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W25080

ANWAL GAS TRADERS: CAPITAL BUDGETING FOR EXPANSION

PROJECT

Imran Yousaf, Zhichuan (Frank) Li, and Aaqib Nawaz wrote this case solely to provide material for class discussion. The authors
do not intend to illustrate either effective or ineffective handling of a managerial situation. The authors may have disguised certain
names and other identifying information to protect confidentiality.

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Copyright © 2021, Ivey Business School Foundation Version: 2021-08-13

In the early morning of February 16, 2021, Malik Ahmed Nawaz, the owner of Anwal Gas Traders, was
sitting in his office when his son, Malik Asad Nawaz, the company’s managing director, delivered a detailed
report prepared by a consultancy firm. The report proposed a solution to the liquefied petroleum gas (LPG)
shortage, a recurrent problem due to delays by the suppliers when demand was high. Without proper storage,
the company could not store the gas and needed to depend on the supplier; therefore, the company was unable
to meet the demands of its customers, which negatively affected the company’s image and risked losing
potential customers. The report recommended that the company expand and build its storage, ending its
dependence on the supplier.

This was the first year that Malik Asad had managed the company’s operations. After completing his
master’s degree in business administration, he had joined the family business. Implementing his
knowledge allowed him to identify this problem and opportunity for the company. He thought it was time
that the company aimed for backward integration and ended its dependence on suppliers. He decided that
a financial feasibility study would provide financial insights into how much investment would be required
and how long it would take for the project to become profitable.

COMPANY BACKGROUND

Anwal Gas Traders was a small, privately owned LPG distribution company in Sakesar, Khushab District,
in the province of Punjab, Pakistan. Malik Ahmed founded the company in 1998. In 2003, the company
acquired a licence from the country’s largest distributor, and in 2020 it had distribution licences for 19
companies, including major brands.

The company dealt with four major LPG products: cylinders, stoves, cylinder regulators, and gas pipes. It
also provided the primary service of delivering LPG-filled cylinders. The company delivered domestic,
medium, and commercial bottles in sizes ranging from 5 kilograms (kg) to 45 kg.

In 2020, Pakistan had a total LPG consumption of 1.8 million metric tons (t), of which 61 per cent was
consumed in Punjab, where Anwal Gas Traders was located. It was one of the top LPG cylinder
distributors in the Khushab District.

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COMPANY PERFORMANCE

As the company had been operational in the market for almost 22 years, it had a solid customer base. The
company provided products and services to the whole district, and its financial performance was
encouraging. A two-year analysis showed that in 2020 the company had a net profit margin of 12 per cent
in the COVID-19 pandemic, a slight decrease of 0.7 per cent from the previous year. The operating profit
margin was 15 per cent in 2020, a decrease of 0.8 per cent from the previous year (see Exhibit 1). The
company made sales of Rs 94.6 million,1 with an Rs 11.4 million net profit (see Exhibit 2).

THE EXPANSION PROJECT

This proposed expansion project was intended to resolve the company’s low storage issue and any issues
arising from supplier dependence. At the time, Anwal Gas Traders was both an LPG distributor and sub-
distributor. By implementing this project, it would integrate backward to become an LPG marketing and
distribution company. It would receive LPG directly to its storage tanks from the production site, and its
role as a pure intermediary for the supplier would end (see Exhibit 3). Malik Asad believed this was a
necessary strategic move to reduce risk and build a competitive advantage over other distributors in the
market.

THE PROPOSAL

After reading the report, Malik Ahmed agreed that there was an opportunity for the company to expand.
He was a passionate entrepreneur who was always ready to take risks. However, he also wondered
whether he and his company should move out of its comfort zone. After all, the current business was
sustainable, as it generated steady cash flows and profits. The company had accumulated a sizable amount
of cash, and its bank was willing to extend a loan for 10 years at an interest rate of 16 per cent, which
would provide strong financial support for the expansion project.

Malik Asad applied what he had learned in university and conducted a feasibility study of the expansion.
He estimated that the company would need a Rs 95.1 million investment for the project. The company
wanted to run this project for only 10 years. As the company wanted to maintain a 50-50 debt-to-equity
capital structure, the weighted average cost of capital (WACC) of the project was 14 per cent.

Since there was no existing storage facility, the company needed to purchase and install a new plant. The
storage plant required a storage container, a pump, filling dispensers, LPG bottles, a supporting structure,
and firefighting equipment. For the storage tanks, pumps, and filling dispensers, there were three potential
suppliers. The operational department expressed concern that an issue in any element would disturb the
whole process, requiring the storage plant to be shut down for repair. Consequently, Malik Asad favoured
the Chinese company that would provide the storage plant, pumps, and dispensers all assembled as one
unit. The cylinders, firefighting equipment, and supporting structure would be purchased from local
companies (see Exhibit 4). Anwal Gas Traders planned to build a storage capacity of 480 t; therefore, it
would need four 100- t tanks and one 80-t storage tank. 2 The overall life of the plant would be 20 years,
but Anwal Gas Traders would use this plant for 10 years and then sell it to the market at the end of the
project’s life.

The amount of initial investment (Rs 95.1 million) included the cost of machinery and equipment, land and
buildings, vehicles, factory and office furniture, and working capital. Malik Asad liked the 20 kanal (1 hectare)
of

1
Rs = PKR = Pakistani rupee; Rs 1 = US$0.0065 on February 16, 2021.
2
1 t = 1,000 kg.
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land located in the industrial area of Khushab.3 Of the 20 kanal (1 hectare), 20 per cent would be used for
offices, and the remaining 80 per cent would be used for the storage plant. The LPG distribution required a
cargo pickup truck, and the office staff required a car and motorcycles. The annual depreciation expense would
be Rs 3.63 million for all depreciable assets under the proposed project. The depreciation treatment for all
items was on a straight-line basis. The expected salvage value of fixed assets was Rs 35.15 million4 at the end
of the project’s life.

With the storage facility, the estimated annual sales of the company would be 212,160 cylinders in the
first year of the project. 5 For one cylinder, the expected price and material costs were Rs 1,307 and Rs
983, respectively. The expected increase in sales volume and material costs for one cylinder would be 2
per cent annually. The price of the LPG cylinder was expected to increase by 1 per cent annually.

The human resources department expected to hire administrative and site staff to run the storage plant. It
would also hire experienced, responsible technical staff who could deal with highly flammable gas. Any
negligence could cause immense damage to the company and the lives of the employees. A total of 21
employees would be hired and compensated at the market rate (see Exhibit 5).

Electricity and fuel were significant utility expenses for the business. The plant would run on electricity
and need a constant power supply, while the vehicles and power generators ran on diesel. Utilities for the
first year would cost Rs 2,136,000 annually. The proposal outlined estimates for the selling and
distribution expenses of 3 per cent of annual sales. The estimated annual miscellaneous expenses would
be Rs 180,000.

The company was a small to medium-sized enterprise and was therefore charged a flat tax rate of 29 per
cent. Salaries, utility expenses, and miscellaneous expenses would increase by 5 per cent annually. The
data shown in Exhibits 1–5 are also available in the student spreadsheet (see Ivey product W25082.)

THE DECISION

The report listed all the costs related to setting up the storage plant. Malik Ahmed called his son, Malik
Asad, and told him that he liked the plan. However, before making a decision, he wanted Malik Asad to
further analyze the financials; in particular, he wanted his son to perform capital budgeting and give a
presentation on the net present value of the project, the internal rate of return, and the profitability index.
Malik Asad believed he should also perform a scenario analysis based on the following situations and
study the effects of these scenarios on the financials:

 Scenario 1 (base case): Capital budgeting techniques were performed as per the information provided
in the proposal.
 Scenario 2: The consultant advised that the government could increase the sector’s tax rate from 29
per cent to 35 per cent. The resulting increase in sales price would be 3 per cent annually.
 Scenario 3: The finance department predicted local bank interest rates of 19 per cent and WACC of
15 per cent.

Imran Yousaf is an assistant professor at Air University, Islamabad. Zhichuan

(Frank) Li is an associate professor at Ivey Business School, Western University.
Aaqib Nawaz is a student at Edinburgh Business School, Heriot-Watt University.

3
Northern India and Pakistan used the kanal for land measurement; 1 kanal = 0.05 hectare.
4
This included the after-tax salvage value (the proceed from the sale of assets) and recoverable working capital at the end of
the project’s life.
5
One cylinder contained 11.3 kg of LPG.

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EXHIBIT 1: ANWAL GAS TRADERS’ INCOME STATEMENTS, 2019–2020 (RS)

2020 2019
LPG 91,400,000 83,793,000
LPG Bottles 2,810,000 2,473,800
LPG Accessories 400,000 385,950
Total Net Revenue 94,610,000 86,652,750

Cost of Goods Sold 72,456,000 65,603,200

Gross Profit 22,154,000 21,049,550

Expenses:
Advertising & Promotion 120,000 111,600
Depreciation & Amortization 240,000 223,200
Insurance 120,000 111,600
Maintenance 914,000 839,790
Office Supplies 120,000 111,600
Rent 600,000 558,000
Salaries, Benefits & Wages 1,080,000 1,004,400
Telecommunication 48,000 44,640
Vehicle Rent 4,570,000 4,198,950
Utilities 120,000 111,600
Total Expenses 7,932,000 7,315,380
Earnings Before Interest & Taxes 14,222,000 13,734,170

Interest Expense 0 0
Earnings Before Taxes 14,222,000 13,734,170

Income Taxes 2844400 2,746,834

Net Earnings 11,377,600 10,987,336

Note: Rs = PKR = Pakistani rupee; Rs = US$0.0065 on February 16, 2021; and LPG = liquefied petroleum gas.
Source: Company documents.

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EXHIBIT 2: WATERFALL CHART OF ANWAL GAS TRADERS’ NET EARNINGS, 2020

(RS THOUSANDS)

Note: Rs = PKR = Pakistani rupee; Rs = US$0.0065 on February 16, 2021; COGS = cost of goods sold; and EBIT = earnings
before interest and taxes.
Source: Company documents.

EXHIBIT 3: ANWAL GAS TRADERS’ LPG DISTRIBUTION PROCESS

Note: LPG = liquefied petroleum gas.

Source: Company documents.

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EXHIBIT 4: ANWAL GAS TRADERS’ MACHINE AND EQUIPMENT COSTS

Required Unit Price

Machine Cost (Rs) Local/Imported
Number of Units (Rs)
Storage Tank + Pump + Filling
Dispenser 46,800,000 Imported
Single Unit = 160 Metric Tons
Cylinders:
11.8 Kilograms 600 5,000 3,000,000 Local
45.4 Kilograms 600 8,000 4,800,000 Local
Support Structure 500,000 Local
Firefighting Equipment 1,500,000 Local
Total 56,600,000

Note: Rs = PKR = Pakistani rupee; and Rs. 1 = US$0.0065 on February 16, 2021.
Source: Company documents.

EXHIBIT 5: ANWAL GAS TRADERS’ SALARIES, FACTORY AND ADMINISTRATIVE STAFF

Staff Title No. of People Individual Salary (Rs) Monthly Total (Rs)
Plant Incharge 1 105,000 105,000
Supervisor:
Operations 1 55,000 55,000
Dispatch 1 45,000 45,000
Dispenser 3 32,000 96,000
Clerk 2 18,000 36,000
Technical Staff 2 24,000 48,000
Guard 3 14,000 42,000
Total Plant Staff 13 293,000 427,000
Marketing Manager 1 40,000 40,000
Accountant 1 45,000 45,000
Office Assistant 2 14,000 28,000
Driver 4 22,000 88,000
Total Office Staff 8 121,000 201,000
Total 21 414,000 628,000

Note: Rs = PKR = Pakistani rupee; and Rs. 1 = US$0.0065 on February 16, 2021.
Source: Company documents.

This document is authorized for use only by Arthur Langlet in Sustainable Financial Management & Policy taught by rachel pownall, Maastricht University from Nov 2022 to Apr
2023.