Introduction:

•Chiragh Din, who opened his own shop in the of street of Teli Mohalla of Rawalpindi on 3rd June, 1962.

•His new shop was specialized in lighting items offering both sales and service.

•Soon he was winning contracts to large contractors.

•His son Roshan completed his BBA and join his father’s business.

•They also decided to retain their Muree shop as that was a cash cow for them.

A new private limited company was formed under the name of “Chiragh Din Lights private Ltd”

•They put up the basic building structure out of their savings at Kahota Industrial area.

•They put up the basic building structure out of their savings at Kahuta Industrial area.

•They were able to rise a loan for purchase of the plant by pledging the factory land..

•After some initial problem Chiragh Din Lights pvt(Ltd), started competing well with larger firms and with importers as well.

• At that time they sold of their Muree road shop and paid off the factory debt .

•His sole focus on the customer satisfaction were the key elements of all their manufacturing policies .

•Thus clients have greater faith in his products.

•Thus clients have greater faith in his products.

•Roshan control the administration side the business.

•They hired a professional, Malik Khalid, to look after the marketing aspects of the company.

•In the year 1990, the company’s annual sales touches 100 million mark.

•In the early 2006 the company approached to the English Electronics PLC, a British firm.

•This company has been supplying their switches to Pakistani market for over seven years.

•Their interest to have an assembly plant in Pakistan.

•Their trade name was ZAAP.

•Their research make them to have potential partnership with CDL.

•They proposed an agreement:

English Electronics were supply the plant and relevent technology.

They will also offer technically support program for three years.

They were willing to arrange loan for them to cover the cost of the plant.

No separate charge was to be levied on the CDL, for use of the ZAAP trade name.

The components for the assembly will be supplied by the British firm.

Malik Khalid the marketing manager of CDL proposed that they should double the manufacturing capacity of their products by installing a new plant.

Currently the company was sailing products to Rawalpindi, Islamabad, Punjab, Peshawar and Sindh as well.

Their opinions about the project…..

R0shan who now acted as the CEO of the CDL, have the opinion to take up both the projects, i.e.

i. Increase the production capacity of light.

ii. Set up new plants to manufacture electrical fittings.

Chiragh Din, serving as the chairman of the company, was not in favor of the projects. He think that company shouldn’t its capital resources as well as managerial.

So…

They hired financial consultants, in order to advise the company whether to carry the projects or not.

The small team, headed by Mehvish Khan, was assigned by sterling assosiates work on the CDL’s projects.

Mehvish was able to gether information:

Chiragh Din was not in favor of both the projects at the same time.

He agreed with Malik Khalid that expansion of current lights project should not be delayed in order to penetrate the upper Punjab market.

Roshan was quite keen at the prospects of working with British company.

He think that they will soon the international champion.

He think that CDL financial position and structure should enable them to rise finance for both the projects.

He also pointed out that English Electronics were prepare a loan for the switches assembly plant.

And he reason that CDL needed long term funds for the lamps plant expansion project.

Malik Khalid asummed that they have already good name in their on business of lights. And switches on other hand is a new business for them.though they will use the trade name ZAAP but they will never own that trade name.He said all the efforts that they will serve will strengthen PLC in Pakistan not CDL & English Electronics will never allow CDL to start their own line in Switches

Mehvish analyze the financial aspects of both projects.

oThe company pay 10% of dividend over the past few years

oThe owners believe that cost of equity funds about 20%, the cost of long term fund will be 12% if they borrow funds to put up any of the plant.

oCharagh Dinn believes that they should add an additional cost 2% on what ever weighted Average cost (WAC is the average of the costs of these sources of financing, each of which is weighted by its respective use in the given situation. By taking a weighted average, we can see how much interest the company has to pay for every dollar it finances. A firm's WACC is the overall required return on the firm as a whole and, as such, it is often used internally by company directors to determine the economic feasibility of expansionary opportunities and mergers. It is the appropriate discount rate to use for cash flows with risk that is similar to that of the overall firm) of funds comes for the switches project and it carries a higher degree of risk.

All figures in millions 0f Rs

2003actual

2004 actual

2005actual 2006 estimated

Gross Revenue 113 128 149 174 

Gross profit 39 46 54 65 

Administration overhead 9 10 11 13 

Marketing overhead 16 19 20 26 

financial overheads 3.4 3.2 3.5 2.8 

Net profit   11 14 19 25 

Dividends   5 5 5 5 

unapprpriated Profit 84 93 107 127 

Rs in millions  Increase light making capacity Put upNew switches plant

plant cost     75    80 

new buildings capital   5    5 

Additional investment in working capital   15    25 

total investment required   9.5    110 

    Sales Direct Admin Market Rs in million Revenue cost overhead overheadyear 1   45 27 2 6.2year 2   60 36 2.5 5year 3   75 45 3 5year 4   85 51 3.5 5.5year 5   100 60 4 5.5year 6   110 66 4.5 6year 7   124 74.4 5 6year 8   135 81 5.5 6.5year 9   151 90.6 6 6.5year 10   165 99 6.5 7

    Sales Direct Admin Market

Rs in million   Revenue Cost Overhead overhead

year 1   80 57.6 3 7.5

year 2   88 63.4 3.5 5

year 3   96 69.7 4.2 5

year 4   106.5 76.7 5 5.5

year 5   117.1 84.3 5.5 5.5

year 6   128.8 92.8 6 6

year 7   141.7 102 6.6 6

year 8   155.9 112.2 7 6.5

year 9   171.5 123.5 7.5 6.5

year 10 188.6 135.8 8 7

Large Investment In Plant Or Equipment With Returns Over A Period Of Time.

Investment May Take Place Over A Period Of Time

A Strategic Investment Decision

Purpose

ExpansionImprovementReplacementR & D

To maximise shareholders wealth..

Projects should give a return over and above themarginal weighted average cost of capital.Projects can be;

Mutually exclusiveIndependent

Select the project that maximises shareholders wealthConsider all cash flowsDiscount the cash flows at the appropriate marketdetermined opportunity cost of capitalW ill allow managers to consider each projectindependently from all others

. Estimate the cash flows.

. Assess the riskiness of the cash flows.

. Determine the appropriate discount rate.

. Find the PV of the expected cash flows.

.  Accept the project if PV of inflows > costs.

A. PaybackB. Internal Rate of Return (IRR)C. Net Present Value (NPV)D. Profitability Index

For a project with equal annual receipts:

Where:I= iitial ivestmentc=net annual cash inflow

The IRR is the discount rate at which the NPV for aproject equals zero. This rate means that the presentvalue of the cash inflows for the project would equalthe present value of its outflows.oThe IRR is the break-even discount rate.oThe IRR is found by trial and error.

oDiscount cash inflows to their present value andthen compare with capital outlay required by theinvestmentoDiscount rate (hurdle rate or required rate of return) - required minimum rate of return givenriskiness of investmentoProposal is acceptable when NPV is >zerooThe higher the NPV ,the more attractive theinvestment

The profitability index,or PI,method compares the presentvalue of future cash inflows with the initial investment on arelative basis.  Therefore,the PI is the ratio of the presentvalue of cash flows (PVCF) to the initial investment of theproject.

PI=        PVCF/Initial Investment

In this method,a project with a PI greater than1is accepted, but a project is rejected when its PI is less than 1.

Easy to understandBased on cash flows Highlights risk

Difficult to determine discount rate

Payback

NPV&IRR

Question # 1

What capital mix do you recommend for each project?

Definition:

Capital mix is the combination of debt and equity. Which a business is use to assess the percentage of debt and equity.

Capital Mix for New Lights Plant

Particular Weight Rupees( in Million)

Cost(in %age)

Weighted cost

Equity 70% 66.5 20% 14%Loan 30% 28.5 12% 3.60%Total 100% 95   17.60%

By using the weighted average cost of capital method we assumes that how much is the percentage of debt and how much is equity for the project of New lights plant. The result shows that company needed 70% equity and 30% debt for the project of New lights plant. It shows that the company depend upon 70% of this project is on equity rather than the debt.

Capital Mix for New Electrical Switches Plants

Particular Weight Rupees Cost (in %age)

Weighted cost( in Million)

Equity 20% 22 20% 4%Loan 80% 88 12% 9.60%Additional       2%Total 100% 110   15.60%

By using the weighted average cost of capital method we assumes that how much is the percentage of debt and how much is equity for the project of new lights and plants. The result shows that company needed 20% equity and 80% debt for the project of new electrical switches plants. It shows that the company depend upon 80% of this project is on debt rather than the equity.

Question#2

Based on your recommended capital mix, what discounting rate would you use for each project?

Definition;

The percentage rate which you use to calculate present value is called discounting rate.

Discounting rate for New lights and Plants:

Base on the recommendation of capital mix the company can use 17.6% for the project of New lights plant.

Discounting Rate for New Electrical Switches Plant:

Base on the recommendation of capital mix the company can use 15.6% for the project of new electrical switiches plant.

Question #3:

Do you agree with the Chiragh Din that a higher discounting rate should be used for the switches project? Why?

Yes, I am agreed with the Chiragh Din that they should use higher discounting rate for the project of switches. Because in this project company is going to enter new international market, this is considered to be risky market because they are new in this market and they have a lot of competitor in the market. There is a lot of risk involved that’s why Chiragh Din use higher discount rate. As the factor of risk increases that may also increase the interest rate.

Question #4:

Calculate each project’s Payback period, ARR, NPV and IRR?

Estimated Revenue and Expenses of New Lights Plant:

Years Sales Direct Admin Marketing Profit Depreciation Cash Accumulated

                     

  Revenue cost overhead overhead       Profit Cash flows

0                 (95)  

1 45 27 2 6.2 9.8 7.5   17.3 (77.7)  

2 60 36 2.5 5 16.5 7.5   24 (53.7)  

3 75 45 3 5 22 7.5   29.5 (24.2)  

4 85 51 3.5 5.5 25 7.5   32.5 (8.3)  

5 100 60 4 5.5 30.5 7.5   38 46.3  

6 110 66 4.5 6 33.5 7.5   41 87.3  

7 124 74.4 5 6 38.6 7.5   46.1 133.4  

8 135 81 5.5 6.5 42 7.5   49.5 182.9  

9 151 90.6 6 5.5 47.9 7.5   55.4 238.3  

10 165 99 6.5 7 52.5 7.5   60 298.3  

Payback period:

The payback period for the project is 4 year. Because in this year the company has return its initial investment

Accounted Rate of Return (ARR):

Average profit/Initial Investment*100 39.33/95*100=41.4%

Year Cash flowsPresent value of future cash flow

present value of future cash flow

        -17.60%       -31%    0 (95)     (95)       (95)    1 17.3     14.71       13.206    2 24     17.353       13.985    3 29.5     18.138       13.122    4 32.5     16.992       11.035    5 38     16.894       9.8497    6 41     15.5       8.1125    7 46.1     14.82       6.963    8 49.5     13.531       5.7073    9 55.4     12.877       4.876    

10 60     11.859       4.0312      Total     57.696       (4.11)    

Net present value (NPV):

Internal rate of return (IRR):

LDR+ (HDR-LDR) (PNPV) / (PNPV-NNPV)0.176+ (0.31-0.176) (57.696) / (57.696+4.110) = 30.10%

Estimated Revenue and Expenses of New Electrical Switches Plant

Year Sales Direct Admin Marketing Profit Deprecation Cash Accumulated                       Revenue Cost Overhead overhead       profit cash flows

0                 (110)  1 80 57.6 3 7.5 11.9 8   19.9 (90.1)  2 88 63.4 3.5 5 161.1 8   24.1 (66)  3 96.8 69.7 4.2 5 17.9 8   25.9 (40.1)  4 106.5 76.7 5 5.5 19.3 8   27.3 (12.8)  5 117.5 84.3 5.5 5.5 21.8 8   29.8 17  6 128.8 92.8 6 6 24 8   32 49  7 141.7 102 6.6 6 27.1 8   35.1 84.1  8 155.9 112.2 7 6.5 30.2 8   38.2 122.3  9 171.5 123.5 7.5 6.5 34 8   42 164.3  

10 188.6 135.8 8 7 37.8 8   45.8 210.1  

Payback period:

The payback period for the project is 5 year. Because in this year company has return its initial investment.

Accounted Rate of Return (ARR):

Average Profit/Initial Investment*100 32.01/110*100=29.1%

Net Present Value (NPV):

Yearcashfows  

Present value of future cash flow

present value of future cash flow

        (15.60%)       (23%)    0 (110)     (110)       (110)    1 19.9     17.214       16.17886    2 24.1     18.034       15.92967    3 25.9     16.765       13.91824    4 27.3     15.287       11.9273    5 29.8     14.435       10.585    6 32     13.409       9.241007    7 35.1     12.723       9.240837    8 38.2     11.978       7.291594    9 42     11.392       6.517834    

10 45.8     10.747       5.77849      Total     31.988       (4.391)    

Internal rate of return (IRR):

LDR+ (HDR-LDR) (PNPV) / (PNPV-NNPV)0.156+ (0.23-0.156) (37.988) / (37.988+4.391) = 22.23%

Question # 5:

Do you think the company should undertake both the projects simultaneously? Give reasons to support your answers?

No we don’t think so that company should undertake both the projects simultaneously. Because if you see the different techniques of evaluating the investment than these techniques didn’t support the project. Base on these techniques we suggest Chiragh din that they cannot accept the new electrical switches plant project. Now we can compare both the project on the basis of techniques which we can use for evaluating the project. If you can compare it with the payback period of both the project than the payback period for new lights plant are a 4 year and new electrical switch plant is 5 year. So the payback for new electrical switches plant is higher than the new lights plant. Which can support our first project?If you can compare it with the technique of accounted rate of return than the accounted rate of return of new lights plant are higher than the new electrical switches plant. 

The  ARR  for  new  lights  and  plant  is  41.4%  and  ARR  for  new electrical switches plant is 29.1%. So the ARR for is higher which can be in favor of them. If you can compare it with the technique of net present value, than the discounting rate which we can be assumed on the weighted cost that can also support the project. Because the present value of future cash flows of new lights plant is better than electrical switches.  If you can compare  it with the technique  of  IRR,  than  the  IRR  also  accept  the  project  of  new lights  plant.  The  IRR  for  new  lights  plant  is  30.10%  and  IRR for new  electrical  switches  is  22.23% If  the  company  can  go  for switches  project  than  they  can  use  their  name  ZAPP.  If  that company  can  cancel  the  contract  or  the  contract  duration  are completed  and  they  didn’t  continue  anymore  then  the  chiragh has no reorganization in this market they are zero. So at the end we can conclude that all of the techniques which we can use for evaluating  the  projects  are  in  favor  of  new  lights  and  plant project. That’s why  it’s better  for  the company that  they should not undertake both the projects simultaneously.

Question # 6

If the company should implement only one project, which one it should be? Why?

On my recommendation the company should implement only one project that is project. Because company is already in the same project in the north of the twin cities of Rawalpindi and Islamabad, going up to Peshawar. So it’s better for the company that they should enter into the market of Punjab. This can not only expand its business in other market but also increase the good will of Chiragh Din’s Company. If the company go for the switches project that’s not the better option. Because in this project the company is using the name of British firm that is Zapp. So its self Chiragh din has no reorganization in international market. If British firm has cancel the project then Chiragh din is zero in that market. The techniques which we can use to evaluate the project are totally supporting the project of new lights plant. This project is less risky than the new electrical switches project. Because in this project company is more depend upon equity rather than the loan.