A Case Study On DIVYA HANDTOOLS PRIVATE LIMITED (DHPL) In Strategic Financial Management

Submitted To: Prof.Darshita Mirani

Prepared By: Darji Mukesh Patel Krutik Patel Swapna

DHPL is a small-sized firm manufacturing hand tools. Its manufacturing plant is situated in Faridabad. The companys sales in the year ending on 31 march 2009 were Rs 1000 million (Rs 100 crore) on an asset base of Rs 650 million. The net profit of the company was Rs 76 million. The management of the company wants to improve profitability further. The required rate of return of the company is 14%. The company is currently considering two investment

proposals. One is to expand its manufacturing capacity. The estimated cost of

the new equipment is Rs 250 million. It is expected to have to have an economic life of 10 years. The accountant forecasts that net cash flows would be Rs 45 million per annum for the first three years, Rs 68 million per annum from year four to year eight and for the remaining two years Rs 30 million per annum. The plant can be sold for Rs 55 million at the end of its economic life.

The second proposal before the management is to replace one of the old machines in the Faridabad plant to reduce the cost of operations. The new machine will involve a net cash outlay of Rs 50 million. The life of the machine

is expected to be 10 years without any salvage value. The company will go for
the replacement only if it generates sufficient cost saving to justify the investment.

If the company accepts both projects, it would need to raise external funds of Rs 200 million, as about Rs 100 million internal funds are available. The company has the following options of borrowing Rs 200 million:

The company can borrow funds from the State Bank of India (SBI) at an interest
rate of 14% per annum for 10 years. It will be required to pay equal annual installments of interest and repayment of principal. The managing director of the company was wondering if it were possible to negotiate with SBI to make one single payment of interest and principal at the end of 10 years (instead of annual installment).

A large financial institution has offered to lend money to DHPL at a lower rate

of interest. The institution will charge 13.5 per annum. The company will have
to pay equal quarterly installments of interest and repayment of principal.

The financial institution has made yet another offer to the company. It can lease the equipments for the capacity expansion and for replacing old equipment to the company at annual lease rental of Rs 52 million payable at the beginning of the year.

Assume that there are no taxes.

Sales on 31 March 2009 were Rs 1000 million Net profit Rs 76 million Required rate of return is 14% Estimated cost of new equipment is Rs 250 million

Economic life of 10 years

Cash flow Rs 45 million per annum for the first three years, Rs 68 million per annum from year four to year eight Plant sold for Rs 55 million at the end of its economic life. SBIs interest rate is 14% per annum for 10 years

Q-1 Should the company expands its capacity? Show the calculation of NPV. Ans:-Years 10 Cash Flows include Salvage Value.

Year 0 1 2 3 4 5 6 7 8 9 10 NPV

NCF -250 45 45 45 68 68 68 68 68 30 85

PVF 1.000 0.877 0.769 0.675 0.592 0.579 0.456 0.400 0.351 0.308 0.270

PV, 14% -250.0 39.5 34.6 30.4 40.3 35.3 31.0 27.2 23.8 9.2 22.9 44.20

Q-2 What is the minimum amount of savings from the replacement that would justify the expenditure? Ans:-Minimum Savings Each Year from Replacement Particulars Cash outlay (Rs million) Life (Years) PVFA 14%,10 Annuity (Annual Savings (Rs million)) Amount 50 10 5.2161 9.6

Q-3 What is the annual installment of the SBI loan? Ans:-

Particulars Amount (Rs million) Interest Rate Period (Years)

Amount 200 14% 10

PVFA 14%,10
Annual Installment (Rs million)

5.5161
38.3

Q-4 What is the amount of the single payment of interest and principal to SBI after 10 years? Ans:Particulars Amount (Rs million) Interest Rate Period (Years) Future Value Factor Single Payment (Future Value) Amount 200 14% 10 3.7072 741.40

Q-5 Calculate the quarterly installments of the financial institution loan? Ans:-The company should borrow from Financial Institution since the annual interest rate is lower. Particulars Amount (Rs million) Annual Interest Rate Quarterly rate Quarterly Period PVFA3.375%,40 Quarterly Installment (Rs million) Amount 200 13.50% 3.375% 40 21.7754 9.2

Q-6 Would you recommend borrowing from the financial institution or get the equipment on lease? Show necessary calculations. Ans:Particulars Amount (Rs million) Period (Years) Lease rental (beginning of the year) Amount 300 10 52

PVFA of annuity due (13.5%)

Value of lease rentals

6.038
314.00

The value of lease rentals is higher than the amount of borrowing (Rs.300 million). Hence, borrowing is cheaper than leasing.