G.S. Petropull Company (GSPC)

Prepared by Shivangi Jani (49)Brij Sisodiya (50)

Nature of Investment Decisions

The investment decisions of a firm are generally known as the capital budgeting, or capital expenditure decisions

The firm’s investment decisions would generally include expansion, acquisition, modernisation and replacement of the long-term assets. Sale of a division or business (divestment) is also as an investment decision.

Features of Investment Decisions

The exchange of current funds for future benefits.

The funds are invested in long-term assets.

The future benefits will occur to the firm over a series of years.

Types of Investment Decisions

One classification is as follows

 Expansion of existing business  Expansion of new business  Replacement and modernisation

Investment Evaluation Criteria Three steps are involved in the

evaluation of an investment:1. Estimation of cash flows2. Estimation of the required rate of

return (the opportunity cost of capital)3. Application of a decision rule for

making the choice

Case study

G.S. Petropull Company (GSPC)

Given information

Current sales : Rs 360 million  (2009 ) Expected sales : Rs 1,100 million (2010) Other planning's: Gas pipelines : Cost Rs 250 million Revenue from sale to SEB is expected to be

Rs 120 million per annum. Additional revenue of Rs 80 million per

annum cash profit to sales ratio of 20% per annum

for first 12years and 17% per annum for the remaining life of the project

Given information

The company requires a rate of return of 15% from the project.

Expected life of the project 20 years.

Particulars year Cash flows(in mm.)

Cumm. Cashflows(Rs mm.)

Cost of project (Rs million) 250 0 -250 -250

Revenue from SEB (Rs million) 120 1 40 -210

Revenue from other users (Rs million)

80 2 40 -170

Total revenue (Rs million) 200 3 40 -130

Cash profit,20% from year 1 to 12 (Rs million)

40 4 40 -90

Cash profit, 17% from year 13 to 20 (Rs million)

34 5 40 -50

Average cash profit (Rs million) 37.6 6 40 -10

Average investment (Rs million) 125 7 40 30ROI 30.1% 8 40 70

9 40 110

Discount rate 15% 10 40 150

PVFA 12,15% 5.4206 11 40 190PVFA 20,15% 6.2593 12 40 230PVFA (20,12),15% 0.8387 13 34 264PV of cash profit, year 1 to 12 (Rs million)

216.82 14 34 298

PV of cash profit, year 13 to 20 (Rs million)

28.52 15 34 332

NPV (Rs million) -4.66 16 34 366

17 34 400

18 34 434

19 34 468

20 34 502NPV -4.66IRR 14.65%Pay back >6 years

Should the project be accepted and why? The project should not be accepted due

to following reasons… NPV is in negative The Internal rate of return of investment

is less than the expected rate of return. Moreover the company is at its growth

stage so any such long term investment may have high opportunity cost.

 

Thank you