. During the analysis, when the lease options are weighed using the IT rate,
they generally prove to be expensive since actually it’s difficult to realize that high salvage
value of the depreciated asset from the market.

OPPORTUNITY COST
Opportunity cost is the profit foregone in choosing the current option that could have been
earned in the second best option.

While using own funds to purchase the asset in addition to cash outlays, we are incurring
opportunity cost by blocking the funds in that asset instead of investing them in productive
business operations or any other investment option. Whereas when the asset is leased out or
purchased using borrowed funds, funds are not blocked and are available for alternative
investment. This variable is used to compute the present values of the cash flows associated
with both the leasing and purchase options

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However while assessing proposals in BHEL this element was not considered since the
assumption of availability of funds free for reinvestment every year couldn’t hold true here.
Also a constant rate of return is assumed for the calculation of Opportunity cost, which might
not actually be possible to earn over a long period of time due to the volatility in market rate
of returns.
INTEREST ON BORROWED FUNDS
The Rate taken for the option of Purchase using borrowed funds is generally SBI MTLR
(State Bank of India – Medium Term Lending Rate.)
TAX CONSIDERATIONS
Tax Rates and the Tax Shield earned on the cash outlays and expenses incurred have a
substantial impact on the costs and thus the viability of various options. In all these options,
tax shield is availed by the person who is actually bearing the charges. Tax shields bring
down the costs substantially
Lease payments are deductible expenses for tax purposes. This is an important point because
it means every Rupee one pays as a lease payment reduces one’s taxable income. This is not
the case when a one elects to purchase an asset and finance the purchase with a loan. In this
latter case only depreciation expenses and interest paid on loans are tax deductible expenses.

This difference in the deductions that can be claimed depending on whether an asset is leased
or purchased is something one needs to consider when determining whether it is preferable to
lease or own an asset.
EXPECTED END OF LEASE CONTRACT

Many lease arrangements (generally financial lease) give the lessee (user) the option of
purchasing the leased asset at the termination of the lease. This right to purchase a leased
asset can be beneficial to a person because it can put them in essentially in the same position
they would have been if they had initially purchased the asset in question. In cases where the
lessee purchases an asset that was previously leased, the price paid for the asset may be pre-
decided or at or near the current fair market value of the asset. While in others (like operating
lease) the Lessor takes back the asset at the end of lease period.

The expected end of lease would determine whether the lessor or the lessee would recover
the salvage value of the asset.
SALVAGE VALUE

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Depending upon the expected end of lease agreement, the salvage value is recorded in the
books of Lessee or Lessor. If the Lessee retains the asset and recovers the salvage value, the
lessor would include it for the purpose of lease rental calculation. Whereas if the Lessor takes
back the asset at the end of lease period, its effect shows on the reduced rentals. Thus
Salvage value is an important determinant of the amount of lease rentals.

ORANISATION’S ASSET MANAGEMENT CAPABILITIES

Leasing and asset management go hand in hand. The process of buying, maintaining and
disposing of equipment can distract valuable organizational resources from mission-
critical priorities. Leasing can be implemented as outsourced asset management.
Hence the choice of asset finance depends upon the organization’s efficiency levels
in asset management.

THE DECISION PLATFORM- NET CASH OUTFLOW

The techniques for comparing lease and purchase alternatives may be applied in different
ways. Like most financial decisions, the lease-versus-purchase decision requires a certain
degree of judgment or intuition. There are basically 2 prime considerations in evaluating the
financial options available. These are:

• The net (after tax benefit) cash flow; and

• The net present value of the cash flows.

THE NET CASH OUTFLOW CALCULATION

The amount of money spent on purchasing an asset or in lease or loan repayments does not
reflect the net cost of financing the acquisition of the asset. This is because tax deductions are
available in relation to each option. These deductions may take the form of:

• A straight deduction for repayments

• Depreciation of the plant or equipment acquired, or . The interest pertaining to the

loan etc.

The net cash flow calculation involves taking the cash outlay on financing the purchase using
own funds / purchase using borrowed funds / leasing and subtracting the tax saving from that
figure in order to arrive at the net cash outflow.

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The results generated by the standardized decision spreadsheet developed in this project
reflect the net present values of the cash costs and savings (tax savings) one would
experience depending on whether an asset is leased or purchased. A net present value is
reported for the lease option and another one is reported for the case where the asset is
purchased. By comparing these net present values it can be determined whether it is less or
more costly to lease an asset. In cases where the net present value for leasing is less than it is
for purchasing, leasing would be the least costly method for acquiring an asset. Alternatively,
leasing would be more costly, and therefore not preferable, any time the net present value
reported for leasing is greater than it is for purchasing the asset.

These spreadsheets were successfully used for analysis of proposals such as Asset Lease,
Equipment Purchase etc. that came for consideration to the Financial Services Deptt. The
working of the worksheet is being presented using assumed values.

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 THE FINANCING CONCEPT

The Projects are building blocks of a development plan. Creation of utilities is the sine qua
non of business. Schemes in which investment is made in anticipation of deriving future
benefits therefrom are known as projects. Project is thus a package of measures selected to
reach an objective that has been precisely designated beforehand and is objectively
verifiable.

The basic characteristic of project is that it involves current outlay of funds in the expectation
of future benefits. The inputs of the project come in the form of equipment, supplies,
personnel, etc. An efficient project makes productive use of land and other natural resources
with the help of capital applying technical capability of human resources, giving an output
adequate to enhance the nation’s economic growth.

Project Financing involves raising funds for the acquisition of fixed assets such as land and
buildings, plant and machinery, vehicle furniture and fittings etc. which are used in business
to earn income. It is necessary to define the financial requirements of a project at the
investment and initial operational stage. During the period of construction or the project stage
usually called the gestation period, the investment does not give anything in return. The
investments in procurement of assets are illiquid and are known as Sunk Capital. Hence the

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project planners try to get such assets financed through external sources such as Buyer’s
Credit.

PARTIES TO PROJECT FINANCING

The principal parties to a project financing includes the following:

 SPONSORS – The parties behind the project, which may be single entity or a
consortium of, for example, the principal contractors and the prospective buyers of
the output of the project when it is completed.

 SUPPLIERS – The party which is supplying the equipments or assets to the sponsors
and arranging credit through banks and financial institutions for them. They have to
analyze the sponsors for their creditworthiness and the project for it’s feasibility to
ensure timely payment of their dues.

 BORROWERS – The choice of legal entity to act as a borrower will be dependent

upon, for example, the applicable laws, taxes and exchange controls. If the sponsor is
a consortium then two or more than one borrower for that project.

 FINANCIERS / LENDERS – Because the amounts involved are usually large and
the risks high it is normal for any facility to be syndicated between two or more
providers of finance. One bank is usually “mandated” by the other to act as the
“arranger”, putting together the funding package. That bank, or another as appropriate
then acts as “agent” to coordinate the syndicate of financiers once the funds have

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 been made available. Those banks providing the most are often named as “managers”
or “lead managers”.

Some banks may, instead of lending themselves, provide guarantees to other banks or
organizations able to provide subsidized or lower cost-finance since they either cannot or do
not want to carry the credit risk. Finance may be provided in the form of a loan or, for
example, bonds, guarantees, export credits, commercial paper or leases.

Interest on the facility is often “rolled up” and added to capital during the construction phase
of a project . Charges on the project asset and revenue streams( Escrow Account ) are
sometimes taken by lenders solely to stop third parties obtaining prior charges.

PROJECT FINANCING IN BHEL

As per the needs and demands of the customers interested in purchasing equipments from
BHEL, proposals for financing the asset purchase are called from a selected group of banks
and financial institutions. The marketing division refers the proposal of customers to
Financial Services Deptt. (FSD) .The details of the project and other financials supplied by
the customer thoroughly analyzed to establish his creditworthiness. Thereafter proposals are
sent to the selected banks and financial institutions.

SELECTION OF THE BANK / FINANCIAL INSTITUTION

All the banks and financial institutions verify the receipt of these proposals and upon
carrying out the feasibility analysis from financing point of view, they respond with their
terms and conditions, clearly defined. On receipt of proposals from banks and financial
institutions BHEL carries out their analysis to arrive upon the best suited and cheapest source
of finance for it’s customer.

The major aspects of the analysis are:

 Principal Amount

 Moratorium Period

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  Interest During Construction Capitalized (IDC)

 Interest Rate on Borrowings

 Drawdown Schedule

 Repayment Schedule and timing of outflows.

 Commitment Charges

 Other Charges.

PRINCIPAL AMOUNT

It is the amount of financing agreed upon by the bank / FI. This amount may be equal or less
than the value of the equipment or asset. It may be in Indian or foreign currency in case any
foreign bank has come up with a financing proposal. In case the principal amount is less than
value of the asset, the supplier of asset may himself finance the remaining part.

MORATORIUM PERIOD

It is the Initial period (Construction or Gestation) of the project in which no repayment of the
borrowed funds has to be made. Moratorium may be allowed either on Principal amount or
Interest or both. The length of moratorium period depends upon the ability of project to start
generating returns and the terms acceptable to the Lender.

INTEREST DURING CONSTRUCTION CAPITALISED (IDC)

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Generally, the amount of interest not paid during Moratorium period is capitalized and added
to the principal. At the end of Moratorium period, a revised principal is calculated by adding
up the accumulated interest into original principal. This revised principal is repaid as per the
repayment schedule after the Moratorium period. Higher the capitalized amount, costlier the
financing option becomes.

RATE AND COMPUNDING OF INTEREST ON BORROWINGS

The Banks / FIs use the Term lending rates for the purpose of Project Financing since these
are generally long term projects spreading from 5-10 years. These rates may be fixed ,
floating or a combination of both. Generally, the benchmark used in floating rates is
LIBOR( London Inter- Bank Offered Rate). This is a major contributory factor rendering any
financing option viable or unviable. The rate of compounding of interest during moratorium
period effects the cost of financing. Higher the frequency of compounding, the costlier the
option becomes.

REPAYMENT SCHEDULE AND TIMING OF OUTFLOWS

This factor majorly affects the present value of different financing options. A quarterly

repayment schedule will be dearer than a six monthly repayment schedule since the earlier

repaid amount is discounted by a lower discounting rate. The rate used for discounting is

generally the minimum rate of return, the project is expected to generate or the interest rate

being charged by the bank.

COMMITMENT CHARGES

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These are charged on the undrawn or otherwise unutilized portion of a facility, to compensate
the lender for any capital adequacy costs for tying up its funds or limits in case they are
needed by the borrower. These add up to the cost of financing option and are payable over
the moratorium period.

OTHER CHARGES

These charges may include Management fees, Success fee, processing fee etc.

THE DECISION PLATFORM – NET PRESENT VALUE AND

INTERNAL RATE OF RETURN
For arriving at the best suited and cheapest source of financing for the project, both the NPV

and IRR of each option are considered.

Considering all these factors, standard formats in MS Excel were developed for various

possibilities of variation in these factors such that only the initial details had to be put in to

find out the most viable financing option.

The variants were :

 Without Moratorium on Interest (18 months moratorium on principal)

• Monthly Compounding Monthly Payment of Interest

• Monthly Compounding Quarterly Payment of Interest

• Quarterly Compounding Six monthly Payment of Interest

• Six monthly Compounding Six monthly Payment of Interest

 Without Moratorium on Interest (36 months moratorium on principal)

• Monthly Compounding Monthly Payment of Interest

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• Monthly Compounding Quarterly Payment of Interest

• Quarterly Compounding Six monthly Payment of Interest

• Six monthly Compounding Six monthly Payment of Interest

 With Moratorium on Interest (18 months moratorium on principal)

• Monthly Compounding Monthly Payment of Interest

• Monthly Compounding Quarterly Payment of Interest

• Quarterly Compounding Six monthly Payment of Interest

• Six monthly Compounding Six monthly Payment of Interest

 With Moratorium on Interest (36 months moratorium on principal)

• Monthly Compounding Quarterly Payment of Interest

• Quarterly Compounding Quarterly Payment of Interest

• Quarterly Compounding Six monthly Payment of Interest

• Six monthly Compounding Six monthly Payment of Interest

These Standardized formats were successfully utilized for analyzing the projects that came

up consideration in the duration of the project. Changes in these formats whenever required

depending upon the individual cases were made from time to time. Enclosed are two of such

worksheets i.e. With Moratorium on Interest (36 months moratorium on principal) with

Quarterly Compounding Quarterly Payment of Interest and Without Moratorium on Interest

(36 months moratorium on principal) with Quarterly Compounding Quarterly Payment of

Interest using Assumed Figures.

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 CONCLUSION

 The Valuation of BHEL carried out through this projects was accepted as fairly correct

by the internal officials since the expected valuation of BHEL stands between 10000 to

15000 crore.

 In General, while going for an asset lease, company’s own funds should not be used untill

the funds are lying absolutely idle or their opportunity cost is quite low.

 Project Financing proposals can be analysed quite accurately and objectively using the

tools of NPV and IRR.

BIBLIOGRAPHY

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• www.pemintranet.com

• www.about.in

• www.bhel.com

• Bharat Heavy Electricals Limited last 5 years Annual

reports (2004-2008).

• BHEL Corporate, Power Sector, Industrial Sector & Various

Units website.

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