Financial Management & Corporate Finance Case Study

Appraisal of Bharat Insulation Limited (BIL): Is the Project Financially Viable?

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Abstract:
Bharat Insulator Limited (BIL) was contemplating production of the Super Insulator (SI) in India under a license agreement from Global Insulator Limited (GIC), which held the patent for SI. The product was to be manufactured and marketed in India by BIL for the next 10 years after which all its assets were to be sold to GIC who would then directly enter the growing Indian market. Understanding that BIL had to make the most of the limited period license, its management decided to concentrate only on the most profitable and certain market segment of the domestic market demand which would agree to pay a market skimming price. Under the deal between GIC and BIL, since the surplus production was to be sold to GIC who were offering a very low margin to BIL over its variable cost of production, it simply was not appealing to the licensee. BIL contended that GIC intended to use its (BIL’s) excess production to fulfill its international demand without sharing the gains, which would mean BIL would be investing in assets without much gain and working as a low cost supplier to GIC. On the other hand, GIC argued that its global strategy had benefited licensees the world over and that a large production facility would only be to the benefit of BIL. To add to the uncertainty was the covenant imposed by the financing body, the Industrial Finance Corporation (IFC), which BIL had approached for project finance. IFC insisted that if it were to finance BIL for its required equity, it would do so only to the extent required to cater to the certain portion of the projected domestic demand of SI in the first year of operation and that it would not allow any further fund raising by BIL from any other source.

Pedagogical Objectives:

• Project valuation and valuation of alternative strategic choices
• Valuation of a project from the equity investor point of view
• Interaction between contribution and scale of production
• Demand forecasting and concept of derived demand
• Certainty equivalence and incremental cost and benefit of effecting a change in certainty equivalence
• Real Options.

Keywords : Capital Budgeting, Certainty Equivalence, Contribution, Covenant, Demand Forecasting, Derived Demand, Incremental Cost, Project appraisal, Project Finance, Project Management, Project Valuation, Real Options, Scale, Strategic Finance