CASE STUDY CAPITAL BUDGETING

The below mentioned case study will be discussed on Friday, March 18th 2011- All students are requested to mail the ppts, group wise before Friday 9:00 a.m.

Camel Corporation Ltd. is a manufacturing concern that produces and sells a wide range of products. The company not only produces a number of products and equipment components but also is capable of producing special purpose manufacturing equipment as per customer requirements. The firm is considering adding a new stapler to one of its product lines. More equipment will be required to produce the new stapler. There are three different ways to acquire the needed equipment 1) purchase general purpose equipment, 2) Lease general purpose equipment, 3) Build special purpose equipment. A fourth alternative Purchase of special purpose equipment has been ruled out because it would be prohibitively expensive. The general purpose equipment can be purchased for Rs 12,50,000 and has an estimated salvage value of Rs 4 lakhs at the end of 5 years. Alternatively, the general purpose equipment can be acquired by a 5 year lease for Rs 4 lakhs annual rent. The lessor will assume all responsibility for taxes, insurance and maintenance. Special purpose equipment can be constructed by the contract equipment department of the company. While the department is operating at a level that is normal for the time of the year, it is below full capacity. The department could produce the equipment without interfering with its regular production activities. The estimated departmental costs for the construction of the special purpose equipment are: Material and spare parts Direct Labour Variable overheads(50% of DLC) Total Rs 7,50,000 6,00,000 3,00,000 16,50,000

Engineering and management studies provide the following revenue and cost estimates (excluding lease payments and depreciation) for producing the new stapler depending upon the equipment used: General Purpose Self Constructed Equipment Equipment Lease Purchase (Rs) (Rs) (Rs) 50.00 50.00 50.00 18.00 16.50 34.50 15.50 40,000 6,20,0 00 1,60,0 00 18.00 16.50 34.50 15.50 40,000 6,20,000 1,60,000 30,000 30,000 2,20,000 17.00 14.00 31.00 19 40,000 7,60,000 1,80,000 50,000 20,000 2,50,000

Unit Selling price Unit Production Costs: Materials Conversion costs Total unit production costs Unit Contribution margin Estimated Volume Estimated Total contribution Other costs: Supervision Taxes and insurance Maintenance

1,60,0 00

This type of equipment is subject to 5 years depreciation on straight line basis. At the end of 5 years, the special purpose machine can be sold for Rs 3,00,000. The company uses an after tax cost of capital of 10%. Its marginal tax rate is 40%. You have to advise the company on which proposal should the company use and why. You can use NPV method for evaluation of all the three alternatives.