Proposed Capital Budgeting: Should PT.FST Close its Kelambu Division?

Abstract

In 2021, the manufacturing industry is Indonesia’s most significant contributor to its Gross Domestic Product (GDP). Within the manufacturing industry, there is a sub-industry called the textile industry. The textile industry in Indonesia is highly fragmented. For instance, there are three niche textile markets: textile for households, textile for clothing, and textile for agriculture. The three segments have different growth of 4%, 7.5%, and 5%, respectively, and this difference in growth rate will create a dilemma for companies. For instance, companies must decide which segment needed to be perused or avoid since each segment will have its opportunities and threats. PT. FST also faces this dilemma. The differences in each segment’s growth rate are reflected by the company’s sales growth of each product. The sales of plastic products Waring and Benang growth rates are 34% and 52% five years CAGR, respectively. Those are substantial growth compared to the textile products of Kelambu with only 23% five years CAGR. From there, the company’s owner and CEO see a shift in the growth of products sold, from textile products to plastic products. To capture the shifts in demand within the market, he decided to close the Kelambu division to make the company leaner and will be able to focus its resources on the products that will generate revenue the most. From capital budgeting analysis, the plan of shutting down the Kelambu division will result in a faster payback period of 7.2 years compared to 8 years for the regular cash flow and 8.05 years compared to 8.12 years for the regular cash flow the discounted cash flows. More importantly, it generates a higher NPV of IDR 1,087 bio than IDR 976 bio. In addition, the plan also has a higher Profitability Index and IRR of 6.04 and 25% compared to 5.01 and 22%. From risk analysis, the expected value of the project’s is IDR 1,457 bio, with a probability of NPV less than zero is 8%. Lastly, this final project contributes to the literature by providing an alternative framework on how to use capital budgeting techniques to compare two expansion plans or closing down divisions within a company. Moreover, other textile industry players, especially SMEs could also refer to this final project if they face a similar dilemma.