Egret Printing and publishing Company

Egret Printing and publishing companyFinancial reportFinancial ManagementSubmitted byNishan RajbhandariSudhir BogatiSuprava shramaSujata PathakSiddhartha ChhetriMaster of Business Administration (MBA)Global College International (GCI)Submitted inpartial fulfillment of the requirement for the Master of Business Administration(MBA) degreeSubmitted toProf.Dr. Radhe Shyam PardhanGlobal College International (GCI)In Affiliation with Shinawatra UniversityKathmandu, NepalSubmitted onSept 18, 2015

Theory and Case Background:

The term capital budgeting refers to the process of decision making by which firms evaluate the purchase of major fixed assets, including building, machineries, and equipment. Capital budgeting describes the firms formal planning process for the acquisition and investment of capital and results in capital budget that is the firms formal plan for the expenditure of money to purchase new fixed asset for expansion or replacement of business. Egret printing and publishing company is a family owned company established by Jhon and Keith in 1956. Patrick Hill joined the firm in 1979 in accounting department. As being in this department he has responsibility for both internal and external financial decision. Egret is an all equity capital structured company. It was a success company specially, in printing business. It has also made a investment in a diversified business named local video text service. Over one half of the systems subscribers pay for the video text service. Belford had identified four major investment proposals for his firms internal fund 3 million. The four projects are as follows:

Project A: It has been designed to alleviate the capacity problem by constructing a new wing of the main plant.

Project B: The project can be finish more quickly and will allow to take several major printing jobs.

Project C: The project would alleviate the capacity by acquiring the latest equipment designed for such printing functions.

Project D: Upgrade of Egrets Video Text ServiceThis project is an 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.

Question 1Payback periodPayback period is the time in which the initial cash outflow of an investment is expected to be recovered from the cash inflows generated by the investment. It is one of the simplest investment appraisal techniques. Payback period as a tool of analysis is often used because it is easy to apply and easy to understand for most individuals, regardless of academic training or field of endeavor. When used carefully or to compare similar investments, it can be quite useful. As a stand-alone tool to compare an investment to "doing nothing," payback period has no explicit criteria for decision-making.The payback method should not be used as the sole criterion for approval of a capital investment. Instead, consider using the net present value and internal rate of returnmethods to incorporate the time value of money and more complex cash flows, and use throughputto see if the investment will actually boost overall corporate profitability. There are also other considerations in a capital investment decision, such as whether the same asset model should be purchased in volume to reduce maintenance costs, and whether lower-cost and lower-capacity units would make more sense than an expensive "monument" asset.

Calculation of Payback periodUsing 15% discount factorFor project A(In thousand US dollar)YearCash flowDiscount factor (15%)Discounted Cash flowCumulative Discounted cash flow

13000.8696260.88260.88

23500.7561264.64525.52

35000.6575328.75854.27

46000.5718343.081197

Amount to recover

Cash flow during the year

Payback period = Minimum year +(1000 854.27)

343.08

= 3 years +

= 3.425 years

Project B(In thousand US dollar)YearCash flowDiscount factor (15%)Discounted Cash flowCumulative Discounted cash flow

18000.8696695.68695.68

24000.7561302.44998.12

32000.6575131.501129.62

41000.571857.181186.80

Amount to recover



131.50

= 2 years + = 2.014 years

Project C(In thousand US dollar)YearCash flowDiscount factor (15%)Discounted Cash flowCumulative Discounted cash flow

16500.8696565.24565.24

26500.7561491.471,056.71

36500.6575427.381,484.08

46500.5718371.671,855.75

56500.4972323.182,178.93

66500.4323281.002,459.93

76500.3759244.342,704.26

86500.3269212.492,916.75

96500.2843184.803,101.54

106500.2472160.683,262.22

Amount to recover



323.18

= 4 years + =4.446yearsProject D(In thousand US dollar)YearCash flowDiscount factor (15%)Discounted Cash flowCumulative Discounted cash flow

13500.8696304.36304.36

23500.7561264.64569.00

33500.6575230.13799.12

43500.5718200.13999.25

53500.4972174.021,173.27

Amount to recover


Payback period = Minimum year +

(1000 999.25)

174.02


Using 21% discount factorProject A(In thousand US dollar)YearCash flowDiscount factor (21%)Discounted Cash flowCumulative Discounted cash flow

13000.8264247.92247.92

23500.6830239.05486.97

35000.5645282.25769.22

46000.4665279.901049.12

Amount to recover



(1000 769.22)

279.90


Project BYearCash flowDiscount factor (21%)Discounted Cash flowCumulative Discounted cash flow

18000.8264661.12661.12

24000.6830273.20934.32

32000.5645112.901047.22

41000.466546.651093.86

Amount to recover



112.90


Project C(In thousand US dollar)YearCash flowDiscount factor (15%)Discounted Cash flowCumulative Discounted cash flow

16500.8264537.16537.16

26500.6830443.95981.11

36500.5645366.931,348.04

46500.4665303.231,651.26

56500.3855250.581,901.84

66500.3186207.092,108.93

76500.2633171.152,280.07

86500.2176141.442,421.51

96500.1799116.942,538.45

106500.148696.592,635.04

Amount to recover



(2000 1901.84)

207.09

= 5 years +

= 5.274 years

Project D(In thousand US dollar)YearCash flowDiscount factor (21%)Discounted Cash flowCumulative Discounted cash flow

13500.8264289.24289.24

23500.6830239.05528.29

33500.5645197.58725.87

43500.4665163.28889.14

53500.3855134.931,024.07

Amount to recover



(1000 889.14)

134.93


From the given calculation Payback period of project are:Project AProject BProject CProject D

Cost of project1000100020001000

Discount rate (15%)3.787 years2.014 years4.446 years4 years

Discount rate (21%)3.826 years2.582 years5.274 years4.822 years

Life of project4 years4 years10 years5 years

With limited capital budget $3.0 million project B and Project C should be accepted, hence Project A and Project B are mutually exclusive. Project B has 2.014 years at 15% discount factor and 2.582 years 21% discount factor and project C has 4.446 years payback period at 15 % and 5.274 years payback period at 21% discount factor. Project D has higher payback period compare project B and life of project also higher then Project B and if project B and project C accepted capital budget also fulfill that is 3.0 million.

Net Present valueNet present value is difference between the present value of cash inflows and the present value of cash outflows, NPV is used in capital budgeting to analyze the profitability of a project investment or project. Net present value is a calculation that compares the amount invested today to thepresent value of the future cash receipts from the investment. In other words, the amount invested is comparedto thefuture cash amounts after they are discounted bya specified rate of return.A positive net present value indicates that the projectedearningsgenerated by a project or investment (in present dollars) exceed the anticipated costs (also in present dollars). Generally, an investment with a positive NPV will be a profitable one and one with a negative NPV will result in anet loss. This concept is the basis for theNet present value rule. This dictates that the only investments that should be made are those with positive NPV values. When the investment in question is anacquisitionor amerger, one might also use thediscounted cash flow metric. Apart from the formula itself, net present value can often be calculated using tables, spreadsheets such as Microsoft Excel ownNPC calculator.

Calculation of Net Present Value At 15% and 21 % discount rateProject A(In thousand US dollar)YearCash FlowPV Factor 15%Present valuePV Factor 21%Present Value

0(1000)1(1000)1(1000)

13000.8696260.880.8264247.92

23500.7561264.640.6830239.05

35000.6575328.750.5645282.25

46000.5718343.080.4665279.90

Net present value197.35

49.12

Project A have 197.35 Net present value at 15 % discount factor and 49.12 Net present value at 21% discount factor.

Project B(In thousand US dollar)YearCash FlowPV Factor 15%Present valuePV Factor 21%Present Value

0(1000)1(1000)1(1000)

18000.8696695.680.8264661.12

24000.7561302.440.6830273.20

32000.6575131.500.5645112.90

41000.571857.180.466546.65


93.87

Project B have 186.8 Net present value at 15 % discount factor and 93.87 Net present value at 21% discount factor.

Project C(In thousand US dollar)YearCash flowPV factor (15%)Present valuePV factor (21%)Present value

0(2000)1(2000)1(2000)2635.165

1-106505.01883262.224.0541

NPV 1262.22 635.165

Project C have 1262.22 Net present value at 15% discount factor and 63.165 Net present value at 21% discount factor.

Project D(In thousand US dollar)YearCash flowPV factor (15%)Present valuePV factor (21%)Present value

0(1000)1(1000)1(1000)1024.1

1-53503.35221173.272.9260

NPV 173.27 24.1

Project C have 173.27 Net present value at 15% discount factor and 24.1 Net present value at 21% discount factor.From the above calculation Net present value of project A, B, C and D are as follows:Project AProject BProject CProject D


Net Present value (15%)197.35

186.8

1262.22 173.27

Net Present Value (21%)49.1293.87635.16524.1


At 15% discount factor project A and project C has higher Net present value ie 197.35 and 1262.22 respectively comparison with project B and project D with 186.8 and 173.27 Net present value respectively so according to NPV at 15% discount factor project A and project C should be accepted. At 21% discount factor project B and project C has higher Net present value ie 93.87 and 635.165 respectively comparison with project A and project D with 49.12 and 24.1 Net present value respectively so according to NPV at 21% discount factor project B and project C should be accepted.

Internal rate of returnInternal rate of return (IRR)is the interest rate at which the netpresent value of all thecashflows (both positive and negative) from a project orinvestmentequal zero. Internalrate of return is used to evaluate the attractiveness of a project orinvestment. If the IRR of a new project exceeds a companys required rate of return, that project is desirable. If IRR falls below the required rate of return, the project should be rejected.IRR allows managers to rank projects by their overallrate of returnrather than their net present values, and theinvestmentwith the highest IRR is usually preferred. Ease of comparison makes IRR attractive, but there are limits to its usefulness. For example, IRR works only forinvestmentsthat have an initialcashoutflow (the purchase of theinvestment) followed by one or more cash inflows.Calculation of internal rate of returnProject A(In thousand US dollar)YearCash FlowPV Factor 23%Present valuePV Factor 24%Present Value

0(1000)1(1000)1(1000)

13000.8130242.90.8065241.95

23500.6610231.310.6504227.64

35000.5374268.70.5245262.25

46000.4369262.140.4230253.8


-14.36

NPVLR

NPVLR - NPVHR

IRR = LR + (Different in rates)6.09

6.09 + 14.36

= 23 + (24% -23%)

= 23.30%Internal rate of return of project A is 23.30 % which the netpresent value of all thecashflow from a project equal zero.

Project B(In thousand US dollar)YearCash FlowPV Factor 28%Present valuePV Factor 29%Present Value

0(1000)1(1000)1(1000)

18000.7913633.040.7752620.16

24000.6104244.160.6009240.36

32000.476895.360.465893.16

41000.372537.250.361136.11


-10.21

NPVLR

NPVLR - NPVHR

IRR = LR + (Different in rates)9.81

9.81 + 10.21

= 28 + (29% - 28%)

= 28.49%Internal rate of return of project B is 28.49 % which the netpresent value of all thecashflow from a project equal zero.

Project CProject C have equal cash flows, so first calculate the factorInitial investment

Annual cash flow

=2000

650

Factor = =3.0769Referring PVIFA table in 10 years the factor 3.0769 lies between 30% and 31% whose corresponding values are 3.0915 and 3.0091.Factor LR Factor true

Factor LR Factor HR

IRR = LR + (HR-LR)3.0915 - 3.0769

3.0915 - 3.0091

= 30% + (31 -30)0.0146

0.0824

= 30% + = 30.18%Internal rate of return of project C is 30.18% which the netpresent value of all thecashflow from a project equal zero.Project DProject D have equal cash flows, so first calculate the factor,Initial investment

Annual cash flow

=1000

350

Factor =

=2.8571Referring PVIFA table in 5 years the factor 2.8571 lies between 22% and 23% whose corresponding values are 2.8636 and 2.8035.Factor LR Factor true

Factor LR Factor HR

IRR = LR + (HR-LR)2.8636 2.8571

2.86362.8035

= 22% + (23 -22)0.0065

0.0601

= 22% + = 22.11%Internal rate of return of project D is 22.11% which the netpresent value of all thecashflow from a project equal zero.From the above calculation Internal rate of return of project A, B, C and D are as follows:Project AProject BProject CProject D


Internal rate of return (IRR)23.30%28.49%30.18%22.11%


According to internal rate of return Project A and Project B have higher IRR compare with project A and Project. So according to IRR project B and Project B should be accepted.

Ranking of individual projects based on different CriteriaPayback Period Net Present Value 15 % 21 %Internal Rate of Return

BC CC

AB BB

DA AA

CD DD

Question 2Equivalent annual annuity (EAA) Equivalent annual annuity (EAA) is an approach used in capital budgeting to choose between mutually exclusive projects with unequal useful lives. It assumes that the projects are annuities, calculates net present value for each project, and then finds annual cash flows that when discounted at the relevant discount rate for the life of the relevant project, would equal the net present value. When used to compare projects with unequal, the one with the higher EAA should be selected.The equivalent annual annuity formula uses the annuity payment formula for when present value is given. Net present value replaces present value to give relevance to the use of the equivalent annual annuity formula. A simple net present value analysis of the two alternatives will miss the point that the investment. The equivalent annual annuity is the appropriate tool for this problem. Egret printing and Publication Company has four different projects, project A and B have same life of the project and project C and D have unequal project life to equal comparisons of the project EAA is useful measure with unequal project life. IRR and NPV are not effective measure to compare for different life of the project company should have to calculate EAA for effective calculation.Calculation of EAAFor project AA 15 % Discount factor

=197.35

2.8550

NPV of project A

PVIFA (15%, 4 yrs.)

EAA =

= 69.12At 21% Discount factorNPV of project A

PVIFA (21%, 4 yrs.)

=49.12

2.5404

EAA=

= 19.34For Project BAt 15% Discount factorNPV of project B

PVIFA (15%, 4 yrs.)

=186.8

2.8550

EAA== 65.43At 21% Discount factorNPV of project B

PVIFA (15%, 4 yrs.)

=93.87

2.5404

EAA=

= 36.95For project CAt 15% Discount factorNPV of project C

PVIFA (15%, 10 yrs.)

=1262.22

5.0188

EAA== 251.50At 21% Discount factorNPV of project C

PVIFA (21%, 10 yrs.)

=635.165

4.0541

EAA== 156.67

For Project DAt 15% Discount factor

NPV of project D

PVIFA (15%, 5 yrs.)

=173.27

3.3522

EAA=

=51.69At 21% Discount rateNPV of project D

PVIFA (21%, 5 yrs.)

=24.1

2.9260

EAA= =8.24From the above calculation EAA of projects A, B, C and D are as follows:Project AProject BProject CProject D


Equivalent annual annuity (15%)69.1265.43251.5051.69

Equivalent annual annuity (21%)19.3436.95156.678.24


According to EAA project C and project B should be accepted. At project B and project have higher EAA compare with project A and project D.

Question 3New Cash flow of Project D YearCash flow

1380

2380

3380

4380

5380

First Calculation of Payback periodAt 15% Discount factorYearCash flowDiscount factor (15%)Discounted Cash flowCumulative Discounted cash flow

13800.8696 330.45 330.45

23800.7561 287.32 617.77

33800.6575 249.85 867.62

43800.5718 217.28 1,084.90

53800.4972 188.94 1,273.84

Amount to recover



(1000 867.62)

217.28


At 21% Discount factorYearCash flowDiscount factor (21%)Discounted Cash flowCumulative Discounted cash flow

13800.8264 314.03 314.03

23800.6830 259.54 573.57

33800.5645 214.51 788.08

43800.4665 177.27 965.35

53800.3855 146.49 1,111.84

Amount to recover



(1000 965.35)

146.49


Now calculation of NPVAt 15% and 21% Discount factor

YearCash flowPV factor (15%)Present valuePV factor (21%)Present value

0(1000)1(1000)1(1000)1111.88

1-53803.35221273.8362.9260

NPV 273.836 111.88

Now Calculation of IRR of Project DProject D have equal cash flows, so first calculate the factor,Initial investment

Annual cash flow

=1000

380

Factor =

= 2.6316Referring PVIFA table in 5 years the factor 2.6316 lies between 26% and 27% whose corresponding values are 2.6351 and 2.5827.Factor LR Factor true

Factor LR Factor HR

IRR = LR + (HR-LR)2.6351 2.6316

2.6351 2.5827

= 26% + (27 -26) 0.0035

0.0524

= 26% + = 26.07%Internal rate of return of project D is 22.11% which the netpresent value of all thecashflow from a project equal zero.

Calculation of EAA for project DAt 15% Discount factorNPV of project D

PVIFA (15%, 5 yrs.)

=273.836

3.3522

EAA== 81.69At 21% Discount rateNPV of project A

PVIFA (21%, 5 yrs.)

=111.88

2.9260

EAA= = 38.24From the above calculation Detail of Project DProject DBefore change in cash flowAfter change in cash flowRemarks

15%21%15%21%

Payback period4 years4.822 year3.61 years4.237 yearsImprove in PBP

Net Present value173.27 24.1273.836 111.88Improve in NPV

EAA51.698.2481.6938.24Improve in EAA

Internal rate of return21.11%26.07%Improve in EAA

This situation also bears decision on mutually exclusive because after change in cash flow project provide higher payback period, NPV, IRR and also higher EAA.Question 4Assuming that return on Project A is representative of investment opportunities generally found on the printing industry:particularProject A(industry average)Project BRemarks

Payback period(PBP)3.425 year2.014 yearProject B (good)

Net present value(NPV)197.35186.8Project A (good)

Internal rate of return(IRR)23.3028.49Project B (good)

Payback period and IRR of project B has higher than industry average but at NPV project B has less than industry average. If we consider payback period and IRR project B is good project but according to NPV Project is not higher return than industry average. So, Hill claim is no sufficient to prove that Project B will generate a return higher than industry average because NPV is the best measure of return of project.Question 5Patrick hill join the company in 1986 as a vice president of finance in his father in laws company. He was responsible for managing the internal as well as external financial operation of the company and has been trying to change the company policy of not using any debt financing. At the moment the company has an internal fund of approximately 3 million available for investment. With this amount company will only be able to invest in either project A and C or projects B and C i.e. without using debt financing company is losing the opportunity to invest in project D.As NPV of all projects are positive it would be highly profitable for the company, if it could invest in all the projects. But for this they would have to acquire 1 million as long term debt. Acquiring the long term debt would change the capital structure and cost of capital reducing it from 15% to 12% only.Investing in project D is important as it upgrades the service provided by the company. Egret purchases a local video text services that had been operating locally for several years. It is included as an extra-charge feature on the local cable television system, and over one half of the systems subscriber pay for the video text service. The upgrade would make it possible to update the information presented on the screen much more quickly and would increase the reliability significantly. Although the NPV of project D is positive, So in this case, project D will also profitable if Belford brothers invest from debt financing..Question 6Source of capitalAmountWeightAfter tax cost of capitalProduct

Long term debt1 M0.257.21.8

Common equity3M0.751511.25

Total4 MWeighted average cost of capital13.05 %

For Project AYearCash FlowPV Factor 13.05%Present value

0(1000)1(1000)

13000.8846265.38

23500.7825273.88

35000.6921346.05

46000.6122367.32


For Project BYearCash FlowPV Factor 13.05%Present value

0(1000)1(1000)

18000.8846707.68

24000.7825313

32000.6921138.42

41000.612261.22


Project CNet Present Value = 650 x PVIFA 13.05%, 10 years 2000= 650 x 5.42 2000= 1523

Project DNet Present Value= 350 x PVIFA 13.05%, 10years 1000= 350 x 3.51 -1000= 228.5

COST OF CAPITALNET PRESENT VALUES OF PROJECT

ABCD

15%197.35

186.8

1262.22 173.27

21%49.1293.87635.16524.1

13.5%252.625

220.32

1523228.5

If the Belford agrees to Hills proposal to use a modest amount of debt finance the project this year then Capital structure will change to 25% debt and 75% equity. This will overall decrease the cost of capital to 13.5%. Now, using this capital structure, the Belford family has to bear a comparatively a lower cost of capital which in turn will increase the net value of the projects. As per this capital structure, proposed by hill, projects A, C and D stands best to invest in.

Question no. 7EBIT$6120000

Less: Interest(12%)$120000

EBT$6000000

Less: tax @40%$2400000

EAT$3600000

Less : dividends$600000

Retained Earnings$3000000

Times interested earned ratio = EBIT/ Interest= 6120000/120000= 51 timesQuestion 8.Project C is best according to the NPV analysisBased on the NPV analysis we came to know :1. project with higher NPV is better2. In case of independent project, having Higher positive NPV project should be selected3. In case of mutually exclusive, project with highest NPV is selected.Profitability index of A&C and B&C ranked first and second respectivelyProject C handled in the case earlier is valid because project C cannot be chosen without choosing either Projects A or B.

Question 9Capital budgeting is extremely important section for any project because the decisions made here, involves the future cash flows. In the evaluation stage, the capital budgeting evaluations are made to measure the payback period or the time it requires to recoup. Only the quantitative data is likely to result in overlooking important aspects of decisions. Such as: issues related to financing the project and availability of capital to the project.No, using only quantitative factors for capital making decisions is not enough to make efficient decisions. Although using quantitative factors for decision making is important, qualitative factors may outweigh the quantitative factors in making a decision. For example, a large manufacturer of medical devices recently invested several million dollars in a small start-up medical device firm. When asked about the NPV analysis, the manager responsible for the investment indicated that a certain project was deemed unprofitable looking at its NPV. However, the technology they were using for manufacturing was of great strategic importance. This is an example ofqualitativefactors (strategic importance to the company) outweighingquantitativefactors (negative NPV). The following qualitative factors should be considered while making capital budgeting decisions: It doesnt represent the annual decline in value of asset. It doesnt measure the value of asset. It doesnt generate sufficient cash flow to measure payback period.So, In theory we should be more concerned with measuring the risk subjectively or judgmentally rather than quantitatively. Therefore, the Quantitative measures alone are not sufficient for evaluating firms performance. Quantitative factors can only be measured in numeric terms. Whereas, Qualitative measures is judgment based. It involves: Some preliminary quantitative analysis and judgments. It plays an important role in the overall capital budgeting. It is used in project evaluation.Not the only factor is effective for evaluation. So, both the factors are required for the capital budgeting evaluation.Lesson learn From this lesson, we learnt that both quantitative and qualitative techniques helps manager for good decision. Quantitative factors review the past whereas qualitative factors forecast the future. SWOT analysis, PEST analysis, competitors analysis, alignment with mission, vision, corporate strategies and Effects on capital structure and working capital, these all are necessary to identify and analysis for better decision making. Management must be able to adopt and adjust with those changes created by external or internal factors. These all analysis and further best decision making is only possible when the both quantitative and qualitative techniques are adopted.MAJOR LESSON LEARNTDebt financing is important for any company.A positive NPV is a best criteria.Profitability index helps in deciding the combinations of projects to be undertaken.Equity holders have ultimate authority over investment decisions.

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Egret Printing and publishing Company