Fertilizer industry in Pakistan is currently facing sheer competition. Players in the
fertilizer industry are offering huge discounts on Urea. FFC is unable to manage discounts as it has higher variable cost per unit of production. The reason behind the higher variable cost is unavailability of cheap gas which is available to its competitors. Inability of the company to offer the discounts has resulted in reduced unit sales, Profit Margins and return. The company is unable to manage the profit streams and is currently facing huge losses. Company directors and senior management is very anxious on the poor performance of the company and they are thinking to bring some changes in the production process and equipment which can reduce variable cost. On this, production manager has prepared a complete report on how the company can reduce the variable cost marginally to stay competitive in the market. Production manager suggests to buy a new machinery cost Rs. 180 million and another cost relevant to making the machinery available for use will amount Rs 20 million. Which will reduce the variable cost of the company by Rs. 50 per unit and will enhance the production capacity of the company by 25%, which incremental sales of 25,000 bags of urea per year for the next 8 years. Experts of the company have discussed the probability of different situations that might occur keeping in view the current condition of the economy and Industry. Data for each variable in different scenario is given as follows. You being finance manager in the company have been assigned the responsibility to analyse the project. Directors have asked you to calculate NPV of the project and to see whether the project will increase the value of the company or not? And can it be helpful in improving current situation of the company. You are therefore asked to run the complete scenario analysis of the project to see how will the company fluctuate with changes to different market conditions. You are also asked to give your recommendations whether the company should go for the project or not.
Before After Replacement
Replaceme nt Name Initial Data Base Worst Best Case Case Case Probability 0.6 0.2 0.2
Equipment cost 200,000,0 220,000,0 180,000,00
00 00 0 Depreciation 500,000 Double Declining Method (20% per year) Salvage value 500,000 500,000 500,000 Units sold (year 1) 300,000 375,000 275,000 450,000 Annual change in units 0.05 0.05 0.04 0.08 sold Sales Price 1400 1400 1400 1500 Change in Sales Price 0.04 0.04 0.04 0.04 Variable Cost per unit 1150 1100 1150 1050 Change in Variable cost 0.04 0.04 0.04 0.04 Fixed Cost 2,000,000 2,000,000 2,300,000 1,800,000 Change in Fixed cost 0.04 0.04 0.04 0.04 Project WACC 12% 12% 12% 12% Tax Rate 0.3 0.3 0.3 0.3 Working capital as % of 0 0.08 0.08 0.08 next year sales Life of newly purchased 8 8 8 Machine Depreciation Rate 0.2 0.2 0.2