In April 2013, Rajiv Sharma had a business plan. For quite some time, he had been doing some market research exploring the potential of his dream project establishing a fly ash brick manufacturing unitand had seen huge potential for profit in the project.

On the basis of preliminary analysis, he decided to set up a plant that would have the capacity to manufacture four million bricks per year. Though actual production would depend on market demand, the partners estimated that 2.4 million bricks could be sold per year at an average selling price of Rs7,000¹ per 1,000 bricks. He wanted to ascertain the feasibility of the project using a cost-volume-profit (CVP) analysis.

MANUFACTURING PROCESS

The manufacturing process for these bricks, known as fly ash-lime-gypsum bricks, required intimate mixing of fly ash, sand, lime and gypsum. Gypsum and lime were first ground to fine particles and then fly ash and sand added to make a fine blend. The ratio of the input material was as follows:

Fly ash: 60 to 80 per cent

Sand: 10 per cent

Gypsum: 10 per cent

Lime: 10 to 20 per cent

NTPC established pilot ash brick manufacturing plants at its 13 thermal power plants. Approximately 150 million bricks had already been manufactured in these plants and used for in-house consumption. To guarantee the quality of manufactured bricks, it was suggested that the new brick manufacturing plants follow the guidelines of the quality standard of IS 12894:1990.⁴

SHARMAS BRICK PROJECT

. . . the use of coal for power generation results in increased quantum of fly ash production, which has reached over 100 million tonnes per year. All-out efforts are needed to utilize this fly ash not only for environmental considerations, but also to avoid land usage for fly ash dumping. Though there has been a steady progress in fly ash utilization from 1990, we have a long way to go to reach the target of 100 per cent fly ash utilization. It is reported that the agricultural increase of grains is around 15 per cent, green vegetables 35 per cent and root vegetables 50 per cent when

fly ash is mixed with the soil. Presently, the fly ash utilization is in the range of 40 million tonnes per year providing employment for over 50,000 personnel. At the full utilization of the generating stock, this will provide employment potential for 300,000 people and result in a business volume of over Rs40,000 million per year.⁵

After considering this speech, the two friends continued to discuss the project.

Gupta: I think its a great idea to use fly ash to manufacture bricks. The availability of fly ash, I guess, will never be a problem. Nearly three-fourths of the installed power generation capacity of India comes from thermal plants, in 90 per cent of which coal is used as the primary fuel. As long as coal is used to generate thermal power, the residual product fly ash will continue to be produced.

Investments Required

Sharma: Alok, at the outset we require Rs8 million as an initial investment in fixed assets. Here, take a look at the costing [he hands over a sheet of paper. According to my estimate, the major expenses would be in transport vehicles and machinery. The building modifications will require approximately Rs1.40 million.

Gupta examined the table illustrating the estimated expenses (see Exhibit 2).

Sharma: In addition to the above investments, I have estimated the working capital requirements, which are expected to be approximately Rs2 million. Other routine expenses are estimated as follows [see Exhibit 3]. Have a look. [He hands over another sheet of paper].

These are essentially the raw materials, electricity and labour for making the final product. According to my estimates, the cost of major raw materials, energy requirements and labour would be Rs900,000 per month (see Exhibit 4).

Sharma handed the estimates of the manpower costs to Gupta (see Exhibit 5). Sharma himself would work as production manager, since hiring another person for the post would cost them Rs50,000 per month.

They agreed to consult expert to evaluate their business plan.

FINAL DECISION

Although the proposed plant had the capacity to produce four million bricks per year, actual production would depend on market demand. Further, output would decline in case of any breakdowns of plant and equipment. Finally, the partners estimated that a sales volume of 2.4 million bricks could be sold per year at an average price of Rs7,000 per 1,000 bricks. The initial investment would cost them Rs10 million, out of which Rs6 million would be invested by the partners from their own resources. A local bank had agreed to provide a loan for the balance at an interest rate of 12 per cent per annum against the mortgage of the equipment. Sharma would work full time in the business and would draw a salary of Rs50,000 per month. The life of the project was estimated to be five years. The salvage value of the plant and equipment at the end of five years would be negligible and could be ignored. However, investments in the working capital would be recovered in full.

EXHIBIT 2: ESTIMATED INVESTMENT IN INDIAN RUPEES

Building Modification	1,400,000
Water supply arrangements	100,000
Machinery	2,000,000
Trucks	3,000,000
Payload machine	1,500,000
Total	8,000,000

EXHIBIT 3: ROUTINE EXPENSES PER MONTH IN INDIAN RUPEES

Building rent	50,000
Administrative cost	10,000
Office supply	5,000
Electricity (for lighting)	10,000
Miscellaneous	20,000

EXHIBIT 4: EXPENSES RELATED TO VOLUME OF PRODUCTION PER MONTH IN INDIAN RUPEES (FOR 0.20 MILLION BRICKS)

Fly ash	250,000
Gypsum	250,000
Lime	300,000
Sand	40,000
Electricity	10,000
Labour	50,000
Total	900,000

EXHIBIT 5: PERSONNEL COSTS PER MONTH IN INDIAN RUPEES

Workers	100,000
Office assistant	20,000
Watchman	15,000
Drivers	25,000

Answer the following questions:

Briefly explain the return on equity (ROE). How do volumes affect the return on equity? Illustrate your answer using the data given in the exercise document.

What advice would you like to offer to the owners on operating this venture, and at what scale? Or even the rejection of the venture, with proper justifications for your advice.