Relocation of Chemical Plant

I: Your client is a residential society based in Mumbai. They are facing problems from the smoke emitted from the chemical plant present in the adjacent area. You are hired to make a proposal to the plant to shift to another location

C: Firstly, I would like to know more about the client. How long has the residential society been in existence? What type and how many houses are there?

I: The society was established five years back and it has 2000 flats. 

C: I would now like to understand the area where our client is located. Is it majorly a residential area or industrial area? What were the developments in the area since the client’s society has been established?

I: It was majorly an industrial area in the past. However, with time, industries started shifting to other location and the chemical plant is the only industry left in the area.

C: What were the major reasons of other industries shifting from this area? What were the developments on their lands?

I: There were multiple reasons such as rising operating costs such as utilities, tax, etc.; attractiveness of other areas in terms of modern infrastructure, etc. However, the chemical plant doesn’t have any issue with it. 

C: Ok, now I would like to know about the chemical plant. What do they produce? How many plants do they have? Whom do they cater to? Where do they lie in the value chain?

I: The plant procures raw materials and manufactures chemicals, which are raw materials for other chemical plants. They directly deal in B2B business and cater to different manufacturers based out of India.

C: I would like to perform cost-benefit analysis while considering financial, and operational aspects for understanding how favourable it will be to the plant to shift to different location. We need to consider challenges and risks involved in project.

I: Sounds good, you may proceed.

C: Starting with financial aspect, I would like to understand cash-flows that will happen in the shifting operation. Cash in-flow will be sale of existing property, while Cash out-flow will be expenses for land acquisition, construction of new facilities, moving equipment, and reestablishing operations. First to estimate cash in-flow, do we have valuation of land at current site?

I: Yes, can you estimate assuming that the current site’s land area is similar? Also, many builders are planning to build similar property as ours at the plant’s property.

C: In this case, we have to estimate the amount the builder will pay for the land. Cost of land will majorly be Revenue – Cost of Construction – Expected Profits. Revenue will be (No. of Flats)x(Area of each flat)x(Rate per sq. ft.). Do we have these data?

I: Yes, in the client’s society, flats on average have 1000 sq. ft. and the rate is Rs 30K/ sq. ft. Cost of construction is Rs 10000/ sq. ft. Builder will expect 1K Cr profit.

C: Ok, for a single flat, revenue will be 3 Cr and for 2000 flats, it will be 6000 Cr, provided all flats will be sold. Cost of construction is one-third of sale value. Hence, cost of construction will be 2000 Cr. Considering Revenue, Construction Cost and Profits, the builder should be willing to pay 3000 Cr for the land of plant.

I: Good. How will you calculate cash out-flows?

C: Cash out-flow will be expenses for land acquisition, construction of new facilities, moving equipment, and opportunity cost. Opportunity cost is the loss of profit during the time of shifting and constructing the new location. Do we have any data to estimate these costs?

I: Yes, the costs of acquiring new land, construction of new facilities, and moving equipment are 1000 Cr, 500 Cr, and 125 Cr respectively. Plant is having annual revenue of 6000 Cr with 15% profit margin. Shifting and reestablishing operation will take around 3 months.

C: Opportunity cost due to loss of profit will be (Annual Revenue) x (Profit Margin)x(Months required for Reestablishing)/ 12. It will come to 725 Cr. Hence, total cash out-flows will be 2350 Cr. Net cash flow will be 650 Cr i.e., positive.

I: Correct, however, you are missing on one aspect while calculating cash-flow. Will the cash-flow occur at present time period?

C: No, these cash flows will occur in future, and hence we have to consider time value of money. We also need to calculate ROI for the relocation project over a defined timeframe (e.g., 5, 10, or 20 years).

I: Correct, what other aspects will you consider?

C: Now, I would like to focus on cost-benefit analysis on operational aspects. Firstly, we need to analyse changes in costs of RM procurement, manufacturing costs, and distribution costs. New site may have potential operational benefits, such as improved plant efficiency, access to better transportation infrastructure, a larger labor pool, and proximity to suppliers or customers.

I: We can close the case. Thank you.