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 RAW MATERIAL

◦ AGRICULTURAL PRODUCTS
◦ MINERAL PRODUCT
◦ LIVE STOCK AND FOREST PRODUCTS, AND
◦ MARINE PRODUCTS
 PROCESSED INDUSTRAIL MATERIALS &
COMPONENTS
 AUXILIARY INDUSTRAIL MATERIALS &
FACTORY SUPPLIES
 UTILITIES
 CHOICE OF THE TECHONOLOGY:
◦ PLANTS CAPACITY
◦ PRINCIPAL INPUTS
◦ INVESTMENT OUTLAY & PRODUCTION
COST
◦ USE BY OTHER UNITS
◦ PRODUCT MIX
◦ LATEST DEVELOPMENT
◦ EASE OF ABSORPTION
 ACQUIRING TECHNOLOGY:
◦ TECHNOLOGY LICENSING
◦ PURCHASE OF TECHNOLOGY
◦ JOINT VENTURE TECHNOLOGY ARRANGMENT
 APPRORIATENESS OF TECHNOLOGY:
◦ LOCAL RAW MATERIALS
◦ LOCAL MAN POWER
◦ LATER TO BASIC NEEDS
◦ ECOLOGICAL BALANCE
◦ SOCIAL & CULTURAL CONDITIONS
D.PLANT CAPACITY:

 TECHNOLOGICAL REQUIREMENT
 INPUT CONSTRAINTS
 INVESTMENT COSTS:
C1=C2[Q1/Q2]∞
Where:
C1= derived cost for Q1 Units of
capacity
C2= known cost for Q2 units of
capacity
∞= a factor reflecting capacity cost
relationship
This usually between 0.2 and 0.9
Ex : The known investment cost for 5,000 units of
capacity for the manufacture of a certain item is
Rs. 10,00,000. What will be the investment cost
for 10,000 units a capacity if the capacity cost
factor is 0.6.

SOLUTION:
The derived investment cost for 10,000 units
of may be obtained as follows :
C1=10,00,000 X [10,000/5000]0.6=15,16,000
 MARKET CONDITIONS
 RESOURCES OF FIRM
 GOVERNMENT POLICY
 PROXIMITY TO RAW MATERIALS AND
MARKETS
 AVAILABILITY OF INFRASTRUCTURE
 GOVERNMENT POLICY
 OTHER FACTORS – ENVIRN. POLLUTION,
LABOUR SITUTATION
SITE SELECTION – COST OF LAND, SITE
PREPA & DIV.
ESTIMATE LIKELY LEVEL OF PRODUCTION
OVERTIME
DEFINE MACHINE & OPERATIONS.
CALCULATE MACHINE HOUR FOR EACH
HOURS
SELECT MACHINE & EQUIPMENTS
REQUIRED
 Type:
PLANT EQUIPMENT
MECHANICAL EQUIPMENT
ELECTRICAL EQUIPMENT
INSTRUMENTS
CONTROLS
INTERNAL TRANSPORT SYSTEM
CONSTRAINTS IN SELECTION:

◦ LIMITED AVAILABILITY OF POWER


◦ DIFFICULTY IN TRANSPORTATION
◦ INABILITY OF WORKERS
◦ IMPORT POLICY OF GOVERMENT
 SITEPREPARATION AND
DEVELOPMENT
 BUILDING AND STRUCTURES
 OUT DOOR WORKS
H.PROJECT CHARTS AND LAYOUT:
◦ GENERAL FUNCTIONAL LAYOUT
◦ MATERIAL FLOW DIAGRAM
◦ PRODUCTION LINE DIAGRAM
◦ TRANSPORT LAYOUT
◦ UTILITY CONSUMPTION LAYOUT
◦ COMMUNICATION LAYOUT
 COST OF PROJECT:
◦ LAND AND SITE DEVELOPMENT
◦ BUILDING AND CIVIL WORKS
◦ PLANT AND MACHINERY
◦ TECHNICAL KNOW-HOW AND ENGN. FREE
◦ EXP. ON FOREIGN TECHNICIANS AND TRAINING
◦ MISC. FIXED EXPENSES
◦ PRELIMINARY AND CAPITAL ISSUE EXP.
◦ PRE-OPERATIVE EXP.
◦ PROV. FOR CONTINGENCIES
◦ MARGIN MONEY FOR CAPITAL [WORKING]
◦ INITIAL CASH LOSSES
 SHARE CAPITAL
 TERM LOANS
 DEBENTURE
 DEFERRED CREDIT
 INCENTIVE SOURCES
 MISC. SOURCES
1. NORMS OF REGULATORY BODIES & FIN.
INST.
2. KEY BUSINESS CONSIDERATIONS
I. COST
II. RISK
III. CONTROL
IV. FLEXIBILITY
PROFITABILITY PROJECTIONS STARTS
FROM FORECAST FOR SALES REVENUES
CONSIDERATIONS IN ESTIMATES S.R:
 CAPCITY UTILISATION-LOWER TO
HIGHER
 PRODUCTION=SALES [MAYASSUME]
 SELLING PRICE NET OF EXCISE DUTY
 SELLING PRICE MAY BE PRESENT SELLING
PRICE
 MATERIAL COST
 UTILITIES COST
 LABOUR COST
 FACTORY OVERHEAD COST
POINTS TO BE CONSIDERED
 WORKING CAPITAL REQUIRMENT IS
SUM OF:
RAW MATERIAL COMPONENTS
WORK-IN-PROGRESS
BOOKS DEBTS, AND
OPERATING EXPENSES
 PRINCIPAL SOURCE OF WORKING
CAPITAL FINANCE:
◦ COMMERCIAL BANKS
◦ TRADE CREDIT
◦ ACCRUALS AND PROVISIONS
◦ LONG TERM SOURCES OF FINANCING
 LIMITS OF WORKING CAPITAL
ADVANCES: COMMERCIAL BANKS
1.AGGREGATE PREMISSIBLE BANK FINANCE
AS SUGGESTED BY TANDON COMMITTEE:
THREE METHOD, SECOND USE
MAXIMUM PERMISSIBLE BANK FINANCE =
CURRENT ASSETS AS PER NORMS NON-BANKING CURRENT
LAID DOWN BY TONDON LIABILITIES LIKE TRADE
COMMITTEE X 0.75 CREDIT& PROV.
AS PER THIS NORM AT LEAST 25 PERCENT OF
CURRENT ASSETS MUST BE SUPPORTED BY
LONG-TERM SOURCES OF FINANCE
2. MARGIN REQUIREMENT VARIES WITH TYPE
OF C.A
NO FIXED FORMULA FOR MARGIN AMOUNT
RANGES OF MARGIN REQUIREMENT FOR CA:
CURRENT ASSETS MARGIN
RAW MATERIALS 10-25 percent
WORK-IN-PROGRESS 20-40 percent
FINISHED GOODS 30-50 percent
DEBTORS 30-50 percent
The estimates of working results may be prepared
along the following lines:
 Cost of production
 Total adm. Exp
 Total sales exp.
 Royalty and know-now payable
 Total cost of production [A+B+C+D]
 Expected sales
 Gross profit before interest
 Total financial expenses
 Depreciation
 Operating profit [G-H-I]
 Other income
 Preliminary exp. Written off
 Profit/loss before tax [J+K-L]
 Provision for tax
 Profit after tax
less: Dividend on
-pref. capital
-Equity capital
 Retained profit
 Net cash accrual [P+I+L]
FIXED COSTS F
B.E.P USP-UVC
C/U
GIVEN : FIXED COST RS. 1,00,000
CONTRIBUTION PER UNIT RS 200
BEP {UNITS} = 1,00,000/200=500UNITS

BREAK EVEN POINT FOR A NEW PROJECT:


In case of new projects, fixed costs are
normally planned in such a way that are
stepped-up as and when necessary to meet
the projected increase in capacity utilization
GIVEN: sales Rs 270M, F.C Rs. 80M, V.C Rs120M
units -1,80,000
B.E.P [IN TERMS OF VOLUME OF PRODUCTION]:
FIXED COSTS EXPECTED
= X PRODUCTION
CONTRIBUTION IN THE YEAR

80 80 {96000
1,80,000
270-120 150 Units }
B.E.P [IN TERMS OF PERCENTAGE ON
INSTALLED CAPACITY]
FIXED COSTS EXPECTED CAPACITY
UTILIZATION
CONTRIBUTION IN THE YEAR

80 48 percent
90% (say )
150
BEP OF SALES {IN THE TERMS OF RUPEES }

FIXED COSTS EXPECTED SALES


REALIZATION IN THIS
CONTRIBUTION YEAR

80 270 = 144M
150
 SOURCES OF FUNDS:
 ISSUE OF SHARE
 PBT WITH INTEREST
 DEPRECATION PROV. FOR THE YEAR
 DEVELOPMENT REBATE RESERVE
 INCREASE IN SECURED MEDIUM & LTL
 Other LTL/MTL
 INCREASE IN UNSECURED LOANS & DEPOSITS
 INCREASE IN LIABILITIES FOR DEFERED PAYMENT
 SALE OF FIXED ASSETS
 SALE OF INVESTMENT
 OTHER INCOME
 DISPOSITION OF FUNDS:
◦ CAPITAL EXP. FOR PROJECT
◦ OTHER NORMAL CAPITAL EXP.
◦ INCREASE IN WORKING CAPITAL
◦ DECREASE IN SECURED MEDIUM & LTL
◦ DECREASE IN BORROWING FOR WORKING CAPITAL
◦ DECREASE IN LIABILITIES IN DEFERRED PAYMENTS
◦ INCREASE IN INVESTMENT
◦ INTEREST ON TERM LOAN
◦ INTEREST ON BANK BORROWING FOR W.C
◦ TAXATION
◦ DIVIDEND
◦ OTHER EXP.
EX: THE BALANCE SHEET OF X LTD. AT THE END OF
THE YEAR N
[THE YEAR WHICH IS JUST OVER] IS AS FOLLOWS:

Liabilities Amount Assets Amount

Share capital 100 Fixed capital 180


Reserve & 20 Current assets 180
surplus
Secured loan 80 Cash 20
Unsecured loan 50 Receivables 80
Current liabilities 90 Inventories 80

360 360
The projected income statement and the
distribution of earning for the year n+1 is
given below:
PARTICULAR Amount
SALES 400
COST OF GOODS SOLD 300
DEPRECIATION 20
EBIT 80
INTEREST 20
TAX 30
PAT 30
DIVIDEND 10
RETAINED EARNING 20
During the year n+1 the form plans to raise
a secured term loan of 20, repay a previous
term loan to the extent of 5 and increase
unsecured loans by 10, current liabilities
and provisions are expected to remain
unchanged. Further, the firm plans to
acquire fixed assets worth 30 and increase
its inventories by10. receivables are
expected to increase by 15. other assets
would remain unchanged, excepting, of
course cash. The level of cash would be the
balancing amount in the projected balance
sheet
SOLUTION: PROJECTED CASH FLOW
STATEMENT OF X LTD.

Source of funds Rs.


EBIT 80
Depreciation 20
Increase in secured loans 15
[20-5]
Increase in unsecured 10
loans
Total (A) 125
DISPOSITION OF FUNDS AMOUNT
CAPITAL EXP. 30
INCREASE IN W.C [10+15] 25
INTEREST 20
TAXATION 30
DIVIDEND 10
TOTAL(B) 115

Opening balance of cash& bank 20

Closing balance of cash & bank 30

Net surplus balance of cash & bank 10


PARTICULAR OPENING BAL. CHANGES CLOSING
SHARE 100 - 100
RES & SURP. 20 +20(R.E) 40
SECURED LOAN 80 +20-5 95
PROJECTED50BALANCE
UNSECURED LOAN +10
SHEET 60
C.L. 90 - 90
PROVISION 20 - 20
405
FIXED ASSETS 180 +30-20DEP 190
CURRENT ASSETS 180 215

CASH 20 30
INVENTORIES 80 +10 90
RECEIVABLES 80 +15 95
BALANCING FIGURE 405
 STEPS
INVOLVED IN TESTING
PROJECT VIABILITY:

◦ ESTIMATE PROJECT CASH FLOWS


◦ ESTABLISH COST OF CAPITAL
◦ APPLY APPRAISAL CRITERION
1.INCREMENTAL PRINCIPLE :

CASH FLOW FOR


CASH FLOEW FOR
THE FIRM
PROJECT CASH THE FIRM WITH
WITHOUT THE
FLOW FOR YEAR t THE PROJECT FOR
PROJECT FOR THE
THE YEAR t
YEAR t

FOR THIS POUPOSE CONSIDER EFEFCTS


 CONSIDER ALL INCIDENTAL EFFECTS
 IGNORE SUNK COST
 INCLUDE OPPORTUNITY COSTS
 QUESTION THE ALLOCATION OF 0VERHEAD
COSTS

2. LONG-TERM FUND PRINCIPAL –TLTF,TF,


TE.
COST AND BENEFIT FROM LTF POINT OF VIEW
3. EXCLUSION OF FINANCING COST
PRINCIPLE:
PBIT [1-TAX RATE]
PBT + [INTEREST] [1-TAXRATE]
[PBT] [1-TAXRATE] +INTEREST [1-
TAXRATE]
[PAT+INTEREST (1-T.R.)]
4.POST TAX PRINCIPLE:
COMPONENT OF THE CASH FLOW STREAM:
 INITIAL INVESTMENT:
 NEW PROJECT
◦ COST OF CAPITAL ASSETS
 + INSTALLATION COSTS
 + WORKING CAPITAL MARGIN
 + PRELIMINARY AND PRE-OPERATIVE EXP.
 - TAX SHIELD, IF ANY ON CAPITAL ASSETS
 REPLACEMENT PROJECT:
◦ Cost of replacement capital assets
 + Installation costs
 - Post tax proceeds from sale of old assets
 + Change in working capital margin
 + Preliminary and preoperative exp.
 - Tax shield, if any, on replacement capital assets.
 OPERATING CASH INFLOWS:
◦ NEW PROJECT :
 PAT
 + DEPRECATION
 +OTHER NON-CASH CHANGES
 +INTEREST ON LTD [1-TAXRATE]
◦ REPLACEMENT PROJECT:
 CHANGE IN PROFIT AFTER TAX
 +CHANGE IN DEPRECATION
 +CHANGE IN OTHER NON-CASH CHARGES
 +CHANGE IN INTEREST ON LTD [1-TAX RATE]
 TERMINAL CASH FLOW:
◦ NEW PROJECT:
 POST TAX PROCEEDS FORM SALE OF CAPITAL
ASSETS/NET SALVAGE VALUE
 +NET RECOVERY OF WORKING CAPITAL
MARGIN
◦ REPLACEMENT PROJECT:
 POST TAX PROCEEDS FROM THE SALE OF
REPLACEMENT CAPITAL ASSETS
 - POST TAX PROCEEDS FROM THE SALE OF
PRESENT CAPITAL ASSETS
 +NET RECOVERY OF WORKING CAPITAL
MARGIN
 NET SALVAGE VALUE OF CAPITAL ASSETS:
◦ SALE VALUE – TAX, IF ANY IN SALE [PROFIT]
◦ SALE VALUE – TAX SHIELD, IF ANY ON SALE
[ON LOSS]
A company purchase a machinery a few years
back for Rs. 10,000. it wants to replace this
machine by a new one costing Rs. 15,000. the
company is subject to income tax @50% while
capital gains tax @30% the present book
value of the machine in Rs. 6000. calculate
the net initial cash outflows if the company
decides to purchase the new machine, in each
of t he following cases, if the old machine is
sold for:
(a) Rs. 6,000; (b) Rs. 8,000; (c) Rs. 12,000;
(d) Rs. 4,000
(A) CASH REQUIRED TO PURCHASE NEW MACHINE Rs. 15,000
CASH REALIZED ON SALE OF OLD MACHINE Rs. 6,000
NET CASH OUTFLOW Rs. 9,000

(B) CASH REQUIRED TO PURCHASE NEW MACHINE Rs. 15,000


CASH REALIZED ON SALE OF OLD MACHINE Rs. 8,000
Rs. 7,000
INCOME TAX LIABILITY ON PROFIT MADE ON SALE OF Rs. 1,000
MACHINERY (2000 X 50/100 )
NET CASH OUTFLOW Rs. 8,000
(C) CASH REQUIRED Rs 15,000
LESS: CASH REALIZED Rs 12,000
Rs 3,000
LESS: INCOME TAX 4000 X 50% 2000
CAPITAL GAINS TAX 600 Rs 2,600
NEW CASH OUTFLOW Rs 5,600
(D) CASH REQUIRED Rs 15,000
LESS : CASH REALIZED Rs 4,000
LESS : SAVING ON TAX LIABILITY 2,000 X 50% Rs 1,000
Rs 10,000
Example:
A company intends to replace on OLD machine with a New
machine. From the following the information you are required to
determine the net cash required for such replacement.

PARTICULAR
Cost of old machine Rs. 50,000
Life of old machine 5 years
Deprecation according to straight line remaining useful life 2 years
Cost of the new machine Rs. 70,000
Installation charges Rs. 10,000
Amount realized on sale of old machine Rs. 25,000
Additional working capital required Rs. 5,000
Income tax 50%
Capital gains tax 30%
Investment allowance 20%
Solution:

ESTIMATION OF CASH REQUIREMENT FOR REPLACE


COST OF THE NEW MACHINE Rs.70,000
ADD: INSTALLATION CHARGES Rs.10000
ADDITIONAL WORKING CAPITAL Rs.5000
ADDITIONAL TAX LIABILITY :
INCOME TAX (5000 X 50%) Rs.2,500
CAPITAL GAINS TAX -
Rs. 87,500
LESS: AMOUNT REALIZED ON SALE OF OLD MACHINE
25,000
INVESTMENT ALLOWANCE 14,000 Rs.39,000
NET CASH OUTFLOW Rs.48,500