Indian Retail Market

The Indian retail market is at the cusp of a sweet spot driven by strong GDP $($Gross Domestic Product$)$

growth, benign inflation, and rising per capita income and purchasing power of consumers. Currently, the

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retail industry accounts for more than ten percent of the Indian Gross Domestic Product and approximately

eight percent of employment. The industry is expected to nearly double, from US$ $600$ billion in $2015$ to US$

$1$ trillion, by $2020$ driven by income growth, urbanization, and attitudinal shifts $($Indian Terrain Annual Report,

$201516).$ It has been estimated that, by $2030,$ the Indian apparel market, in particular, is expected to grow

at a CAGR $($compounded annual growth rate$)$ of approximately $1012\%,$ backed by increasing affordability

on account of an increase in disposable incomes, increase in aspirations, and a shift from unbranded to

branded products by the burgeoning middle class. This trend is likely to be further accentuated by the rise

of e$-$commerce companies that enable shopping from anywhere, thereby leading to increased penetration in

small cities and towns $($Indian Terrain Annual Report, $201516).$

Company Background

Bhatia Textiles is a small, privately owned clothing company based in New Delhi, India. It was founded in

$1995$ by Harish Bhatia, a retired executive. Since then, the company had grown steadily by catering to middle

to low income consumers in the Delhi$-$National Capital Region $($NCR$).$ The company recorded a stellar growth

of $50\%$ in its sales during the last financial year of $201516.$ With a healthy operating margin ratio and low

leverage levels, the company had been able to grow its profits at a CAGR of $25\%$ during the last $10$ years.

With a good brand name and healthy financial metrics, the company was now looking to expand its footprint

to new product lines catering to middle to high income customers.

Project Investment Proposal Details

The project is estimated to be of $10$ years duration. It involves setting up new machinery with an estimated

cost of as much as INR $500$ million, including installation. This amount could be depreciated using the straight

line method $($SLM$)$ over a period of $10$ years with a resale value of INR $15$ million. The project would require

an initial working capital of INR $20$ million with cumulative investment in net working capital to be maintained

at $10\%$ of each year$$s projected revenue. With the planned new capacity, the company would be able to

produce $240,000$ pieces of shirts each year for the next $10$ years. In terms of pricing, each shirt can initially

be sold at INR $1,300$ apiece, which takes into account the target segment and competitor pricing. The project

proposal incorporates an annual increase of $3\%$ in the price of the shirt to compensate for inflationary impact.

With regards to the raw material costs and other expenses, the project estimated the following details:

$$ Raw material cost for manufacturing shirts at INR $400$ per shirt, slated to rise by $5\%$ per annum on

account of inflation.

$$ Other direct manufacturing costs at INR $125$ per shirt with an annual increase of $5\%$ per annum on

account of inflation.

$$ Selling, general, and administrative expenses $($including employee expenses$)$ at INR $35$ million per

annum, expected to increase by $10\%$ each year.

$$ Depreciation expense on the basis of SLM$.$

$$ Tax rate was assumed to be $25\%.$

Funding

For funding of the expansion project, the promoters agreed to infuse $50\%$ in the form of equity with the rest

$(50\%)$ being financed from issue of new debt. Based on the current credit position and market scenario, new

debt can be raised by the company at $12\%$ per annum. Cost of equity was assumed to be $15\%$ by Saurabh.

The requisite discounting rate or weighted average cost of capital $($WACC$)$ for NPV and IRR calculations can

now be calculated with the help of the above assumptions.

Demand Scenario

Although the project proposal estimates maximum annual production of $240,000$ shirts, Saurabh decided

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$1.$

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to do capital budgeting analysis under two demand scenarios: Optimistic and Expected. The likely annual

demand estimated under each scenario is as follows:

Scenario Annual demand

Optimistic $240,000$ Shirts

On the basis of the financial information given in the case, calculate the after$-$tax operating cash

flows, NPV$,$ and IRR under the Optimistic and Expected scenarios. Clearly specify the calculations

required for the same.

Based on your analysis, as Saurabh Sharma, what recommendation would you make on whether

the company should undertake the project or not? Clearly specify the decision based on both the

NPV technique as well as the IRR criterion.