Paraffin Wax Ltd. (P.W.L) produces different grades of lube-base stocks of various
grades. These stocks are dewaxed to remove paraffinic waxes as slack waxes to meet
certain technical specifications. The slack waxes are presently merely blended into
furnace oil. PWL now (2006) proposes to install a solvent deoiling plant to refine slack
waxes to produce paraffin wax. The residual oil will be routed to furnace oil again.
The estimated investment cost for the new plant is Rs.4.54 crores (financed internally) of
which the foreign exchange component is Rs.1.68 crores. No extra land is required for
this plant. The plant will employ 30 people. The sum of Rs.3,00,000 as royalty for
foreign technology, included in Rs.1.68 crores will be paid in three equal instalments (i)
upon execution of licence agreement, (ii) upon the start up of the licensed unit, and (iii)
on the first anniversary of the start up. The proposed plant will have a production
capacity of 20,000 T.P.A.
The finance department of PWL has gone about working out the detailed financial
projections of the new plant. It finds that the working capital requirement is Rs.26.3 lacs,
and the annual operating costs of the plant are Rs.90.4 lacs. The details of capital cost
are:
Rs./lacs ForeignExchangeCost
Dollar/lacs
Equipment 263.00 4.61
Tankage 18.00 ---
Packaging facilities 50.00 5.50
Royalties
(including GOI taxes @ 40%) 70.25 4.80
Engineering Fees
(including GOI taxes @ 40%) 52.50 3.50
TOTAL 453.75 18.41
The total outlay on the project was to be spread over three years as Rs.1.5, Rs.2.00 and
Rs.1.04 crores. In the first year of operation 80% of the capacity would be utilized.
Thereafter, it would be 100% price formula for sales is assumed to allow a return of 15%
on net fixed assets and 15% return on working capital, in addition to covering other
operating costs. Depreciation on fixed assets is assumed @ 10% p.a. on income tax
method (i.e., written down value method) for pricing. In the first year of operation raw
material cost is 16,000 MT Rs.598.16 and in subsequent years 20,000 MT’s @
Rs.598.16. Other operating costs, excluding depreciation, for the first year are Rs.78.6
lacs, and for subsequent years Rs.90.4 lacs. Working Capital is assumed at 1½ months’
of all manufacturing units. For computing the internal rate of return for the enterprise a
debt/equity ratio of 1:1 has been assumed. Terminal value after 15 years of operation is
assumed @ 30% of capital cost. The GOI holds 75% of the share capital of PWL. The
new project will enjoy a tax concession for the first 5 years of operations on profits equal
to 7.5% on capital employed. Corporate income tax rate is applicable at the rate of
57.75%. Compute the IRR (internal rate of return) for the project. How would you assess
if the IRR is good enough or not?
CAclubindia
