Case 32 HE NEOGI CHEMICAL COMPANY heer. ‘pe Neos Chemical Company (NCC) was sarin IB as apatite company ‘Than nial investment of Rs 28 crore, Undertheablegdance fs chairman, Atrchamn Lal Neogi the compiny mode temerdous progress during the last Jade Asa result of ts increasing sles and profits and ineeasing demand of fds or financing the expansion, he company was onvered ino publi ited 1994 On March 31,1997, the tol eapalsaion ofthe company was Rs Although the company is highly prfabe and growing constantly there is ample scope t0 introduce more scientific manager techniques to improve probly further Forexanpl, the company hasnt been lowing sophistested [poch in serening and evaiating septal poets The finance committees ‘Morse to serecn and approve only those pects which involve capital ipa exceeding R25 ah Deparment bend are members of he commitee ft te eontoler of finance 1 its chaiman. Its the responsibility of the Stprtnenal ead to submit detailed description af proposed proecsstogcther wih estimates of cost and benefits. Six sch projects are currently under coneration Exhibit) Thefinance commits doesnot follow a standed procedure sereen capital prec. Rather the commits listens to the views ofthe various members and ‘esis onthe basso the mers and fre ofthe arguments made by he commitee ‘embers After tending an Exeutve Development Programme on Techniques ot vesment Analysis recently, Me Chaman Lal Neogi, the chairman ofthe inp yas convinced that hi company would eal allocate funds rationally tops more scientific approsch towards investment decisions. He, therefore, "led th finance commit to standardise its Srening procedure and adopt “oe Scent evaluation techniques to ese equine treatment to each projest Ssdmaximum possible return tothe company on its nvesment expenditure Keeping in view the desire ofthe company’s chairman, te finance committee ®etnconse the erent projects. Me Neol ws bo present atthe meeting. A !unbeofisues were ised by the commie members han amp estalish en.Oe Ee 242. Cases in Financial Management jew of Mr Jagat the chit screening programme, Forexampleaitwas He ° a sound screening programe Po Gnoes) ofthe company shoul! athe ‘accountant, that thfirst and foremest &S° < jer riod of time. He. joney invested in ne efecovered within a short period phil Se four years for NCC should be the 1 axmum aceepable, payback period ‘hata maximum acceptable, ay epithe argued tha such an approach ts to accept a project. To emphasise his point an basis wae pte, but als didnot require the calculator ‘of the,€ost of capita vend, the marketing manager, reacted ici a formidable tase Mr Laxmi Ci Sly ws view: He potted ut hat 1 a tows projets tht were not bent seeping ths a atic dstlity of oe GePOES a profil ones He aed anne, lhe i othe the sped wih which invests favoured the ws fhe internal i fae (IRR) method. This method, ‘according to him, incorporates all cash flows over the (RR) met Tas mt em retin ake Well He stated te ie othe poet and ad pital sot necessary forthe wse oF ht mao aoa ede thn agen hy sting ta eae ofa ie wi eee a er evatting projets Because of he ale isin and atin ren era ate feu, could give mull igh formule econ ron nvaroert projet Defending te we of sh main ncn pinot ates ing Se re aed ar amen isk and ity He ated hee papock mt pe masimum acpi payenk prod acount rk silent te mtd ao ge an eno priest ind ii eo ofcontan cath hows anda sity og eo afr es aneprnimon te! sa OTE enn meen sage ofthe dies sy hpi 8 soe ean bts seth only rteron cannarbe defend ch a econ ofbde labs use at Me Vinod Mi Pv) md Ise inates what wealth woul 2 roe Prspners ofthe company fom the project. Mr Mital also stated that if present to aan, cna compat th rato a the rest vals of waa cash uty, order to aes the lative sig esr? “various investmgot proposals. He explained further that fike ‘internal rte of sentence rane Hesen value’ methods pve the same aecept-eject decisions, those who have at Ft hha ecu neoven cero eh ca atations andthe possibility of multiple rats of return would have no obeeto® commepting the use ofthe net present value method as an investment criterion Mr Neogi reacted to Mr Mittal’s arguments by saying that under certit raft and pee a Re ald ive cnn ‘aking lng to him, this pethaps happens due to the difference in the cash 0™ Towing such a poticy may result in I to the company and rejectingThe Neogi Chemical Company 243 patems of the mutually exch, Tenalenienes destin cncnt eee emetfemeing ht tinder eco He drclopmen programme whieh he sven byfIRR and NPVmetnoae 8g the cause of theeonfliting rankings Ofte ieatimptanree os OPP oven westattichonee tose mnctods APV method nS" aSunponsisherentinte eee ee imesinefareinvescran® ith inemefae cat eacenere wnat of scout ost of capital tothe fim) while rpc TiNeel atthe pj's ine ata on ‘aking confit arose solely due to the inde Heintomesn geNsetthe woes erehncaner gers PV ttt he majority ew inthe exeatne epee the issues relating tothe conto teiltatedtheexample gente requie the same intial gulag ‘equited rate of return of 10 per cent, e r ‘Sent, projet A's NPV (Rs 4,40) i higher th Project B's NPV (Rs 3,824). However fry i =) thine A 285 eran Pre Desir RRG pen) Mr Pramod: the proton manager shitedthe dicusion othe question of Se cio He complained tt he comm adios ee thepastin approving projects. Hefelt thatthe wold boo difcly frei allthose project that enn rates higher than the costo ety, whith a poses spproximately9.75 per cent (af-ax). This view was countered by Mr La, the finance manage. He contended that indiscriminate wef debt fancy was rake ewould put the capital structure in imbalance and lam he lenders The rt vas likely to be an increase in effective interes rates and moe restive loan covenants. Ths also could have an adverse effect onthe sharp pies af he company. He, therefore, felt that abasic change the capil srvctre would ave serious consequences forthe compan. Hedi ot know wha would be the cst andrepereussions ifthe projects were financed raising equity capil instead of deb eapital- ~ Some committee members also raised the question of using retained earings for financing the project since tis a cost free source. However, the chiman of the committee informed the members that, ahi pinion, na sours of finds oul be said to be fre of cost atleast, there was an opportunity cos invoied, The airman alo said atthe problem wouldbecomesimplifthecostf cepts could be calculated. He also informed the members thatasa policy the company would | | lke to maintain a debt-equty rato of :2atitsboo vlusinthe long-run. ALthis | juncture, the chairman ofthe committe ajournedthe meeting requesting themem- bers to come with their recommendations regarding Project No. inthe light of the discussion inthe meeting. The estimates ofthe costs and benef of Project No (Gahibit tn) were cirulatedto each member. The iformaton abouthe company'sNg 244 _Coses in Financial Management capital structure and other relevant data (Exhibit IV) were also circulated. The cha. ‘man also informed the members that this year for financing any investment projec the company may have taraise debt at 15 per cent per aamum-~.The Neogi Chemical Company _ 246 Exhibit | THE NEOGI CHEMICALS COMPANY List of Proposed Capital Projects Poet Deston Tee Basten Goss Oar ett) Adoption of New Replacement Gost Saving and 480 Chemical Ming Expansion Revenue Generation Process Starting a New Expansion Increased Revenue 600 Produ iision Purchase ofLand Statagie Management soo forPossible Future Expansion Strategy Expansion Purchase ofan Expansion Increased Profs 600 ‘Adonai Warehouse Improvement of Replacement Cost Saving 200 Material Handing Fests Opening aNew Stratego ‘Management 400 Offee to Handle Expansion Strategy Foreign Operations Independenty Exhibit I! THE NEOGI (CHEMICALS COMPANY tustration of NPV vs. RA a Fs) ar aes mor [ote | | A ctog00 2000 «4000 12000 4.140 2685 ® — ~MG00 10000 3000 3000 3824 37.69246 Cosesin Financial Management Exhibit Ii THE NEOG| CHEMICALS COMPANY Estimated Revenue and Costs of Project No. 1 @Rsintkt) Present Peat Proposed Projet ‘Annual Revenue Sales 510 692 ‘Annual Costs Raw Material 282 348 Labour Costs 80 65 ‘Supervision 8 6 Power 15 " Repairs and Maintenance 4 5 Depreciation (Straightline Method) 3 45 ‘Allocated Corporate Overheads 5 7 Note: In adaton tothe gros outa o Rs 450 lakh, he proposed projet wil equ a ‘net increase in working capt of Rs 32 lakh, The estimated fe of the proposed projects 10 years. The preset project has Book valve of 30 lah and @ ‘market value of Rs 45 lath and retained for 10 yeas, ts salvage valu at the fend ofthe tenth years expected tobe Rs 15 lth. The proposed projec has estimated savage vale of Rs 40 ath at the end of ste, Corprat ax rates 35 percent, anda 25 percent writen down deprecation rte fr tx purposes (see Append). Exhibit IV ‘THE NEOGI CHEMICALS COMPANY Capital Structure Year Ended March 31, 1998 (sine) pointy Pald-up share capital (30 lakh shares @ Rs 100) 3,000 Reserves and surplus oa Total Borrowings 7200 ‘The Capital Employed 72.000 {Cd Notes: 4, The Company's share is curenty song fr Rs 200. The companys dividend {ates 22 per cant whch I expected to grow at7§ percent fora ang pet o time 2. The average noes eon borrowings inpast year hasbeen about 16 perceThe Neog Chemical Company _247 _ OO oooorrvrvo>vov- ‘APPENDIX 1 Foc tax purposes depreciation is alowed as deduction every year in respect cof buildings, machinery, plant or furniture til he cost of such asset as fly writen of 1. Coneitions for allowing depreciation allowance: {a) The asset should be owned by the assessee: (b) the assets should actualy be used forthe purpose ofthe assessee's business or profession 2. Basis of calculation of depreciation allowance: Depreciation willbe allowed on the witan down value ofthe block of assets. “Block of assets’ means a group of assets fang wihin a class of assets, being buildings, machinery, plant or future, in respect of Uihich the same percentage of depreciation is prescribed. 3, Written down value: ‘This defined under section 43(6) ofthe Income Tax Act. Inthe case of block of assets, the written down value sal be artved as under: (@) The aggregate of the writen down valve of all the assets fang within that block of assets at the beginning of the previous year shall fist be calculated: (by the aggregate ofthe written down value arived at a in) shallbe inereased by the actual cost of any asset alin in that block which ‘was acquired during the previous year: and the sum so arrived at in (0) shall be “educed by the money cei fle together with scrap value, any inrespect of any asset fling ‘vthin that block which is sold or discarded or demolished or ‘destroyed during the previous year, so, however, thatthe amount Sf such reduction does not exceed the witen down value as so o increased