ByProf. Sitangshu Khatua

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Financing Decision

Investment Decision

Dividend Decision

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Capital Structure Debt Equity Ratio Optimal Capital Mix Maximize firm’s value Minimize Cost of Capital

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Equity – external equity, Retained Earning , Pref. Capital

Public Issue, Bonus Issue, Right Issue, Private Placement, BOD

Seed Capital, Angel investment, Venture Capital

Debt – Long Term Vs Short term relevance/irrelevance Theory Trade- off Theory Agency Cost – ACE and ACD Signaling Theory Pecking Order Theory

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Appraisal Criteria DCF Vs Non DCF NPV Vs IRR MIRR APV WACC REAL Option – Option to expand, Option to

Postpone, Option to shut down

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Decision regarding dividend Decision regarding rate of dividend Retained Earning Short term gain Long term gain due to price appreciation

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M/S Purple Haze limited an Indian Company was incorporated in the year 1980 and it had started commercial production from early 1981. They were the manufacturers of industrial products. Initially establish itself as the primary player in the Indian market, as regards their product range. The Indian market has accepted that the quality of the products offered by M/S Purple Haze limited was definitely among the best if not the best in the country. It was even said that their products are in no way inferior to that of their global competitor.By 1990’s it had an average annual turnover of Rs. 700 crores netting an average annual after tax profit of Rs. 150 crores approximately.

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However in 1983 the management of the said company, (working hand in hand with a number of unscrupulous employees of the same company) started to gradually shifon out the funds through various modes and the company as a whole fell in to a difficult position. Although it was originally known as one of the most cash rich company of the country, it started to feel the pinch of acute cash crunch. The company reported cash losses in 1996 and 1997 and by early 1998 its net worth became negative. Consequently, the company was declared sick and accordingly referred to BIFR.

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The mismanagement of the company coupled with several horror stories of siphoning the fund by the management of the said company became the headline news of the Indian newspapers and all the related facts came into open. Consequently, the company lost its goodwill and image in the market and chances of revival and survival was only reduced to an impractical dream. In the view of the above, the entire board was replaced by a new set of directors who were professionally capable, energetic, hard task masters and quite ethical in their business focus.

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The new board of directors drafted a revival plan for the said company which was accepted and passed by the BIFR team. However, they were obviously a little apprehensive about the future prospects of M/S Purple Haze limited and they that they will not allow the management to go ahead with their proposal on a test run basis. They were ready to provide financial assistance to the tune of Rs. 50 crores which was estimated as the funds required to restart the operation of the said company inclusive of the post production of the first month of operations.

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BIFR commented that, if the company is able to record a cash profit within a period of six months of their operations (starting from 1/10/2000), then it may be inferred that the revival plan is suggested by the company will prove to be successful in future. In that case BIFR showed their willingness to support the operations of the company in their endeavor of survival.

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• The board of directors conducted a meeting involving the top executives of different functional areas of the said company. Mr. Murray (V.P – Production) said that his team will perform efficiently and will produce industrial products of excellent quality as it is used to do before. He assured the boards that as regards the quality of products are concerned the customers of the company won’t have anything to complain about.

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Mr. Halford (M.D) asked Mr.Ozborne (V.P – Marketing) about the existing selling methodology and credit policies of the company. Mr. Ozborne commented that the entire sales of the company used to be through dealers spread over the entire country. It was the company policy to give a standard credit term of two months to the dealers with an understanding that if payment is made within a period of one month from date of sale the company will allow a cash discount of 3% percent to the respective dealers

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Mr. Halford told Mr.Ozborne to continue with the existing policy of cent percent sales through the dealers but advised him to discontinue the credit terms. He explained, that if M/S Purple Haze limited desires to survive it must generate cash resources within a very short span of time. He requested Mr. Richards to give discounts up to 8%. He felt that such heavy discounts will definitely act as incentive from dealer’s point of view. Mr.Ozborne was discovered that if the company is ready to give such generous discounts, his team members will not face any difficulties in selling their products to the respective dealer’s point of view.

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Mr.Ozborne was convinced that if the company is ready to such generous discounts, his team members will not face any difficulties in selling their products to the respective dealers against cash terms. Accordingly he had communicated the idea to his subordinates and had strict instructions for selling materials only against cash. The Reality:The reaction of the market, however, did not appear to be as rosy as it was expected. The marketing team of M/S Purple Haze limited came up with a completely different story as given below.

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The marketing professionals of the said company said that none of the dealers are ready to accept their materials against strict cash terms. Their conditions are here as under:-1. In the past couple of years M/S Purple Haze limited has totally lost their market standing and reputation and presently there will be a few takers of their products, especially, since a number of competitors are also doing pretty well in this trade and the customers are more or less satisfied with their products and services.

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2. The dealers were not at all confident about selling the products of M/S Purple Haze limited and for obvious reasons they cannot be rigid with their own credit terms. The ultimate customers will definitely ask for the same credit terms as offered by the competitors. 3. This dealers felt that, why should they take the risk when the future is so uncertain? In a nutshell the dealers are not impressed by the concept of “cash purchases with heavy discount.”

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Mr.Ozborne communicated the same to Mr. Halford, but, the MD commented that it is nothing but a complete failure of the marketing team and unless they can assure cash sales of their products the company’s mission can never be successful. Mr. Halford said, “I don’t know how you manage to do it Mr.Ozborne, but it is very evident that unless you manage to do it there is absolutely no chance of survival. You must find out a way. I don’t want our company to suffer because of you and your marketing team.

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When Mr. Ozborne came out from the room of Mr. Halford he was very dejected and depressed due to obvious reasons. He was having a cup of coffee with Mr. Gilmore and was just having an informal chat with him. He explained the entire situation to Mr. Gilmore and told him that he is totally at a loss and cannot even think of any solution.

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Mr. Gilmore asked him whether it is possible for the company to directly sell their products to the ultimate customers. Mr. Ozborne explained that probably that may be considered as a long term policy decision of the company but due to various reasons it is not a very feasible option in such a crisis situation.After considering the situation for sometime Mr. Gilmore actually came up with a brilliant idea which may tackle the situation quite well. He was quite confident that the probability of success will be reasonably high if this particular methodology is adapted. He explained the same to Mr. Ozborne and he agreed that this is definitely one option worth trying.What can be the Mr. Gilmore’s idea..........................????

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In view of the "case facts" it appears that Mr. Gillmore (i.e The VP - Finance), of M/S Purple Haze limited is considering the option of "bill discounting." In order to understand the significance and utility of the same it is necessary to understand the salient features of "bill discounting" transactions :-

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Analogically, a "Bill of Exchange " is like a post dated cheque. It is an instrument containing an unconditional order signed by a drawer directing a certain person (the drawee) to pay a certain some of money to the bearer of the instrument (the payee). Thus, there are three parties in a bill of exchange transaction, namely, the drawer, the drawee and the payee. The method of operation of the same is quite simple. The drawer through the instrument asks the drawee to pay the specified amount after the lapse of a predetermined period The drawee accepts the same and thus gets the desired credit facilities.

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Once accepted, it becomes a negotiable instrument and it can be bought or sold in the market. However, as per the standard practice, the drawer sells it at a discounted value to the concerned banker and obtains immediate money. Thus, both the drawer and the drawee derive benefits out of such arrangements. It may be noted that, a bill of exchange moves in the money market on the strength of the creditworthiness of the drawer and the drawee. Once the bill is accepted, credit of the drawer is substituted by the credit of the drawee.

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Thus in the instant case, an arrangement of "bill discounting" may sort out the problems which are being encountered by M/S Purple Haze limited. The company may act as the drawer of the "bill" and the dealers (i.e. the drawee) may accept the same. In the process, the dealers will get the desired credit terms and M/S Purple Haze limited may obtain ready cash by discounting the bill with the bankers. It is needless to mention that, the discounting charges may be quite high but it may also be appreciated that the said company should be ready to accept such high charges in view of the acute cash crunch it is encountering at present. Moreover, the company had already taken a decision to offer very generous discounts to its dealers (against cash terms) and hence, logically it should be prepared to bear the high bill discounting charges of the bank as well.

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It may be noted that, the concerned company may also consider the option of "Factoring" in order to resolve the problem at hand. An effort is being made here to explain the salient features of factoring :-Factoring: The motto of factoring is "produce, sell and forget". It is an arrangement under which a business sells its receivables to a specialized agency known as factor. Functionally the credit department of a business is substituted by a factor. The factor undertakes collection, accounting and management of debts. The customer, at the time of sale, are informed about the arrangement so that they make the payment directly to the factor. Normally a factor agrees to pay substantial advance against the receivables. The business thus gets the benefit of immediate availability of cash.

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A factor may purchase receivables without recourse or with recourse. If the arrangement is without recourse, then the factor becomes liable to bear the loss of bad debts. In the case of with recourse factoring arrangements, such loss is borne by the business firm itself The fees charged by the factor in case of without recourse arrangement is much more than the other variety for obvious reasons. Thus, it is needless to mention that from the cash flow point of view, factoring is an extremely valuable arrangement. The other benefits include elimination of collection costs and costs associated with credit investigation and analysis.

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