Case study on DHPL

DHPL is a small sized firm manufacturing hand tools. It manufacturing plan is situated in
Faridabad. The company’s sales in the year ending on 31 March 2013 were 1000 million (100
crore) on an asset base of 650 million. The net profit of the company was 76 million. The
management of the company wants to improve profitability further. The required rate of
return of the company is 14 percent. The company is currently considering two investment
proposals. One is to expand its manufacturing capacity. The estimated cost of the new
equipment is 250 million. It is expected to have an economic life of 10 years. The accountant
forecasts that net cash inflows would be 45 million per annum for the first three years 68
million per annum from year four to year eight and for the remaining two years 30million per
annum. The plant can be sold for 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 50 million. The life of the machine is expected to be 10 years without any salvage
value. The company will go for the replacement if it generates sufficient cost saving to justify
the investment.
If the company accepts both projects, it would need to raise external funds of
200million, as about 100 million internal funds are available. The company has the following
operations of borrowing 200 million:
 The company can borrow funds from the State Bank of India (SBI) at an
interest rate of 14 per cent per annum for 10 years. It will be required to pay
equal annual installments of interest and repayment of principal. The
managing director wondering if it were possible to negotiate with SBI to make
one single payment of interest and principal at the end of the 10 years(instead
of annual installment).
 A large financial institution has offered to lend money to DHPL at lower rate
of interest. The institution will charge 13.5 per cent per annum. The company
will have to pay equal quarterly installments of interest plus 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 lease rental of 52 million payable at the
beginning of the year. Assume that there are no taxes
.

1|P age
Discussion Question

1. Should the company expand its capacity? Show the computation of NPV

Answer: Here NPV is positive. So, The Company should expand its capacity so that they can
increase their profitability further.

A positive NPV indicates that the projected earnings generated by a project (in present
value) exceed the anticipated costs (also in present value). An investment with a positive
NPV will be a profitable one.

Here,

Interest Rate, i = 14%

Number of period, n = 10 Years

Cash inflows> R1 – R3 = 45 Million

R4 – R8 = 68 Million

R9 – R10 = 30 Million

Salvage Value = 55 Million

Initial Investment = 250 Million

We know,

𝑅1 𝑅2 𝑅3 𝑅4 𝑅5 𝑅6 𝑅7 𝑅8 𝑅9 𝑅10
NPV = [ (1+𝑖)1 + (1+𝑖)2 + (1+𝑖)3 + (1+𝑖)4 + (1+𝑖)5 + (1+𝑖) 6 + (1+𝑖)7 + (1+𝑖)8 + (1+𝑖) 9 + ( 1+𝑖) 10
]

– Initial Investment

45 45 45 68 68 68 68 68
= [ (1+.14)1 + (1+.14) 2 + (1+.14) 3 + (1+.14) 4 + (1+.14 )5 + (1+14) 6 + (1+.14)7 + (1+.14) 8 +
30 30+ 55
( 1+.14) 9
+ (1+.14)10 ] – 250

2|P age
 = 39.473 + 34.626 + 30.373 + 40.261 + 35.317 + 30.979 + 27.175 + 23.838 + 9.225 +

22.928 – 250

= 294.176 – 250

= 44.176 Million

2. What is the minimum amount of savings from the replacement that would justify the
expenditure?

Answer:

Here,

PVA = 50 million

Interest rate, i = 14%

Number of period, n = 10 years

𝑖𝑥 𝑃𝑉𝐴
Annuity = 1
1−
(1+𝑖)𝑛

0.14𝑥 50
= 1
1−
(1+.14)10

7
=
1− 0.2697

7
=
𝑜.7303

=9.5851 million

Therefore, Minimum Savings Each Year from the replacement of the equipment is 9.5851
million

3. What is the annual installment of the SBI loan?

Answer: Annual installment of SBI loan

3|P age
Here,

i= interest rate=14%

p= principle amount =200 million

n= number of period = 10 years

We know that,

(𝑖𝑝)
Annual installment =
{1−(1+𝑖 ) −𝑛 }

(0.14𝑥200)
= {1−(1+.14 )−10 }

28
= 1−.269743

28
=
0.73025

=38.343 million

So, Annual installment of SBI loan is 38.343 million

4. What is the amount of the single payment of intere st and principal to SBI after 9
years?

Here,

PV= present value =200million

i=Interest rate= 14%

n= number of period = 9 years

We know,

FV=PV(1+i)n

=200(1+.14)9

=200x3.2519

4|P age
 =650.398 million

SO, the amount of the single payment of interest and principle to SBI after 9 years is 650.398
million

5. Calculate the quarterly installments of the Financial Institution loan?

Here,

Principal amount, p= 200 million

Interest rate, i = 13.5% / 4 = 3.375% = 0.03375 (quarterly)

Number of periods = 10 x 4 = 40 times

𝑖𝑥 𝑃
Quarterly Installment = 1
1−
(1+𝑖) 𝑛

0.03375 𝑥 200
= 1
1−
(1+0.03375) 40

6.75
= 1
1−
1.03375 40

6.75
= 1− 0.2650

6.75
=
0.735

= 9.1836 million

So, quarterly installment of the financial institution loan is 9.1836 million

6. Should the company borrow from the SBI or the financial institution? Give reasons
for your choice

Answer:

In case of SBI;-

Company has to pay 38.343 million / year

5|P age
At the end of 10 years 383.43 million

In case of Financial institution;-

Company has to pay 9.1836 million /quarterly

At the end of 10 years 367.34 million

Company should barrow money from financial institution. Because if they borrow money
from SBI they have to pay 0.5% more Yearly and 16.03 million more at the end of the 10
years, it’s not beneficial for company.

7. Would you recommend borrowing from the financial institution or get the equipment
on lease? Show necessary calculations.

Answer:

In case of financial institution

Loan from financial institution 200 million

Internal founds 100 million

Total expenses of two projects 300 million (present value)

In case of equipment lease

Here,

PMT=52 million

i =13.5%

n= 10 years

We know that,

𝑃𝑀𝑇 1
PVAD=( ) {1 − ( }(1 + 𝑖)
𝑖 1+𝑖) 𝑛

52 1
=( ) {1 − ( }(1 + .135)
.135 1+.135 ) 10

6|P age
 =385.185 x 0.719 x 1.135

=314.33 million

Total expense of two projects is 314.33 (present value)

The value of lease rentals is higher than the amount of borrowing. So, borrowing is cheaper
than leasing, DHPL should borrow loan from the financial institution as they have pay less
amount of money.

Recommendations

At last we can say that, DHPL should go for both of the projects and they may get financial
support from financial institution by taking loan instead of taking on lease

7|P age