Reference no: EM132595857
Medha Ltd. is a small-sized firm manufacturing hand tools. The company's sales in the year ending un 31 March 2013 were INR 1000 million on an asset base of INR 650 million. The net profit of the company was INR 76 million. The management of the company wants to improve profitability further. The required rate of return of the company is 15 per cent. The company is currently considering two investment proposals. One is to expand its manufacturing capacity.
The estimated cost of the new equipment is INR 250 million. It Is expected to have an economic life of 10 years. The accountant forecasts that net cash inflows would be INR 45 million per annum for the first three years. INR 68 million per annum from year four to year eight and for the remaining two years INR 30 million per annum. The plant can be sold for INR 55 million at the end of Its economic life. Tax rate is 30% on profits on sale.
If the company accepts the project, it would need to raise external funds of INR 200 million. as about INR 50 million internal funds are available in retained earnings. Companies cost of equity is 12%.
The company has the following options of borrowing INR 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 Instalments of Interest and repayment of principal. The managing director of the company was wondering if it were possible to negotiate with SBI to make one single payment of interest and principal at the end of 10 years (instead of annual instalments). A large financial institution has offered to lend money to Medha Ltd. at a lower rate of Interest. The Institution will charge 13.5 per cent per annum. The company will have to pay equal quarterly instalments of interest plus principal.
Answer the following Questions in detail (State your assumptions if any)
Question 1. Should the company expand its capacity? Show the computation of NPV.
Question 2. What is the annual instalment of the SBI loan? Calculate a loan amortization schedule
Question 3. What is the amount of the single payment of Interest and principal to SBI after 10 years?
Question 4. Calculate the quarterly instalments of the financial institution loan?
Question 5. Should the company borrow from the SBI or the financial institution? Give reasons for your choice.