Fly Ash Brick Project Case Solution
Furthermore, the project would incur these costs irrespective of the production of the bricks at the plant. Meanwhile, there would be other variable costs that are related to production such as the raw material, electricity, labor cost. See Exhibit 3 Which gives details of the variables cost of INR 900,000 that would incur if they produce 0.2 million bricks in a given month. Which means that variable cost of the producing one ash brick would be INR 4.50.
Breakeven Point & CVP Graph
The project would have fixed cost of 393,333 in a given month. However, the cost of producing a single brick would be INR 7 rupees. Meanwhile, the variable cost per brick would be 4.5 rupees. However, it is determined that project would be on break even when the company would produce 157,333 bricks in a given month. See figure 1.
On the other hand, the company would sell one brick at the cost of 7 rupees. Similarly, it would have a total capacity of the producing 4 million bricks in a year.However, due to the demand in the market, it is anticipated that company would be able to sell 2.4 million bricks in the first year of its operations. Similarly, break even point would help to estimate the expenses of the company.
Indeed, it would also reveal the cost associated with production. Meanwhile, projectâ€™s feasibility can be judged through the cost of production, and return on the investment. However, it would also provide help to make extra efforts to exceed the break even point to make a profit for the company by reducing the cost of production.
The company would sell one brick for 7 rupees in the market. Whereby, company has the capacity of producing 4 million bricks per annum. However, itis estimated that company would sell around 2.4 million bricks in the market so that it would have around 1.28 million earnings before the tax. Meanwhile to achieve the target of 2 million income before tax then company would need to sell around 2.688 million bricks to achieve targeted income.
Effect of Volume on Return on Equity
There would be high impact on the return on equity when the volume of sales increases. Meanwhile, the return on equity means that investment that has been made by the partners. However, the debt is not included in the equity. Because, the bank is not a partner in the profit, loss situation. However, because the equity holders are partners in the profit and loss. Hence, the volume of sales would have a positive effect on the return to them.
Also, the bank is not the partner in the profit, because, it only has to collect the interest rate only periodically. Similarly, if the project could sell the 2.4 million bricks at the price of 7 rupees per brick, then its return on the equity would be 21% annually. However, if the company sell the 2.7 bricks in the market at the same price, then the company would have 33% return on equity.
I addition, if the companyâ€™ sell volume increases by 2.4 million to 2.7 million around by 300,000 units, then its return on the equity increases by 11%, which is very attractive for the company to focus on increasing the volume of the sales. Similarly, if the companyâ€™s sales volume declines by same units, its return on equity would also decline by the same rate of 11%
Similarly, the increasing volume of the sells units would have a positive impact on the return on equity, but the declining sells units would have a negative impact on the return on equity. Because, the company would have to meets first its debt obligations, and then to the equity holders. Hence, the volume of sale would affect the return on equity.
Conclusion & Recommendation
The project has an initial investment of 10 million rupees. Whereas the 8 million rupees would be invested in the fixed assets, and remaining balance would be fulfilling the working capital requirements of the company to carry the daily operations. Meanwhile, the amount of 6 million would be invested by the partners, and 4 million rupees would be provided by the bank against the mortgage loan with interest rate of 12% per annum.
Also, the company would have around 393,000 rupees fixed cost irrespective of production increases or decreases. Whereas company has the variable cost unit 4.5 rupees, and it has the sales price of one brick in the market is 7 rupees. On the other hand, if a company produces 157,333 units of bricks in the market at given price of 7 rupees per brick then company would be on break even.
That is means company would be able to generate profit, if it exceeds the given break even point. Similarly, if the company able to produce the estimated 2.4 million bricks, then its return on the equity would be 21% before tax.Since the increase in sales volume would have a positive impact on the return on the equity.
Moreover, the project is very attractive regarding the return on equity.So, both partners should go with the project. However, it is also important to know that production plant would have a production capacity of 4 million. However, the sales are anticipated to be 2.4 million. So, it is recommended to partners that they should increase perfectly plan and contact with real estate construction companies in confidence.
It should perfectly place its product on the market and utilize the all production capacity so that company completely get back what it has invested in fixed assets. Because the plant and equipment have the average life five years with no salvage value in the market. Thus, the partners should take a look at this problem. Otherwise, partners would need to again look towards the bank, which risky for the company and hurdle to expansion…………………
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