1 esmba06 finance 5405 financial management. 2 team 07 sushil bhattachan christina danver ben...
TRANSCRIPT
04/20/23 Team 7
1
ESMBA06
Finance 5405
Financial Management
04/20/23 Team 7
2
Team 07
Sushil BhattachanChristina Danver
Ben GumpertAdan MontoyaGurinder Virdi
04/20/23 Team 7
3
IntroductionAssumptionsAnalysisConclusionsRecommendations
Case 7Make or Buy Analysis
Dixie Holdings
04/20/23 Team 7
4
I. Introduction
Company Overview
Current Situation
Analysis’ Objectives
Financial theory applied in case
04/20/23 Team 7
5
Company Overview
Dixie HoldingDixie AirDixie PropertiesDixie Support
Dixie Support provides support services to Holding, including print services
04/20/23 Team 7
6
Current Situation
Dixie Support not capable of accommodating printing needs of Holding
$830,000 in 2003 for commercial print services
$293,000 can be brought in-house
EBIT of $50,000 in 2004 and EBIT of $75,000 in 2005 in local commercial printing (external business)
04/20/23 Team 7
7
Analysis’ Objectives
Should Dixie Support outsource or expand print shop?
3 Alternatives for Dixie SupportClose print shop completely and use
outside vendors for all printing.Expand print shop and perform all
feasible printing in-house.Expand print shop as above and enter
commercial printing business.
04/20/23 Team 7
8
Financial Theory
Make vs. Buy AnalysisPurposeChoosing a discount rate (riskiness) or
cost of capital (CC)
Project financial indicatorsNPV (dollar contribution of project)IRR (expected rate of return)MIRR (forces reinvestment at cost of
capital)
04/20/23 Team 7
9
Financial Theory
Risk AssessmentSensitivity Analysis (used in this case)Scenario AnalysisMonte Carlo Simulation
Cash FlowsEstimatingDiscounting
Investment project vs. Borrowing projectDifferences
04/20/23 Team 7
10
II. Assumptions
3% annual inflation rate for vendor pricing
2% annual volume increase in printing needs
Supplies as % of billing (30%)
No additional maintenance costs for alternative 2 and 3
Marketing/Sales expenses for alternative 3 are included in EBIT
Five year analysis assumes no additional external factors other than specified
04/20/23 Team 7
11
III. Analysis
Overview
Summary of case information
Alternatives’ analysis
04/20/23 Team 7
12
Alternatives Overview
Alternative 1. Close the print shop completely and use outside vendors for all printing.
Alternative 2. Expand the print shop as envisioned to perform all feasible work in-house.
Alternative 3. Expand the print shop as in Alternative 2 to perform all feasible work in-house. In addition, the print shop will enter the commercial printing business.
04/20/23 Team 7
13
Case Information
GeneralCost of CapitalAssumptions
Current costs and values for alternatives 1, 2 and 3
New costs for alternatives 2 and 3
Incremental savings for alternatives 2 and 3
External Revenues for alternative 3
04/20/23 Team 7
14
Cost of capital (Given)
Dixie Holdings (Overall corporate) 10%
Dixie Support 8%
Dixie Properties 7%
Dixie Air 12%
04/20/23 Team 7
15
Case assumptions
Projected general inflation rate 3.0%
Projected printing volume increase 2.0%
Supplies as % of billing 30.0%
Tax rate 40.0%
04/20/23 Team 7
16
Current costs and values for alternatives 1, 2 and 3 – Yr (2003)
Annual lease costs $7,125
Annual utilities/insurance $2,400
Annual labor $50,000
Annual material costs $42,837
Annual depreciation exp $20,000
Market value of existing equipment $230,000
04/20/23 Team 7
17
New costs for Alt. 2 and 3 – Yr 2003
Incremental annual lease expense $13,125
Building remodeling $50,000
Equipment investment $212,600
Depreciation on new equipment $25,000
Added annual labor costs $90,016
Added annual utilities/insurance $3,600
Annual vehicle expense $2,060
04/20/23 Team 7
18
Incremental savings for alternatives 2 and 3 – Yr 2003
Graphics printing $118,839
Forms printing $174,540
04/20/23 Team 7
19
External Revenues for alternative 3
Pre-tax earnings for 2004 $50,000
Pre-tax earnings for 2005 $75,000
Revenue growth rate after 2005 5.0%
04/20/23 Team 7
20
Alternative 2
Risk AnalysisMost conservative alternativeExtension of work performed by the Dixie
Support subsidiaryControl in house
Cost of CapitalUse Dixie Support CC (8%)
04/20/23 Team 7
21
Alternative 2 – Cash flows
Capital Flows 2003 2004 2005 2006 2007 2008 Building remodeling $50,000 Equipment purchases 212,600 Total investment $262,600
Incremental Savings Graphics printing $124,852 $131,170 $137,807 $144,780 $152,106 Forms printing 183,371 192,650 202,398 212,640 223,399 Total savings $308,224 $323,820 $340,205 $357,419 $375,505
Incremental Costs Lease expense $6,000 $6,000 $6,000 $6,000 $6,000 Printing supplies 92,467 97,146 102,062 107,226 $112,651 Utilities 3,708 3,819 3,934 4,052 4,173 Labor 92,716 95,498 98,362 101,313 104,353 Depreciation 25,000 25,000 25,000 25,000 25,000 Vehicle expense 2,122 2,185 2,251 2,319 2,388 Total costs $6,000 $222,013 $229,648 $237,609 $245,910 $248,566 Revenues - Costs ($6,000) $86,211 $94,172 $102,596 $111,510 $126,939 Taxes (2,400) 34,484 37,669 41,038 44,604 50,776 After-tax op earnings ($3,600) $51,726 $56,503 $61,558 $66,906 $76,163Plus: Depreciation 25,000 25,000 25,000 25,000 25,000Net cash flow ($266,200) $76,726 $81,503 $86,558 $91,906 $101,163
04/20/23 Team 7
22
0
$77
1
$82
2
$87
3
($266)
Net cash flows (000s)
NPV = $80.
IRR = 18.3%.
MIRR = 13.8%.
8%4 5
$101$92
04/20/23 Team 7
23
Alternative 1 Risk Analysis
Second most conservative alternative. Higher risk than alternative 1
All work performed by vendorsNo control in house
Cost of CapitalPenalize the Dixie Support CC (8%) by 2% to incorporate
higher riskIt is a borrowing project. CC = 8% – 2% = 6%
04/20/23 Team 7
24
Alternative 1 – Cash flows
Capital Flows 2003 2004 2005 2006 2007 2008 Sale of equipment (net of taxes) $230,000
Incremental Savings Materials $45,005 $47,282 $49,674 $52,188 $54,828 Lease $7,125 7,125 7,125 7,125 7,125 Utilities 2,472 2,546 2,623 2,701 2,782 Labor 51,500 53,045 54,636 56,275 57,964 Total savings (net of taxes) $4,275 $63,661 $65,999 $68,435 $70,974 $69,345
Incremental Costs Vendor billing $150,015 $157,606 $165,581 $173,959 $182,762 Loss of depreciation 20,000 20,000 20,000 20,000 20,000 Total costs (net of taxes) $102,009 $106,564 $111,348 $116,376 $121,657
Net cash flow $234,275 ($38,348) ($40,565) ($42,914) ($45,402) ($52,312)
04/20/23 Team 7
25
0
($38)
1
($41)
2
($43)
3
$234
Net cash flows (000s)
NPV = $51.
IRR = -2.3%.
MIRR = 11.3%.
6%4 5
($52)($45)
04/20/23 Team 7
26
Alternative 3 Risk Analysis
Least conservative alternative. Higher risk than alternatives 1 and 2 due to external cash flows
Extension of work performed by the Dixie Support subsidiary + commercial printing business
Some control in house
Printing Industry
USA LouisianaEBIT 5.3% 4.0%ROA 7.5% 5.1%
04/20/23 Team 7
27
Alternative 3
Cost of CapitalLower EBIT and ROA in LouisianaPenalize the Dixie Support CC (8%) by 3%
to incorporate higher risk for external cash flows
It is an investment project. CC = 8% + 3% = 11%
Use Dixie Support CC (8%) for internal cash flows
04/20/23 Team 7
28
Alternative 3 – Cash flows
2003 2004 2005 2006 2007 2008Internal work CF (Alternative 2) ($266,200) $76,726 $81,503 $86,558 $91,906 $101,163Pre-tax earnings on external work $50,000 $75,000 $78,750 $82,688 $86,822Taxes on external work 20,000 30,000 31,500 33,075 34,729 External work cash flow $30,000 $45,000 $47,250 $49,613 $52,093Net cash flow ($266,200) $106,726 $126,503 $133,808 $141,518 $153,257
04/20/23 Team 7
29
0
$30
1
$45
2
$47
3
Net cash flows (000s)
NPV = $242. IRR = 37.6%. MIRR = 23.6%.
11%4 5
$53$50
0
$77
1
$82
2
$87
3
($266)
8%4 5
$101$92
0
$107
1
$127
2
$134
3
($266)
4 5
$153$142
Internal
External
Net
04/20/23 Team 7
30
Sensitivity Analysis - Overview
Most likely caseNPV and MIRR vs internal cost of capitalExternal CC = Internal CC + 3%
Worst caseNPV and MIRR vs internal cost of capitalExternal CC = Internal CC * 2
04/20/23 Team 7
31
Sensitivity Analysis – Most likely case
Alternative 1CC 4.0% 5.0% 6.0% 7.0% 8.0% 9.0% 10.0% 11.0% 12.0% 13.0% 14.0%NPV $39,941 $45,549 $50,911 $56,040 $60,949 $65,650 $70,155 $74,473 $78,615 $82,590 $86,407IRR -2.0% -2.0% -2.0% -2.0% -2.0% -2.0% -2.0% -2.0% -2.0% -2.0% -2.0%MIRR 8.0% 9.6% 11.3% 13.0% 14.7% 16.4% 18.1% 19.8% 21.5% 23.3% 25.0%
Alternative 2CC 4.0% 5.0% 6.0% 7.0% 8.0% 9.0% 10.0% 11.0% 12.0% 13.0% 14.0%NPV $121,590 $110,446 $99,790 $89,594 $79,835 $70,487 $61,529 $52,940 $44,700 $36,792 $29,199IRR 18.3% 18.3% 18.3% 18.3% 18.3% 18.3% 18.3% 18.3% 18.3% 18.3% 18.3%MIRR 12.1% 12.5% 13.0% 13.4% 13.8% 14.2% 14.7% 15.1% 15.5% 16.0% 16.4%
Alternative 3CC In-house 4.0% 5.0% 6.0% 7.0% 8.0% 9.0% 10.0% 11.0% 12.0% 13.0% 14.0%CC External 7.0% 8.0% 9.0% 10.0% 11.0% 12.0% 13.0% 14.0% 15.0% 16.0% 17.0%NPV $302,493 $286,233 $270,678 $255,789 $241,530 $227,867 $214,768 $202,204 $190,147 $178,570 $167,450IRR 37.6% 37.6% 37.6% 37.6% 37.6% 37.6% 37.6% 37.6% 37.6% 37.6% 37.6%MIRR 21.8% 22.2% 22.7% 23.1% 23.6% 24.0% 24.5% 24.9% 25.4% 25.9% 26.3%
04/20/23 Team 7
32
Sensitivity Analysis – Most likely case
NPV vs CC
$0$50,000
$100,000$150,000$200,000$250,000$300,000$350,000
cost of capital
NP
V
Alternative 1
Alternative 2
Alternative 3
04/20/23 Team 7
33
Sensitivity Analysis – Most likely case
MIRR vs CC
0.0%
5.0%
10.0%
15.0%
20.0%
25.0%
30.0%
4.0%
5.0%
6.0%
7.0%
8.0%
9.0%
10.0
%
11.0
%
12.0
%
13.0
%
14.0
%
cost of capital
MIR
R
Alternative 1
Alternative 2
Alternative 3
04/20/23 Team 7
34
Sensitivity Analysis – Worst case
Alternative 1CC 4.0% 5.0% 6.0% 7.0% 8.0% 9.0% 10.0% 11.0% 12.0% 13.0% 14.0%NPV $39,941 $45,549 $50,911 $56,040 $60,949 $65,650 $70,155 $74,473 $78,615 $82,590 $86,407IRR -2.0% -2.0% -2.0% -2.0% -2.0% -2.0% -2.0% -2.0% -2.0% -2.0% -2.0%MIRR 8.0% 9.6% 11.3% 13.0% 14.7% 16.4% 18.1% 19.8% 21.5% 23.3% 25.0%
Alternative 2CC 4.0% 5.0% 6.0% 7.0% 8.0% 9.0% 10.0% 11.0% 12.0% 13.0% 14.0%NPV $121,590 $110,446 $99,790 $89,594 $79,835 $70,487 $61,529 $52,940 $44,700 $36,792 $29,199IRR 18.3% 18.3% 18.3% 18.3% 18.3% 18.3% 18.3% 18.3% 18.3% 18.3% 18.3%MIRR 12.1% 12.5% 13.0% 13.4% 13.8% 14.2% 14.7% 15.1% 15.5% 16.0% 16.4%
Alternative 3CC In-house 4.0% 5.0% 6.0% 7.0% 8.0% 9.0% 10.0% 11.0% 12.0% 13.0% 14.0%CC External 8.0% 10.0% 12.0% 14.0% 16.0% 18.0% 20.0% 22.0% 24.0% 26.0% 28.0%NPV $297,377 $276,640 $257,169 $238,859 $221,613 $205,347 $189,983 $175,454 $161,696 $148,654 $136,276IRR 37.6% 37.6% 37.6% 37.6% 37.6% 37.6% 37.6% 37.6% 37.6% 37.6% 37.6%MIRR 21.8% 22.2% 22.7% 23.1% 23.6% 24.0% 24.5% 24.9% 25.4% 25.9% 26.3%
04/20/23 Team 7
35
Sensitivity Analysis – Worst case
NPV vs CC
$0$50,000
$100,000$150,000$200,000$250,000$300,000$350,000
cost of capital
NP
V
Alternative 1
Alternative 2
Alternative 3
04/20/23 Team 7
36
Sensitivity Analysis – Worst case
MIRR vs CC
0.0%
5.0%
10.0%
15.0%
20.0%
25.0%
30.0%
4.0%
5.0%
6.0%
7.0%
8.0%
9.0%
10.0
%
11.0
%
12.0
%
13.0
%
14.0
%
cost of capital
MIR
R
Alternative 1
Alternative 2
Alternative 3
04/20/23 Team 7
37
IV. Conclusions Summary
Alternative 3Higher NPV and MIRR under assumed conditions.Best alternative in sensitivity analysis. It has the higher NPV and MIRR
under different scenarios.
Alternatives 1 2 3 Cost of capital 6.0% 8.0% 8.0%
11.0% NPV $50,911 $79,835 $241,530 IRR -2.0% 18.3% 37.6% MIRR 11.3% 13.8% 23.6%
04/20/23 Team 7
38
Real world
Industry NameNumber of Firms Beta
Cost of Equity E/(D+E)
Std Dev in Stock
Cost of Debt Tax Rate
After-tax Cost of Debt D/(D+E)
Cost of Capital
Advertising 35 1.34 10.72% 78.62% 59.79% 5.75% 13.41% 4.98% 21.38% 9.49%
Bank 505 0.58 7.03% 56.70% 25.23% 5.00% 28.11% 3.59% 43.30% 5.54%
Computer Software/Svcs 400 1.83 13.07% 96.55% 83.99% 6.25% 9.95% 5.63% 3.45% 12.82%
Entertainment 95 1.27 10.35% 79.14% 52.99% 5.75% 17.16% 4.76% 20.86% 9.18%
Financial Services 232 0.89 8.52% 44.48% 49.78% 5.50% 19.49% 4.43% 55.52% 6.25%
Grocery 24 0.77 7.97% 57.13% 38.19% 5.25% 25.57% 3.91% 42.87% 6.23%
Homebuilding 35 0.88 8.51% 61.59% 39.11% 5.25% 26.29% 3.87% 38.41% 6.73%
Information Services 33 0.96 8.85% 91.18% 32.58% 5.25% 18.52% 4.28% 8.82% 8.45%
Medical Services 203 0.81 8.13% 82.65% 65.24% 6.25% 16.52% 5.22% 17.35% 7.63%
Newspaper 19 0.85 8.36% 86.43% 24.56% 4.75% 28.88% 3.38% 13.57% 7.68%
Oilfield Svcs/Equip. 88 0.9 8.61% 80.34% 47.22% 5.50% 19.29% 4.44% 19.66% 7.79%
Publishing/Printing 41 0.83 8.27% 82.67% 41.91% 5.50% 20.14% 4.39% 17.33% 7.60%
Retail Store 49 0.95 8.83% 84.23% 44.66% 5.50% 24.67% 4.14% 15.77% 8.09%
Securities Brokerage 26 1.31 10.59% 33.87% 35.89% 5.25% 21.28% 4.13% 66.13% 6.32%
Telecom. Services 146 1.27 10.38% 76.25% 77.70% 6.25% 13.42% 5.41% 23.75% 9.20%
Utility 5 0.84 8.30% 51.45% 30.96% 5.25% 16.68% 4.37% 48.55% 6.39%
Wireless Networking 63 2.32 15.43% 73.77% 89.61% 6.25% 4.26% 5.98% 26.23% 12.95%
Market 7133 0.91 8.64% 71.59% 60.55% 6.25% 16.70% 5.21% 28.41% 7.66%
04/20/23 Team 7
39
V. Recommendations
Alternative 3Expand the print shop as envisioned to perform
all feasible work in-house. In addition, the print shop will enter the commercial printing business.
NPV($241,530) and MIRR(23.6%)
04/20/23 Team 7
40
Centrally control printing contractsReduce the list of printing vendors from 9 to 2 Get better prices and payment conditions
Fiscal YearVendors 2002 2003 ChangeMercury $85,002.31 $7,727.86 -91%Universal Color Graphics $16,982.44 $12,588.00 -26%Crescent Press $9,300.00 $24,446.00 163%Southern Lousiana Printing $5,628.50 $711.94 -87%Pickett Press $3,526.14 $2,337.10 -34%Sir Speedy $1,962.58 $8,939.50 355%French Quarter Printing $85.46 $0.00 -C & S Printing $1,161.00 $0.00 -Metairie Printing Service $0.00 $75,292.83 +Total $123,648.43 $132,043.23 7%
04/20/23 Team 7
41
Improve assumptions by using industry or historic data
Expand cash flow analysis to more than 5 yearsPro: higher precision in our results if future
flows are know, otherwise it will increase uncertainty.
Con: more difficult to calculate results. Unlikely to change recommendation.
04/20/23 Team 7
42
Perform lease vs. buy analysisfor buildingfor equipment
Buy additional equipment to perform 100% of work in-house instead of90% of graphics printing25% of forms printing
Explore ways to reduce cost and improve productivityRecycling cartridges and paperPrint same colors in batch to reduce rollers’
wash-up charges
04/20/23 Team 7
43
Perform additional analysis as part of business plan for alternative 3Window of opportunityMarket environment (demand and supply)Competitor analysisMarket positioningRisk recognitionRisk reduction strategiesFinancial Plan
04/20/23 Team 7
44
Questions and Answers
Any questions