1

Contents

1. Introduction 1
2. Acknowledgements 7

PART I: Identifying

3. Project Proposal
4. Strategy & Capital Allocation
5. Screening of Project Ideas

PART II: ANALYSIS

6. Market Analysis & Demand Analysis

7. Technical Analysis
8. Financial Estimates & Projections

PART III: Selection

9. Investment Criteria

PART IV: Risk Analysis

10. Project Risk

11. Firm Risk
12. Market Risk

PART V: Financing

13. Notes & References

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Introduction
This section is HEADED Introduction rather than Preface in the hope of decoying
habitual skippers into reading for their own comfort.

Before getting into detail discussion of the Capital budgeting & other section a
brief introduction about telecommunications sector.

Normally any Financial Research report first contains the Company Profile &
then the Industry Profile to facilitate the reader. I have changed the order
because it is hard to define Tejas Networks without knowing the Industry.

“Communication has joined food, clothing, housing &

transportation as a basic human right.”

Telecommunication is the transmission of signals over a distance for the

purpose of communication.

Based on the above definition & as per my understanding of the above

definition I have classified the telecom sector into the following categories:

Telecommunications

Fixed Mobile Telecom Products

Telecom Telecom Telecom/Netwo

Telecom Service Equipments Cables rking
Providers/Operators (1) (2) Infrastructure
(3)

Basic Cellular ISP Intl. Long National PMRTS Unified VSAT

Services Mobile Dishn Distances 1
Long Arya Access Services
BSNL & Hutch,Airtel etDSL RIL, VSNL Distances Offshore Service Bharati
MTNL Railtel Shyam, televentu
TTML res
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Telecom
Telephone Mobile handset
Accessories
Instruments Manufactures
Gupta Telecom
Canara Ericsson India
Communicati
on Systems

Twisted Pair Co-Axial Fiber Optic

Cable Cable Sudarshan
Telecom

3
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Broadband Carrier Carrier IP Optical Wireless

Infrastructure Infrastructure Telephony Infrastructure Infrastructure
CMTS, Digital Carrier Core Application Metro Access CDMA 2000
Loop Carrier, Switch/Routing Servers, Hosted Systems, Metro Network,
DSL, CPE, , Carrier Edge Multimedia Core ROADM, GSM/UTS
DSLAMs, Switch/Routing Application Metro Edge-SDH, Network, IMS,
IMS, IP , Carrier Servers, Metro Edge- Metroscale, Wi-Fi
Services Ethernet, Switching & SONET, Mobile Infrastructure,
Platform, IPTV Carrier Signalling, Backhaul for Imax
(Alcatel- Ethernet Class5 Radio Access Infrastructure.
Lucent, Cisco) Access & Alternatives, Networks, Optical (Cisco, Huawei,
Aggregation IMS, Transport Switching Juniper
Routers, IMS, & End-Points, Systems, PON Networks,
Mobile Media systems, WAN Nortel)
Backhaul for Gateways, DWDM systems.
Radio Access Session Border (Huawei, Nortel,
Networks. Controllers. ECI, Tejas)
(Cisco, ECI, (Nokia-
Force 10, Siemens)
Tejas)

After going through the above classification of Telecom Sector, I give a try to
understand Tejas Network.

Basically Tejas is Telecom Infrastructure1 Company whose domain is Optical

Infrastructure.

Tejas develops state-of-the-art products that bring the power of intelligent

optical networking to optical access.

Before getting into detail discussion of Capital Budgeting, a few words on this
Project. The aim of this Project is to “improve my own understanding” on the
subject of CAPITAL BUDGETING.
This Project should be seen as an “academic project “not as a Professional
report.

Capital budgeting also referred to as Capital Investment or Capital project or

just project or project valuation.

Organization of the Project

1
DEFINITION: Organizations, personnel, procedures, facilities and networks employed to transmit and receive
information by electrical or electronic means
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Organized in terms of the broad phases of capital budgeting, this project is

divided into five parts:

Part 1: Identifying consists of Topic 3 to 5; Part 1 covers the planning phase of

capital budgeting. Topic3 consists of project proposal. Topic 4 discusses the key
concepts, models & considerations that are helpful in articulating the capital
allocation strategy for this project. Topic 5 looks at the ways of screening the
project proposal.

Part 2: Analysis topic 6 to 8. Topic 6 basically focuses on gathering & analyzing

the basic information about the project. It discusses the key steps involved in
market & demand analysis. Topic 7 dwells on the various facets of Technical
analysis. Topic 8 explains how financial estimates & projections relating to a
project are developed.

Part 3: Selection focuses extensively the various investment criteria.

Part 4: Risk analysis expounds the techniques for measuring & evaluating the
risk of the project. Topic 10 deals with project risk. Topic 11 deals with firm
risk & Topic 12 on market risk.

Part 5: Financing discusses how projects may be financed.

I look forward to receiving suggestions from the readers for further improving
my knowledge.

A brief introduction on Capital budgeting:

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Capital budgeting is the process of Identifying, analysis & selecting investment

projects whose return are expected beyond one year.

Capital budgeting is important to the management due to the following

reasons:

 Their long-term consequences, significantly impact the company’s future

activities
 Capital expenditure decisions often involve substantial cash outlays
 Decisions once taken become difficult to reverse

Capital budgeting process

The entire capital budgeting process can be divided into the following steps:

1. Identification

The process of capital budgeting begins with identifying potential investment

opportunities.

2. Analysis

The focus of this process of capital budgeting is on gathering, preparing, &

summarizing relevant information about various project proposal which are
begin considered for inclusion in the capital budget.

3. Selection

The focus of this process is judge the worthwhile ness of a project. They are
divided into two broad categories viz. non-discounting criteria & the
discounting criteria. The details of this process will be discussed later.
Since the selection process considers the worthwhile ness of the project we are
supposed to consider the risk factors that are associated with the project.
The details of the risk analysis are considered in the later sections.

PART 1
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PLANNING

Nobody can really guarantee the future. The best

we can do is to size up the chances, calculate the
risks involved, estimate our ability to deal with
them and make our plans with confidence. –
HENRY FORD II
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Project Proposal
1
Needs of Customers through ISP2 are:

 High Speed Internet access.

 A combination of application delivering Voice, Video and data through
Internet.
 High Bandwidth at low cost.
 Flexibility for future services & availability regardless of location.

Solution: Ethernet3 over SDH/SONET.

Advantages of Using Ethernet:

 It’s flexible, easy to manage & operate.

 It is capable of handling up to 10Gbs4 with excellent reach via Optical
networks.
 It’s is the lowest cost network technology on the Market.
 It provides efficient Ethernet transport with excellent OAM (Operations,
Administration & Maintenance) features.
 It uses Bandwidth in an efficient manner.

2
ISP means Internet Service Provider.
3
Ethernet is a packet based transmission protocol that is primarily used in LANs. Ethernet is
the common name for the IEEE 802.3 industry specification and it is often characterized by its
data transmission rate and type of transmission medium (e.g., twisted pair is T and fiber is F).
4
Gigabits per second.
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Strategy & Capital Allocation.

2
If you look at any organization, which are successful, or failure today is mainly
the result of capital allocation decisions made in the past.

Capital is scarce and must be allocated across competing claims very

judiciously.

Capital Budgeting may be viewed as a two-stage process. In the first stage,

promising growth opportunities are identified through the use of strategic
planning techniques and in the second stage; individual investment proposals
are analyzed and evaluated in detail to determine there worth.

This topic discusses strategic planning techniques & approaches aimed at

promising growth opportunities.

Caution: The strategy discussed here are about the project proposal mentioned
in the Topic 1 & it should not be confused or compared with the Company’s
strategy.

A strategy is a long term plan of action designed to achieve a particular goal,

most often "winning".

To formulate any effective strategy, it's essential to understand two basic

questions:
What are we doing and what are your competitors doing?

Before answering the second question, let’s discuss about the first question.

Strategy involves matching a firm’s ‘Strengths’ and ‘Weakness’ (Internal-

Analysis)-its distinctive competencies- with the ‘opportunities’ and ‘threats’
present in the external environment. Fig 1 shows schematically how strategies
are formulated based on the concept.
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Fig 1. Formulation of Strategy

External Environmental Analysis Internal Environmental Analysis

1. Customers: They can bargain for price 1. Technical Know-How: A team of

cut, ask for superior quality & better
service.
A classic example is BSNL; it wants
prices lower than China, quality of Japan
& the most up-to-date technology with the
broadest functionality of U.S.A
2. Competitors: They inflate cost, push
prices down & reduce profits.
highly motivated individuals
equipped with latest technology
developments.
2. Marketing & Distribution
Capacity: A team of highly
motivated individuals.
3. Logistics: No Issues

3. Suppliers: They can rise prices, lower 4. Financial Resource: Always

quality & curtail the range of free spends 10% of Sales revenue on
offers they provide. R&D projects.

4. Regulation: TRAI rules & regulations 5. Resource: Highly skilled

&IEEE standards. employees.

5. Infrastructure: Has the state of art

R&D labs.

6. Political Environment: As far as

Political environment is conducive in
doing the business.

Based on the above analysis of Internal & External environment, we will use
SWOT Analysis & TOWS matrix.

SWOT is an acronym for Strength, Weakness, Opportunities & Threats. SWOT

Analysis is a powerful technique for understanding our Strengths and
Weaknesses, and for looking at the Opportunities and Threats we face.
TOWS Analysis is a variant of the classic business tool, SWOT Analysis. TOWS
and SWOT are acronyms for different arrangements of the words Strengths,
Weaknesses, Opportunities and Threats.
By analyzing the external environment (threats and opportunities), and your
internal environment (weaknesses and strengths), you can use these
techniques to think about the strategy of your whole organization, a
department or a team.
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At a practical level, the only difference between TOWS and SWOT is that TOWS
emphasizes the external environment whilst SWOT emphasizes the internal
environment.
Note: The word “Weakness” has been changed to “Areas of Improvement”

External Environment

External External Threat

Opportunities (T)
(O) 1.Customers
1.Demand Variability 2. Compitetors.
2. Political 3. Suppliers.
Environment. 4. Regulation.
3. Entry barriers. 5.Price
6.Substitutes

Internal Strength SO “Maxi-Maxi” ST”Maxi-Mini” Strategy

(S) Strategy
1.Technical Know- 1. Product 1. Long-term
How Differentiation & low relationship with
2. Financial cost. suppliers.
Resource. 2. Create & capture 2. Difficult for
Internal 3. Resources. new demand. competitors to imitate.
Environment 4. Marketing & 3. Enter into new 3. Building a product
Sales developing markets. image.
Distribution.
5.Infrastrucure
Areas of IO “Mini-Maxi” IT “Mini-Mini” strategy
Improvement strategy
(I)
1.

Portfolio Strategy
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The business portfolio is the collection of businesses and products that make up
the company. The best business portfolio is one that fits the company's
strengths and helps exploit the most attractive opportunities.

The aim of a portfolio is:

1. Analyze its current business portfolio & decide which SBU’s should
receive more or less investment, and
2. Develop growth strategies for adding new products & business to the
portfolio.
3. Decide which businesses or product should no longer be retained.

Mc Kinsey Matrix

McKinsey Matrix has two dimensions, viz, competitive position & industry
attractiveness. The criteria or factors used for judging industry attractiveness
and competitive position along with suggested weights for them are as follows:

Industry Attractiveness Competitive position

Criteria Weight Key Success Factors Weight
Industry Size 0.10 Market share 0.15
Industry Growth 0.30 Technological Know-How 0.25
Industry Profitability 0.20 Product Quality 0.15
Capital Intensity 0.05 After-Sales Service 0.20
Technological Stability 0.10 Price Competitveness 0.05
Competitive Intensity 0.20 Low Operating Costs 0.10
Cyclicality 0.05 Productivity 0.10

Applying the above McKinsey Matrix criteria to Tejas Networks:

Industry Attractiveness

Criteria Weight Rating Weighted Score

Industry Size 0.10 4 0.40

Industry Growth
Industry Profitability
Capital Intensity
Technological Stability
Competitive Intensity
Cyclicality
0.30 4 1.20
0.20 4 0.80
0.05 4 0.20
0.10 3 0.30
0.20 3 0.60
0.05 3 0.15

3.65
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Competitive Position

Key Success Factors Weight Rating Weight Score

Market Share 0.15 3 0.45

Technological Know-How 0.25 5 1.25
Product Quality 0.15 4 0.60
After-Sales Service 0.20 3 0.60
Price Competitiveness 0.05 4 0.20
Low Operating costs 0.10 4 0.40
Productivity 0.10 5 0.50

4.00

Strategic Planning & Capital Budgeting

Capital expenditures particularly the major ones are supposed to sub serve the
strategy of the Firm. Hence relationship between strategic planning & capital
budgeting should be properly recognized. Exhibit 1 presents a way of defining
this relationship. As emphasized in this exhibit Capital budgeting should be
squarely related to corporate strategy.
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Exhibit1

Environmental Managerial vision, Corporate

Assessment Values Appraisal

Strategy Plan

Product Strategy
Capital Budgeting
Market Strategy
Production Strategy
And so on

This part of the concept is drawn from the book Strategic Management-A
Methodological Approach by A.J.Rowe

STRATEGIC POSITION AND ACTION EVALUATION (SPACE)

SPACE is an approach to hammer out an appropriate strategic posture for a firm
and its individual businesses. An extension of the two-dimensional portfolio
analysis, SPACE involves a consideration of four dimensions:
 Company’s competitive advantage
 Company’s financial strength
 Industry strength
 Environmental stability

Strategic Postures
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The basic strategic postures associated with the SPACE approach are as
follows:

Aggressive Posture This is appropriate for a company which

 Enjoys a competitive advantage and considerable financial strength and
 Belongs to an attractive industry that operates in a stable environment.

Competitive Posture This is suitable for a company which

 Enjoys a competitive advantage but has limited financial strength,
and
 Belongs to an attractive industry operating in a relatively unstable
Environment.

Conservative Posture This is appropriate for a company which

 Enjoys financial strength but has limited competitive advantage, and
 Belongs to a not-so-attractive industry operating in a relatively stable
environment.

Defensive Posture This is suitable for a company which

 Lacks competitive advantage as well as financial strength, and
 Belongs to not-so-attractive industry operating in an unstable
environment.

Applying the SPACE concept to Tejas Networks

Tejas Networks falls under Competitive posture. The key planks of the
competitive posture are as follows:

 Maintain and enhance competitive advantage by product improvement

and differentiation
 Widen the product line
 Improve marketing effectiveness and
 Augment financial resources.

There is a commonality between competitive posture described here and the

generic strategy of product differentiation suggested by Michael Porter.

The generic strategy of Porter and the key options associated with SPACE are
shown below for Competitive posture.

Financial Strength
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Competitive Industry
Strength Strength
Competitive
DIFFEREN
TIATION

Environmental Strength
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Screening of Project Ideas

3
The search for promising projects ideas is the first step towards establishing a
successful venture. As the tradition adage goes the key to success lies in
“getting into right business at the right time”. While this advice is simple, its
accomplishment is difficult because good business opportunities tend to be
elusive. Identification of such opportunities requires imagination, sensitivity to
the environmental changes and realistic assessment of what the firm can do.

Identification is often the outcome of a triggering process rather than an

analytical exercise. While the notion of identification is simple, it is difficult to
develop methods or procedures for accomplishing it, as there is no well-defined
theory to guide this task. And as Gordon & Pinches observed:” These difficulties
more severe as one move up the hierarchy of organizational decision-making
levels because of the relative uniqueness of higher level decision as compared
to low-level decision.”

With this note of caution, this topic discusses certain broad considerations &
guidelines helpful in screening of project ideas. The objective is to identify
investment opportunities, which are prima facie feasible & promising & which
merit further examination and appraisal. The discussion is divided into six
sections as follows:

 Monitoring the environment

 Corporate appraisal
 Profit potential of industries: Porter Model
 Preliminary screening
 Project rating index
 Sources of positive net present value.

3.1 MONITORING THE ENVIRONMENT

Basically a promising investment idea enables the firm to exploit

opportunities in the environment by drawing on its competitive strengths.
Hence the firm must systematically monitor the environment & assess its
competitive abilities.
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3.2 CORPORATE APPRAISAL

A realistic appraisal of corporate strengths & weaknesses is essential for

identifying investment opportunities, which can be profitably exploited. The
broad areas of corporate appraisal & the important aspects to be considered
under them as follows:

 Marketing & distribution

 Productions & operations
 Research & developments
 Corporate resources & personnel
 Finance & accounting

3.3 TOOLS FOR IDENTIFY PROMISING INVESTMENTS

There are several useful tools or frameworks that are helpful in identifying
promising investment opportunities. The most popular ones are the Porter
Model, Life Cycle approach & Experience Curve.

In this project we will be discussing only Porter Model.

The model of the Five Competitive Forces was developed by Michael E. Porter
in his book “Competitive Strategy: Techniques for Analyzing Industries and
Competitors” in 1980. Since that time it has become an important tool for
analyzing an organizations industry structure in strategic processes.

Porter’s model is based on the insight that a corporate strategy should meet
the opportunities and threats in the organizations external environment.
Especially, competitive strategy should base on and understanding of industry
structures and the way they change.

Porter has identified five competitive forces that shape every industry and
every market. These forces determine the intensity of competition and hence
the profitability and attractiveness of an industry. The objective of corporate
strategy should be to modify these competitive forces in a way that improves
the position of the organization. Porter’s model supports analysis of the driving
forces in an industry. Based on the information derived from the Five Forces
Analysis, management can decide how to influence or to exploit particular
characteristics of their industry.

The five basic competitive forces are:

1. Threat of new Entrants

2. Rivalry among the existing firms
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3. Pressure from the substitute products.

4. Bargaining power of buyers
5. Bargaining power of sellers.

Fig 2 diagrammatically shows the forces that drive competition & determine
the industry profit potential.

Potential Entrants

Threat of
New entrants

THE INDUSTRY
Suppliers Bargaining Powers Rivalry between Bargaining Power of Buyers
Of Suppliers existing firms Buyers

Threat of
Substitute
Products

Substitutes

 Threat of New Entrants: New entrants add capacity, inflate costs, push prices
down and reduce profitability.

 Rivalry between existing firms: If the rivalries between the firms are strong,
competitive moves & countermoves dampen the average profitability of the
industry.

 Pressure from the Substitute: Substitute products may limit the profit potential
of the industry by imposing a ceiling on the prices that can charge by the firms in
the industry.
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 Bargaining Power of Buyers: They can bargain for price cut, ask for superior
quality & better service and induce rivalry among competitors. If they are
powerful, they can depress the profitability of the supplier industry.

 Bargaining Power of Suppliers: Suppliers like buyers can exert a competitive

force in an industry as they can raise prices, lower quality & curtail the range of
free services that they provide.

Applying the above Porter’s Model to Tejas Networks

Threat of New
Entrants

Suppliers Tejas Networks

Rivalry (Competitive) Buyers
Flextronics,
companies are BSNL, ITI,
Jabil
Cisco, ZTE, Force10, Airtel
Nortel, Orion Networks

Threat of Substitutes

An overview to overcome the Porter’s Five Forces is:

1. Reducing the Competitive Rivalry between Existing Players

 Avoid price competition
 Differentiate your product
 Focus on different segments

2. Reducing the Treat of New Entrants

 Create a marketing / brand image
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 Patents
 Tie up with suppliers
 Tie up with distributors
 Customer Loyalty

3. Reducing the Bargaining Power of Suppliers

 Partnering
 Increase dependency

4. Reducing the Bargaining Power of Customers

 Increase loyalty
 Value added services

5. Reducing the Threat of Substitutes5

 Legal actions
 Switch costs

3.4PRELIMINARY SCREENING

Preliminary screening is required to eliminate ideas, which prima facie are not
promising.
For this purpose the following aspects may be looked into:

• Compatibility with the promoter

• Consistency with governmental priorities
• Availability of inputs
• Adequacy of markets
• Reasonableness of cost
• Acceptability of risk level

3.5PROJECT RATING INDEX

A preliminary evaluation may be translated into a project-rating index. The

steps involved in determining the project-rating index are as follows:
• Identify factors relevant for project rating.
• Assign weights to these factors.
• Rate the project proposal on various factors, using a suitable rating
scale.
• For each factor, multiply the factor rating with the factor weight to
get the factor score.
• Add all the factor scores to get the overall project-rating index.

5
Threat of substitutes in Telecom Infrastructure Company is very rare.
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Applying the project-rating index to Ethernet over SDH/SONET.

Factor Factor Rating Factor

Weight Score
VG G A P VP
5 4 3 2 1
Input Availability 0.25 * 1.00

Technical Know-How 0.10 * 0.50

Reasonableness of Cost 0.05 * 0.20

Adequacy of market 0.15 * 0.75

Complementary relation
-ship with other product 0.05 * 0.20

Stability 0.10 * 0.40

Dependence on firm’s
Strength 0.20 * 1.00

Consistency with govern

-Mental priorities 0.10 * 0.40

Rating Index 4.45

3.6 SOURCES OF POSITIVE NET PRESENT VALUE

There are six main entry barriers that result in positive NPV projects. They are as
follows:
• Economies of scale
• Product differentiation
• Cost advantage
• Marketing reach
• Technological edge
• Government policy
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PART 2
ANALYSIS
4.Market and Demand Analysis
5.Technical Analysis
6.Financial Estimates and
Projections

Statistics may be defined as "a body

of methods for making wise
decisions in the face of
uncertainty."
W.A. Wallis