egret case study

7/27/2019 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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egret case study

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