Egret Printing and Publishing company

A case study.

PRESENTERS:

NISHAN RAJBHANDARI

SIDDHARTHA CHHETRI

SUDHIR BOGATI

SUPRAVA SHARMA

SUJATA PATHAK

# Egret Printing and Publishing Company is a family owned specialty printing business Found by Keith

Belford in 1986.

# Hill has responsibility for the both internal and external financial operations.

# Belford’s have identified four major capital investment proposals as potential candidates for funding

in the coming year.

# All equity capital structure to be overly conservative

# Belford family not willing to go for debt financing.

Background of the study

Project A: Major Plant Expansion

Project B: Alternative Plan For Plant Expansion

Project C: Purchase Of New Press

Project D: Upgrade Of Egret’s Video Text Service

Four Major Capital Investment Proposals

Pay Back Period(In thousand US dollar)

Project A Project B Project C Project D Remarks

Project Cost 1000 1000 2000 1000

Discount rate (15%)

3.787 years 2.014 years 4.446 years 3 years Accept B and D

Discount rate (21%)

4.826 years 2.582 years 5.274 years 4.822 years Accept B and D

Life of project

4 years 4 years 10 years 5 years

Capital budget $3.0 million

Project A and B mutually exclusive

Net present Value

Project A Project B Project C Project D Remarks

Cost of project 1000 1000 2000 1000

Net Present value (15%) 197.35

186.8

1262.22

173.27

Accept A and C

Net Present Value (21%) 49.12 93.87 635.165 24.1 Accept B and C

Life of project 4 years 4 years 10 years 5 years

IRR Project A Project B Project C Project D Remarks

Cost of project 1000 1000 2000 1000

Internal rate of return (IRR) 23.30% 28.49% 30.18% 22.11% Select B and C

Life of project 5 years 5 years 10 years 6 years

The company should use NPV method instead of payback period method and IRR method. It takes into account all cash flows. All cash flows are discounted at the appropriate market-determined opportunity cost of capital. NPV of a project is exactly the same as the increase in shareholders’ wealth.A zero NPV is one, which earns a fair return to compensate both debt holders & equity holders.A positive NPV project earns more than the required rate of return, & equity holders receive all excess cash flows.

SUGGESTION TO COMPANY

EAA Project A Project B Project C Project D Remarks

Cost of project 1000 1000 2000 1000

Equivalent annual annuity (15%)

69.12 65.43 251.50 51.69 Select A and C

Equivalent annual annuity (21%)

19.34 36.95 156.67 8.24 Select B and C

Life of project 4 years 4 years 10 years 5 years

Cash Flow with 380000$

Project D Before change in cash flow

After change in cash flow Remarks

15% 21% 15% 21%

Payback period 4 years 4.822 year 3.61 years 4.237 years Improve in PBP

Net Present value

173.27

24.1 273.836

111.88 Improve in NPV

EAA 51.69 8.24 81.69 38.24 Improve in EAA

Internal rate of return

21.11% 26.07% Improve in EAA

particular Project A(industry average)

Project B Remarks

Payback period(PBP) 3.425 year 2.014 year Project B (good)

Net present value(NPV) 197.35 186.8 Project A (good)

Internal rate of return(IRR) 23.30 28.49 Project B (good)

Comparison of Project B with Project A( industry average)

-Approximately 3 mill ion available for investment

-With this amount company will only be able to invest in ei ther project A and C or projects B and C.

-Without using debt f inancing company is losing the opportunity to invest in project D.

-1 mill ion as long term debt.

-All projects are posit ive i t would be highly profi table for the company.

-Debt financing capital reducing i t from 15% to 12% only.

-Project D will also profi table if belford brothers invest from debt financing.

If cash flows project D = $380000

Payback period Net present value IRR EAA

15% 3.61 years $273.836 26.07 $81.69

21% 4.237 years $111.88 26.07 $38.24

Project D has a positive NPV hence, shows a good profitability. It has low return compared to that of project C.In the situation , Belford brothers acquire the loan of 1 million , project D is advisible

Effect on capital structure and COC - debt

Source of capital Amount Weight After tax cost of capital

Product

Long term debt 1 M 0.25 7.2 1.8

Common equity 3M 0.75 15 11.25

Total 4 M Weighted average cost of capital 13.05 %

Comparison before debt and after debtCOST OF CAPITAL

NET PRESENT VALUES OF PROJECT

A B C D

15% 197.35

186.8

1262.22

173.27

21% 49.12 93.87 635.165 24.1

13.5% 252.625

220.32

1523 228.5

Time interest earned RatioEBIT $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 times

Handling of project C valid? Project C is best according to the NPV analysis

Based on the NPV analysis we came to know :

project with higher NPV is better

In case of independent project, having Higher positive NPV project should be selected

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.

Quantitative Vs Qualitative Factors

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.

Lesion learntDebt fi nancing is important for any company.

A positive NPV is a best criteria.

Profi tability index helps in deciding the combinations of projects to be undertaken.

Have ultimate authority over investment decisions equity holders

Thank You