N.B.: 1) Attempt any Four Questions
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.
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 selecte
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