egret printing and publishing ppt
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case of Egret Printing and Publishing CompanyTRANSCRIPT
Egret Printing and Publishing Company
Minakshi PathakMuna BaralPadam ShresthaPragati DahalPrathana ShresthaRavi BhandariRitu MalekooRubina Shrestha
Date:11th April,2013
Background
•Egret Printing and Publishing Company is a family owned specialty printing business• Egret printing and publishing operates mainly as a full-range printer of high quality; four colors offset advertising materials, calendars, specialty tabloids, business printing and some books•Hill has responsibility for both internal and external financial operations.•Belford’s have identified four major capital investment proposals as potential candidates for funding in the coming year.•Belford brothers considers an all equity capital structure to be overly conservative.
•Project A : Project A has been designed to alleviate the capacity problem by constructing a new wing of the main plant.• Project B : Project B has the same cost as project A. It can be finished more quickly and will allow to take several major printing jobs.
• Project C : Project C would alleviate the capacity by acquiring the latest equipment designed for such printing functions. • Project D : Extra charge features on the local cable television system. It is targeted at updating information presented on screen more quickly and will increase reliability of their service.
Discounted Pay back Period
Project A Project B Project C Project D0
1
2
3
4
5
6
Discounted Payback period@ 15%
Discounted Payback period@ 21%
NPV @ 15% And 21%
Project A Project B Project C Project D0
200000
400000
600000
800000
1000000
1200000
1400000
Npv @15%
Npv @21%
Internal Rate Of Return
Project A Project B Project C Project D0.00%
5.00%
10.00%
15.00%
20.00%
25.00%
30.00%
35.00%
Irr
Irr
Ranking of the projectC, A, B, D at 15% discount rateC, B, A, D at 21% discount rate
Which projects should the company choose and why?
A and c B and C C and D A and D0
0.2
0.4
0.6
0.8
1
1.2
1.4
1.6
PI index @ 15%
PI index @ 15%
A and c B and C C and D A and D B and D0.95
1
1.05
1.1
1.15
1.2
1.25
1.3
PI index @ 21%
PI index @ 21%
Ranking of investment proposal considering 3m
Rank
Projects 15% 21%
A and C 1st 2nd
A and D 3rd 4rd
B and C 2nd 1st
B and D 4th 3th
Which discount rate is more appropriate?
Project A Project B Project C Project D0
200000
400000
600000
800000
1000000
1200000
1400000
Npv @15%
Npv @21%
Question no.2
Do you find anything wrong in choosing the projects based on pay back, NPV and IRR as stated above? What suggestions can be made to the company? How should be the projects with unequal lives dealt with? Determine equivalent annuity (EAA) for each project, and based on the calculations, which projects should Egret Printing and Publishing Company accept for the coming year and why?
Demerits of payback period
1. Fails to consider time value of money.
2. Not a measure of profitably.
3. Ignores cash flows occurring after the payback period.
Demerits of NPV
1. may not give correct decision when the projects are of unequal life.
Demerits of Internal Rates of Return1. Difficult to calculate2. Unrealistic Assumption
SUGGESTION THAT COULD BE MADE TO THE COMPANY
PROBLEM IN NEPALESE COMPANY
The evaluation techniques for the selection proposals adopted by the Nepalese enterprise are not sound. Example:
•Not familiar with the discounted cash flow method.
•Don’t perceive the concept of risk in evaluating capital budgeting proposal.
Necessary suggestion1. Follow modern capital budgeting
techniques.
2.Focus on incremental cash flows 3.Account for time
4.Account for risk.
Project with unequal lives
Project with unequal lives can be dealt with:
1. The Replacement Chain Method2. Equivalent annual annuity approach
Replacement chain method
If two mutually projects with unequal lives to be dealt we used replacement chain
method.
NPVc at 10%=1013 IRR=11.7%
Cement factory(Project C)
Year 0 1 2 3 4 5 6
CFs (18000)
3000 4000 5000 4000 5000 6000
Year 0 1 2 3
CFs (9000) 4000 4500 3000
Sugar factory(Project S)
NPVs at 10%=609,IRR=14.1%
After replacement of Sugar factory(Project S)
Years
0 1 2 3 4 5 6
CFs (9000)
4000 4500 (6000)
4000 4500 3000
NPVs at 10%= 1067,IRR=14.1%
•Accept project S.
Equivalent Annual Annuity(EAA)•Alternative of Replacement chain method
•Compare the EAA of each project and select the project with the highest EAA.
CALCULATING EAAEAA = NPV
Particulars
Project A Project B Project C Project D
EAA@ 15%
57645.39 54654.29 122006.87
25887.53
EAA@ 21%
27969.92 39562.2 76489.39 4178.06
PVIFA(i,n)
Project
Combination
EAA @ 15% Rank EAA at
21%
Rank
A and C $179652.26 1 $104,459.31 2
B and C $176661.16 2 $116051.59 1
C and D $147894.4 3 $80667.45 3
A and D $83532.92 4 $32147.98 5
B and D $80541.82 5 $43740.26 4
•At 15% A and C’s combination is the best as highest EAA is achieved.
•At 21% B and C’s combination is the best.
NPV at different rates
Discount Rate
NPVA NPVB
0% 526800 344000
10% 260845.2 209413.5
20% 84917.64 109140.2
30% -36368.5 32073.9
40% -36368.5 -28718.3
Question no.3
Cross overhead rateNPV profiles of both
Project decline as the discount rate increases.
Project A has the higher NPV at low discount rate.
Project B has the higher NPV if the discount rate is greater than the cross over rate.
A’s NPV is more sensitive to changes in the discount rate as compared to project B’s NPV
0% 10% 20% 30% 40%
-200000
-100000
0
100000
200000
300000
400000
500000
600000
NPV Project ANPV Project B
IRR=34.99%%
IRR=26.36%
cross over rate 16.16%
Calculation of crossover rateYear Project A Project B Difference PVIF@16
%
PV PVIF@17
%
PV
0 (500000) (500000) 0 1 0 1 0
1 136000 370000 (234000) 0.862 (201708) 0.855 (200070)
2 136000 270000 (134000) 0.743 (99562) 0.731 (97954)
3 136000 155000 (19000) 0.641 (12179) 0.624 (11856)
4 618800 49000 569800 0.552 314529.6 0.534 304273.2
Total 1080.6 (5606.8)
= = 16.16%
Crossover Rate=
Project B is superior than A because of,
Basis Project A Project B
Payback period 3.15 year,3.54 year 1.48 year, 1.87 year
IRR 26.36% 34.99%
Project B provides more return than A at Higher discount rate.
Question no 4.Now suppose that Hill made a mistake in the projected cash flows for project D-they should have been $195,000 per year. Determine the effect of this change would have on capital budgeting. Would this situation bear on the decision about the mutually exclusive projects? Explain
Solution to no.4
Cash Flows Cumulative Cash Flows
Original Investment -500,000 -500,000
Year 1 195,000 -305,000
Year 2 195,000 -110,000
Year 3 195,000 85,000
Year 4 195,000 200,000
Year 5 195,000 375,000
Project D (After correction in Cash Flows)a) Ordinary Payback Period
PaybackPeriod
=
500,000
195,000
= 2.56 Years
Project D @ 15 % discount rate
Year Cash Flows PVIF@15% PV Cumulative CFs
0 -500,000 1 -500,000 -500,000
1 195,000 0.8696a 169,572 -330,428
2 195,000 0.7561 147,439.5 -182,988.5
3 195,000 0.6575 128,212.5 -54,776
b) Discounted Payback Period
4 195,000 0.5718 111,501 56,725
5 195,000 0.4972 96,954 153,679
NPV 153,679
Discounted Payback Period= 3 + 54,776/
111,501
= 3.49 years
Project D @ 21 % discount rate
Year Cash Flows PVIF@21% PV Cumulative CFs
0 -500,000 1 -500,000 -500,000
1 195,000 0.8264 161,148 -338,852
2 195,000 0.6830 133,185 -205,667
3 195,000 0.5645 110,077.5 -95,589.5
4 195,000 0.4665 90,967.5 -4,622
5 195,000 0.3855 75,172 70,550
NPV 70,550
Discounted Payback Period= 4 + 4,622/
75,172
= 4.06 years
Year CFs PVIF @ 27% PV Cumulative CFs
0 -500,000 1 -500,000 -500,000
1 195,000 0.7874 153,543 -346,457
2 195,000 0.6200 120,900 -225,557
3 195,000 0.4882 95,199 -130,358
4 195,000 0.3844 74,958 -55,400
5 195,000 0.3027 59,026.5 3,626.5
NPV 3,626.5
Year CFs PVIF @ 28% PV Cumulative CFs
0 -500,000 1 -500,000 -500,000
1 195,000 0.7813 152,353.5 -347,646.5
2 195,000 0.6104 119,028 -228,618.5
3 195,000 0.4768 92,976 -135,642.5
4 195,000 0.3725 72,637.5 -63,005
5 195,000 0.2910 56,745 -6,260
NPV -6,260
c) IRR
IRR = Lower Rate + NPV of lower Rate (diff in rates)
NPV lower rate - NPV higher rate
= 27% + 3,626.5 (28 - 27)
(3626.5 - (-) 6260)
= 27% + 0.357948718
= 27.36
IRR = 27.36 %
Changes on Project D, after correction in class flows
Criterion
Project D (cash flow of
Rs.175,000 each year)
Project D
(cash flow of
Rs. 195,000
each year) Changes Remarks
Payback
2.86 2.56 0.30
Decrease
in payback
NPV @ 15 % 86,635 153,679 (67,044)Increase in
NPVNPV @ 21%
12,032.5 70,550 (58,517.5)
IRR
22.11 27.36 (5.25)
Increase in
IRR
Discounted payback
period @ 15%
4.00 3.49 0.51
Decrease
in
discounted
payback
Discounted payback
period @ 21%
4.82 4.06 0.76
NPV @ 15% $163,887.60 $155,829.7 $621,072.4 $153,679
NPV @ 21% $70,347.40 $100,534 $309,409.7 $70,550
IRR 26.59% 35.00% 29.94% 27.36%
Payback period 3.15 years 1.48 years 3.1 years 2.56 years
Discounted payback period
@ 15% 3.53 years 1.87 years 4.48 years 3.49 years
Discounted payback period
@ 21% 3.75 years 2.11 years 5.53 years 4.06 years
Comparison of Different Projects
Project A Project B Project C Project D
37
IRR of A is 27 % IRR shows the unrealistic cash flows Investment opportunity is only 27% MIRR gives better and realistic results MIRR is 30.253% It would be better not to select project B because anything
above the MIRR rate would be uncertain and risky.
MIRR= 25% + 89,497.96/ (89497.96+66,655.68)*(35-25)= 30.73%
Year Cash Inflows FVIF @ 27% FV of Inflows
1 $370,000.00 2.0483 $757,871.00
2 $270,000.00 1.6129 $435,483.00
3 $155,000.00 1.27 $196,850.00
4 $49,000.00 1 $49,000.00
Terminal Value of Cash Inflows $1,439,204.00
PVIF @ 35% PV @ 35% PVIF @ 25% PV@ 25%
Present Value of
Terminal Cash Inflow
$1,439,204 0.3011 $433,344.32 0.4096 $589,497.96
Present Value of
Outflow
$500,000 1 $500,000 1 $500,000
Present Value of
Outflow
$500,000 1 $500,000 1 $500,000
NPV $(66,655.68) $89,497.96
MIRR is calculated to determine the rate at which the present value of a project’s outflow equals the terminal value of the project’s inflows. Trying at 35% and 25%, we get
Answer to question 5:
Question no.6If Mr. Hill is confident that he will be able to generate more and better projects in the years to come, but relatively doubtful that he will be able to persuade the Belford brothers to employ debt financing, how might this influence his recommendations? Could there ever be a situation in which Project D would be advisable? Explain
Egret Printing and Publishing Company, owned by the Belford brothers who possess extreme conservative nature .Patrick Hill who was responsible for managing the internal as well as the external financial operations of the company has been trying to change the firm’s policy of not using any debt.He puts forward a proposal to the Belford brothers in which he states that he would complete the current task .Earlier when the company did not make use of debt, it could only invest in Projects A & C, but if the company takes debt.But by making use of debt financing the cost of capital would only be 12% and this would help in lowering the WACC which in turn would improve the company’s current NPV. Use of debt would increase the level of investments by $500,000.
Question no.7Source of capital
Amount ($) Weight After tax cost Percent
Long term debt 500,000 0.25 6.48 % 1.62
Common equity 1,500,000 0.75 15% 11.25
Weighted average cost of capital 12.87%
Discount rate Combination of Projects Initial Investment NPV PV of Inflow Profitability
Index(PI)
12.87% A, C & D 2 million 1,082,314.28 3,082,314.28 1.54
12.87% B, C & D 2 million 1,056,987.10 3,056,987.10 1.53
Profitability Index
Value addition in NPV after changes in capital structure
Particulars Amount
($)Net present value of selected projects after inclusion of debt in capital
structure (A,C&D)X
Less: Net present value of selected projects before inclusion of debt in
capital structure (A,C)Y
1,082,314.74
785,417.04
Extra value additional due to use of debt financing (X-Y) 296,897.70
New capital structure yield more return than without using debt in capital structure due to low cost of capital .
Question no.8Assuming that the $1.5 million of internal funds available to finance new investment is after paying a dividend of $300,000 and represents an average addition to retained earnings; do you consider the use of $500,000 of debt to increase the risk to the Belford's by very much? Explain by considering times interest earned ratio.
Solution no. 8
EBIT $3,393,333.33
Less: Interest (12%) $60,000.00
EBT $3,333,333.33
Less: Tax @ 46% $1,533,333.33
EAT $1,800,000.00
Less: Dividends $300,000.00
Retained Earnings $1,500,000.00
Times Interest Earned= EBIT / Interest Expense
= $ 3,393,333.33/60,000
= 56.5555 times
Question no.9
The case stated that Project C would be feasible unless either Project A or B was also accepted. What is the implication of this statement on the current capital budgeting analysis? Is the way Project C handled earlier in the case valid?
Project C is best according to the NPV analysis.
Based on the NPV analysis we came to know:
1. project with higher NPV is better.2. In case of independent project, having
higher positive NPV should be selected.3. In case of mutually exclusive, project with
highest NPV is selected.
Profitability index of A & C and B & C ranked first and second respectively.
Project C handled in the case earlier is valid because project C cannot be chosen without choosing either projects A or B.
Question no 10.Are quantitative measures alone important in capital budgeting evaluation? What qualitative factors could also be important in capital budgeting evaluation No,-Quantitative Factors
•Pay back period•Net present value •Profitability index •Internal rate of return •Modified Internal Rate of Return •Equivalent annual annuity
Qualitative factors•SWOT analysis•PEST analysis•Competitors analysis Alignment with mission, vision, corporate strategies and strategic fit•Effect on capital structure, dividend policy and working capital•Management ability to carry out the project
-Both quantitative and qualitative technique helps manager for good decision. -Quantitative factors review the past whereas qualitative factors forecast the future.
Conclusion:The objective of each firm is maximizing
shareholders’ wealthA firm adopting an all-equity structure
faces certain drawbacksIt would be an asset to a firm to consider
the qualitative factors as well to make effective decisions
Lesson learnt from caseDebt financing is important for any company .A positive NPV is the best criteria.Profitability index helps in deciding the
combinations of projects to be undertaken. Equity holders have ultimate authority over
investment decisions.Both quantitative and qualitative factors need
to be considered to decide the undertaking of projects.
Thank You