Reference no: EM133306582
Project Investment Proposal Details The project is estimated to be of 10 years duration. It involves setting up new machinery with an estimated cost of as much as INR 500 million, including installation. This amount could be depreciated using the straight line method (SLM) over a period of 10 years with a resale value of INR 15 million. The project would require an initial working capital of INR 20 million with cumulative investment in net working capital to be maintained at 10% of each year's projected revenue. With the planned new capacity, the company would be able to produce 240,000 pieces of shirts each year for the next 10 years. In terms of pricing, each shirt can initially be sold at INR 1,300 apiece, which takes into account the target segment and competitor pricing. The project proposal incorporates an annual increase of 3% in the price of the shirt to compensate for inflationary impact. With regards to the raw material costs and other expenses, the project estimated the following details:
• Raw material cost for manufacturing shirts at INR 400 per shirt, slated to rise by 5% per annum on account of inflation.
• Other direct manufacturing costs at INR 125 per shirt with an annual increase of 5% per annum on account of inflation.
• Selling, general, and administrative expenses (including employee expenses) at INR 35 million per annum, expected to increase by 10% each year.
• Depreciation expense on the basis of SLM.
• Tax rate was assumed to be 25%.
Funding For funding of the expansion project, the promoters agreed to infuse 50% in the form of equity with the rest (50%) being financed from issue of new debt. Based on the current credit position and market scenario, new debt can be raised by the company at 12% per annum. Cost of equity was assumed to be 15% by Saurabh. The requisite discounting rate or weighted average cost of capital (WACC) for NPV and IRR calculations can now be calculated with the help of the above assumptions. Demand Scenario Although the project proposal estimates maximum annual production of 240,000 shirts, Saurabh decided to do capital budgeting analysis under two demand scenarios: Optimistic and Expected. The likely annual demand estimated under each scenario is as follows: Scenario Annual demand Optimistic 240,000 Shirts Expected 200,000 Shirts.
On the basis of the financial information given in the case, calculate the after-tax operating cash flows, NPV, and IRR under the Optimistic and Expected scenarios. Clearly specify the calculations required for the same.