Bhargava Oils Ltd., was started by Ranjit Bhargava in 1972 near Ahmedabad, Gujarat.

The company
is engaged mainly in the exploration of crude oil, natural gas and production of some other valueadded products. The company has 12 divisions across the country for specific activities like
exploration, drilling, reservoir management, safety and environment protection etc. The company
processed 12.7 million tons of crude oil during 1972-73. The average capacity utilization was 85%. So
far, the company has drilled a total of 848 wells (exploratory 405 and development 443).
Recently, the company's exploration team discovered oil wells in Andhra Pradesh, Gujarat and
Madhya Pradesh. It will take the company Rs. 10 crore to drill a well and the company will get returns
for 3 years from each of these wells. But the cash flows generated by each of these projects will be
different because oil reserves may be located at different levels from the surface, and the digging time
will depend on the hardness of the land. Because of financial constraints, the company can accept any
one of these three projects.
Vishwanath Datta, the finance director of the company received the cash flow estimates of the three
projects from its divisions in Andhra Pradesh, Gujarat and Madhya Pradesh. The project in Andhra
Pradesh likely receive cash flows of Rs. 2 crore, Rs. 4 crore, and Rs. 12 crore at the end of the first,.
second and third years respectively. The cash flows of the project in Gujarat are Rs. 10 crore, Rs. 3
crore, and Rs. 3 crore respectively and that of the project in Madhya Pradesh are Rs. 4 crore, Rs. 6
crore and Rs. 7crore receptively.
Datta calculated the net present values for each of these projects considering the cost of capital as 10
percent. He submitted his report to the managing director, Ashok Reddy, which stated that the
company could start the project in Andhra Pradesh because of the highest net present value. Along
with his report, Datta also sent the cash flow estimates of all the three projects and his calculations.
Then Reddy calculated the internal rate of return for all the three projects. To his surprise, the project
in Andhra Pradesh had the least internal rate of return. Immediately, he called Datta and showed him
his calculations. They were in a bind about the selection of the project.
Questions for Discussion:
I.
As per Datta's NPV calculation, what are the rankings of the three projects in Andhra Pradesh,
Gujarat and Madhya Pradesh?
2.
What is internal rate of return? Do you think Andhra Pradesh project has the least internal rate
of return?
3.
What was the reason behind the conflict between Datta and Reddy? In this situation, which
project is likely to be taken up by the company?