Preface to the Seventh Edition

This book is now nearly three decades old. Its longevity may be attributed to the growing number of academics and practitioners who have found it useful, relevant, and readable. My effort has been to present the key principles and techniques for evaluating capital expenditure proposals that have been developed primarily by financial economists. The book explains the rationale behind these principles and suggests ways and means to improve project appraisal and capital budgeting in practice. The book spans the gamut of capital budgeting, defined in its broadest sense. eginning with project planning, it culminates in the review of projects undertaken. In this respect, it is wider in coverage than other books in the field. !umerous examples have been included to illustrate the principles and techniques. "here necessary, two or more examples in the ascending order of complexity have been included. #part from analytical methods, the book discusses strategic, qualitative, and organisational considerations which impinge on capital budgeting decisions. It also describes and evaluates business practices in various areas. The book is primarily designed for two categories of readers $ students and practitioners. %tudents of professional programmes &like M #, '(M, '(#, #'#, and #I'"#) and post graduate courses in 'ommerce, (inance, and *conomics will benefit from this book. The book will also prove a valuable reference to corporate policy makers who formulate and shape corporate investment strategies+ to consultants and others who prepare project feasibility studies+ to executives who have a say in the selection of projects and development of the firm,s capital budget+ to officials of banks and financial institutions who evaluate projects as lenders and investors+ and to managers who are concerned with implementing as well as reviewing projects. The key guidelines relevant to project planning, analysis, selection, financing, implementation, and review discussed in this book are

.evelop a strategy that leads to sustainable competitive advantage. %harpen the ability of the firm to identify promising investment opportunities. (ormulate the project, considering the interrelationships among various aspects. (orecast realistically the incremental cash flows attributable to the project. *stablish a hurdle rate that is consistent with the risk exposure of the project. 'alculate the net present value of the project and value the real options. lend judgment with analytical reasoning. 'hoose a financing structure that lowers the cost of capital, preserves financial flexibility, and mitigates agency costs. (ormulate the project adequately, assign specific responsibilities to project managers, and use network techniques for project planning and control. 'onduct post/audit and periodically review project performance.

CHANGES IN THE SEVENTH EDITION

0

*nthused by the overwhelming response to the previous edition, I revised and updated most of the chapters and appendices. To strengthen the book further, I added the following material (ifteen new sections- 1.2 - 3ey Issues in Major Investment .ecisions+ 2.14(inancial Modeling 5sing %preadsheet+ 16.1- 7ros and 'ons of Multiple 'osts of 'apital+ 16.8- 9urdle :ate and 'ost of 'apital+ 12.;- %trategy as a 7ortfolio of :eal <ptions+ 12.11- Mistakes Made in :eal <ption =aluation+ 1>.?- :everse (inancial *ngineering+ 1>.2- @roup 7rocess+ 1>.>- Impact on *arnings+ 1A.2- 'redit :isk :ating+ 1;.>- Managing :isks in 7rivate Infrastructure 7rojects+ 1;.A- 7ublic 7rivate 7artnerships+ 1;.;- :ecommendations of the 'ommittee on Infrastructure (inancing+ 61.2- *ssence of 7roject Management+ and 68.>- .isciplining the 'apital udgeting 7rocess for %mall Ticket Items. (our new minicases on the following topics- BMarket and .emand #nalysis,, B%pecial .ecision %ituations,, B%ocial 'ost enefit #nalysis,, and B=enture 'apital and 7rivate *quity., # number of boxes containing valuable perspectives and practical insights.

ORGANISATION OF THE BOOK <rganised in terms of the broad phases of capital budgeting, this book is divided into seven partsPart 1 Planning: 7art 1 covers the planning phase of capital budgeting. 'hapter 1 provides an overview of capital budgeting. 'hapter 6 discusses the key concepts, models, and considerations that are helpful in articulating the capital allocation strategy of a firm. 'hapter 8 looks at the ways and means of generating project ideas and screening them at a preliminary level. Part Analysis: 7art 6 focuses on gathering and analysing basic information about the project. 'hapter C discusses the key steps involved in market and demand analysis. 'hapter ? dwells on the various facets of technical analysis. 'hapter 2 explains how financial estimates and projections relating to a project are developed. Part ! SelectionI: The content on the selection phase is very extensive. It has thus been split into two parts, %electionDI &7art 8) and %electionDII &7art C). 7art 8 consists of 'hapters >D11. 'hapter > discusses the principles of compounding and discounting. 'hapter A covers extensively the various investment appraisal criteria. 'hapter ; shows how project cash flows are defined. 'hapter 14 explains the concept and measurement of cost of capital. (inally, 'hapter 11 expounds the techniques for measuring and evaluating the stand/alone risk of a project. Part " SelectionII: 'oncerned with more advanced techniques of selection or broader methodologies of evaluation, 7art C consists of 'hapters 16D1>. 'hapter 16 discusses how the project rate of return can be fine tuned. 'hapter 18 looks at

how capital budgeting decisions may be made in certain special situations. 'hapter 1C presents the methodology of social cost benefit analysis. 'hapter 1? shows how the capital budget may be drawn up in face of constraints, using the technique of mathematical programming. 'hapter 12 explains the key insights provided by the option pricing theory and how the same may be employed for valuing the options embedded in capital projects. 'hapter 1> explores the qualitative, strategic, and organisational issues relating to capital budgeting. Part # Financing: 'onsisting of 'hapters 1A/64, 7art ? discusses how projects may be financed. 'hapter 1A discusses various sources of finance used for setting up a project. 'hapter 1; focuses on financing of infrastructure projects. 'hapter 64 explains the concept and practice of venture capital and private equity. Part $ Implementation: 7art 2 includes two chapters which look at the implementation of the selected projects. 'hapter 61 discusses various aspects of project management. 'hapter 66 explains how network techniques &7*:T, '7M, and !etwork 'ost %ystem) may be employed for project planning, scheduling, and control. Part % Review: 7art > discusses various issues involved in project review &'hapter 68). It also covers the administrative aspects of capital budgeting. ANCI&&AR' (ATERIA& To enhance the utility of the book for students and instructors, the following ancillary materials are available. S)read*heet* Mr. =enugopal 5nni developed *xcel spreadsheets for all the major numerical exhibits in the book. These spreadsheets may be downloaded from the website of Tata Mc@raw/9ill &http-EEhighered.mcgraw/hill.comEsitesE44>44>>;86) So+ved Pro,+e-* # number of solved problems have been prepared for various chapters of the book. They can be downloaded from the website of Tata Mc@raw/9ill &&http-EEhighered.mcgraw/hill.comEsitesE44>44>>;86). Additiona+ Pro,+e-* and (inica*e* To enable students to practice more, a number of additional problems and minicases have been prepared. They can be downloaded from the website of Tata Mc/@raw 9ill &&http-EEhighered.mcgraw/hill.comEsitesE44>44>>;86). So+.tion* (an.a+ and Po/er)oint Pre*entation* # solutions manual containing solutions to the end of the chapter problems and cases and powerpoint presentations of all chapters are hosted on the web site of Tata Mc@raw/9ill &&http-EEhighered.mcgraw/ hill.comEsitesE44>44>>;86). This can be accessed by the instructors who adopt the book. They may contact Tata Mc@raw/9ill for assistance in accessing the solutions manual and powerpoint presentation. I look forward to receiving suggestions from the readers for further improving the content of this book.

PRASANNA CHANDRA chandra@cfm-india.com

Ac0no/+ed1e-ent*
I am indebted to my students and the participants of executive development programmes conducted by me for providing the stimulus for writing this book. They pointed to me the need for a comprehensive book, akin to a manual, on managing capital expenditures. In writing this book I have drawn on materials from a variety of disciplines that have a bearing on different facets of project appraisal and capital budgeting. I owe a profound intellectual debt to numerous authors whose ideas and contributions have shaped my thinking on this subject. I am extremely thankful to =enugopal 5nni for thoroughly combing the book and adding useful material. I am grateful to 7rof. @. %abarinathan, 7rof. 7admini %rinivasan, %uman %aha, 7rof. !aganna, 7rof. F.G.:. Murthy, 7rof. 7ratap %ubramanyam, and 7radeep Gath for their valuable contributions to this book. I am indebted to a number of practitioners who have generously shared their views with me and to 'handra %ekhar of Tata Mc@raw/9ill for his interest in this book. I am thankful to :enuka for her help in preparing the manuscript of this book. My deepest gratitude is to my wife, 7adma, for her unstinted support. #t places I have drawn on my articles published in Indian anagement! "hartered Acco#ntant! anagement Acco#ntant! $ecision! "hartered Financial Analyst! and %o& 'dyog. I am grateful to the editors of these journals. PRASANNA CHANDRA chandra@cfm-india.com

A.thor2* Profi+e
.r. 7rasanna 'handra, .irector of 'entre for (inancial Management, is an M #, 7h. &(inance). 9e has about four decades of teaching experience in postgraduate and executive education programmes. 9e was a 7rofessor of (inance at Indian Institute of Management, angalore for nearly two decades. 9e was a =isiting 7rofessor of (inance at %outhern Illinois 5niversity, 5%#, for two years. 9e has been a member of several committees including the 'apital Issues #dvisory 'ommittee, the 9igh 7owered 'ommittee on Insurance %ector :eforms, and the %* I 'ommittee on .erivatives. 9e has served or is serving on the boards of a number of organiHations including 7ower (inance 'orporation, Torrent 7harmaceuticals Gimited, 5nit Trust of India Investment #dvisory %ervices Gimited, Inter/'onnected %tock *xchange of India, I('I, IIM & ), I'(#I, Templeton Mutual (und, angalore %tock *xchange Gimited, and 3arnataka %oaps and .etergents Gimited. 9e has been a consultant to many organiHations. .r 'handra has conducted executive seminars for a number of organiHations like I!.#G, Infosys, Tata Motors, IT', !IIT, Tata %teel, %asken 'ommunications, T#T#/ I M, Tata 7ower, 9*G, harat %hell, #!I @rindlays, 9MT, 'anara ank, =ysya ank, <!@', "ipro, @#IG, Microsoft, Motorala, and 9industan 5nilever. 9is other books include Financial anagement: (heory and Practice! Investment Analysis and Portfolio anagement! anaging Investments! Finance Sense! F#ndamentals of Financial anagement! and )al#ation of *+#ity Shares. 9e has authored over >4 articles in professional journals and business periodicals. .r 'handra has been a (ullbright %cholar and a 5!.7 (ellow. 9e has received several honours including the ,est (eacher Award from the association of Indian Management %chools.