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Capital Budgeting

Essay by   •  February 21, 2017  •  Essay  •  456 Words (2 Pages)  •  814 Views

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Capital Budgeting

CASE: Expansion Plan – Opening a new retail outlet

XYZ Oil Limited is an Oil Marketing Company. It is planning to open another outlet in Delhi. To identify a suitable location and to carry out a detailed feasibility study the company hired a consultant and paid a fees of Rs.5,00,000 towards the same.

Based upon the feasibility report the following details were identified:

MARKET ANALYSIS AND PRODUCT-MIX

The following demand estimates were made for the first year of operations

  • Petrol: 30,000 liters per day
  • Diesel: 10,000 liters per day

It is estimated that the petrol will generate a margin of Rs.2 per liter whereas the margin on diesel would be Rs.1.20 per liter. The demand is expected to grow by 10% per annum. The margins are expected to grow by 3% per annum.

COST OF THE PROJECT

The land would be taken on a 10 years lease at an initial deposit of Rs.2 crores and a monthly rent of Rs.2 lakhs. The other costs are estimated as follows:

  • Leveling of plot, site preparation, construction etc.   Rs.2 crores
  • Equipments cost and installation                              Rs.3 Crores
  • Working Capital Requirement                                   Rs. 1 Crore.

It is estimated that the residual value of the plant and machinery would be just sufficient to meet the cost of removal. As per the lease agreement any building and structure would revert back to the Landlord. The working capital requirement would increase by 10% every year. The funds blocked in the working capital would be recovered in full at the end of the project life.

MEANS OF FINANCE

The project would be financed 50% by internal resources and 50% by borrowed funds. The rate of interest on the borrowed funds is 10%. As per the internal policy of the company the required rate of return on equity is 14%.

OPERATING COST

  • Manpower cost   : Rs.100,000 per month
  • Maintenance       :  10% per annum of the cost of equipment
  • Other Expenses  :  Rs.1,00,000 per month.
  • Contingent Expenses : 10% of the above expenses

It is estimated that the expenses would increase by 5% every year.

Cost of site preparation and building would be depreciated at the rate of 20% per annum on the written down value basis. The rate of deprecation on Equipments would be @ 25% on the WDV basis.

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