The Hindu Business Line : What the future holds for Gemini

GEMINI Ltd is launching a new project to manufacture a plastic component. At full capacity of 250,000 units, the details of the proposed project are as follows:

Investment: Land — Rs 2,00,000; building — Rs 8,00,000; plant and machinery — Rs 12,00,000

ii) Cost of production per unit: Material — Rs 80; direct wages and variable expenses — Rs 45; fixed manufacturing expenses — Rs 12; fixed administration expenses — Rs 8; depreciation — Rs 12; total — Rs 157.

iii) The selling price per unit is expected to be at Rs 205 and the selling expenses per unit will be Rs 10, seventy per cent of which will be variable.

iv) In the first year, the production and sales are expected to be as follows:

Production — 18,000 units; sales — 15,000 units.

v) The following additional information are provided: a) stock of material to be maintained — three months' average consumption; b) work-in-process — nil; c) debtors — one month's average cost of sales; d) creditors for supply of materials — two months' average purchase of the year; e) creditors for expenses — one month's average of all expenses during the year; and f) minimum cash balance to be maintained — Rs 25,000

You are required to: a) prepare a projected statement of profit/loss (valuation of closing stock to be made by average cost method; ignore interest and tax); b) prepare a statement showing projected requirement of working capital on cash basis; and c) find out percentage of yield on investment.

a) The projected P&L account for the first year is shown in Table 5.

Assumption: Full capacity is 25,000 units, and not 2,50,000 units as given in the question.

b) The statement of projected working capital (on cash basis) is presented in Table 6.

c) The yield on investment is as follows:

Land, buildings, and so on — Rs 22 lakh

Net working capital (on cash basis) — Rs 1.63 lakh

Total investment — Rs 23.63 lakh

Yield on investment = Net profit / Investment

3.53 / 23.63 = 0.1494, that is, 14.94 per cent

WN1: Consumption during first year (18,000 x 80) = Rs 14,40,000

Add: Stock of material to be maintained (3/12 of 14,40,000) = Rs 3,60,000

Total purchases = Rs 18,00,000

WN2: Cost of production of 18,000 units = 34.10 - 3.60 = Rs 30.50 lakh

Per unit = Rs 169.4444

Closing stock of finished goods (3,000 units at Rs 169.4444) = Rs 5.08 lakh

WN3: Debtors: One month's average cost of sales:

Cost of production — Rs 30.50 lakh

Add: Opening stock of finished goods — Nil

Less: Closing stock of finished goods — Rs 5.08 lakh

Cost of goods sold — Rs 25.42 lakh

Add: Selling expenses (0.75 + 1.05) — Rs 1.80 lakh

Cost of sales — Rs 27.22 lakh

Less: Depreciation — Rs 3 lakh

Cash cost of sales — Rs 24.22 lakh

Debtors: 1/12 of 24.22 = Rs 2.02 lakh

WN4: Creditors for expenses:

Direct wages and variable expenses — Rs 8.10 lakh

Fixed mfg, fixed admn and selling expenses — Rs 6.80 lakh

Sub-total — Rs 14.90 lakh

1/12 of 14.90 = Rs 1.24 lakh

Note: Depreciation is a non-cash expense.

ROI computation

THE net profit margin of a company is 6 per cent when turnover is three times of its capital. The return on investment of the concern is: a) 20 per cent; b) 16 per cent; c) 18 per cent; d) none of the above

Let the capital be Rs 100. The turnover is three times the capital, that is, sales of Rs 300. The net profit margin is 6 per cent, that is, 6 per cent on sales of Rs 300 is Rs 18. Return on investment will be 18 per cent (profit of Rs 18 on capital of Rs 100). Hence, the answer is (c).

Current loss

THE budgeted result of Target Ltd for 2003-04 are as given in Table 1.

Fixed overhead for the period is Rs 5,70,000. Prepare a statement showing the amount of profit/loss being incurred currently and recommend a change in the individual sales value of each product to arrest if there is loss, if any.

Change in individual sales value: To arrest the loss of Rs 45,000, the sales of Product A should be increased by Rs 90,000 (that is, 45,000 / 50 per cent PV ratio).

The sales of Product A increased by 45,000 / 50 per cent = 90,000

That of Product B (45,000 / 40 per cent) = 1,12,500

And Product C (45,000 / 30 per cent) = 1,50,000

Costing in anticipation

THE cost structure of an article, the selling price of which is Rs 500, is as follows:

Direct material — 50 per cent of total cost

Direct labour — 30 per cent of total cost

Overhead expenses — 20 per cent of total cost

Owing to anticipated increase in existing material price by 20 per cent and in the existing labour rate by 10 per cent, the existing profit would come down by 30 per cent if the selling price remains unchanged.

Prepare a comparative statement showing the cost, profit and sale price under the present and anticipated conditions.

Working notes: In this problem, the total cost and profit are not given.

Let T be the total cost and P, the profit

Direct material (50 per cent) — 0.50 T; direct labour (30 per cent) — 0.30 T; overheads (20 per cent) — 0.20 T; total cost (100 per cent) — 1.00 T

Total cost + profit = sales

T + P = 500 — Equation (1)

WN2: This is presented in Table 3. The increase in cost would reduce the present profit by 30 per cent if the selling price remains unchanged. Then 1.13T + 0.70 P = 500 — Equation (2)

WN3: By solving equations (1) and (2) above,

T = 348.84

P = 151.16

Selling price = 500

Solution: The comparative statement is shown in Table 4.

Comparative profitability

ELECTRONICS Ltd specialises in the manufacture of a computer component, the current sale price of which is Rs 1,000 and variable cost is Rs 800. During the last year, the company sold 400 components per month. The company grants one month's credit to its customers at present. It has been proposed by the sales staff that if the credit period is extended to two months they can increase sales by 25 per cent. This will, however, result in increase in stocks by Rs 2,00,000 and creditors, by Rs 1,00,000. The company expects a minimum return of 40 per cent on its investments.

Advise the company on whether to extend the additional credit term of two months or not if: i) the same is extended to all customers, and ii) the same is extended only to the new customers.

Assume that the 25 per cent increase in sales is entirely attributable to new customers.

Working notes: i) P/V Ratio = S - V/S x 100 = 1000 - 800/1000 x 100 = 20 per cent; ii) present sales = 400 x 12 x 1000 = Rs 48,00,000; iii) existing debtors = 1/12 of 48,00,000 = Rs 4,00,000.

Solution: The comparative statement of profitability is shown in Table 7.

Advice: Even after meeting the requirement of minimum return at 40 per cent, still there is excess of contribution in both the cases. Hence, the company should extend the credit terms in both the cases. But the option at (ii) is highly profitable.

WACC

THE following information are provided for CAP Ltd:

i) Present capital structure at book value:

Debenture (Rs 100 per debenture) — Rs 8,00,000

Preference shares (Rs 100 per share) — Rs 2,00,000

Equity shares (Rs 10 per share) — Rs 10,00,000

All these securities are traded in the capital market and the current ruling market prices are: debentures (per debenture) — Rs 110; preference shares (per share) — Rs 120; equity shares (per share) — Rs 22. The anticipated external financing opportunities are: i) Rs 100 per debenture redeemable at par; 10 year maturity, 13 per cent coupon rate, 4 per cent floatation costs, sale price Rs 100.

ii) Rs 100 preference share redeemable at par; 10 year maturity, 14 per cent dividend rate, 5 per cent floatation costs, sale price, Rs 100.

iii) Equity shares; Rs 2 per share floatation costs, sale price Rs 22, dividend expected on the equity share at the end of the year, Rs 2 per share.

The anticipated growth rate in dividends is 7 per cent and the company has the practice of paying all its earning in the form of dividends.

The corporate tax rate applicable is 35 per cent. Determine the weighted average cost of capital of the company using market weights from the above information.

First we have to ascertain the specific cost of each component as follows:

a) After tax cost of debentures (kd):

Sale price, Rs 100; floatation cost 4 per cent, that is, net sales value = 96

RV (redeemable value) — Rs 100

Kd = [1 - T R + (RV - P) / n) / 0.5 (RV + P)] x 100

(1 - 0.35) [13 + (100 - 96) / 10) / 0.5 (100 + 96)] x 100

0.65 x 13.4 x 100 / 98 = 8.89 per cent

b) Cost of preference shares (kp): Sale price Rs 100; floatation cost 5 per cent, that is, net sales value = 95

RV — Rs 100

kp = D + (RV - P / n) / 0.5 ( RV + P ) x 100

14 + (100 - 95) / 10) / 0.5 (100 + 95) 10 x 100 = 14.87 per cent

c) Cost of equity shares (ke): Floatation cost Rs 2