CASE STUDY: DIVYA HANDLOOMS PRIVATE

LIMITED

DHPL is a small sized firm manufacturing hand

tools. The company sales in the year ending on
31st march 2004 were Rs 100 million 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
is 14 % per annum. 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 an economic life
of 10 years. The accountant forecasts that net
cash inflows would be Rs 45 million per annum
for the first three years, Rs 68 million per
annum from year four to 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 operation.
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 savings 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 SBI at an
interest rate of 14% per annum for 10 years. It
will be required to pay EMI. 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 EMIs).
A large FI 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 instalments of
interest and repayment of principal.
Assume there are no taxes
Questions
1. Should the company expand its capacity?
Show the computation of NPV.
2. What is the minimum amount of savings
from the replacement that would justify the
expenditure?
3. What is the annual instalment of the SBI
loan?
4. What is the amount of single payment of
interest and principal to SBI after 10 years?
5. Calculate the quarterly instalments of the
financial institution loan?
6. Should the company borrow from SBI or FI?
CASE STUDY: DIVYA HANDLOOMS PRIVATE
LIMITED

DHPL is a small sized firm manufacturing hand

tools. The company sales in the year ending on

31st march 2004 were Rs 100 million 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
is 14 % per annum. 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 an economic life
of 10 years. The accountant forecasts that net
cash inflows would be Rs 45 million per annum
for the first three years, Rs 68 million per
annum from year four to 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 operation.
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 savings 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 SBI at an
interest rate of 14% per annum for 10 years. It
will be required to pay EMI. 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 EMIs).
A large FI 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 instalments of
interest and repayment of principal.
Assume there are no taxes
Questions
1. Should the company expand its capacity?
Show the computation of NPV.
2. What is the minimum amount of savings
from the replacement that would justify the
expenditure?
3. What is the annual instalment of the SBI
loan?
4. What is the amount of single payment of
interest and principal to SBI after 10 years?
5. Calculate the quarterly instalments of the
financial institution loan?
6. Should the company borrow from SBI or FI?

Solution
Case 2.1: Divya Handtools Pvt.
Ltd.

Capacity expansion
Year
NCF
PVF
PV, 14%
0
-250
1.000
-250.0
1
45
0.877
39.5
2
45
0.769
34.6
3
45
0.675
30.4
4
68
0.592
40.3
5
68
0.519
35.3
6
68
0.456
31.0
7
68
0.400
27.2
8
68
0.351
23.8
9
30
0.308
9.2
10
85
0.270
22.9
NPV
44.2
Year 10 cash flows include salvage value.
Minimum savings each year from replacement
Cash outlay (Rs million)
50
Life (years)
10
PVFA 14%, 10
5.2161
Annuity (annual savings, Rs mn)
9.6
Annual instalment of SBI loan
Amount (Rs million)
Interest rate
Period (years)
PVFA 14%, 10
Annual instalment (Rs mn)

200
14%
10
5.2161
38.3

Payment at maturity - SBI loan

Amount (Rs million)
Interest rate
Period (years)
Future value factor
Single payment (future value)

200
14%
10
3.7072
741.4

Quarterly instalment - FI loan

Amount (Rs million)
Annual interest rate
Quarterly rate
Quarterly periods
PVFA 3.375%, 40
Quarterly instalment (Rs mn)

200
13.50%
3.375%
40
21.7754
9.2

capital recovery

The company should borrow from FI since the the annual interest rate is lower.