Pepper Pantry: Financing a ₹5 Crore Expansion Without Losing Control
Pepper Pantry Pvt Ltd, a Kochi-based spice processor, has revenue of ₹18 crore and expects EBIT of ₹3.2 crore next year after the expansion. It already carries ₹4 crore of debt at 11% and ₹6 crore of equity spread over 10 lakh shares; promoters hold 62%. A ₹5 crore expansion is needed before the December–March export season. The bank offers a term loan at 12% with a covenant that interest coverage must stay above 2.5 times. Alternatively, 5 lakh new shares can be issued at ₹100 each. Separately, the accounts show inventory of 90 days, receivables of 75 days and payables of 30 days. Cash balances are ₹40 lakh. Suppliers currently offer a 1% discount for payment within 30 days; the bank offers cash credit at 10%. The promoter family is willing to accept higher risk but will not let its stake fall below 51%.
1. Calculate Pepper Pantry's operating cycle and explain why the expansion will need more money than the ₹5 crore project cost suggests.
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Calculation
Operating cycle = Inventory period + Receivable period − Payable period = 90 + 75 − 30 = 135 days.
Interpretation
- Every ₹1 of sales locks up working capital for 135 days, i.e. about 135/365 ≈ 37% of annual sales. At ₹18 crore revenue that is roughly ₹6.7 crore tied up in the operating cycle.
- Spice processing is seasonal: nuts and packaging must be bought and processed weeks before export orders are invoiced, so inventory builds before receivables arise. The peak funding need is therefore worse than the average 135-day figure.
- If the expansion lifts revenue, say, to ₹21.6 crore, working capital rises by roughly ₹1.3 crore on the same cycle.
Conclusion: the financing plan must cover ₹5 crore of fixed assets plus about ₹1.3 crore of additional working capital, with a seasonal peak. Funding only the project cost would leave the company technically expanded but cash-starved in December.
2. Advise the company on debt versus equity. Use interest coverage, EPS and the promoter stake constraint, and show your figures.
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Option 1: full debt of ₹5 crore
- Interest = ₹0.44 crore (existing) + ₹0.60 crore (new) = ₹1.04 crore.
- Interest coverage = 3.2 / 1.04 = 3.08 times, above the 2.5 covenant but with modest headroom.
- PAT at 25% tax = (3.2 − 1.04) × 0.75 = ₹1.62 crore; EPS on 10 lakh shares = ₹16.20.
Option 2: full equity of 5 lakh shares
- Interest = ₹0.44 crore; PAT = (3.2 − 0.44) × 0.75 = ₹2.07 crore; EPS on 15 lakh shares = ₹13.80.
- Promoter holding falls to 6.2/15 = 41.3%, breaching the 51% floor. Equity is therefore not even feasible as proposed: the maximum fresh issue is 6.2/0.51 − 10 = 2.16 lakh shares, i.e. about ₹2.16 crore.
Recommendation: part debt, part equity. For example, ₹3 crore loan plus ₹2 crore equity (2 lakh shares): interest ₹0.80 crore, coverage 4.0 times, PAT ₹1.80 crore, EPS ₹15.00, promoters at 51.7%. Trading on equity still works because return on capital employed (3.2/15 ≈ 21%) exceeds the 12% cost of debt. Pure debt maximises EPS but a 40% fall in EBIT would push coverage to 1.85 and breach the covenant; the balanced plan preserves both control and financial slack.
3. For working capital, should the company use 10% cash credit or stretch supplier payment to 60 days? Recommend, with reasoning.
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Cost of stretching payables
Stretching payment by 30 days means losing the 1% early-payment discount. Annualised cost = (1/99) × (365/30) ≈ 12.3%, higher than the 10% cash credit. It also buys only 30 of the 135 days, so it is not a complete solution.
Non-financial cost
Stretching payables in the peak season risks delayed raw-nut supply, poorer grading and loss of the supplier's priority allocation - a serious risk in a seasonal business where quality determines yield.
Recommendation
- Use cash credit as the main seasonal source, since it is cheaper and does not damage supply relationships.
- Match maturity to the cycle: a working capital term loan or overdraft for the permanent 135-day core, cash credit only for the peak above it. Funding long-term working capital with short-term credit creates renewal risk.
- Attack the cycle itself: reduce inventory through better forecasting, invoice faster, and negotiate 45 days with suppliers rather than unilaterally stretching to 60.
- Keep the ₹40 lakh cash as a buffer for covenant or season shocks. The 1% discount should be retained wherever cash flow allows, because 12.3% is an expensive form of credit.