Financing an ₹8 Crore Plant and Parking an Idle Export Advance
Kovai Knit Exports, a Tiruppur garment exporter with turnover of ₹38 crore, needs ₹8 crore to build a washing-and-finishing plant before the next season. The finance director has three offers. A public sector bank will lend ₹8 crore for seven years at 11.5% floating, against hypothecation of stock and a mortgage of the promoter's house. An NBFC has offered the same amount at 14% fixed, a 2% processing fee, and no mortgage. A merchant banker proposes a public issue of secured non-convertible debentures at 12.5%; the issue would cost about ₹32 lakh in fees, needs a credit rating and SEBI registration, and the banker privately warns that public debt issues of this size are often undersubscribed, in which case the money is refunded. The company has four promoter shareholders and 60 employees, and the promoter's house is the family's only property. Separately, a ₹1.2 crore export advance will lie idle for about 90 days before it is paid to fabric suppliers, and the treasurer must park it in one of: a one-year bank fixed deposit at 7.1%, a liquid mutual fund yielding about 6.6% with near-instant redemption, or 91-day Treasury Bills at 6.9%.
1. Compare the three long-term funding options on effective cost, security, control and risk, and recommend one.
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Bank loan (11.5% floating): cheapest headline cost, but the rate is floating - a 100 basis point rise costs ₹8 lakh a year on ₹8 crore, which is more than the company's likely margin on the new plant in its first year. The mortgage over the promoter's only house transfers business risk onto the family: if the plant fails, the family loses its home. Requires stock hypothecation and covenants.
NBFC (14% fixed + 2% fee): ₹16 lakh upfront, which amortised over seven years adds roughly 0.3% a year, so the effective cost is about 14.3%. Fixed rate removes interest-rate risk; no mortgage keeps the house free; sanction is usually faster. It is the most expensive in year one but the most predictable.
NCD public issue (12.5% + ₹32 lakh): the fee is 4% of the issue, roughly 0.6% a year over seven years, so effective cost is about 13.1% if fully subscribed - and no collateral. But a ₹38 crore first-time issuer will attract a modest rating (perhaps A- or BBB), which may push the coupon above 12.5%; add the debenture trustee, listing, ongoing disclosures, and the real risk of undersubscription, in which case the money is refunded after the fees are largely spent. Deferring the plant by a season may cost more than the interest saved.
Recommendation: the NBFC loan, or the bank loan only if a fixed-rate option can be negotiated and the promoter accepts the mortgage. Reject the NCD at this size: it is the cheapest on paper and the most fragile in practice. No option dilutes the four promoters, so control is preserved in all three - the merchant banker's alternative of an equity issue would dilute them and is not in the case.
2. Where should the ₹1.2 crore be parked for 90 days? Explain why the highest-yielding option may still be the wrong one.
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Fixed deposit at 7.1%: that is a one-year rate. Breaking it after 90 days normally attracts a penalty of 0.5–1%, so the realised yield falls to roughly 6.1–6.6% - no better than the alternatives, with extra paperwork.
91-day Treasury Bills at 6.9%: sovereign, so effectively zero credit risk, and the tenor matches the known payment date exactly, which means no price risk if sold. Issued at a discount and redeemed at face value. Slightly less liquid to arrange, but the cleanest match for a liability with a fixed date.
Liquid fund at 6.6%: the 7-day yield is not a guarantee. The fund is marked to market, so it carries small interest-rate and credit risk, and returns can dip in a tight-money week. Its advantage is T+1 redemption and no break penalty, which matters only if the payment date may slip.
Recommendation: split - about ₹1 crore in 91-day Treasury Bills to match the supplier payment, and about ₹20 lakh in the liquid fund as a buffer. The 0.2–0.3% difference being chased is worth roughly ₹7,000 over 90 days on ₹1.2 crore; missing the supplier payment would cost far more in interest and reputation.
One caution: if the advance is in foreign currency it must sit in the EEFC account and conversion timing creates exchange-rate exposure. Long-duration or equity funds are disqualified outright - this is money with a fixed repayment obligation.