Project Report on Cost Analysis of Rice Mill in India Essay

1.1 Introduction Rice is the staple food for 65% of the population in India. It is the largest consumed calorie source among the food grains. With a per capita availability of 73.8 kg it meets 31% of the total calorie requirement of the population. India is the second largest producer of rice in the world next to China. The all India area, production, and yield of rice in the year 2001-02 was 44.62 million hectares, 93.08 million tons and 2086 kg/ ha respectively. In India paddy occupies the first place both in area and production. The crop occupies about 37 % of the total cropped area and 44% (2001-02 position) of total production of food grains in India. West Bengal is the leading producer of paddy in the country. It accounts for 16.39% of the total production, and the other leading states are Uttar Pradesh (13.38%), Andhra Pradesh (12.24%), Punjab (9.47%), Orissa (7.68%) and Tamil Nadu (7.38%); the remaining states account for 33.45% of the production. India is also one of the leading exporters of rice in the world market. India’s export of rice stood at 23.89 lakh MT in 1997-98. The corresponding value of foreign exchange earned was to the tune of Rs. 3371.00 crore in 1997-98. Indian Basmati Rice has been a favorite among international rice buyers. Following liberalization of international trade after World Trade Agreement, Indian rice will become highly competitive and has been identified as one of the major commodities for export. Look more:  capital budgeting examples essay This provides us with ample opportunity for development of rice based value-added products for earning more foreign exchange. Apart from rice milling, processing of rice bran for oil extraction is also an important agro processing activity for value addition, income and employment generation. Many of the rice processing units are of the traditional huller type and are inefficient. Modern rice mills are having high capacity and are capital intensive, although efficient. Small modern rice mills have been developed and are available in the market but the lack of information is a bottleneck in its adoption by the prospective entrepreneur. The present model will go a long way in bridging the information gap. 1.2 Description of Rice Milling Operations Paddy in its raw form cannot be consumed by human beings. It needs to be suitably processed for obtaining rice. Rice milling is the process which helps in removal of hulls and barns from paddy grains to produce polished rice. Rice forms the basic primary processed product obtained from paddy and this is further processed for obtaining various secondary and tertiary products. The basic rice milling processes consist of: 1. Pre Cleaning: Removing all impurities and unfilled grains from paddy 2. De-stoning: Separating small stones from paddy 3. Parboiling (Optional): Helps in improving the nutritional quality by gelatinization of starch inside the rice grain. It improves the milling recovery percent during de-shelling and polishing / whitening operation 4. Husking: Removing husk from paddy 5. Husk Aspiration: Separating the husk from brown rice/ unhusked paddy 6. Paddy Separation: Separating the unhusked paddy from brown rice 7. Whitening: Removing all or part of the bran layer and germ from brown rice 8. Polishing: Improving the appearance of milled rice by removing the remaining bran particles and by polishing the exterior of the milled kernel 9. Length Grading: Separating small and large brokens from head rice 10. Blending: Mixing head rice with predetermined amount of brokens, as required by the customer 11. Weighing and bagging: Preparing the milled rice for transport to the customer The flow diagram of the various unit operations are as follows: Figure 1: Block Diagram of Rice Processing 1.3 Status of Rice Milling Units in India Rice milling is the oldest and the largest agro processing industry of the country. At present it has a turnover of more than 25,500/- crore per annum. It processes about 85 million tons of paddy per year and provides staple food grain and other valuable products required by over 60% of the population. Paddy grain is milled either in raw condition or after par-boiling, mostly by single hullers of which over 82,000 are registered in the country. Apart from it there are also a large number of unregistered single hulling units in the country. A good number (60 %) of these are also linked with par-boiling units and sun -drying yards. Most of the tiny hullers of about 250-300 kg/hr capacities are employed for custom milling of paddy. Apart from it double hulling units number over 2,600 units, underrun disc shellers cum cone polishers numbering 5,000 units and rubber roll shellers cum friction polishers numbering over 10,000 units are also present in the country. Further over the years there has been a steady growth of improved rice mills in the country. Most of these have capacities ranging from 2 tons /hr to 10 tons/ hr. 1.4 Need for Improved Rice Mills The recovery of whole grains in a traditional rice mill using steel hullers for dehusking is around 52-54%. There is excessive loss in the form of coarse and fine brokens. Further loss of large portion of endosperm layers during the dehusking operation further accentuates the problem. Against it, the recovery percent of whole grains in modern rice mills using rubber roll shellers for dehusking operation is around 62-64%. The whole grain recovery percent further increases to 66-68% in case of milling of parboiled paddy. Thus it can be seen that there is an overall improvement of recovery of whole grains by about 10-14% if one uses rubber roll shellers for rice milling operations. The conversion ratio (i.e. recovery % of various final product and byproduct for every 100 kg feed of raw paddy) for these improved rice mills are can be as follows: 1. Percent of milled rice : 62-68%2. Percent of rice bran : 4-5% 3. Percent of rice husk : 25% 4. Percent of germ wastages : 2%-8% It has been observed that dehusking using rubber roll shellers reduces the risk of breaking the grain because husk is pulled off almost at once and pressure is applied by means of resilient surfaces across the width of the grain, where kernels, generally are much more uniform than they are by length. Moreover, the process does not remove the internal epidermis of the husk. Thus the deshelled grains with their silver skin envelope are protected against scratches and keep longer and better while the silver skin and the germ increases the quantity of bran which is produced while whitening. The improved rice mills have a better husk and rice bran aspiration system. The same prevents mixing of fine brokens with rice bran. Therefore the quality of rice bran obtained is better. It has also been observed that the location of rice mills are confined to a few selected production centers. Their development as a village level agro processing unit is yet to take a proper shape. In the absence of village level rice milling unit, the farmers have to travel great distances for milling the rice. This leads to increased transportation and handling losses. Thus there is a need to develop improved rice mills as a village level agro processing unit for bringing about technical up-gradation and development of the sector. Value addition and generation of gainful and sustainable employment opportunities are the other possible benefits arising out of this agro processing industry. The Central Govt. is also providing a big boost towards the development of this industry. It has since repealed w.e.f. May 27, 1998 the Rice Milling Industry (Regulation) Act, 1958 and Rice Milling Industry (Regulation and licensing) Rules, 1959. Further, rice milling sector which was earlier reserved for the small scale sector, have now been de-reserved. As such, no license/ permission is now required for setting up a rice mill. 1.5 Rice Husk Gasifier A rice husk gasifier aims at using wastes from rice mills to fuel a spark-ignition engine that will drive a generator to produce electricity. Instead of dumping rice husks along roadsides, it can now be converted into valuable fuel that can help in substituting the energy required at the mill itself. The gasifier basically employs a moving-bed downdraft gasifier reactor developed by CRHET in combination with a gas-conditioning device that removes impurities from the gas thereby making it highly suitable fuel for heat engines. The gasifier produces a clean gas with a very low amount of black carbon (i.e., only 50 um/m3of gas), and so the gas coming out of the muffler of an engine is also clean. CO2 emission is Operation of the likewise relatively low of about 0.6 kg per ton of rice husks. Figure 2: Block Diagram of Rice Husk Gasifier 1.6 Problem Description The Rice milling is the process that helps in removal of hulls and bran’s from paddy grains to produce polished rice. Rice is rich in genetic diversity with thousands of varieties grown throughout the world. Rice has been one of man’s most important foods. Today, this unique grain helps sustain two-thirds of the world’s population. It is life for thousands of millions of people. It is deeply embedded in the cultural heritage of their societies. About four-fifths of the world’s rice are produced by small-scale farmers and are consumed locally. The major portion of the paddy is being processed through hullers. The hullers are usually low capacity mills. In these hullers, both shelling and polishing operations are carried out simultaneously. Hence, there is no control on the polishing of rice, bran and a higher breakage of rice occurs. Today the number of middle class people is rising who want good quality of food. Thus a number of small, technically advance rice mills are being set up to meet the quality needs of the people and substitute for huller mill, to get polished rice, rice bran and paddy husk. In this project, profit analysis of a small scale technically advance rice mill is carries out using the business case of Jay Laxmi Rice Mill, Bazpur in Udham Singh Nagar district in the state of Uttarakhand. It has a nominal capacity of 4000kg/hr. It has been built for the production of raw rice. The relation between the cost of capital and the net present value of the project was developed. The internal rate of return was determined by finding the appropriate discounting rates for which the net present value is zero. Sensitivity analysis of various factors like paddy price, raw rice price, bran price versus internal rate of return and the net present value of the project were done to estimate profit. Also, the owner want to know the effect on internal rate of return and net present value if the husk produced is used for generating electricity for the plant. What is the minimum percentage of electricity consumption that should be substituted by rice husk gasifier such that the process is profitable? There are a lot of bottlenecks and unforeseen problems in estimating it. The owner needs to know the fixed and variable costs for operating this. The market forces decide the price/unit of raw rice in the market. Thus, the owner has to follow the supply demand dynamics and price its product. To maintain a pre-defined profit margin the owner should know its revenue and costs and aim to increase its revenue and decrease its costs. These problems are discussed and solved in this report. 1.6 Objectives On the light of the above discussion the following objectives will be addressed in this investigation: * Obtaining an exhaustive asset list along with its initial cost, life and salvage value to compute the Net Present Value, Payback Period and Internal Rate of Return of the project. * To create a programme in C and obtain a relationship between Internal Rate of Return (IRR) and yearly cash flow generated. * To obtain relationship between Net Present Value and Cost of Capital * To obtain relationship between Net income, Internal Rate of Return and Net Present Value * To perform sensitivity analysis for the owner on the basis of: * Buying price of Paddy versus Internal Rate of Return and Net Present Value * Selling price of Raw Rice versus Internal Rate of Return and Net Present Value * Selling price of Bran versus Internal Rate of Return and Net Present Value * Salvage value versus Internal Rate of Return and Net Present Value * To find the minimum percentage of total electricity consumption that should be generated from Rice Husk Gassifier so that the process is economic and obtain a relationship between percentage electricity substituted from the husk gassifier, Internal Rate of Return and Net Present Value. Chapter 2: Review of Literature ————————————————- This is a specific case study partening to Jay Laxmi Rice Mill at Bazpur in Udham Singh Nagar district in the state of Uttarakhand. This case study is an analysis of the establishment and functioning of small scale modern rice mill in India. It is neither a story of spectacular success, nor of a spectacular failure as case studies usually are. Rather, it is written with a purpose of illustrating the complexity of factors that enter into the establishment and functioning of an enterprise in a low income economy. These factors often distort both the factor and the product prices and make it difficult to measure the efficiency of an enterprise with the usual yardsticks of cost-benefit analysis. In conducting the analysis the classical analytical tools have been used. These tools take into account the Time Value of Money and are the core topics in books on Engineering Economics. The equations used in the analysis of the project have been taken from the book on ‘Essentials of Engineering Economics’ by James L. Riggs and Thomas M. West. The current market price of the assets used in the rice mill has been obtained from Satake, Japanese manufacturer and supplier of rice mill machinery. The Kolkata representative of Satake recommends the market price and setting up cost. The list of assets used in Rice Husk Gasifier, their current market price and salvage value were obtained from the various sites. The papers on ‘Electricity generation from rice husk in indian rice mills’ and ‘Rice husk gasifier for melting and reheating process’ helped me in detailed understanding of the rice husk gassifier. Keeping all these study in mind, I have perform the sensitivity analysis of various factors like paddy price, raw rice price, bran price versus the internal rate of return and the net present value of the project. Also found out the relationship between factors like Cost of Capital, Net Present Value and Internal Rate of Return. Chapter 3: Problem Solving ————————————————- 3.1 Important Terminology Time Value of Money: * It is the idea that money available at present time is worth more than the same amount in the future due to its potential earnings capacity. * Thus any amount of money is worth more the sooner it is received. For example, assuming a 5% interest rate, $100 invested today will be worth $105 in one year ($100 multiplied by 1.05). Cash Flow Diagram: * A cash flow diagram is a tool used to represent the transactions which will take place over the course of a given project. * Transactions can include initial investments, maintenance costs, projected earnings or savings resulting from the project, as well as resale salvage value of equipment at the end of their lives. * Cash inflow is positive e.g. – revenue, resale salvage value * Cash outflow is negative e.g. – cost of equipments and set-up, disbursements etc. Figure 3: Cash Flow Diagram Resale Salvage Value: The estimated value that an asset will realize upon its sale at the end of its useful life. The salvage value is used in conjunction with the purchase price and accounting method to determine the amount by which an asset depreciates each period. For example, with a straight-line basis, an asset that cost $5,000 and has a salvage value of $1,000 and a useful life of five years would be depreciated at $800 ([$5,000 – $1,000]/5 years) each year. Within the tax system, when a person donates a car he or she receives a tax deduction. The value of this deduction depends on the salvage value of the car. This salvage value is determined to be the current fair market value that could be obtained had the car been sold on that day rather than donated. Disbursements: Money paid out in the discharge of a debt or expense. Disbursements can include money paid out to run a business, spending cash, dividend payments, and/or the amounts that a lawyer might have to pay out on a person’s behalf in connection with a transaction. When money is disbursed, it is a cash outflow. Cash flow is a measure of the cash inflow, revenue, and cash outflows, or disbursements. Ideally, there will be more money flowing in than flowing out. If cash flow is negative (in other words disbursements are higher than revenues), it can be an early warning of potential insolvency. Internal Rate of Return (IRR): The discount rate often used in capital budgeting that makes the net present value of all cash flows from a particular project equal to zero. Generally speaking, the higher a project`s internal rate of return, the more desirable it is to undertake the project. As such, IRR can be used to rank several prospective projects a firm is considering. Assuming all other factors are equal among the various projects, the project with the highest IRR would probably be considered the best and undertaken first. IRR as the rate of growth a project is expected to generate. While the actual rate of return that a given project ends up generating will often differ from its estimated IRR rate, a project with a substantial higher IRR value than other available options would still provide a much better chance of strong worth. IRR can also be compared against prevailing rates of return in the securities markets. If a firm cannot find any project with IRRs greater than the returns that can be generated in the financial market, it may simply choose to invest its retained earnings into the market. IRR (before tax) of a business venture / commercial project can be computed when all the cash flows (P, R, D, F) and lives (n) of assets are given. It is calculated by equating the Net Present Value (NPV) to zero. The corresponding value of ‘i’ is the IRR. Payback period: Payback Period in capital budgeting refers to the period of time required for the return on an investment to â€Å"repay† the sum of the original investment. For example, a $1000 investment which returned $500 per year would have a two year payback period. The time value of money is not taken into account. Payback period intuitively measures how long something takes to â€Å"pay for itself.† All else being equal, shorter payback periods are preferable to longer payback periods. Payback period is widely used because of its ease of use despite the recognized limitations described below. Useful Life: Period during which an asset or property is expected to be usable for the purpose it was required. It may or may not correspond with the item`s actual physical life or economic life. The length of time that a depreciable asset is expected to be usable is its useful life. Cost of Capital: The required return necessary to make a capital budgeting project, such as building a new factory, worthwhile. Cost of capital includes the cost of debt and the cost of equity. It determines how a company can raise money (through a stock issue, borrowing, or a mix of the two). This is the rate of return that a firm would receive if it invested in a different vehicle with similar risk. The cost of capital is a term used in the field of financial investment to refer to the cost of a company’s funds (both debt and equity), or, from an investor’s point of view â€Å"the shareholder’s required return on a portfolio of all the company’s existing securities†. It is used to evaluate new projects of a company as it is the minimum return that investors expect for providing capital to the company, thus setting a benchmark that a new project has to meet. For an investment to be worthwhile, the expected return on capital must be greater than the cost of capital. The cost of capital is the rate of return that capital could be expected to earn in an alternative investment of equivalent risk. If a project is of similar risk to a company’s average business activities it is reasonable to use the company’s average cost of capital as a basis for the evaluation. A company’s securities typically include both debt and equity, one must therefore calculate both the cost of debt and the cost of equity to determine a company’s cost of capital. However, a rate of return larger than the cost of capital is usually required. Market Price: Market price is the economic price for which a good or service is offered in the market place. Market pricing is primarily determined by the interaction of supply and demand. Price is interrelated with both of these measures of value. The relationship between price and supply is generally negative, meaning that the higher the price climbs, the lower amount of supply is demanded. Market price is just the price at which goods and services are sold. Price, the amount of goods for which a product is sold, may be seen as a financial expression of the value of the product. Setting the right price is an important part of effective marketing, being the only part of the marketing mix that generates revenue, as product, promotion, and place are all about marketing costs. Price is also the marketing variable that can be changed most quickly. Collin Ta’eed’s ‘Making Money’ describes pricing strategy as a difficult task that depends on nine major factors. They are as follows: 1. Total Costs: If the market price doesn`t include enough just to break-even, one is heading for trouble. The best thing to do is sum up all costs and divide by the number of hours that can be billed a year. This doesn`t include sick days, holidays, and hours working on the business, hours with no work and so on. All hidden costs must be factored. E.g.: insurance, invoices that never get paid for one reason or another, and taxes. 2. Profit: The aim of every business is to make money. Profit is the target money one wants to make above breaking even. Profit is affected by the revenue generated which in turn depends on market price. 3. Market Demand: The concept of demand – supply states that if what one does is in high demand, then make your services more expensive. Conversely if there`s hardly any work around, then decide the market price based on competitors pricing strategy. Signs that demand are high include too much work coming in, other freelancers being overloaded and people telling you they`ve been struggling to find someone to do the job. Signs that demand are low include finding yourself competing to win jobs, a shortage of work and fellow freelancers re-entering the workforce. 4. Industry Standards: It is a technical standards used in business. It is based on the industry market price, value for money, services offered etc. in order to fit in the market, one must adhere to industry standards. 5. Skill Level: Different people, depending on the result they produce, possess a different skill level. When applies to companies, it implies that the market price must be commensurate with the company`s skill. 6. Experience: Although often bundled with skill, experience is a different factor altogether. Experience affects how much a company must charge. E.g.: You may have two very talented photographers, but one with more experience might have better client skills, be able to foresee problems (and thus save the client time and money), and intuitively know what`s going to work for a certain audience and so on. 7. Business Strategy Adopted: Business strategy or angle will make a huge difference to the pricing strategy. E.g.: Think about the differences between Revlon and Chanel, the two could make the same perfume but you would never expect to pay the same for both. Pitching oneself in front of the target customers helps define a company as cheap and cheerful, high end or somewhere in between. This largely affects the market price as people are ready to pay a premium for high end goods. 8. Service Offered: Services are an intangible equivalent of economic goods. Service provision is often an economic activity where the buyer does not generally, except by exclusive contract, obtain exclusive ownership of the thing purchased. The benefits of such a service, if priced, are held to be self-evident in the buyers` willingness to pay for it. Public services are those societies as a whole pays through taxes and other means. The services that a company provides for its clients make a big difference to its price tag. For example you might be a freelancer, who will do whatever it takes to get a job just right, or perhaps you are on call 24-7, or perhaps you provide the minimum amount of communication to cut costs. Whatever the case, adjusting the pricing to the type and level of service provided is a must. 9. Market Segment: Prices will often vary for different clients. This happens for a few reasons. Some clients require more effort, some are riskier, some are repeat clients, some have jobs you are dying to do, some you wouldn`t want to go near with a stick. Thus these factors must be taken into account while pricing a commodity. Fixed Costs: A cost that does not change with an increase or decrease in the amount of goods or service produced. Fixed costs are expenses that have to be paid by a company, independent of business activity. It is one of the two components of the total cost of a good or service, along with variable cost. Fixed costs are defined as expenses that do not change as a function of the activity of a business, within the relevant period. E.g. rent, property tax, insurance, or interest expense. An example of a fixed cost would be a company`s rent on a building. If a company has to pay $10,000 each month to cover the cost of the rent but does not manufacture anything during the month, the rent payment is still due in full. In economics, a business can achieve economies of scale when it produces enough goods to spread fixed costs. For example, the $100,000 lease spread out over 100,000 widgets means that each widget carries with it $1 in fixed costs. If the company produces 200,000 widgets, the fixed cost per unit drops to 50 cents. Variable Costs: A corporate expense that varies with production output. Variable costs are those costs that vary depending on a company`s production volume; they rise as production increases and fall as production decreases. Variable costs differ from fixed costs such as rent, advertising, insurance and office supplies, which tend to remain the same regardless of production output. Variable costs can include direct material costs or direct labor costs necessary to complete a certain project. For example, a company may have variable costs associated with the packaging of one of its products. Conversely, when fewer of these products are sold the costs for packaging will consequently decrease. Marketing Costs: It is the amount of money spent on advertisement, distribution and selling of finished goods in the market. It has components of fixed and variable costs. It is difficult to obtain an estimate of the marketing cost. Hence, it is taken as a percentage of total costs and added to it. Total Costs: Total costs (TC) describes the total economic cost of production and is made up of variable costs, which vary according to the quantity of a good produced and include inputs such as labour and raw materials, plus fixed costs, which are independent of the quantity of goods produced and include (capital) that cannot be varied in the short term, such as buildings and machinery. Total cost in economics includes the total opportunity cost of each factor of production as part of its fixed or variable costs. If one assumes that the unit variable cost is constant, as in cost-volume-profit analysis developed and used in cost accounting by the accountants, then total cost is linear in volume, and given by: total cost = fixed costs + unit variable cost * quantity. Figure 4: Total Cost = Fixed Cost + Variable Cost Revenue: In business, revenue is income that a company receives from its normal business activities, usually from the sale of goods and services to customers. Revenue may refer to business income in general, or it may refer to the amount, in a monetary unit, received during a period of time. Profit: It is the difference between a firm`s total revenue and all costs. It is the positive gain from an investment or business operation after subtracting for all expenses. It is the opposite of loss. Profit = Total Revenue – Total Costs Profit is the money a business makes after accounting for all the expenses. Regardless of whether the business is a couple of kids running a lemonade stand or a publicly traded multinational company, consistently earning profit is every company`s goal. The path toward profitability can be long. For example, online bookseller Amazon.com was founded in 1994 and did not produce its first annual profit until 2003. Many startups and new business fail when the owners run out of capital to sustain the business. Profit Before Tax: A profitability measure that looks at a company`s profile before the company has to pay corporate income tax. This measure deducts all expenses from revenue including interest expenses and operating expenses, but it leaves out the payment of tax. This measure combines all the company`s profits before tax, including operating, non-operating, continuing operations and non-continuing operations. PBT exists because tax expense is constantly changing and taking it out helps to give an investor a good idea of changes in a company`s profits or earnings from year to year. 3.2 Data Procurement Data required for analysis * List of Assets * Cost Spent on assets at t=0 * Useful life of each asset * Resale salvage price of each asset * Average repair and maintenance cost per year * Administrative cost per year * Fixed expenses incurred per year like rent, wages etc. * Variable costs involved in rice production * Quantity of rice, bran, husk produced * Unit price of raw material (paddy) and products (rice, bran, husk) The current asset price, useful life and salvage value was provided by Satake. Refer: Appendix A, Table 1.1. Data Description Each asset has a list of the following variables (whichever is applicable) * Quantity * Model type * Capacity * Electrical Rating * Market Price Data required for analysis of Rice Husk Gassifier * List of assets * Cost Spent on assets at t=0 * Useful life of each asset * Resale salvage price of each asset It is obtained from various sites online. Refer: Appendix B, Table 2.1. 3.3 Specifications and Assumptions Some specific data: * Capital Expenditure incurred = Rs. 9,05,04,240 * Capacity of Rice Mill = 4 tons per hour * Maximum Run = 270 days * 16 hours * Annual Requirement of Paddy at installed capacity = Capacity*Maximum Run = 17280 Metric Tonnes per year * The yield of rice is Particulars| Yield Percentage| Annual Yield (in MT)| Raw Rice| 65| 11232| Husk| 21| 3628.80| Broken Rice| 4| 691.20| Rice Bran| 8| 1382.40| Rejected Rice| 1| 172.80| Impurities| 1| 172.80| * Price of Paddy in the market = Rs. 1250 per quintal * Market Price of Raw Rice = Rs. 2000 per quintal * Market Price of Broken Rice = Rs. 1400 per quintal * Market Price of Bran = Rs. 1500 per quintal * Market Price of Husk = Rs. 320 per quintal Assumptions: * The plant is assumed to run for 270 days (approximate value for the rice mill) for calculations pertaining to profitability of rice mill. * The salvage cost is unknown and is taken as 10% of total assets cost. * Quantity of raw rice produced = Quantity of raw rice sold. No inventory is utilized. * No wastage of products and byproducts. 3.4 Solution Approach Payback Period Payback Period Internal Rate of Return Internal Rate of Return Net Present Value Net Present Value Solutions Solutions Net Present Value: * It is the algebraic sum of all cash flows pertaining to the project discounted to present time (t=0) at a chosen rate (i.e. Cost of Capital) NPV= -P+R-DÃâ€"1+in-1i*1+in+SÃâ€"11+in Where, P = Cost of Asset spent at time t=0 R = Revenue Income D = Disbursements S = Resale Stock Salvage Value i = Cost of Capital n = Number of Periods (Useful life of asset) Internal Rate of Return: The internal rate of return on an investment or project is the â€Å"annualized effective compounded return rate† or â€Å"rate of return† that makes the net present value (NPV) of all cash flows (both positive and negative) from a particular investment equal to zero. Payback Period: It is calculated by calculating Cumulative Cash Flow = (Net Cash Flow Year 1 + Net Cash Flow Year 2 + Net Cash Flow Year 3 †¦ etc.) Accumulate by year until Cumulative Cash Flow is a positive number: that year is the payback year. k= ln⠁ ¡(R-DR-D-P*i)ln⠁ ¡(1+i) Where, K = Payback Period P = Cost of Asset spent at time t=0 R = Revenue Income D = Disbursements i = Cost of Capital For calculation of Profit obtained Profit Function = Revenue generated – Cost Incurred Revenue generated = ∑(Qi*pi) Where, Qi = Quantity of commodity i sold per year pi = Unit Price of commodity i in the market Cost Incurred = Fixed Costs (FC) + Variable Costs (VC) Refer: Appendix A, Table 1.3 and Table 1.4. Chapter 4: Results and Discussions ————————————————- Result 1: For initial estimated values of input parameters * Initial Project Cost incurred at t=0 (P) = Rs. 90504240 (Refer: Appendix A, Table 1.2) * Gross Revenue Income (R) = Rs. 266664960/year (Refer: Appendix A, Table 1.4) * Operating Expenditure/ Disbursement (D) = Rs. 223860420/year (Refer: Appendix A, Table 1.3) * Salvage Value /Resale Value (S) = Rs. 6707544, * Useful life of assets (n) = 20 years, * Cost of Capital (i) = 15% Figure 5: Cash Flow Diagram at estimated values of input parameters Refer: Appendix A, Table 1.5. Using engineering economics equations (Refer Chapter 3, section 3.4 – Solution Approach), we have found * NPV= -90504240+266664960-2435595801+0.1520-10.15*1+0.1520+6707544[11+0.1520] = Rs. 54529825.06 * IRR = 25.27% at NPV = 0 * Payback period, k= ln(266664960-243559580266664960-243559580-90504240*0.15)ln(1+0.15) = 6.34 years Figure 6: C programme for calculating IRR Refer: Appendix C. This is the C programme return to calculate the IRR of any cash flow correct upto two decimal places. This programme can be used for any type of cash flows. Result 2: The following two graphs depict the relation of Cost of Capital with NPV and Payback Period. Figure 7: Effect of Cost of Capital on NPV Refer: Appendix A, Table 1.6. This graph helps obtain an estimate of the NPV based on the Cost of Capital. In order to get higher NPV, the Cost of Capital should be less. With a variation of 10% in the Cost of Capital, from 11% to 20% the NPV decreases substantially from 94 million INR to 22 million INR. Figure 8: Effect of Cost of Capital on Payback Period Refer: Appendix A, Table 1.6 This graph helps obtain the estimate of the Payback period based on the Cost of Capital. In order to get lesser Payback Period, the Cost of Capital should be less. With a variation of 11% in the Cost of Capital, from 10% to 20% the Payback Period increases substantially from 3.56 years to 10.95 years. Discussion: The value of Cost of Capital is varied over a feasible range of 10% to 20% and the corresponding values of NPV and Payback period. If the Cost of Capital decreases, the NPV of the firm increases while the Payback Period of the firm will reduce as expected from the formulae of NPV and Payback Period – Refer Chapter 3, section 3.4 – Solution Approach. Result 3: The following two graphs depict the relation of cost of unit amount of paddy (raw material cost) with NPV and IRR. 1 Unit = 1 Quintal Figure 9: Effect of unit Paddy Price on NPV Refer: Appendix A, Table 1.7. This graph helps obtain an estimate of the NPV based on the cost of unit amount of paddy. The graph shows more or less a linear variation as expected. In order to get higher NPV, the cost of raw material should be less. A large variation could be seen in the NPV i.e. from 324 million INR to -216 million INR, when the price of paddy varies from 1000 INR per quintal to 1500 INR per quintal, keeping all other market price and other factors constant. In India, the Government of India fixes the minimum paddy price to save the interests of the farmers. So, if the price of the paddy goes above 1300 INR per quintal, the firm will not be beneficial at all instead will start incurring a loss. Figure 10: Effect of unit Paddy Price on IRR Refer: Appendix A, Table 1.7 In the graph the effect on IRR for different unit price of Paddy is shown. As the price of paddy increases from 1000 INR per quintal to 1350 INR per quintal, the IRR decreases substantially from 73.26% to 2.99% in eight uniform steps. Discussion: For a fixed market price of Raw Rice, NPV and IRR decreases substantially with increase in unit price of Paddy. This is an obvious conclusion from the NPV equation – Refer Chapter 3, section 3.4 – Solution Approach. As the unit price of paddy rises, the operating cost also starts increasing thus our annuity per year will decrease. With decrease in NPV and IRR, the payback period also increases. Result 4: In the following two graphs the unit price of Raw Rice (product) is varied to see the effect on the NPV and IRR. 1 Unit = 1 Quintal Figure 11: Effect of unit Raw Rice Price on IRR Refer: Appendix A, Table 1.8 This graph helps obtain the NPV of the firm based on the unit market price of Raw Rice. As the unit market price of Raw Rice increases, the Gross Revenue Income increases substantially which leads to increase in NPV. This graph shows linear variation with unit price of Raw Rice as expected. A large variation could be seen in the NPV i.e. from -191.5 million INR to -441.2 million INR, when the price of raw rice varies from 1650 INR per quintal to 2550 INR per quintal, keeping all other market price and other factors constant. With 1% increase in the unit market price of Raw Rice, the NPV of the firm increases substantially by 25.784%. If the unit market price of Raw Rice is above 1920 INR per quintal, the firm will be beneficial and below that price it will be running in loss. Figure 12: Effect of unit Raw Rice Price on IRR Refer: Appendix A, Table 1.8 In the graph, the variation of IRR for different unit market price of Raw Rice is studied. The unit market price of Raw Rice is varied in a feasible range of 1850 INR to 2550 INR, to estimate the effect on IRR. The IRR of the firm increases substantially from 3.71% to 93.79% in twelve uniform steps. This happens because as the unit market price of Raw Rice increases, the gross revenue income also increases which increases the IRR of the firm and reduce the payback period. Discussion: The unit market price of Raw Rice is required to estimate the profit that can be earned. As the unit price of Raw Rice increases, the gross revenue income increases and thus the NPV and IRR of the firm increases substantially. If the revenue increases, the payback period of the firm will reduce. If the unit market price falls beyond a certain point i.e. 1920 INR per quintal, the firm will start incurring loss. These graphs help in setting competitive market price of Raw Rice. Result 5: The following two graphs show the effect of unit market price of Bran (byproduct) on the NPV and IRR of the firm. 1 Unit = 1 Quintal Figure 13: Effect of unit Bran Price on NPV Refer: Appendix A, Table 1.9 This graph helps obtain the NPV of the firm based on the unit market price of Bran. The NPV of the firm increases from 11.27 million INR to 141 million INR in fifteen equal steps assuming 50 INR hike in unit market price of Bran at every step. This graph shows linear variation with unit price of Raw Rice as expected. With 1% increase in the unit market price of Bran, the NPV of the firm increases substantially by 2.38%. Figure 14: Effect of unit Bran Price on IRR Refer: Appendix A, Table 1.9 Since with the increase in the unit market price of Bran the NPV of the firm increases, therefore IRR of the firm also increases. With 1% increase in the unit price of Bran the IRR increases about 0.24%. This graph shows more or less a linear variation. The IRR of the firm increases from 17.20% to 40.76% as the price of Bran increases from 1000 INR per quintal to 2500 INR per quintal. Discussion: The unit market price of Bran, a byproduct, also has substantial effect on gross revenue income as it forms 8% part of the total outcome which is about 1382.40 Metric tons. Today market price of Bran is about 1500 INR per quintal through which 20.736 million INR revenue is generated per year. Since, an increase in unit market price of Bran increases the gross revenue income, the NPV and IRR of the firm also increases. With increase in revenue, the payback period of the firm decreases. Result 6: Figure 15: Effect of Salvage on NPV Refer: Appendix A, Table 1.10 Figure 16: Percentage change in NPV with percentage change in Salvage Value Refer: Appendix A, Table 1.10 Basic Assumption: Salvage value is hard to define as it is the future value of 20 years down the line from now. Hence it is assumed to be certain percentage of the total assets cost. It is assumed to be 10% of the total assets cost incurred and is discounted to today’s value at a rate of 15% to find the Net Present Value of the firm. The salvage value can vary over a range of 5% to 20% of the total assets cost. The NPV changes from -0.5% to 0.75% i.e. from 54.32 million INR to 54.94 million INR by changing the salvage value by -5% to 10% i.e. from 5% to 20% of the total assets cost. Discussion: The NPV of the firm doesn’t increases substantially with increase in the salvage value of the assets. The graph shows a straight line variation as expected. With 1% increase in salvage value the NPV increase by 0.075%. This increase in the NPV is negligible, therefore, even if the assumed resale value of the assets change in the future, it will not affect the calculations done in this case study for the profitability analysis of Jay Laxmi Rice mill. Result 7: The following two graphs will help in assessing the economy of generating electricity from husk (by product) using Rice Husk Gassifier. Figure 17: Effect of percentage of Total electricity requirement that is substituted by Rice Husk Gasifier on NPV Refer: Appendix B, Table 2.3 The graph shows that the NPV of the firm increases linearly as the amount of electricity produced by the husk Gasifier increases as expected. The NPV of the firm increases from 51 million INR to 89 million INR as the amount of electricity that is substituted by the Rice Husk Gasifier increases from 65% to 100% of total electricity requirement. The minimum amount of total electricity that should be produced from husk so that the firm has the same NPV as before implanting the husk gasifier is 68.8% Figure 18: Effect of percentage of Total electricity requirement that is substituted by Rice Husk Gasifier on IRR Refer: Appendix B, Table 2.3 This graph shows the variation of the IRR of the firm with respect to the percentage of the total electricity requirement that is substituted by Rice Husk Gasifier. The graph shows an expected linear increase in IRR as the amount of electricity produced by the husk Gasifier increases. The IRR of the firm increases from 24.52% to 31.32% as the amount of electricity that is substituted by the Rice Husk Gasifier increases from 65% to 100% of total electricity requirement. Discussion: To be economic at least 68.8% electricity requirement needs to be generated from Husk Gasifier i.e. the minimum amount of total electricity requirement that should be substituted by the Rice Husk Gasifier so that the firm profit as before setting up of the Rice Husk Gasifier. If the amount of electricity produced is more than this amount than the plant will earn more profit than before but if it is less, then the rice husk gasifier should not be set up, because the plant will be earning less than before. The plant may be beneficial but will be in loss as comparison to the current scenario. The following figure 19 shows the cash flow diagram when 68.8% of electricity requirement is generated from Husk Gasifier. Figure 19: Cash Flow diagram with Rice Husk Gasifier Refer: Appendix 8, Table 2.2 Chapter 5: Summary and Conclusions ————————————————- 5.1 Summary The main aim of this study was was to analyze the Jay Laxmi Rice Mill, Bazpur in Udham Singh Nagar district in the state of Uttarakhand, from its business point of view. It has a nominal capacity of 4000kg/hr. It has been built for the production of raw rice. Some estimates were required to analyze its profitability. The economic analysis of the project was carried out using engineering economics equations. The sensitivity of NPV, IRR and Payback period with respect to various factors like Cost of Capital, paddy price, raw rice price, bran price and salvage were studied. Also the economy assessing of generating electricity from husk (by product) using Rice Husk Gassifier was done. The minimum electricity requirement that needs to be generated from Rice Husk Gasifier for economic purposes was calculated. The following conclusions are drawn from the study: * For initial estimated values of input parameters (P = Rs. 90504240, R = Rs. 266664960/year, D= Rs. 223860420/year, S = Rs. 6707544, n = 20 years, i = 15%) * NPV = Rs. 54529825.06 * IRR = 25.27% * Payback period = 6.34 years * With a variation of 10% in the Cost of Capital, from 11% to 20% the NPV decreases substantially from 94 million INR to 22 million INR and Payback Period increases from 4.03 increases to 10.95 years. * A large variation could be seen in the NPV i.e. from 324 million INR to -53.5 million INR, when the price of paddy varies from 1000 INR per quintal to 1350 INR per quintal while IRR increases from 73.26% to 2.99%. * NPV increases from -50.9 million INR to -441.2 million INR and IRR increases from 3.71% to 93.79%, when the price of raw rice varies from 1850 INR per quintal to 2550 INR per quintal. * As the price of Bran increases from 1000 INR per quintal to 2500 INR per quintal, the NPV and IRR of the firm increases from 11.27 million INR to 141 million INR and 17.20% to 40.76% respectively. * With 1% increase in salvage value the NPV increase by 0.075%. This increase in the NPV is negligible, therefore, even if the assumed resale value of the assets change in the future, it will not affect the calculations done in this case study for the profitability analysis of Jay Laxmi Rice mill. * To be economic at least 68.8% electricity requirement needs to be generated from Husk Gasifier i.e. the minimum amount of total electricity requirement that should be substituted by the Rice Husk Gasifier so that the firm profit as before setting up of the Rice Husk Gasifier. References ————————————————- * James L. Riggs 2004, Engineering Economics, 4th edition, Tata Mc Graw Hill Education Private Limited, pp 67-147. * Chandra P. 2011, Fundamentals of Financial Management, 11th edition, Tata Mc Graw Hill Education Private Limited, pp 150-167. * T. Kapur, T. C. Kandpal and H. P. Garg, Electricity Generation from Rice Husk in Indian Rice Mills: Potential and Financial Viability, Indian Institute of Technology, New Delhi (1995). * Alexis Belonio, Victoriano Ocon, and Antonio Co, Garbage-In Fuel-Out: Small-Scale Rice Husk Gasifier Plant for Community Street Lighting, Suki Trading Corporation, Philippines (2011). * Email from Gaurav Vashisht (gaurav@satakeindia.com) working at Satake, kolkata.