DHPL is a small sized firm manufacturing hand tools. It
manufacturing plan is situated in Haryana. The company’s
sales in the year ending on 31st March 2007 were Rs.1000
million (Rs.100 crore) 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 of the company is 14
percent.
The company is currently considering an investment
proposal. 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 year eight and for the
remaining two years Rs.30million per annum. The plant can
be sold for Rs.55 million at the end of its economic life.
The company would need to raise debt to the extent of
Rs.200 million. The company has the following options of
borrowing Rs.200 million:
a. The company can borrow funds from a nationalized bank at
the interest rate of 14 percent for 10 years. It will be
required to pay equal annual installment of interest and
repayment of principal.
b. A financial institution has offered to lend money to
DHPL at 13.5 per annum but it needs to pay equated
quarterly installment of interest and repayment of
principal.
Questions:
1. Should the company expand its capacity? Show the
computation of NPV
2. What is the annual installment of bank loan?
3. Calculate the quarterly installments of the Financial
Institution loan
4. Should the company borrow from the bank or from the
financial institution?