On September $20,2016,$ Saurabh Sharma, Senior Vice President of Bhatia Textiles Company,

sat in his office pondering the new capital budgeting proposal for setting up a product line

of branded shirts. As per standard company practice, he was required to evaluate the capital

budgeting project using the traditional Net Present Value $($NPV$)$ approach and the Internal

Rate of Return $($IRR$)$ criterion and present his findings to the management committee meeting

scheduled for the next week. Saurabh wondered whether this new proposal would turn out to be

a good investment for his company, which was looking to deploy funds in NPV positive projects.

The case puts students in a financial analyst role wherein they conduct capital budgeting

analysis using the popular techniques of NPV and IRR.

Case

Learning Outcomes

By the end of this case study, students should be able to:

$$ Understand the concept and importance of capital budgeting and investment decision$-$making.

$$ Discuss and identify the various information required for financial evaluation of investment proposals.

$$ Understand and calculate after$-$tax operating cash flows for capital budgeting analysis, taking into

account the revenues, costs, depreciation, and working capital.

$$ Determine terminal year cash flows after considering salvage value and working capital.

$$ Understand the computation of cost of capital for determination of discounting rate.

$$ Determine the Net Present Value $($NPV$)$ and Internal Rate of Return $($IRR$)$ for accepting or rejecting

a capital budgeting proposal.

Introduction

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