Egret Case Study
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Transcript of Egret Case Study
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Presentedby:
Himalaya Ban
Egret Printing and PublishingCompany
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General BackgroundCompany Name: Egret Printing and Publishing
Company
Established on : 1956
Founders : John Belford and Keith Belford
Vice President : Patrick Hill
Products offered:
high quality print
advertising materialscalendars
business printing and books
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Capital investment alternatives
Project A : Major Plant Expansion
Project B : Alternative Plan for Plant Expansion
Project C : Purchase of New Press
Project D : Upgrade of Egrets Video TextService.
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Answer 1Discounted Payback Period
Project A Project C0
1
2
3
4
5
6
Discounted Paybackperiod@ 15%
Discounted Paybackperiod@ 21%
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Net Present Value
Project A Project B Project C Project D0
200000
400000
600000
800000
1000000
1200000
1400000
NPV
@15%
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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%
40.00%
IRR
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Ranking of the project individually
C, A, B, D at 15% discount rate
C, B, A, D at 21% discount rate
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Ranking investment proposal considering$1.5 m
Projects 15% 21%
A and C I IIA and D III IV
B and C II I
B and D IV III
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Choice at 15%
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%
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Choice at 21%
A and c C and D B and D0.95
1
1.05
1.1
1.15
1.2
1.25
1.3
PI index @ 21%
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Answer 2
Limitations of Payback Period (PBP)
Fails to consider time value of money.
Not a measure of profitability.
Fails to consider all the cash flows.
Fails to consider the magnitude and timingof cash flows.
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Limitations of NPV
Cost of capital or discounted factor chosen ,may not be the current cost prevailing in themarket.
Assumes the investment that is made havethe same level of risk throughout the entiretime horizon which may not be possible.
It wholly excludes any real option that mayexist within the investment.
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Limitations of IRR
It is not always consistent with the shareholderswealth maximization as compared to NPVmethod
It does not discount at the opportunity cost ofcapital. It assumes that the firm can reinvest atIRR.
The IRR rule can lead to multiple rates of returnwhenever the sign of cash flows changes morethan once.
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Suggestions to the Company
Focus on cash flows, not profits
Focus on incremental cash flows.
Account for time.
Account for risk.
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Comparing Projects
with Unequal Lives
1. Replacement-chain (common life)
approach
2. Equivalent annual annuity
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Equivalent Annual Annuity (EAA)
Projects EAA
Project A 115,127.87
Project B 109,162.66
Project C 247,498.37
Project D 51,688.44
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Answer 3
0% 200% 400% 600% 800% 1000% 1200%
-600000
-400000
-200000
0
200000
400000
600000
800000
1000000
1200000
Project A's NPV
Project B's NPV
IRR
NPV
Crossover rate 16.17%
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DiscountRate
Crossoverrate (16.16%)
Result Remarks
15%k < 16.16% NPV A >NPV B
Project A is
superior
21%k >16.16% NPV B >NPV A
Project B is
superior
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Answer 4
Project A Project B Project C Project DNPV @
15%
$164,577.6
0 $156,038 $621,137 $153,835NPV @
21% $71,043.60 $100,488 $310,088 $70,765
IRR 26.61% 35.02% 29.94% 27.36%
PBP 3.15 years 1.48 years 3.1 years 2.56 yearsDPBP @
15% 3.54 years 1.87 years 4.48 years 3.48 yearsDPBP @
21% 3.75 years 2.11 years 5.53 years 4.05 years
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Discounted PBP & IRR
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NPV
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Thus the conclusion will remainsame whether the cash flow is
$175,000or
$ 195,000
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Question 5 Unreasonable to claim that project B will
generate a return approximately 35% over itsfour year life.
The return of 35% is far higher compared to theactual reinvestment rate in the market.
Project As IRR is equal to reinvestment ratewhich is 27%
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Question 6
Belford Brothers has conservative feelings about debt
Hill should provide them the advantages of debt
financing.
Use of debt financing decreases the cost of capital.
Reduces in the WACC
Saves Tax
Increase in total investment
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Using the debt increases the level of investment to 2 million.
This would make possible for company to invest in additional
projects
Now the company has a total fund of 2 million of investment fund
which would allow the company to invest either in project A, Cand D or Project B, C and D.
Hence investment on Project D would also be possible if we use
debt.
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Question 7New capital structure
Capital
StructureAmount Weight
Cost
(in %)
Weightedaverage
Equity 1,500,000 0.75 15 11.25
Debt 500,000 0.25 6.48 1.62
Total 2,000,000 1 12.87%
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PI at 12.87%
Projects NPV PV PI
A, C & D 2 m 1,082,366.738 3,082,366.74 1.54
B, C & D 2 m 1,057,027.073 3,057,027.07 1.52
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Extra Value Addition
Particulars Amount
Net present value of selected projects after inclusion
of debt in capital structure (New A+C+D)
Less: Net present value of selected projects before
inclusion of debt in capital structure. (Old A+C)
$1,082,366
( $786,714 )
Extra value additional due to use of debt financing $ 295,652
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Question 8
EBIT $3,393,333.33
Less: Interest (12%) $60,000
EBT $3,333,333.33
Less: Tax @ 46% $1,533,333.33
EAT $1,800,000
Less: Dividends $300,000
Retained Earnings $1,500,000
Times Interest Earned Ratio 56.55
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Question 9
In this case Projects A and B are mutuallyexclusive projects which implies that only
one project can be chosen at a particularpoint of time.
Project C is a conditional project whoseacceptance or rejection is dependent on thedecision to accept or reject Project A or B.
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Yes the way project C is handled is valid
Project C stands top at both 15% and 21% with highestNPV.
So as per the rule , the project having highest NPVshould have been chosen
Here Project C is the most suitable project. However itcant be implemented due to its dependency
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Question 10Qualitative factors
Is the organization capable of carrying out the project in termsof human resource, availability of raw materials and suppliers?
What relationship exists between the project and the firm?
Is the market suitable to carry out the project?
What and who can be the competitors for the project whichmight make labor and capital scarce?
What are the Macro environmental elements and the project?
Does this investment effects the quality of products and servicesoffered?
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Conclusion and Lesson Learnt
Belford brothers should not be afraid to go fordebt financing
They can go for debt financing as well alongwith equity financing.
Quantitative as well as Qualitative factorsshould be considered while choosing projects
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As a future mangerCapital Budgeting Techniques should be used
considering their limitations as well
Projects should be choosed based on their return,risk , consistency and incremental cash flows.
Right technique should be chosen based on the nature
of project.
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