Question

Agrotech Fertilisers Limited has planned to set up a plant for manufacturing urea fertiliser which has very high market potential as there is excess demand as compared to supply. It is a capital-intensive project involving an investment of Rs.2,000 crore. Major portion of this investment will be in fixed capital. Financial institutions prefer to finance such a project because it is in the core sector. Since market for urea fertiliser is quite high, it is sold mostly on a cash basis.

(i) What is the most desirable debt/equity ratio for the company?

(ii) On what basis should investment in working capital be determined?

Answer 1

(i) Since the project is capital intensive, proportion of debt should be much higher than equity. Since financial institutions prefer advancing loans for such a project, raising loans from them should not be a problem for the company.

(ii) The company should determine investment in working capital on the basis of meeting the following requirements:

(a) To purchase and maintain required level of inventory of raw materials.

(b) To pay wages/salaries to employee.

(c) To meet overhead expenses for power, fuel, stationery and other items.

(d) To pay taxes, insurance premium, etc.

(e) To meet marketing and general expenses.

(f) To maintain required level of inventory of finished goods.

(g) To have cash in hand and at bank to meet recurring expenses and meet contingencies.