financial management

chiragh din light private ltd case study

The two most significant events in the life of Chiragh Din took place in June 1962. On 3rd of that month, he opened his own small shop in one of the back streets of Teli Mohalla of Rawalpindi after working as an electrician for a large company for about ten years. And on 28th of that month, his wife gave birth to his first son whom he lovingly named Roshan. His shop in Teli Mohalla, aptly called Chiragh Lights, sold small electrical items like bulbs, wire, sockets, plugs, etc. and also carried out repairs of electrical equipment like kettles, toasters, irons, etc. The shop did well, as Chiragh Din was expert in his work, not shy of putting in long hours and always working hard to ensure customers satisfaction. Still, it took him ten years before he moved out of the back streets of Teli Mohalla, and opened a much larger shop on the busy, and business-wise very prestigious, Murree Road of Rawalpindi. His new shop specialized in lighting items only, offering both sales and service of a variety of indoor and outdoor lighting items. Soon enough, he was winning contracts to supply lights to large contractors putting up new office buildings and blocks of flats.

When Roshan completed his BBA from a well-known university at the tender age of 22, he joined his fathers business. In 1986, the father and son team decided to set up a factory to manufacture lighting items. They also decided to retain the retail shop in Murree Road, as it was a cash cow. A new private limited company was formed under the name of Chiragh Din Lights Private Ltd. They were able to buy a piece of land was acquired in Kahuta Industrial area and put up the basic building structure to house their proposed plant out of their savings. By pledging the factory land and buildings, they were able to raise a loan for purchase of the plant. Chiragh Din himself visited some European countries as well China and Korea to find the most suitably priced manufacturing plant. Using his vast experience, he chose a blend of new and used pieces of equipment to form a balanced plant. While many of the machines he bought were second hand items, he made sure that the more crucial equipment was new and of latest design. This ensured that the quality and finish of his companys product were not compromised. After some initial teething problems, Chiragh Din Lights Private Ltd. started competing well with longer established larger firms as well as importers. At that stage, they sold off their Murree Road shop and paid off the factory debt. Chiragh Dins attention to detail and his focus on customer satisfaction were the key elements of all their manufacturing policies. He firmly believed in sparing no costs to achieve the highest quality of his products. He would shun petty savings like using a cheaper substitute raw material if such a savings were to have any negative impact at all on the final product. This clearly led to clients have greater faith in his products. Many architects and consultants started recommending his products to their clients. In turn, this ensured that most orders for bulk supply of lighting items to larger building being constructed in Rawalpindi and neighboring Islamabad started coming to CDL. While they hired a professional, Malik Khalid, to look after the marketing aspects of the companys business, Roshan was able to oversee the accounting and administrative side of the business. In late 1990s, the annual sales of Chiragh Din Lights Private Ltd touched the revered Rs. 100 million mark.

In early 2006, they were approached by English Electronics PLC, a British firm, to set up a new plant to assemble electrical fittings, mainly electrical switches. English Electronics had been supplying their switches to Pakistani market for over seven years and were of the opinion that having an assembly plant in Pakistan will not only give them a better competitive edge in the local market but perhaps also enable them to trap the neighboring countries, mainly Middle East. Their trade name, Zapp, was fairly popular in this part of the world. They had done their local research.

and found CDL a potentially worthy partner. Under an agreement proposed by them, English Electronics PLC would supply the plant and the relevant technology. They will also offer a technical support program for a period of three years to ensure that the new assembly plant gets over the teething problems without any real difficulty. They were willing to arrange a loan for them to cover the cost of the plant. As the components for assembly will be supplied by the British firm, no separate charge was to be levied on CDL for use of the Zapp trade name.

At around the same time Malik Khalid, CDLs marketing manager, proposed that they should double the manufacturing capacity of their lighting products by installing a new plant. He was of the opinion that the current plant had already reached its maximum capacity utilization while the sales were still growing. Currently, the companys products were selling in and north of the twin cities of Rawalpindi and Islamabad, going up to Peshawar. The main cities of Punjab south of Rawalpindi had not yet been tapped. If CDL were to increase its production capacity, it could easily enter the south of Punjab market and perhaps also go to smaller towns of Sind province.

Roshan, who now acted as the CEO of CDL, was of the opinion that they should take up both the projects, i.e. increase the production capacity of lights as well as set up a new plant to manufacture electrical fittings. Chiragh Din was not so sure. He was now an old man who took little part in the affairs of the companys business, serving only as its notional chairman. However, no major decision of the company was ever taken without his consent. He strongly felt that the company should not over-stretch it resources capital as well as managerial.

One of the things that Roshan had learned in his degree program was not to try to do every thing yourself. His management professor had told him, If you face a problem or an issue which you find difficult to tackle, it is often cheaper to take professional help than try to fix it yourself through trial and error method. Making a huge investment, Roshan thought, was a decision which merited professional input. He therefore hired Sterling Associates, a firm of financial consultants, to prepare a financial feasibility study for both projects and to advise CDL on how may it proceed to raise finance for either or both of them.

A small team of three, headed by Mahwish Khan, was assigned by Sterling Associates to work on CDLs project. Mahwish conducted initial interviews with Chiragh Din, Roshan, Malik Khalid and a few other officials of the company. This is what she was able to gather:

Chiragh Din was not in favour of doing both the projects at the same time. He felt that this will not only place an undue stress on CDLs financial resources, but also cause his small management team to over-stretch itself. As an old man, said the chairman of CDL, I am averse to borrowing large sums of money as much as I dislike hiring a whole lot of new managers. I am more comfortable working within my means and with the people I know well. He would have preferred to set up one project first, make sure it is running well and then go for the second project. However, it appeared that neither of the projects could wait. He agreed with Malik Khalid that expansion of current capacity of the lights plant should not be delayed as the time was right to penetrate the upper Punjab market. At the same time, English Electronics PLC could not be expected to wait for three or four years. If CDL did not show an interest, English Electronics PLC could easily to other companies. In fact, one of CDLs competitors, Shan Electronics, was rather too keen on winning over the English companys collaboration.

Roshan was quite keen at the prospects of working with the British company. He felt that could mean a possible entry into the high flying world of international corporations. He liked the idea of exporting his products to Middle East and genuinely felt that this could also lead to opening up export possibilities for his current lights products. While he acknowledged that lights and switches. were different products, he said the market for the two was hardly different. The same clients (wholesalers as well as retailers) would buy both the products, so the marketing staff will hardly be over-extended. Thus, he wanted to implement both the projects simultaneously. He felt that CDLs financial position and stature in the market should enable them to raise finance for both the projects. He also pointed out that English Electronics were prepared to offer a loan for the switches assembly plant. So, he reasoned, CDL really needed to garner long term funds for only the lamps plant expansion project. As for the working capital funds, he was confident that banks will be all too willing to supply short term facilities.

Malik Khalid advocated that lights were their business, they already had a good name in the market and they understood this business well. Switches, on the other hand, were a whole new ball game and they would be entering a totally new market. While they will certainly have the advantage of being able to use the Zapp trade name, they will have to pay for that privilege through higher prices of components. They will never own that trade name. All the work that they will do will actually strengthen English Electronics PLCs business in Pakistan, not CDLs. The technology to be provided by English Electronics will only be related to assembly process, not the actual process of making switches. This was hardly worth CDLs involvement who were well established manufacturers in their own right. Just assembling some one elses products will in effect make CDL only a glorified wholesalers. Again, he argued, CDL will never be allowed by English Electronics to start their own line of switches. He saw little advantage in exporting products to Middle East. He felt that the purpose of a company is to make profits. If adequate profits can be comfortably made by staying within the country, there is hardly any justification for exposing the company to perils of export markets.

Mahwish Khan then turned her attention to collecting financial data for both the projects. Tables 1 to 5 provide this information.

She also learned that while the company has consistently paid a 10% dividend over the past few years, the owners believe that cost of equity funds is in the region of 20% p.a. If they borrow any part of the funds required to put up any of the two plants, the cost of long term funds will be around 12%. However, Chiragh Din believes that they should add an additional 2% on whatever weighted average cost of funds comes to for the switches project as it carries a higher degree of risk.

Table 1 Extracts from Income Statements

All figures in millions of Rs. Gross Revenue

Gross Profit Administration Overheads Marketing Overheads Financial Overheads

Actual Actual Actual Estimated 2003 2004 2005 2006 112.5 128.3 148.8 174.1 39.4 46.2 54.3 65.3 9.0 10.0 11.0 12.0 15.8 19.2 20.4 26.0 3.4 3.2 3.5 2.8 11.3 13.7 19.4 24.5

5.0 5.0 5.0 107.4 126.9

Net Profit

Dividends 5.0 Un-appropriated Profit c/f 84.3 93.0

Notes: o Income Tax is to be ignored.

o Directcostsincludedepreciationwhichisprovidedonfixedassetsat10%ofbook

value each year.

Thecompanyhasnolongtermdebt.Financialoverheadsrepresentbankcharges on funds transfers and interest on occasional short term borrowings.

Actual All figures in millions of Rs. End 2003 Paid Up Share Capital 50.0 Reserves 84.3 Equity 134.3

Actual End 2004 50.0 93.0 143.0 150.1 12.0 305.1

109.4 98.5 64.1 33.2 305.1

Actual End 2005 50.0 107.4 157.4 174.2 9.5 341.0

110.2 114.3 74.3 42.3 341.0

Estimated End 2006 50.0 126.9 176.9 203.8 6.0 386.6

114.0 133.7 87.0 57.0 386.6

Table 2 Balance Sheets

Trade Creditors

Short Term Borrowings Total Equity & Liabilities

Fixed Assets, net of depreciation

Inventories 86.4

131.7 0 266.0

Trade Debtors

Short Term Invest and Cash Total Assets

56.2 17.4 266.0

106.0

Table 3 Estimated Capital Cost of the Proposed Projects

All figures in millions of Rs.

Plant cost, including erection and commissioning New Buildings Required

Additional investment in working capital

Total Investment Required

Increase Lights Making Capacity 75.0 5.0 15.0 95.0

Put Up New Switches Plant 80.0 5.0 25.0 110.0

Notes: Both plants will be depreciated by 10% each year on straight line basis. No depreciation will be provided on buildings.

Table 4 Estimated Revenue & Expenses of New Lights Plant

Rs. Millions Year 1

Year 2 Year 3 Year 4 Year 5 Year 6 Year 7 Year 8

Revenue

45.0 27.0

60.0 36.0 75.0 45.0 85.0 51.0 100.0 60.0 110.0 66.0 124.0 74.4 135.0 81.0

Sales Direct Admin Market

Costs Overhead Overheads 2.0 6.2

2.5 5.0 3.0 5.0 3.5 5.5 4.0 5.5 4.5 6.0 5.0 6.0 5.5 6.5

Zong @ 45% 6:18 PM aisha Case Study 7 Capit... Year Year Year 1940 135.0 45 5.0 55 60 6.0 6.5 810 5 of 5 Year Year 151.0 90.60 6.0 6.5 1650 05 70 Notes: Direct costs include depreciation on plant No additional financial charges are to be considered since additional working capital requirement has been built into project cost Table 5 - Estimated Revenue & Expenses of New Electrical Switches Plant Sales Admin Market Rs. Millions Revenue Overhead Overheads Year 1 576 3.0 75 Year 634 35 5.0 TUITI 106.5 55 843 Year 4 Years Year Year 2 102.0 141.7 1559 171.5 1886 70 75 65 Year 1235 Year 10 Note: Direct costs include depreciation plant. No additional financial charges are to be considered since additional working capital requirement has been built into project cost. Questions for discussion 1. What capital mix do you recommend for each project? 2. Raudcn your recommended capital mix, what discounting rate would you use for each 3. Do you agree with Chiragh in that a higher discounting rate should be used for the Switches project? Why? 4. Calculate macht's My Bae, ARR. NPV and ERR 5 Do you think the company should undertake both the projects simultaneously? Giveasons to support your answer. 6. If the company should implement only one project, which one should it be? Why? PE? Zong @ 45% 6:18 PM aisha Case Study 7 Capit... Year Year Year 1940 135.0 45 5.0 55 60 6.0 6.5 810 5 of 5 Year Year 151.0 90.60 6.0 6.5 1650 05 70 Notes: Direct costs include depreciation on plant No additional financial charges are to be considered since additional working capital requirement has been built into project cost Table 5 - Estimated Revenue & Expenses of New Electrical Switches Plant Sales Admin Market Rs. Millions Revenue Overhead Overheads Year 1 576 3.0 75 Year 634 35 5.0 TUITI 106.5 55 843 Year 4 Years Year Year 2 102.0 141.7 1559 171.5 1886 70 75 65 Year 1235 Year 10 Note: Direct costs include depreciation plant. No additional financial charges are to be considered since additional working capital requirement has been built into project cost. Questions for discussion 1. What capital mix do you recommend for each project? 2. Raudcn your recommended capital mix, what discounting rate would you use for each 3. Do you agree with Chiragh in that a higher discounting rate should be used for the Switches project? Why? 4. Calculate macht's My Bae, ARR. NPV and ERR 5 Do you think the company should undertake both the projects simultaneously? Giveasons to support your answer. 6. If the company should implement only one project, which one should it be? Why? PE