Egret Printing and Publishing ppt

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