Should PT.Kabitama Chem Tex invest on foundry pig iron or HMS (High Mild Steel Scrap) in order to expand its metal business - Free Essay Example

The sole proprietor of PT.Kabitama Chem Tex, which is a foreign Investment Company, had expressed interest in expanding his metal business. And so the aim of this paper was to carry out a feasibility study examining two investment alternatives forKabitama. Therefore, the research question is, à ¢Ã¢â€š ¬Ã…“Should PT.Kabitama Chem Tex invest on foundry pig iron or HMS (High Mild Steel Scrap) in order to expand its metal business?à ¢Ã¢â€š ¬Ã‚  Through primary source (Interviews) and secondary sources (document, websites, textbooks) the SWOT was drawn out followed by decision tree and investment appraisal of the two metal products. The SWOT analyses of the company helped in gaining a clear understanding of Kabitamaà ¢Ã¢â€š ¬Ã¢â€ž ¢s objectives of the project, this was done by identifying the internal and external factors. Major part of this paper went into analysing the quantitative decision-making techniques, as the conclusion is based on these results. The conclusion and recommendation gives an assessment of the two possible investment options for Kabitama and concludes that, on the bases of quantitative factors, HMS is a better product to invest on than Pig Iron. It also suggests that the company should also consider the qualitative factors, in order to reduce the risk factor. Word Count 197 Introduction PT.Kabitama Chem Tex is a foreign Investment Company with Mr Manish Parekh as the sole proprietor. Kabitama chemtex is a trading company that à ¢Ã¢â€š ¬Ã…“deals in various types of chemicals, textiles and metals, with many countries like Indonesia, India, USA, South Africa, Dubai, Australi a, China, and many more, depending on the products, either to sell or buy as per the availability or demand of that product in the respective country. At present chemicals like dyes, dyes intermediates, plasticizers, agro products, glycols, are running smoothly. Where as in textiles, the market is mainly captured by China; therefore there is no big scope to grow. Coming to metals, ità ¢Ã¢â€š ¬Ã¢â€ž ¢s a very promising area.à ¢Ã¢â€š ¬Ã‚  [1] [2] Right now Kabitama is catering 1-2 metal products, but if market starts growing then requirement of many other items will emerge. This needs to be carefully observed, put into marketing research department. This report will carry out a feasibility study investigating two investment alternatives forKabitama. The first investment opportunity is on foundry pig iron. à ¢Ã¢â€š ¬Ã…“Foundry Pig Iron is used mostly for making grey iron steel product, ductile iron steel product used for motor spare parts and many industrial spare parts. These are used in replacement of scrap HMS as it has better properties like fast melting; firm specs and gives uniform results.à ¢Ã¢â€š ¬Ã‚ [3] The second investment opportunity is on HMS (High Mild Steel Scrap). à ¢Ã¢â€š ¬Ã…“Scraps are used to produce steel products as well as in foundry too. Both the products go hand in hand and so the price plays a big role.à ¢Ã¢â€š ¬Ã‚  [4] Therefore the research question is- Should PT.Kabitama Chem Tex invest on foundry pig iron or HMS (High Mild Steel Scrap) in order to expand its metal business? Methodology A range of sources was applied to investigate Kabitamaà ¢Ã¢â€š ¬Ã¢â€ž ¢s two alternative choices. Primary research involves interviews with the owner of Kabitama, Mr Parekh and the accountant, Mr Himawan. This was undertaken in order to identify Kabitamaà ¢Ã¢â€š ¬Ã¢â€ž ¢s future strategic and financial plan. The interviews also contributed to their knowledge and understanding of the companyà ¢Ã¢â€š ¬Ã¢â€ž ¢s SWOT, as well as the venture risks, and operating procedures Secondary research was carried out in order to collect information and data related to the company as well as to learn more about investment appraisal and decision tree. The information was collected from various sources such as financial documents, textbook and websites. The focus of this assignment is to compare the primary and secondary information to explore and companies two alternative product choices, and analyse them through investment appraisal, decision tree and SWOT, in order to compose a suitable solution. Research and findings Product details[5] Indonesia is full of rich minerals but its raw materials are still only exported. Not much raw material are converted to semi finish product which can fetch more money if there will be a support for foreign investor to invest in Smelting plant by which the raw material can be converted to semi finish product and ultimately it will bring more profit to the compan y as well as the country. Indonesia wants to start building automotive and its spare parts manufacturing. Till now all cars are assembled where by the à ¢Ã¢â€š ¬Ã…“population of Indonesia is 250 millionà ¢Ã¢â€š ¬Ã‚ [6] and still not self reliant even though all the ores and man power are available in the country. Therefore, the requirement of metal is quiet huge in Indonesia as some of the products they need to Import. In the last 2 years there is a shift of business in metals from Korea, Thailand, Taiwan and China towards Indonesia. A substantial growth has been detected which can grow into multi product requirement and to capture any big market share. Kabitama has to have a good base to represent and offer its related products before competitors enters, which Kabitama already has. Now they need to do more competitive sourcing, tracking new buyers and upgrade technical aspects of products. Decision Tree[7] Calculations[8] Pig Iron HMS Expected values ($5660949ÃÆ'—0.7)-($566094.9ÃÆ'—0.3)= $3792835.83 ($5649756ÃÆ'—0.9)-($1412439ÃÆ'—0.1)= $4943536.5 Net Expected values $3792835.83-$2500000= $1292835.83 $4943536.5-$2200000= $2743536.5 Investment Appraisal[9] Investment appraisal is a quantitative technique used to calculate the financial cost and benefits of an investment decision. The payback period Works out how long it takes to repay the initial investment Net present value This takes into account the time value of money. It is based on the principle that money is worth more than it is in the future. Investment Project A: Foundry pig iron[10] Investment $2500000 Interest 6% Month Cash flow ($) Cumulative cash flow ($) Discount factor[11] Present value April 424957.5 424957.5 0.943 400734.9225 May 463590 888547.5 0.943 437165.37 June 500505.5 1389053 0.943 471976.6865 July 442127.5 1831181 0.943 416926.2325 August 173417 2004598 0.943 163532.231 September 370872 2375470 0.943 349732.296 October 566610 2942080 0.943 534313.23 November 585497 3527577 0.943 552123.671 December 613827.5 4141404 0.943 578839.3325 January 533557.75 4674962 0.943 503144.9583 February 505227.25 5180189 0.943 476429.2968 March 480760 5660949 0.943 453356.68 Total 5660949 5338274.907 Payback Period= 6 months = 6 months and 6.8 days 2838274.907 Investment Project B: HMS (High Mild Steel Scrap) [12] Investment $2200000 Interest 6% Month Cash flow ($) Cumulative cash flow ($) Discount factor[13] Present value April 461151.6 461151.6 0.943 434865.9588 May 499653 960804.6 0.943 471172.779 June 506142 1466946.6 0.943 477291.906 July 508737.6 1975684.2 0.943 479739.5568 August 245284.2 2220968.4 0.943 231303.0006 September 514794 2735762.4 0.943 485450.742 October 584010 3319772.4 0.943 550721.43 November 517389.6 3837162 0.943 487898.3928 December 472399.2 4309561.2 0.943 445472.4456 January 483646.8 4793208 0.943 456078.9324 February 428274 5221482 0.943 403862.382 March 428274 5649756 0.943 403862.382 Total 5649756  ­- 5327719.908 Payback Period= 4 months = 4 months and 28.4 days 3127719.908 Analysis and discussion SWOT analysis[14] Kabitama has a very good market reputation for keeping commitments in terms of delivery. This will work as an advantage, as the business will easily get suppliers and buyers, and therefore have high customer retention. The owner has high knowledge of the products, which helps the business to respond to the market quickly. As Kabitama is owned by a sole trader, there is no hierarchy, which insinuates quick decision making. At the same time, the size of the company suggests limited human resources and unlimited liability. Another weakness of the business is that, project planning is nonexistent. This can create big problems while making a decision. The automobile industry is growing in Indonesia; therefore there is a huge requirement of metal products. By taking this opportunity of increase in market demand, Kabitama can grow their metal business and earn higher re venues. As a trading company there should be a continuous monitor of price trend as well as market demand. Buying and selling has to be in a swift mode. Goods should not be lying in warehouse. If there is high supply of the product, than there should be a high demand for the product or visa-versa. If this doesnà ¢Ã¢â€š ¬Ã¢â€ž ¢t happen then there this ultimately causes cost, black finance and if there is a poor demand then may cause lost too. So the demand and supply of the products are very important in order to make the project a success. It is also important for the company to analyse the fluctuation of the exchange rates, government laws, payment terms, ect. This is because market price of the raw material depends on these factors. If any of these changes, then it might act as an opportunity or a threat for the business. Decision tree analysis A decision tree is a quantitative decision making tool. A decision tree will help the company to choose between the two proj ects as it projects a balanced picture of the risks and rewards associated with each project, by calculating the expected values. This value refers to the average outcome if the decision was made several times, in exactly same situation. [15] The net expected value for project B ($2743536.5) is more than double than the value for project A ($1292835.83). This clearly states that project B is the best option out of the two projects, and therefore the company should reject project A. But before doing so, it is important for the company to should consider additional financial and non-financial information. Even though a decision tree allows the company to analyze fully the possible consequences of a decision, it can also be incorrect. As a decision tree depends on the accuracy of the estimate data. If the data is biased towards a particular outcome or is wrongly estimated, than automatically the results will be incorrect. To avoid this problem I have also calculate the investment ap praisal of the two projects. Investment appraisal Analysis Project A- Pig Iron Project B- HMS Profit $3160949 $3449756 Payback Period 6 months + 6.8 days 4 months + 28.4 days NPV 2838274.907 3127719.908 The table above gives an overview of the investment appraisal I have calculated. The payback period for project B is shorter than project A. This suggests that project B will take less time to earn enough profits to repay the cost of the initial investments. Therefore project B is more liquid, and less risky as it allows the company to recoup the investment sooner, so they can reinvest the money elsewhere. Moreover, with a shorter payback period, theres less of a chance that the economy, exchange rates, market conditions, or other factors affecting this project will drastically change. This method is the simplest way of comparing investment projects in order to identify which project yields a quick return for the business. However, this method ignores the total revenue on the investment projects and the time value of money.[16] To overcome this problem I have calculated the net present value of these two projects, as it considers the time value of money. The net present va lue method will help the company find the present value in todays dollars of the opportunity cost of money and future netcash flow of the projects. NPV analysis is used to evaluate the projects cash flows, rather than the revenue from the project. This is because à ¢Ã¢â€š ¬Ã…“NPV does not consider depreciation as it is not an out-of-pocket expenseà ¢Ã¢â€š ¬Ã‚ [17] . In this case the opportunity cost is the interest rate which is 6%. Both the projects are giving positive outcomes; this suggests that both the projects are profitable for the company. As Project B has a greater difference between NPV and cost than project A, it is advisable to choose project B. Conclusion and Evaluation In answering the question à ¢Ã¢â€š ¬Ã…“Should PT.Kabitama Chem Tex invest on foundry pig iron or HMS (High Mild Steel Scrap) in order to expand its metal business?à ¢Ã¢â€š ¬Ã‚  This paper clearly delineates the extent of its effectiveness by analysing the SWOT, investment appraisal and decision tree of these two metal products. This paper should help Kabitama in deciding the best investment project for expanding their metal business. Overall, on the bases of the investment appraisal and decision tree, it is advisable for Kabitama to choose project B (HMS) as it has higher profit, lower payback period, higher net present value and a very high net expected value then project A (Pig Iron). But these are only the quantitative decision making techniques, in order to decide the best option it is important to also consider the qualitative side (non-financial factors). Which are[18]:- The aims of the organisation- if Kabitamaà ¢Ã¢â€š ¬Ã¢â€ž ¢s aim is to earn maximum profit then it will focus on the results of investment appraisal, Reliability of the data Risk- this project can be a risk if the data is wrong as the calculations will be wrong which may lead to a wrong decision. Kabitama may prefer to choose a lower but more certain return. The Economy- Interest rates will have a major impact. If interest rates are increasing, any investment will be required to provide a greater profit. Future economic changes, such as a recession or boom, must be considered in the predictions of future costs and revenues. Image- Kabitama should consider how this project might affect its image and public relations Ethics- as Kabitama has a genuine commitment to trading ethically; the company should also consider this factor. So to decide which project is the best, the company should research more on the qualitative factors of investment appraisal technique and other non-financial factors. The company should also include more metal products in their research department, this will help the company in choosing the best metal product to invest and expand their mental business. It may also be useful to adopt other methods of investment appraisal such as the Accounting Rate of Return, which is less sensitive to fluctuations in future cash inflow. This way, with more information, Kabitama will be able to see the advantages and disadvantages of each project more clearly. This will result in reducing the risk factor and there will be a higher possibility for the investment to be a success. [1] Appendix 1- Parekh, Manish. Personal interview. 22 Feb. 2013. [2]Textiles Industry in Hong Kong | HKTDC.Textiles Industry in Hong Kong | HKTDC. 14 Apr. 2013 https://hong-kong-economy-research.hktdc.com/business-news/article/Hong-Kong- Industry- Profiles/Textiles-Industry-in-Hong-Kong/hkip/en/1/1X000000/1X0040EM.htm. [3] Appendix 3 Wira, Himawan. Personal interview. 5 Apr. 2013. [4] Appendix 1- Parekh, Manish. Personal interview. 22 Feb. 2013. [5] Appendix 1- Parekh, Manish. Personal interview. 22 Feb. 2013. [6] Indonesia Population 2013.- World Population Review. Web. 08 Mar. 2013. https://worldpopulationreview.com/countries/indonesia-population/. [7] Appendix 3- Wira, Himawan. PT.Kabitama Chem Tex Financial data on metal products. 5 Apr. 2013. Raw data. Indonesia, Jakarta. [8] Clark, Paul.Business and Management: Course Companion. Oxford: Oxford UP, 2012. Print. [9] Clark, Paul, Peter Golden, and Mark ODea.IB Business and Management. Oxford: Oxford UP , 2009. Print. [10] Appendix 3 4 Wira, Himawan. Personal interview. 5 Apr. 2013. Wira, Himawan. PT.Kabitama Chem Tex Financial data on metal products. 5 Apr. 2013. Raw data. Indonesia, Jakarta. [11] Appendix 5- Brealey, Richard A., Stewart C. Myers, and Franklin Allen. . Principles of Corporate Finance. 8th ed. McGraw-Hill Irwin companies page 1.PRESENT VALUE TABLES. 10 Apr. 2013 https://jcooney.ba.ttu.edu/fin3322/Brealey Files/Appendix A Present Value Tables.pdf. [12] Appendix 3 4 Wira, Himawan. Personal interview. 5 Apr. 2013. Wira, Himawan. PT.Kabitama Chem Tex Financial data on metal products. 5 Apr. 2013. Raw data. Indonesia, Jakarta. [13] Appendix 5- Brealey, Richard A., Stewart C. Myers, and Franklin Allen. . Principles of Corporate Finance. 8th ed. McGraw-Hill Irwin companies page 1.PRESENT VALUE TABLES. 10 Apr. 2013 https://jcooney.ba.ttu.edu/fin3322/Brealey Files/Appendix A Present Value Tables.pdf. [14] Appendix 12- Parekh, Manish. Personal interview. 22 Feb. 2013. [15] Decision Trees.Decision Tree Analysis. Web. 19 Dec. 2014. https://www.mindtools.com/dectree.html. [16] Clark, Paul, Peter Golden, and Mark ODea.IB Business and Management. Oxford: Oxford UP, 2009. Print. [17] Winmark Business Solutions.WBS Online. Web. 12 May 2013. https://www.wbsonline.com/resources/net-present-value-of-major-purchases/. [18] Accounts and Finance.Investment Appraisal. Web. 21 May 2013. https://www.gregglee.biz/ftp/student/Finance/page_28.htm.