On September $20,2016,$ Saurabh Sharma, Senior Vice President of Bhatia Textiles Company, was preparing for a meeting with the management committee scheduled the next week. On his desk was a capital budgeting and investment proposal $$ a new product line of branded shirts that the committee was considering for launch. As the head of the finance department, Saurabh was required to work along with his team on a detailed capital budgeting analysis and present the findings to the management committee for their approval. As per standard company practice, each capital budgeting and investment project was evaluated using the traditional Net Present Value $($NPV$)$ approach and the Internal Rate of Return $($IRR$)$ criterion for determining whether the company would undertake the project or not.

Saurabh had a lot to think about as he considered the analysis of the capital budgeting project using the traditional Net Present Value $($NPV$)$ approach and the Internal Rate of Return $($IRR$)$ criterion. What would be the basis for calculating the after$-$tax operating cash flows for the capital project? How would he arrive at the depreciation and working capital requirements for computing the NPV$?$ What would be the basis for calculating the terminal year cash flows? With all these questions in mind, Saurabh decided to focus on the proposed capital budgeting project for the next few days.

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 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:

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

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

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Selling, general, and administrative expenses $($including employee expenses$)$ at INR $35$ million per annum, expected to increase by $10\%$ each year.

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Depreciation expense on the basis of SLM$.$

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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 $12\%$