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 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.30 million per annum. The plant can be sold for
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 annum 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 installment of the financial
institution loan. (4) should the company borrow from the
bank of from the financial institution?
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Answer / Shiva Tyagi
This question involves a complex financial analysis, including calculating Net Present Value (NPV), annual and quarterly loan installments, and making recommendations on whether to expand capacity and which loan to choose. Here's a simplified breakdown for each part:
(1) To calculate the NPV, we first need to discount the cash inflows and the cost of the new equipment back to their present values. We can then subtract the initial investment (equipment cost) and compare the resulting NPV with zero. A positive NPV suggests that the expansion is profitable.
(2) For the annual installment of a bank loan at 14% interest rate for 10 years, we would use the formula for an annuity: P = [r * PV] / [1 - (1 + r)^(-n)] where P is the annual payment, r is the annual interest rate (as a decimal), PV is the present value of the loan (250 million in this case), and n is the number of years (10).
(3) For the quarterly installment of a financial institution loan at 13.5% interest rate, we would use the formula for an annuity with quarterly payments: P = [r * PV] / [1 - (1 + (4*r))^(-4*n)]
(4) To decide whether to borrow from the bank or the financial institution, we would compare the annual and/or quarterly installments of both options, consider the impact on profitability, and make a recommendation based on these factors.
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