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Hind Petrochemicals LTD - Case

The Hind Petrochemicals Company is considering acquiring a government-owned refinery in Western India for Rs 1,550 million as part of the government's privatization policy. Additional investments of Rs 6,250 million would be required to upgrade facilities and provide working capital. Company valuers estimate the refinery could be sold for Rs 3,800 million after 5 years of operations. The financial controller recommends rejecting the project since profits are only estimated for the first two years, while the production and marketing managers argue strategic and payback period benefits support accepting the project.

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Neil Kenny Abraham Jayasingh
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435 views2 pages

Hind Petrochemicals LTD - Case

The Hind Petrochemicals Company is considering acquiring a government-owned refinery in Western India for Rs 1,550 million as part of the government's privatization policy. Additional investments of Rs 6,250 million would be required to upgrade facilities and provide working capital. Company valuers estimate the refinery could be sold for Rs 3,800 million after 5 years of operations. The financial controller recommends rejecting the project since profits are only estimated for the first two years, while the production and marketing managers argue strategic and payback period benefits support accepting the project.

Uploaded by

Neil Kenny Abraham Jayasingh
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
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Download as PDF, TXT or read online on Scribd
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*Hind Petrochemicals Company

The central government has a refinery in a backward area of Western India. The
petrochemical plants of Hind Petrochemicals Company (HPC) are situated in South and East.
They want to expand in the West. HPC's existing refinery capacity is 9.5 metric ton. The
government refinery has a capacity of 3.5 metric ton. HPC has strategic interest in acquiring the
refinery. As a part of its privatisation policy, the central government is willing to sell the refinery
for Rs 1,550 million. The company is in touch with the government for the purchase of the
refinery for last few months.
According to the company appointed valuers, the refinery would need an additional
investment of Rs 5,950 million in machineries and Rs 300 million for working capital before
starting the operations. According to the valuer, if the company so desired, the refinery including
these facilities (including working capital) could be sold for Rs 3,800 million after the planning
horizon of five years. In that case, the company will have to incur Rs 200 million at the end of
the economic life of the refinery to clean the site. The initial cost of valuers' work was
Rs 25 million. They will be paid an additional amount of Rs 15 million in the first year if the
company buys the refinery. The cost of Rs. 25 million has to be incurred irrespective of the
decision.
The corporate planning department of the company has estimated the profit from the
refinery operation as given in Table.

The company has a policy of charging depreciation on straight-line basis. However, for
tax purposes, the WDV depreciation on the block of assets applies. The depreciation rate is
25 per cent. Corporate overhead costs include the three-fourths costs as the corporate overhead
allocations and one-fourth costs incurred by the corporate office exclusively for the proposed
project.
* adopted from Cases in Finance – Pandey and Bhat-TMH, Delhi

The company proposes to finance the projects mostly by raising a 5-year 10 per cent loan from a
financial institution. The management of the company feels that the investment in the refinery
has the same risk and debt capacity as the current business; it must yield a return of 15 per cent.

The executives of the company are not unanimous on accepting the project. The financial
controller's recommendation is to reject the project as it earns profits only in the first two years
of the five-year period. The production manager considers the location as a strategic advantage
since the company will have a plant in the West and could meet the demand easily. The
marketing manager argues that the company should look at the investment's payback period.
According to her, the depreciation included in the profit estimates is the recovery of the
investment, and in addition, the company also has profit in the first two years.

Discussion Questions:

1. Should the project be accepted? Use the most suitable method of evaluation to give your
recommendation and explicitly state your assumptions.

2. Does your decision to accept the project change if you use other methods of evaluation?
Show computations. Do you agree with the views of the financial controller, the production
manager and the marketing manager?

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