Capital Budgeting
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Capital Budgeting CASE: Expansion Plan – Opening a new retail outletXYZ 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-MIXThe following demand estimates were made for the first year of operationsPetrol: 30,000 liters per dayDiesel: 10,000 liters per dayIt 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 PROJECTThe 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 croresEquipments 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 FINANCEThe 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 COSTManpower cost : Rs.100,000 per monthMaintenance : 10% per annum of the cost of equipmentOther Expenses : Rs.1,00,000 per month.Contingent Expenses : 10% of the above expensesIt 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.