Abstract
The case revolves around the decision to be taken by Mr Sashikant Hegde, Managing Director, Hycons Renewable Private Ltd, on the project viability of a business proposal. The proposal was to start a manufacturing plant in Punjab to produce compressed biogas using paddy straws. Hegde firmly believed that the company would do well considering the growth of the CNG market in India, as the oil and natural gas sector in India is among the top 10 core industries in the country and plays an important role in the existence of other important sectors as well. The proposal would benefit Hycons to establish its presence in northern India, but the project viability and funding of the investment remained an unanswered question.
Discussion Questions
Conduct a SWOT analysis on Hycons and comment on their inherent worth in relation to the external environment. Is the proposed project a strategic fit for Hycons?
Does the project’s financial feasibility from the cash flow estimation perspective impact the proposal’s acceptance?
Evaluate the value and viability of the investment proposal from the standpoint of capital budgeting techniques.
Conduct the stand-alone risk analysis of the project using sensitivity analysis and explain why sensitivity analysis is a useful tool in the capital budgeting decision-making process when economic and financial conditions are likely to change.
‘Financing of renewable energy in India continues to face multiple challenges’. Critically examine the various sources of funding suitable for this project.
One Sunday morning, Mr Shashikant Hegde, Managing Director of Hycons Renewable Private Ltd, Bangalore, India, sat on his balcony with a hot coffee and a newspaper. The lead headline in the newspaper was the burning of padding straws in Punjab 1 to reduce air pollution in Delhi 2 during winters. 3 Hegde, a social entrepreneur, felt distressed reading the news. After a few months from that day, Hedge came up with a proposal to set up a manufacturing plant of Hycons in Punjab to produce biogas using paddy straws. The proposal would benefit Hycons to establish its presence in northern India, but the project viability and funding of the investment remained an unanswered question. He was confident of his idea but not sure of the way forward. Hegde prepared a preliminary report on his business idea and presented the proposal to the other board members for consent.
Hycons Renewable Private Limited
Hycons Renewable Private Limited, a go-green initiative, had a registered office at Kasaba Hobli, Anekal Taluk, Bangalore (Exhibit 1). The company was established to produce biogas from grasses. Hycons pioneered the unique technology of producing the highest volume of gas per ton of feedstock. The company developed and adopted the path-breaking technology of using microbes and enzymes to produce the highest volume of biogas in the shortest possible time, the first of its kind in India (Hycons, 2020). High research and development expense and high waste management fee had always been perennial problems that Hycons had to tackle.
Hycons was established in 2011 on a small scale with no manufacturing facilities and in 2019 was promoted to a private company. They set up their first plant at Kadag, Karnataka, India, with an investment of ₹9.19 million, 4 which was largely funded through a bank loan, and the remaining amount was contributed by the promoters of the firm in the form of equity investment at face value of ₹10 per share. Within a short period, the company established its presence in the compressed bio-CNG market. Hycons had emerged as one of the few companies in this market that used green and energy crops to produce bio-CNG. Over the years, with continuous research and design efforts, the company mastered the art of creating products that met the requirements of its customers. In such a short time, the company had become one of the most trusted firms by oil marketing companies.
Hycons Renewable Private Limited was a B2B unlisted private company with Shashikant Hegde, the Managing Director, Jaipal Reddy, Avial E Mathias, and Thyavakanahalli Najunda as board members.
Bio-CNG Industry in India
India’s oil and natural gas sector was among the country’s top 10 core industries and played an important role in the existence of other important sectors as well. The petroleum ministry announced through the Sustainable Alternative for Affordable Transportation (SATAT) scheme 5 to buy CBG from private companies, which would be used for transportation. The main motive of the SATAT scheme was to make the maximum use of waste like paddy and rice straws for producing bio-CNG, which would replace the dependence on petrol and diesel for both commercial and domestic purposes (Figure 1). Through the scheme, the government would promote establishing at least 5,000 CNG-producing companies. Because of the numerous socioeconomic, economic and technical issues faced, such as rising automobile emissions and the combustion of fossil fuels, CBG had become a need. For business and household reasons, the ultimate answer to difficulties would be to shift the reliance from non-renewable to renewable energy. This would also lead to the utilization of waste to generate electricity, generating rural job possibilities, assisting farmers in increasing farm income, lowering FX expenses and, most crucially, allowing the government to utilize agri-residue as an alternative revenue source (Shete, 2020, Renewable Gas/CBG).
Showing the Floor Diagram of the Production of Bio-CNG.
One of the most abundant lignocellulose wastes on earth was paddy straw. The annual production of rice was about 136.5 million tons. About 1–1.5 kg of straw was produced per kg of grain harvested; thus, 136.5 million tons of paddy straw is estimated to be produced annually. In India, approximately 70–80 million tons of paddy straw were disposed of by burning. One tonne of straw burning released 3 kg particulate matter, 60 kg CO, 1,460 kg CO2, 199 kg ash and 2 kg SO2, which caused lung and respiratory diseases and adversely affected public health. Repeated burning of paddy straw also resulted in soil erosion. Biogas could be produced from paddy straw by anaerobic fermentation using microbial consortium as a source of inoculum. Biogas generation involved a consortium of microorganisms, a group of hydrolytic, acidogenic and methanogenic bacteria. Hydrolytic bacteria degrade complex organic matter (carbohydrates, proteins and fats) into simpler forms (sugars, amino acids, fatty acids and glycerol). Acidogenic bacteria broke down these simpler forms (sugars, amino acids, fatty acids and glycerol) into CH3COOH, H2 and CO2, which was further utilized by methanogenic bacteria to produce biogas. Biogas was a mixture of CH4 (50%–60%), CO2 (30%–40%), H2 (1%–5%), N2 (0.5%), CO, H2S and water vapours. Biodegradable matter emitted methane in various proportions during its decay in the absence of oxygen called anaerobic digestion. Readily available waste sources could be monetized to exploit the opportunity of ever-increasing energy needs (Hycons, 2020) (Figure 2).
In the Meeting Room
Hegde began his presentation with statistics on the number of CNG plants and their production capacity across India (Exhibit 2). The data explained the gap in the number of plants set up in states such as Punjab and Uttar Pradesh compared to those in states such as Maharashtra and Gujrat. He explained the immense scope in India, especially regarding bio-CNG and how it was a close substitution to Liquid Petroleum Gas used for commercial purposes and in vehicles. This gave a good introduction to the discussion. Along with this, he gave a briefing on the project proposal. He explained the process of how easily available waste sources could be monetized to exploit the opportunity of producing the most sort out energy through a scientific process. He also emphasized the benefits of the first-mover advantage that Hycons would get from this project, which would help to establish strong brand recognition and product loyalty before other players entered the market. With its existing plant at Kasaba, it would be able to cater to the needs of the south Indian market, and the new plant in Punjab would help capture the northern part of the Indian market.
Hegde presented to the board explaining the proposal’s scope to understand the feasibility of the project. He made a few technical assumptions based on available information to study the technical and financial feasibility.
Estimated production of compressed biogas (CBG) of 11,000 kg/day (10 TPD) by using paddy straw as input in the Punjab region at a desirable location. He assumed that within seven months from the date of arranging funds, production could be started.
The total raw materials required for production could be estimated at ₹850 per ton for paddy straws and enzymes of 200 per ton. Thus, the total raw material required would be 1,050 per ton of production. The input required for production would be the dried paddy straws and other available biowaste.
Three Digesters and one feed processing unit would be required to take forward the production process, and all of them would need robust insulation. The total digester volume should be 3263.963 m3 (65 ft diameter and 35 ft deep) and 20% headspace, so the filling volume available would be 2,611 m3.
The CBG output would be 11,000 kg/day, which could be sold for ₹48.3 per kg. The output price was calculated based on the government’s fixed selling price for bio-CBG (Auto, 2020). The price fixed by the government was estimated to remain the same for a longer time considering the COVID impact and the fear of the purity of CNG gas among consumers. Even after the purification and refinement process, the fear of purity of the gas used in automobiles might damage the vehicles as it could erode the engine’s metal parts, thus increasing the maintenance cost, which had always been a matter of concern.
The production of CNG gave three different outputs; the main product was the CNG, the carbon dioxide output and the fertilizer output, which could be used for cultivation. Besides the CNG output, the CO2 output, estimated to be 10,000 kg/day, could be sold for a marginal price of ₹2 per kg. The by-product of fertilizer output which would be about 3.5 tons per day could be sold for ₹2 per kg.
The working capital requirements had been estimated at ₹146.512 million considering the estimated cost of the components of working capital. The maintenance cost could be estimated at 6% of the initial investment, while the other overhead cost was 8%. The labour required would be 30 workers for a salary of 20,000 per month. The fuel and power costs could be estimated assuming usage of 16 hours at 300 units per day at a subsidized cost of ₹8 per unit.
The global biogas market was valued at USD 55.1 billion in 2019 and was anticipated to expand at a CAGR of 4.48% over the forecast period. However, Hycons had just entered the market with a high growth prospect. Hence the growth rate had been assumed at 5% pa, for the estimation of revenues.
The company’s expenses comprised raw materials, power & fuel, stores & spares and depreciation. The expenses were projected to grow at a 3% rate to attain a marginal growth in profits.
Under existing regulations, the base tax rate was graded (as 25% if revenue exceeded ₹4,000 million and 30% if revenue exceeded ₹4,000 million). Similarly, a surcharge was determined by the degree of taxable income, that is, the larger the profit, the higher the surcharge, and the cess was paid at 4%. As a result, all-in tax rates might range from 26.00% to 34.94% under the present laws. Income tax rates had been cut between 26% and 29% for domestic firms with revenues of less than ₹4,000 million. Based on this cue, the tax rate used for valuation purposes was 26%.
The total cost of setting up the plant was estimated at ₹304.215 million, including the working capital requirements as given in Table 1.
Assuming the salvage value of the project to be zero and working capital recovery to be 100% as the project only had a life of 5 years, after which the assets would be repurchased and not disposed of. This assumption was based on the present salvage value policy followed at Hycons.
The Indian Renewable Energy Development Agency Limited (IREDA) provided low-interest loans to renewable energy project developers to encourage the development of renewable energy projects. IREDA also used the National Cleaning Energy and Environmental Fund to provide subsidized debt at a 5% interest rate to renewable energy projects through select banks. Based on these data, the interest rate was assumed as 5%.
The project funding was assumed to be financed 100% through subsidized debt at a 5% interest rate to renewable energy projects. Based on this assumption, debt would be the only component in the capital structure. Though this alternative would allow Hycons to maintain sole control of the firm, they would gain all potential income. However, they would lose their home and belongings if the company failed.
The company had earlier followed the straight-line method of depreciation, and thus Hegde assumed to continue with the same method. Thus, the depreciation was estimated as ₹6.76 million.
Cost Layout.
The board members welcomed the concept but were pessimistic about the project’s feasibility. In terms of investment, Hegde recommended another alternative to the board of Hycons to infuse capital by inducing a potential partner willing to participate in the proposed equity plan. On the other hand, some board members were not pleased with the move because it would result in a dilution of power and the probability of a possible creeping takeover.
While further discussing green projects funding options that could be used to fund the project, Hegde said:
The complexities of funding renewable energy in India are intricately linked to the industry’s structure and investment character, which are primarily influenced by the investor’s instrument styles and sentiments. The key difficulties areas continue to follow: Given the nascent stage of renewable energy growth in India, several of those threats, including policy and regulatory risks, perceived risks, technology-related risks, off-taker risks, and foreign-exchange risks, are correlated with renewable energy sector financing.
Challenges Ahead
The meeting lasted several hours, with numerous debates and deliberations; however, no conclusion was made. At the end of the meeting, one of the board members said,
Every business starts with an idea. Whether we have an idea for a great new product or a service that will revolutionize an industry, our inspiration is a great start. But how are we going to bring the idea to life? Building a successful business takes more than a great idea and a vision—it takes planning, discipline, research, and a whole lot of money. We should be able to make our business solid and marketable, all of which needs funding.
They agreed to meet the next day again to finalize their decision. After the meeting, Hegde stayed in his seat while the other members left the meeting room. The board members believed in Hegde’s decision, considering his involvement in the company more than the others. Hegde firmly believed that the company would do well considering the growth of the CNG market but did not want to limit the firm’s success if sufficient funds were unavailable at the right time.
Hegde went back to his office cabin, wondering what to do next. Should he dig a grave and bury his business idea immediately or work on the challenges? Clueless, Hegde looked out of his office window with a cup of hot coffee and his business proposal in hand.
He finally decided to put together his technical assumptions and analyse the project’s financial feasibility using a suitable capital budgeting technique. In addition, he decided to compute the sensitivity analysis to predict the outcome of a decision given a certain range of variables by changing the important assumptions made in the calculations to understand the impact on the project’s viability.
Footnotes
Declaration of Conflicting Interests
The authors declared no potential conflicts of interest with respect to the research, authorship and/or publication of this article.
Funding
The authors received no financial support for the research, authorship and/or publication of this article.
Appendix
State-wise Details of Installed Capacity and Number of Biogas-based Power Generation Projects (Off-Grid Projects in the Capacity Range of 3–250 kW) Set Up in the Country, as of 30 November 2019.
| S. No | Name of the State | Installed Capacity and Numbers of Biogas-based Power Plants |
||
| Nos | M3 | kW | ||
| 1 | Andhra Pradesh | 33 | 4,145 | 466 |
| 2 | Gujrat | 01 | 200 | 20 |
| 3 | Haryana | 02 | 2,370 | 135 |
| 4 | Karnataka | 66 | 15,075 | 1570.5 |
| 5 | Maharashtra | 44 | 7,520 | 825.5 |
| 6 | Punjab | 32 | 8,510 | 922.5 |
| 7 | Rajasthan | 01 | 60 | 7.5 |
| 8 | Tamil Nadu | 38 | 20,970 | 1971 |
| 9 | Uttarakhand | 10 | 625 | 73 |
| 10 | Uttar Pradesh | 34 | 4,950 | 679 |
| 11 | Madhya Pradesh | 05 | 650 | 60 |
| 12 | Kerala | 38 | 1,060 | 124 |
| 13 | West Bengal | 01 | 340 | 60 |
| 14 | Odisha | 01 | 30 | 6 |
| 15 | Telangana | 5 | 2,040 | 208 |
| Total | 311 | 68,545 | 7,128 | |