CASE STUDY

XY COMPANY PROFILE
XY Pvt. Ltd is engaged in the manufacture and marketing of multi purpose
Internal Combustion (IC) engines, a range of its applications such as Pump
sets, Sprayers, Vibrators, etc., and Agricultural Implements.
The company is also engaged in the manufacture and marketing of power
tiller. XY Pvt. Ltd first developed IC engines manufacturing plant and the first
product was an engine meant for needle vibrator in the construction industry.
Since the beginning, the company has been availing credit limits for both
term funding and WC purposes under multiple banking arrangement. The
long term requirement of the bank was met by the bank along with another
reputed bank. The company has been enjoying credit facilities with the bank
for the past ten years. The company has availed the facility from some of the
other top financial institutions as well.

Purpose of loan:
XY Pvt. Ltd requires a term loan for the expansion and purchase of
machinery as a part of development of the company.
Project profile:
Name of the unit : ABC PVT LTD
Project profile:
Name of the unit : ABC PVT LTD
Address

: Mumbai

Constitution

: NA

Registration Date : 19TH NOVEMBER 96

Name and address of the partners:

NAME OF THE
DIRECTORS

DESIGNATION

AGE

EXPERIENCE

Mr. A

Managing

48

Both are
having15
years
experience in
this line of
activity

Mr. B

Director

44

Nature of project
ABC ltd is considering Expansion of the unit by constructing a factory
building. Development of prototype higher capacity 12HP engine. Installation
of new machinery.
Cost of project and means of finance:
The cost of project will be around Rs.4.8 Cr. which includes cost of installation
of new machine and other expenses. The company also applied for loan to
other banks to cover rest of the amount. Loan sanctioned by bank is Rs.4.8
Cr.
Any other firm or branch which is presently being run by the
partners:
ABC Pressure Castings
XY Accessories Ltd.
Security Offered against the loan:
Primary

: Hypothecation of machineries.

Collateral

: Shop no.21, Mumbai

Guarantors:(1) Mr. X

Age: 48 years
Cast: Hindu
Business: Manufacturing of portable engines, Pump sets, Sprayers & other
Agricultural Implements.
(2)

Mr. Y

Age: 40 years
Cast: Hindu
Business: Manufacturing of portable engines, Pump sets, Sprayers & other
Agricultural Implements.
Analysis using financial tools
Capital budgeting
Capital budgeting (or investment appraisal) is the planning process used to
determine a firm's long term investments such as new machinery,
replacement machinery, new plants, new products, and research and
development projects.

Capital Budgeting is a project selection exercise performed by the

business enterprise.

Capital budgeting uses the concept of present value to select the

projects.

Capital Budgeting Tools:

The following are the capital budgeting tools used for appraisal process.

Net Present Value

Profitability Index
Payback Period
Internal Rate of Return
Accounting Rate of Return.

1. Payback period:
Payback period in business and economics refers to the period of time
required for the return on an investment to "repay" the sum of the original
investment. It measure that how long something takes to "pay for itself".
Payback period = Initial investment/ Annual cash inflow
Table 1:YEAR

CFAT

CUMULATIVE CFAT

2006-07

65.25

65.25

2007-08

49.69

114.94

2008-09

54.60

169.54

2009-10

156.23

325.77

2010-11

255.07

572.53

Payback period = Initial investment/ Annual cash inflow

= 4 + 480-325.77/255.07
=4 + 154.23/255.07
=4 + 0.65
=4. 65 years
Payback period = 4.65 years Inference:
PB period of this project is 4 years and 6 months and it consider to be a short
period and short periods are more preferable to long period. Therefore this
project is feasible and should be accepted for appraising loan because the
initial cost of the project is recovered within 4 years.

2. Average rate of return method:

Average Rate of return (ARR) or return on investment (ROI), or sometimes
just return, is the ratio of money gained or lost on an investment relative to
the amount of money invested.
The amount of money gained or lost may be referred to as interest,
profit/loss, gain/loss, or net income/loss. ROI does not indicate how long an
investment is held.
With the help of the ARR, the financial decision maker can decide whether to
accept or reject the investment proposal. The actual ARR would be compared
with a predetermined or minimum required rate of return or cut-off rate.
TABLE 2:YEAR

PAT

2006-07

25.93

2007-08

16.38

2008-09

30.82

2009-10

108.23

2010-11

145.07

TOTAL

318.07

Average Rate of return on Original Investment = Average Annual Net

Earnings/ Original Investment.
= 63.61/ 4.80* 100
ARR ON ORIGINAL INVESTMENT= 13.25%. Average Investment = 4.80/2 =
2.40
= 63.61/ 2.40* 100

ARR on average investment = 26.50%

Inference: This project can be accepted as the actual ARR is higher than the
minimum desired ARR. Here the actual ARR is higher than the cut off rate
that is 5%. So the project should be accepted.
3. NET PRESENT VALUE:
NPV is an indicator of how much value an investment or project adds to the
value of the firm.
If.

It Means

Then

NPV
>0

The investment
would add value
to the firm
The investment
would subtract
value from the
firm
The investment
would neither
gain nor lose
value for the firm

The project may be accepted

NPV
<0

NPV=
0

The project should be rejected

We should be indifferent in the decision whether

to accept or reject the project. This project adds
no monetary value. Decision should be based on
other criteria, e.g. strategic positioning or the
other factors not explicitly included in the
calculation.

Table 3:YEAR

CFAT

PV @ 5%

PV OF CFAT

2006-07

65.25

0.952

62.12

2007-08

49.69

0.907

45.07

2008-09

54.60

0.864

47.17

2009-10

156.23

0.823

128.58

2010-11

255.07

0.784

199.97

Present Value Of

482.91

Cash Inflow
Initial Investment

480.00

Net Present value

(+)2.91

Net Present value = Rs. 2.91lacs Inference:

As the proposal shows positive (+) NPV the proposal should be accepted.
Here NPV is greater than 0 i.e. 2.91 (in lac), it means it would add more value
to the firm and proposal is feasible so it should be accepted.

4. INTERNAL RATE OF RETURN:

The internal rate of return is a capital budgeting matrix used by the firm to
decide whether they should make investment or not. A project is good
investment proposition if IRR is greater than the rate of return. In general if
IRR is greater than the cost of capital, the project will add value for the
money.
TABLE 4:YEAR

CFAT

PV@6%

PV OF
CFAT

PV@4%

PV OF
CFAT

2006-07

65.25

0.943

61.53

0.962

62.77

2007-08

49.69

0.890

44.22

0.925

45.96

2008-09

54.60

0.840

45.86

0.889

48.54

2009-10

156.23

0.792

123.73

0.855

133.58

2010-11

255.07

0.747

190.54

0.822

209.67

TOTAL
IRR (F) = I/C

465.88

500.52

F = Factor to be located
I = Investment
C= Cash Inflow

=4% + 500.52 - 480.00/ 500.52 465.88 * ( 6% - 4%)

=4% + 2052/ 3464* (2)
=4 % + 1.18%
= 5.18%
IRR = 5.18%
Interpretation:
The IRR is usually the rate of return that a project earns. Here IRR i.e. 5.18%
is greater so the project will add good value therefore this proposal should be
accepted.