Case 24

SHYAM LAL AND ASSOCIATES

Shyam Lal&Associates (SLA) was organized as a partnership firm in 1992, with its main o

in Delhi. Since that time, the firm diversified into various product lines, both in manutacturin8
tO
also expanded its market. Sales of SLA increased from Rs. 70
lakh in 19
and trading and 31, 2011.
the estimated hgure of Rs. 15 crore for the accounting year ending on December
At present, SLA has three works offhces engaged in processing ofbasic industrial chemicals,
located in
offices
goods and leather products. All these works
are
of hardware
production cold storage-cum-warehouse
Faridabad, Haryana. In addition to that, SLA also owns one Lal.
Delhi. Each unit under the'overall guidance of Mr. Shyam
located in Azadpur, operates that
for the line of product carried on by
All works offhces serve as a sales and distribution point and
who is responsible for hiring and supervision of personnel
unit and is run by supervisor
a
decisions aftecting
and cost control at the unit level. All
for sales, credit, purchasing, inventory lines reviewed by
expenditure and the addition of product
are

SLAs overallpolicy, capital

Shyam Lal shortage of funds caused by low profits
and
For the last two years, SLA is experiencing as per
term loan to Vishal
Bank. The payments became necessary
the instalment payments of of
However, the problem which bothered Mr. Shyam Lal w a s
the agreement with the bank.
to improve the long-run
to submit his suggestion
low profits. He asked each unit supervisor found
various suggestions, Mr. Shyam Lal
While going through
profitability of the company. he took up for consideration.
He was concerned about the
which
three proposals of investment
estimated that the use of 12 per
schedule of each one of them. He
prohitability and payment in evaluating the proposals. SLA's
cent after-tax required rate of return would be appropriate investment
Lal selected was new
cent. The first one Mr. Shyam
tax rate is estimated at 35 per
Unit.
Chemical Processing
proposal from Faridabad

NEW INVESTMENT PROPOSAL

head has suggested that SLA should invest in a plant

ofice
ihe chemicals processing works chemical would be widely accepted
He expects that the new
which can produce a new chemical. the
The works manager of that unit submitted
and used the manufacturers of plastic bags.
by market survey and sales
forecasts generated by him.
the basis of
Ollowing information on
166 CASES IN FINANCIAL MANAGEMEN
(Rs. in lakh)
A

39.60
Estimated investment 10 years
Estimated life
Annual after-tax cash flows:
7.60
Years 1-4
8.50
Years 5-10

of its
the end of
He has estimated that the salvage value of the
machine at
life expected
in his proposal that SLA
he mentions
likely to be 50 per cen of its book value. Further,cent using diminishing
balance(written
be entitled for depreciation at the rate of 25 per -down
value) method.

COST SAVING PROPOSALL

The hardware unit of SLA used to contribute 40 per cent towards the overall profitabilty
of the company. But recently the contribution had declined significantly because of the ris the rising
cost and labour problems. Therefore, the proposals submitted by the hardware unit supervi
rvisor
emphasized the cost-reduction techniques. Among other suggestions, Mr. Shyam Lal found

aproposal machine which would help the company

to invest in a
to reduce the costs. Th
following note was submitted by the manager of the unit:
Automation Industry is a manufacturer of special machines used in the processes likeours. T
installation of these machines go a long way to reduce the costs, At present, one particularmach
which is being marketed by them will do the job satisfactorily, and will belp the company in reducig
its costs. The machine costs Rs. 46.35 lakh by paying the entire amount in cash.
However, the company also provides the facility of purchasing the machine on instalmentbass
In that case, the amount has to be paid in eigbt equal annual instalments and the rate ofinter
compounded annualy by the company would be 18 per cent'"
Mr. Shyam Lal was interested in knowing the amount of instalment which the company
would be required to pay each year. Further, he wanted to know how much of this amount
was towards interest and repayment of principal each year. Since interest payments were tar
deductible, Shyam Lal was wondering what was the cost of
Given that the life of this machine is 15
machine to him as of today:
years, how much
accrue to SLA each year to recover the investment
after-tax-cost savings snohould
made on instalment basis?
EXPANSION PROPOSAL
The cold storage manager has proposed to install
complex. A distributor of refrigeration
erigeration system in
various makes of refrigeration in their
their newly
newiy 2c the
I he
cquired

prepared In
systems is prepared
1S to insta to
 AsAKMTES

AND
tYAM IAL
bmitted m a n a g e rt h a r

storage
manag hedule
costs Rs. 14 lakh. The distributor has informed the cold
which the following SC
in four
tour years, interest rate being 13 per cent. He submitted
s y s t e n

an pay in
canpay
irhe details of annual payments.
girvingt h e

(Rs. in lakh

14.00
Principal
Four years of interest at 13 per cent
7.28

Total amount
21.28
5.32
Annual payments

of interest paid
distributor's
SLA considers the proposal, what is the implicit rate
In case 13 per
case Mr. distributor and he agrees to e a r n
by the firm? In Shyam negotiates
Lal withthe
to pay
ot return, what will be the annual instalment amount which he will
be required
cent rate
to the distributor?

FINANCING AND ITS COST

estimated that he would require about Rs. 65 lakh of
funds to finance the
Mr. Shyam Lal or
are accepted. Funds from
internal sources were out
three propOsed projects in case
they ihe
Vishal Bank to explore the possibility of seven-year t e r m loan.
question. He approached
informed him that the current rate ofinterest on such
loans would be 15 per cent.
bank officials the end
and interest would be required to be made either at
The payments for both principal
interested in hnding
of each year or at the end of the maturity of loan. In the latter case, he was
suffhcient
investing outside at 18.5 per cent so that he has
how much he should save each year by rate of
also concerned about the after-tax required
hunds to repay the loan at maturity. He was
return which he should use in evaluating the proposals.

DISCUSSION QUESTIONS
What are the key characteristics
1. Whatis the nature of problems being faced by Shyam Lal?
should he decide?
of the options he is examining? How
2. Why do you think he should consider time value of money and what do you do you
mean by time value of money?
3. For this purposewhat discount rate should he use?
4. Explain the concept of present value and future value. While evaluating the profitability
and repayment schedule of various projects use the following concepts:

(a) Future value factor, FVFn,r

(6) Future value annuity factor, FVAFn,r