Case : Expansion Plan

XYZ Limited is engaged in the manufacturing of electronic items. It is planning to commission another plant to manufacture set-top boxes. To carry out a detailed feasibility study the company hired a consultant and paid a fee of INR 1,000,000 towards the same.

Based upon the feasibility report the following details were identified:

MARKET ANALYSIS

It is estimated that the company would be able to sell 10,000 boxes in the first year of operations and the demand would increase by 10% per annum. The selling price per set would be INR 14,000 and is expected to grow by 5% per annum.

COST OF THE PROJECT

The project life is estimated to be 10 years. As the new project would be housed in the existing industrial complex the cost of the land is considered to be NIL. Earlier the company has received a proposal to rent out this piece of land at a monthly rent of INR 2 million.

The other costs are estimated as follows:

Leveling of plot, site preparation, construction etc. INR 20 million

Equipments cost and installation INR 50 million

Working Capital Requirement 10% of sales

It is estimated that the residual value of the plant and machinery would be just sufficient to meet the cost of dismantling and removal of the plant. The funds blocked in the working capital would be recovered in full at the end of the project life.

MEANS OF FINANCE

The project would be financed 50% by internal resources and 50% by borrowed funds. The rate of interest on the borrowed funds is 12%. As per the internal policy of the company the cut off rate used for such projects is 16%.

OPERATING COST

Variable Cost : INR 11,500 per set

Manpower cost : INR 200,000 per month

Maintenance : 10% per annum of the cost of equipment

Other Expenses : INR 200,000 per month.

It is estimated that the expenses would increase by 3% every year.

The new project would be using common services (like HR, Security, Administration etc.) of the existing complex. Based upon the overheads allocation policy of the company, a proportionate annual charge of INR.2 million should be charged as annual operating cost. It is estimated that cost of common services would actually increase by INR.500,000 per annum only as a consequence of the new project

Cost of site preparation and building would be depreciated at the rate of 20% per annum on the written down value basis. The rate of deprecation on Equipments would be @ 25% on the WDV basis.

The applicable tax rate for the company is 25%. Ignore tax on gain/loss on the disposal of building and equipments.

Should the project be accepted?