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N.B.: 1) Attempt any Four cases
2) All
questions carry equal marks.
NO. 1
COOKING LPG LTD
DETERMINATION OF WORKING CAPTIAL
Introduction
Cooking LPG Ltd, Gurgaon, is a private sector firm dealing in the
bottling and supply of domestic LPG for household consumption since 1995. The
firm has a network of distributors in the districts of Gurgaon and Faridabad.
The bottling plant of the firm is located on National Highway – 8 (New Delhi –
Jaipur), approx. 12 kms from Gurgaon.
The firm has been consistently performing we.” and plans to expand its market to include the
whole National Capital Region.
The production process of
the plant consists of receipt of the bulk LPG through tank trucks, storage in
tanks, bottling operations and distribution to dealers. During the bottling process, the cylinders
are subjected to pressurized filling of LPG followed by quality control and
safety checks such as weight, leakage and other defects. The cylinders passing through this process
are sealed and dispatched to dealers through trucks. The supply and distribution section of the
plant prepares the invoice which goes along with the truck to the distributor.
Statement of the Problem :
Mr. I. M. Smart, DGM(Finance) of the company, was analyzing the financial
performance of the company during the current year. The various profitability ratios and
parameters of the company indicated a very satisfactory performance. Still, Mr. Smart was not fully
content-specially with the management of the working capital by the company. He could recall that during the past year, in
spite of stable demand pattern, they had to, time and again, resort to bank
overdrafts due to non-availability of cash for making various payments. He is aware that such aberrations in the
finances have a cost and adversely affects the performance of the company. However, he was unable to pinpoint the cause
of the problem.
He discussed the problem
with Mr. U.R. Keenkumar, the new manager (Finance). After critically examining the details, Mr.
Keenkumar realized that the working capital was hitherto estimated only as
approximation by some rule of thumb without any proper computation based on
sound financial policies and, therefore, suggested a reworking of the working
capital (WC) requirement. Mr. Smart
assigned the task of determination of WC to him.
Profile of Cooking LPG Ltd.
1) Purchases
: The company purchases LPG in bulk from various importers ex-Mumbai and
Kandla, @ Rs. 11,000 per MT. This is
transported to its Bottling Plant at Gurgaon through 15 MT capacity tank trucks
(called bullets), hired on annual contract basis. The average transportation cost per bullet
ex-either location is Rs. 30,000.
Normally, 2 bullets per day are received at the plant. The company make payments for bulk supplies
once in a month, resulting in average time-lag of 15 days.
2) Storage
and Bottling : The bulk storage capacity at the plant is 150 MT (2 x 75 MT
storage tanks) and the plant is capable
of filling 30 MT LPG in cylinders per day.
The plant operates for 25 days per month on an average. The desired level of inventory at various
stages is as under.
·
LPG in bulk (tanks and pipeline
quantity in the plant) – three days average production / sales.
·
Filled Cylinders – 2 days average
sales.
·
Work-in Process inventory – zero.
3) Marketing
: The LPG is supplied by the company in 12 kg cylinders, invoiced @ Rs. 250 per
cylinder. The rate of applicable sales
tax on the invoice is 4 per cent. A
commission of Rs. 15 per cylinder is paid to the distributor on the invoice
itself. The filled cylinders are
delivered on company’s expense at the distributor’s godown, in exchange of
equal number of empty cylinders. The
deliveries are made in truck-loads only, the capacity of each truck being 250
cylinders. The distributors are required
to pay for deliveries through bank draft.
On receipt of the draft, the cylinders are normally dispatched on the
same day. However, for every truck
purchased on pre-paid basis, the company extends a credit of 7 days to the
distributors on one truck-load.
4) Salaries
and Wages : The following payments are made :
·
Direct labour – Re. 0.75 per cylinder
(Bottling expenses) – paid on last day of the month.
·
Security agency – Rs. 30,000 per
month paid on 10th of subsequent month.
·
Administrative staff and managers –
Rs. 3.75 lakh per annum, paid on monthly basis on the last working day.
5) Overheads :
·
Administrative (staff, car,
communication etc) – Rs. 25,000 per month – paid on the 10th of
subsequent month.
·
Power (including on DG set) – Rs.
1,00,000 per month paid on the 7th Subsequent month.
·
Renewal of various licenses
(pollution, factory, labour CCE etc.) – Rs. 15,000 per annum paid at the
beginning of the year.
·
Insurance – Rs. 5,00,000 per annum to
be paid at the beginning of the year.
·
Housekeeping etc – Rs. 10,000 per
month paid on the 10th of the subsequent month.
·
Regular maintenance of plant – Rs.
50,000 per month paid on the 10th of every month to the
vendors. This includes expenditure on
account of lubricants, spares and other stores.
·
Regular maintenance of cylinders
(statutory testing) – Rs. 5 lakh per annum – paid on monthly basis on the 15th
of the subsequent month.
·
All transportation charges as per
contracts – paid on the 10th subsequent month.
·
Sales tax as per applicable rates is
deposited on the 7th of the subsequent month.
6) Sales
: Average sales are 2,500 cylinders per day during the year. However, during the winter months (December
to February), there is an incremental demand of 20 per cent.
7) Average
Inventories : The average stocks maintained by the company as per its policy
guidelines :
·
Consumables (caps, ceiling material,
valves etc) – Rs. 2 lakh. This amounts
to 15 days consumption.
·
Maintenance spares – Rs. 1 lakh
·
Lubricants – Rs. 20,000
·
Diesel (for DG sets and fire engines)
– Rs. 15,000
·
Other stores (stationary, safety
items) – Rs. 20,000
8) Minimum cash balance
including bank balance required is Rs. 5 lakh.
9) Additional Information for
Calculating Incremental Working Capital During Winter.
·
No increase in any inventories take
place except in the inventory of bulk LPG, which increases in the same
proportion as the increase of the demand.
The actual requirements of LPG
for additional supplies are procured under the same terms and conditions
from the suppliers.
·
The labour cost for additional
production is paid at double the rate during wintes.
·
No changes in other administrative
overheads.
·
The expenditure on power consumption
during winter increased by 10 per cent.
However, during other months the power consumption remains the same as
the decrease owing to reduced production is offset by increased consumption on
account of compressors /Acs.
·
Additional amount of Rs. 3 lakh is
kept as cash balance to meet exigencies during winter.
·
No change in time schedules for any
payables / receivables.
·
The storage of finished goods
inventory is restricted to a maximum 5,000 cylinders due to statutory
requirements.
Suppose you are Mr.Keen Kumar,
the new manager. What steps will
you take for the growth of Cooking LPG Ltd.?
NO. 2
M/S HI-TECH ELECTRONICS
M/s. Hi – tech Electronics, a consumer electronics outlet, was opened two
years ago in Dwarka, New Delhi. Hard work and personal attention shown by the
proprietor, Mr. Sony, has brought success.
However, because of insufficient funds to finance credit sales, the
outlet accepted only cash and bank credit cards. Mr. Sony is now considering a new policy of
offering installment sales on terms of 25 per cent down payment and 25 per cent
per month for three months as well as continuing to accept cash and bank credit
cards.
Mr. Sony feels this policy
will boost sales by 50 percent. All the
increases in sales will be credit
sales. But to follow through a new policy,
he will need a bank loan at the rate of 12 percent. The sales projections for this year without
the new policy are given in Exhibit 1.
Exhibit 1 Sales Projections and Fixed costs
|
Month
|
Projected sales without instalment option
|
Projected sales with instalment option
|
|
January
|
Rs.
6,00,000
|
Rs.
9,00,000
|
|
February
|
4,00,000
|
6,00,000
|
|
March
|
3,00,000
|
4,50,000
|
|
April
|
2,00,000
|
3,00,000
|
|
May
|
2,00,000
|
3,00,000
|
|
June
|
1,50,000
|
2,25,000
|
|
July
|
1,50,000
|
2,25,000
|
|
August
|
2,00,000
|
3,00,000
|
|
September
|
3,00,000
|
4,50,000
|
|
October
|
5,00,000
|
7,50,000
|
|
November
|
5,00,000
|
15,00,000
|
|
December
|
8,00,000
|
12,00,000
|
|
Total Sales
|
48,00,000
|
72,00,000
|
|
Fixed cost
|
2,40,000
|
2,40,000
|
He further expects 26.67 per cent of the sales to be cash, 40 per cent
bank credit card sales on which a 2 per cent fee is paid, and 33.33 per cent on
instalment sales. Also, for short term
seasonal requirements, the film takes loan from chit fund to which Mr. Sony
subscribes @ 1.8 per cent per month.
Their success has been due
to their policy of selling at discount price.
The purchase per unit is 90 per cent of selling price. The fixed costs are Rs. 20,000 per month. The proprietor believes that the new policy
will increase miscellaneous cost by Rs. 25,000.
The business being
cyclical in nature, the working capital finance is done on trade – off
basis. The proprietor feels that the new
policy will lead to bad debts of 1 per cent.
(a) As a financial consultant, advise the proprietor whether he
should go for the extension of credit facilities.
(b) Also prepare cash budget for one year of operation of the firm,
ignoring interest. The minimum desired
cash balance & Rs. 30,000, which is also the amount the firm has on January
1. Borrowings are possible which are
made at the beginning of a month and repaid at the end when cash is available.
NO.3
SMOOTHDRIVE TYRE LTD
Smoothdrive Tyre Ltd manufacturers tyres under the brand name “Super
Tread’ for the domestic car market. It
is presently using 7 machines acquired 3 years ago at a cost of Rs. 15 lakh
each having a useful life of 7 years, with no salvage value.
After extensive research
and development, Smoothdrive Tyre Ltd has recently developed a new tyre, the
‘Hyper Tread’ and must decide whether to make the investments necessary to
produce and market the Hyper Tread. The
Hyper Tread would be ideal for drivers doing a large amount of wet weather and
off road driving in addition to normal highway usage. The research and development costs so far
total Rs. 1,00,00,000. The Hyper Tread
would be put on the market beginning this year and Smoothdrive Tyrs expects it
to stay on the market for a total of three years. Test marketing costing Rs.
50,00,000, shows that there is significant market for a Hyper Tread type tyre.
As a financial analyst at Smoothdrive Tyre, Mr. Mani asked by the Chief
Financial Officer (CFO), Mr. Tyrewala to evaluate the Hyper-Tread project and
to provide a recommendation or whether or not to proceed with the
investment. He has been informed that
all previous investments in the Hyper Tread project are sunk costs are only
future cash flows should be considered.
Except for the initial investments, which occur immediately, assume all
cash flows occur at the year-end.
Smoothedrive Tyre must
initially invest Rs. 72,00,00,000 in production equipments to make the Hyper
Tread. They would be depreciated at a
rate of 25 per cent as per the written down value (WDV) method for tax purposes. The new production equipments will allow the
company to follow flexible manufacturing technique, that is both the brands of
tyres can be produced using the same equipments. The equipments is expected to have a 7-year
useful life and can be sold for Rs. 10,00,000 during the fourth year. The company does not have any other machines
in the block of 25 per cent depreciation.
The existing machines can be sold off at Rs. 8 lakh per machine with an
estimated removal cost of one machine for Rs. 50,000.
Operating Requirements
The operating requirements of the existing machines and the new equipment
are detailed in Exhibits 11.1 and 11.2 respectively.
Exhibit 11.1 Existing Machines
·
Labour costs (expected to increase 10
per cent annually to account for inflation) :
(a)
20 unskilled labour @ Rs. 4,000 per
month
(b)
20 skilled personnel @ Rs. 6,000 per
month.
(c)
2 supervising executives @ Rs. 7,000
per month.
(d)
2 maintenance personnel @ Rs. 5,000
per month.
·
Maintenance cost :
Years 1-5 : Rs. 25 lakh
Years 6-7 : Rs. 65 lakh
·
Operating expenses : Rs. 50 lakh
expected to increase at 5 per cent annually.
·
Insurance cost / premium :
Year 1 : 2 per cent of the original cost of machine
After year 1 : Discounted by 10 per cent.
Exhibit 11.2 New production Equipment
·
Savings in cost of utilities : Rs.
2.5 lakh
·
Maintenance costs :
Year 1 – 2 : Rs. 8
lakh
Year 3 – 4 : Rs. 30
lakh
·
Labour costs :
9 skilled personnel @ Rs. 7,000 per month
1 maintenance personnel @ Rs. 7,000 per month.
·
Cost of retrenchment of 34 personnel
: (20 unskilled, 11 skilled, 2 supervisors and 1 maintenance personnel) : Rs.
9,90,000, that is equivalent to six months salary.
·
Insurance premium
Year 1 : 2 per cent of the purchase cost of machine
After year 1 : Discounted by 10 per cent.
The opening expenses do
not change to any considerable extent for the new equipment and the difference
is negligible compared to the scale of operations.
Smoothdrive Tyre intends to sell Hyper Tread of two distinct markets :
1. The
original equipment manufacturer (OEM) market : The OEM market consists
primarily of the large automobile companies who buy tyres for new cars. In the OEM market, the Hyper Tread is
expected to sell for Rs. 1,200 per tyre. The variable cost to produce each
Hyper Tread is Rs. 600.
2. The
replacement market : The replacement market consists of all tyres purchased
after the automobile has left the factory.
This markets allows higher margins and Smoothdrive Tyre expects to sell
the Hyper Tread for Rs. 1.500 per tyre.
The variable costs are the same as in the OEM market.
Smoothdrive
Tyre expects to raise prices by 1 percent above the inflation rate.
The variable costs will also increase by 1 per cent above the inflation rate. In addition, the Hyper Tread project will
incur Rs. 2,50,000 in marketing and general administration cost in the first
year which are expected to increase at the inflation rate in subsequent years.
Smoothdrive Tyre’s
corporate tax rate is 35 per cent.
Annual inflation is expected to remain constant at 3.25 per cent. Smoothdrive Tyre uses a 15 per cent discount
rate to evaluate new product decisions.
The Tyre Market
Automotive industry analysts expect automobile manufacturers to have a
production of 4,00,000 new cars this year and growth in production at 2.5 per
year onwards. Each new car needs four
new tyres (the spare tyres are undersized and fall in a different category)
Smoothdrive Tyre expects the Hyper Tread to capture an 11 per cent share of the OEM market.
The industry analysts estimate
that the replacement tyre market size will be one crore this year and that it
would grow at 2 per cent annually.
Smoothdrive Tyre expects the Hyper Tread to capture an 8 per cent market
share.
You also decide to
consider net working capital (NWC) requirements in this scenario. The net working capital requirement will be
15 per cent of sales. Assume that the
level of working capital is adjusted at the beginning of the year in relation
to the expected sales for the year. The
working capital is to be liquidated at par, barring an estimated loss of Rs. 1.5
crore on account of bad debt. The bad debt will be a tax-deductible expenses.
As
a finance analyst, prepare a report for submission to the CFO and the Board of
Directors, explaining to them the feasibility of the new investment.
No. 4
COMPUTATION OF COST OF CAPITAL OF PALCO LTD
In October 2003, Neha Kapoor, a recent MBA graduate and newly appointed
assistant to the Financial Controller of Palco Ltd, was given a list of six new
investment projects proposed for the following year. It was her job to analyse these projects and
to present her findings before the Board of Directors at its annual meeting to
be held in 10 days. The new project
would require an investment of Rs. 2.4 crore.
Palco Ltd was founded in
1965 by Late Shri A. V. Sinha. It gained recognition as a leading producer of
high quality aluminum, with the majority of its sales being made to Japan. During the rapid economic expansion of Japan
in the 1970s, demand for aluminum boomed, and palco’s sales grew rapidly. As a result of this rapid growth and
recognition of new opportunities in the energy market, Palco began to diversify
its products line. While retaining its
emphasis on aluminum production, it expanded operations to include uranium
mining and the production of electric generators, and finally, it went into all
phases of energy production. By 2003,
Palco’s sales had reached Rs. 14 crore level, with net profit after taxes
attaining a record of Rs. 67 lakh.
As Palco expanded its
products line in the early 1990s, it also formalized its caital budgeting
procedure. Until 1992, capital
investment projects were selected primarily on the basis of the average return
on investment calculations, with individual departments submitting these
calculations for projects falling within their division. In 1996, this procedure was replaced by one
using present value as the decision making criterion. This change was made to
incorporate cash flows rather than accounting profits into the decision making
analysis, in addition to adjusting these flows for the time value of
money. At the time, the cost of capital
for Palco was determined to be 12 per cent, which has been used as the discount
rate for the past 5 years. This rate was
determined by taking a weighted average cost Palco had incurred in raising
funds from the capital market over the previous 10 years.
It had originally been
Neha’s assignment to update this rate over the most recent 10-year period and
determine the net present value of all the proposed investment opportunities
using this newly calculated figure.
However, she objected to this procedure, stating that while this
calculation gave a good estimate of “the past cost” of capital, changing
interest rates and stock prices made this calculation of little value in the
present. Neha suggested that current
cost of raising funds in the capital market be weighted by their percentage
mark-up of the capital structure. This
proposal was received enthusiastically by the Financial Controller of the
Palco, and Neha was given the assignment of recalculating Palco’s cost of
capital and providing a written report for the Board of Directors explaining
and justifying this calculation.
To determine a weighted
average cost of capital for Palco, it was necessary for Neha to examine the
cost associated with each source of funding used. In the past, the largest sources of funding
had been the issuance of new equity shares and internally generated funds. Through conversations with Financial
Controller and other members of the Board of Directors, Neha learnt that the
firm, in fact, wished to maintain its current financial structure as shown in
Exhibit 1.
Exhibit 1 Palco Ltd Balance Sheet for Year Ending March 31, 2003
|
Assets
|
Liabilities
and Equity
|
||
|
Cash
Accounts receivable
Inventories
Total current assets
Net fixed assets
Goodwill
Total assets
|
Rs. 90,00,000
3,10,00,000
1,20,00,000
5,20,00,000
19,30,00,000
70,00,000
25,20,00,000
|
Accounts payable
Short-term debt
Accrued taxes
Total current liabilities
Long-term debt
Preference shares
Retained earnings
Equity shares
Total liabilities and equity shareholders fund
|
Rs. 8,50,000
1,00,000
11,50,000
1,20,00,000
7,20,00,000
4,80,00,000
1,00,00,000
11,00,000
25,20,00,000
|
She further determined that the strong growth patterns that Palco had
exhibited over the last ten years were expected to continue indefinitely
because of the dwindling supply of US and Japanese domestic oil and the growing
importance of other alternative energy resources. Through further investigations, Neha learnt
that Palco could issue additional equity share, which had a par value of Rs. 25
pre share and were selling at a current market price of Rs. 45. The expected dividend for the next period
would be Rs. 4.4 per share, with expected growth at a rate of 8 percent per
year for the foreseeable future. The
flotation cost is expected to be on an average Rs. 2 per share.
Preference shares at 11
per cent with 10 years maturity could also be issued with the help of an
investment banker with an investment banker with a per value of Rs. 100 per
share to be redeemed at par. This issue
would involve flotation cost of 5 per cent.
Finally, Neha learnt that
it would be possible for Palco to raise an additional Rs. 20 lakh through a 7 –
year loan from Punjab National Bank at 12 per cent. Any amount raised over Rs. 20 lakh would cost
14 per cent. Short-term debt has always
been usesd by Palco to meet working capital requirements and as Palco grows, it
is expected to maintain its proportion in the capital structure to support
capital expansion. Also, Rs. 60 lakh
could be raised through a bond issue with 10 years maturity with a 11 percent
coupon at the face value. If it becomes
necessary to raise more funds via long-term debt, Rs. 30 lakh more could be
accumulated through the issuance of additional 10-year bonds sold at the face
value, with the coupon rate raised to 12 per cent, while any additional funds
raised via long-term debt would necessarily have a 10 – year maturity with a 14
per cent coupon yield. The flotation
cost of issue is expected to be 5 per cent.
The issue price of bond would be Rs. 100 to be redeemed at par.
In the past, Palco had
calculated a weighted average of these sources of funds to determine its cost
of capital. In discussion with the
current Financial Controller, the point was raised that while this served as an
appropriate calculation for external funds, it did not take into account the
cost of internally generated funds. The
Financial Controller agreed that there should be some cost associated with
retained earnings and need to be incorporated in the calculations but didn’t
have any clue as to what should be the cost.
Palco Ltd is subjected to
the corporate tax rate of 40 per cent.
From
the facts outlined above, what report would Neha submit to the Board of
Directors of palco Ltd ?
NO. 5
ARQ LTD
ARQ Ltd is an Indian company based in Greater Noida, which manufactures
packaging materials for food items. The
company maintains a present fleet of five fiat cars and two Contessa Classic
cars for its chairman, general manager and five senior managers. The book value of the seven cars is Rs.
20,00,000 and their market value is estimated at Rs. 15,00,000. All the cars fall under the same block of
depreciation @ 25 per cent.
A German multinational
company (MNC) BYR Ltd, has acquired ARQ Ltd in all cash deal. The merged company called BYR India Ltd is
proposing to expand the manufacturing capacity by four folds and the
organization structure is reorganized from top to bottom. The German MNC has the policy of providing
transport facility to all senior executives (22) of the company because the
manufacturing plant at Greater Noida was more than 10 kms outside Delhi where
most of the executives were staying.
Prices of the cars to be provided to the Executives have been as follows
:
|
Manager (10)
|
Santro King
|
Rs.
3,75,000
|
|
DGM and GM (5)
|
Honda City
|
6,75,000
|
|
Director (5)
|
Toyota Corolla
|
9,25,000
|
|
Managing Director (1)
|
Sonata Gold
|
13,50,000
|
|
Chairman (1)
|
Mercedes benz
|
23,50,000
|
The company is evaluating two options for providing these cars to
executives
Option 1 : The company will buy the cars and pay the executives fuel
expenses, maintenance expenses, driver allowance and insurance (at the year –
end). In such case, the ownership of the
car will lie with the company. The details
of the proposed allowances and expenditures to be paid are as follows :
a) Fuel expense and maintenance
Allowances per month
|
Particulars
|
Fuel expenses
|
Maintenance allowance
|
|
Manager
DGM and GM
Director
Managing Director
Chairman
|
Rs.
2,500
5,000
7,500
12,000
18,000
|
Rs.
1,000
1,200
1,800
3,000
4,000
|
b) Driver
Allowance : Rs. 4,000 per month (Only Chairman, Managing Director and Directors
are eligible for driver allowance.)
c) Insurance
cost : 1 per cent of the cost of the car.
The useful life for the
cars is assumed to be five years after which they can be sold at 20 per cent
salvage value. All the cars fall under
the same block of depreciation @ 25 per cent using written down method of
depreciation. The company will have to
borrow to finance the purchase from a bank with interest at 14 per cent
repayable in five annual equal instalments payable at the end of the year.
Option 2 : ORIX, The fleet management company has offered the 22 cars of
the same make at lease for the period of five years. The monthly lease rentals for the cars are as
follows (assuming that the total of monthly lease rentals for the whole year
are paid at the end of each year.
Santro Xing Rs. 9,125
Honda City 16,325
Toyota Corolla 27,175
Sonata Gold 39,250
Mercedes Benz 61,250
Under this lease agreement
the leasing company, ORIX will pay for the fuel, maintenance and driver
expenses for all the cars. The lessor
will claim the depreciation on the cars and the lessee will claim the lease
rentals against the taxable income. BYR
India Ltd will have to hire fulltime supervisor (at monthly salary of Rs.
15,000 per month) to manage the fleet of cars hired on lease. The company will have to bear additional
miscellaneous expense of Rs. 5,000 per month for providing him the PC, mobioe
phone and so on.
The company’s effective
tax rate is 40 per cent and its cost of capital is 15 per cent.
Analyse the financial viability of the two options. Which option would you recommend ? Why ?
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