Egret Printing and Publishing Company

Minakshi Pathak
Muna Baral
Padam Shrestha
Pragati Dahal
Prathana Shrestha
Ravi Bhandari
Ritu Malekoo
Rubina Shrestha
Date:11th
April,2013

Background
Egret Printing and Publishing Company is a family

owned specialty printing business

Egret printing and publishing operates mainly as a fullrange printer of high quality; four colors offset
advertising materials, calendars, specialty tabloids,
business printing and some books
Hill has responsibility for both internal and external
financial operations.
Belfords have identified four major capital investment
proposals as potential candidates for funding in the
coming year.
Belford brothers considers an all equity capital
structure to be overly conservative.

Project A : Project A has been designed to alleviate the

capacity problem by constructing a new wing of the
main plant.
Project B : Project B has the same cost as project A. It
can be finished more quickly and will allow to take
several major printing jobs.
Project C : Project C would alleviate the capacity by
acquiring the latest equipment designed for such
printing functions.
Project D : 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.

Discounted Pay back Period

6

Discounted Payback
period@ 15%

Discounted Payback
period@ 21%

0
Project A

Project B

Project C

Project D

NPV @ 15% And 21%

1400000

1200000

Npv
@15%

1000000

Npv
@21%

800000

600000

400000

200000

0
Project A

Project B

Project C

Project D

Internal Rate Of Return

Irr
35.00%

30.00%

25.00%

Irr

20.00%

15.00%

10.00%

5.00%

0.00%
Project A

Project B

Project C

Project D

Ranking of the project

C, A, B, D at 15% discount rate
C, B, A, D at 21% discount rate

Which projects should the company

choose and why?
PI index @ 15%
1.6
1.4
1.2
1
0.8

PI index @ 15%

0.6
0.4
0.2
0
A and c

B and C

C and D

A and D

PI index @ 21%
1.3

1.25

1.2

1.15

PI index @ 21%
1.1

1.05

0.95
A and c

B and C

C and D

A and D

B and D

Ranking of investment proposal considering

3m
Rank

Projects

15%

21%

A and C

1st

2nd

A and D

3rd

4rd

B and C

2nd

1st

B and D

4th

3th

Which discount rate is more

appropriate?
1400000

1200000

1000000

Npv
@15%

800000

Npv
@21%

600000

400000

200000

0
Project A

Project B

Project C

Project D

Question no.2
Do you find anything wrong in choosing the projects based on
pay back, NPV and IRR as stated above? What suggestions can
be made to the company? How should be the projects with
unequal lives dealt with? Determine equivalent annuity (EAA)
for each project, and based on the calculations, which projects
should Egret Printing and Publishing Company accept for the
coming year and why?

1.

Fails to consider time value of money.

2.

Not a measure of profitably.

3.

Ignores cash flows occurring after the payback

period.

1.

may not give correct decision when the projects are

of unequal life.

Difficult to calculate
2. Unrealistic Assumption
1.

PROBLEM IN NEPALESE COMPANY

The evaluation techniques for the selection proposals
adopted by the Nepalese enterprise are not sound.
Example:
Not familiar with the discounted cash flow method.
Dont perceive the concept of risk in evaluating capital
budgeting proposal.

1.

Follow modern capital budgeting techniques.

2.Focus on incremental cash flows

3.Account for time

4.Account for risk.

Project with unequal lives can be dealt

with:
The Replacement Chain Method
2. Equivalent annual annuity approach
1.

If two mutually projects with unequal lives to be

dealt we used replacement chain method.

Cement factory(Project C)
Year

CFs

(18000)

3000

4000

5000

4000

5000

6000

Sugar factory(Project S)
Year

CFs

(9000)

4000

4500

3000

NPVs at 10%=609,IRR=14.1%

After replacement of Sugar factory(Project S)

Years

CFs

(9000) 4000

4500

(6000) 4000

4500

3000

NPVs at 10%= 1067,IRR=14.1%

Accept project S.

Alternative

Compare

of Replacement chain method

the EAA of each project and select the

project with the highest EAA.

EAA =

NPV
PVIFA(i,n)

Particulars Project A

Project B

Project C

Project D

EAA@ 15%

57645.39

54654.29

122006.87

25887.53

EAA@ 21%

27969.92

39562.2

76489.39

4178.06

Project

EAA @ 15% Rank

Combination

EAA

at Rank

21%

A and C

$179652.26

$104,459.31

B and C

$176661.16

$116051.59

C and D

$147894.4

$80667.45

A and D

$83532.92

$32147.98

B and D

$80541.82

$43740.26

At 15% A and Cs combination is the best as highest EAA is achieved.

At 21% B and Cs combination is the best.

Question no.3

NPV at different rates

Discount
Rate

NPVA

NPVB

0%

526800

344000

10%

260845.2

209413.5

20%

84917.64

109140.2

30%

-36368.5

32073.9

40%

-36368.5

-28718.3

Cross overhead rate

NPV profiles of both Project

decline as the discount rate

increases.
Project A has the higher NPV
at low discount rate.
Project B has the higher NPV
if the discount rate is greater
than the cross over rate.
As NPV is more sensitive to
changes in the discount rate
as compared to project Bs
NPV

600000

500000

400000

cross over rate

16.16%
300000

NPV Project A

200000

NPV Project B

100000

IRR=34.99%%
0
0%
-100000

-200000

10%

20%

30%
IRR=26.36%

40%

Calculation of crossover rate

Year

Project A

Project B

Difference PVIF@16 PV
%

PVIF@17 PV
%

(500000)

(500000)

136000

370000

(234000)

0.862

(201708)

0.855

(200070)

136000

270000

(134000)

0.743

(99562)

0.731

(97954)

136000

155000

(19000)

0.641

(12179)

0.624

(11856)

618800

49000

569800

0.552

314529.6

0.534

304273.2

Total

Crossover Rate=

1080.6

=
= 16.16%

(5606.8)

Project B is superior than A

because of,
Basis

Project A

Project B

Payback period

3.15 year,3.54 year

1.48 year, 1.87 year

IRR

26.36%

34.99%

Project B provides more return than A at Higher discount rate.

Question no 4.
Now suppose that Hill made a mistake in the projected
cash flows for project D-they should have been $195,000
per year. Determine the effect of this change would have
on capital budgeting. Would this situation bear on the
decision about the mutually exclusive projects? Explain

Project D (After correction in Cash Flows)

a) Ordinary Payback Period
Cash Flows

Cumulative Cash Flows

Original Investment

-500,000

-500,000

Year 1

195,000

-305,000

Year 2

195,000

-110,000

Year 3

195,000

85,000

Year 4

195,000

200,000

Year 5

195,000

375,000

PaybackPeriod

500,000

=
195,000

2.56

Years

b) Discounted Payback Period

Project D @ 15 % discount rate

Year

Cash Flows

PVIF@15%

PV

Cumulative CFs

-500,000

-500,000

-500,000

195,000

0.8696a

169,572

-330,428

195,000

0.7561

147,439.5

-182,988.5

195,000

0.6575

128,212.5

-54,776

195,000

0.5718

111,501

56,725

195,000

0.4972

96,954

153,679

NPV

153,679

Discounted Payback Period=

+ 54,776/

111,501
=

3.49

years

Project D @ 21 % discount rate

Year

Cash Flows

PVIF@21%

PV

Cumulative CFs

-500,000

-500,000

-500,000

195,000

0.8264

161,148

-338,852

195,000

0.6830

133,185

-205,667

195,000

0.5645

110,077.5

-95,589.5

195,000

0.4665

90,967.5

-4,622

195,000

0.3855

75,172

70,550

NPV

70,550

Discounted Payback Period=

+ 4,622/

75,172
=

4.06

years

c) IRR
Year

CFs

PVIF @ 27%

PV

Cumulative CFs

-500,000

-500,000

-500,000

195,000

0.7874

153,543

-346,457

195,000

0.6200

120,900

-225,557

195,000

0.4882

95,199

-130,358

195,000

0.3844

74,958

-55,400

195,000

0.3027

59,026.5

3,626.5

NPV

3,626.5

Year

CFs

PVIF @ 28%

PV

Cumulative CFs

-500,000

-500,000

-500,000

195,000

0.7813

152,353.5

-347,646.5

195,000

0.6104

119,028

-228,618.5

195,000

0.4768

92,976

-135,642.5

195,000

0.3725

72,637.5

-63,005

195,000

0.2910

56,745

-6,260

NPV

-6,260

IRR =

Lower Rate +

NPV of lower Rate

(diff in rates)

NPV lower rate - NPV higher rate

=

27% +

3,626.5
(3626.5 - (-) 6260)

27% +

27.36

IRR = 27.36 %

0.357948718

(28 - 27)

Changes on Project D, after correction in class flows

Project

(cash flow of
Project D (cash flow of Rs.

Criterion

Rs.175,000 each year)

195,000

each year)

Changes

Remarks
Decrease

Payback

2.86

NPV @ 15 %

2.56
86,635 153,679

0.30 in payback
(67,044)

Increase in
NPV

NPV @ 21%

12,032.5

70,550

(58,517.5)
Increase in

IRR

Discounted

22.11

payback

period @ 15%
Discounted
period @ 21%

27.36

(5.25) IRR

Decrease
4.00

3.49

payback

0.51 in
discounted

4.82

4.06

0.76 payback

Comparison of Different Projects

Project A

Project B

Project C

Project D

NPV @ 15%

$163,887.60

$155,829.7

$621,072.4

$153,679

NPV @ 21%

$70,347.40

$100,534

$309,409.7

$70,550

IRR

26.59%

35.00%

29.94%

27.36%

Payback period

3.15 years

1.48 years

3.1 years

2.56 years

3.53 years

1.87 years

4.48 years

3.49 years

3.75 years

2.11 years

5.53 years

4.06 years

Discounted payback period

@ 15%
Discounted payback period
@ 21%

 IRR of A is 27 %
IRR shows the unrealistic cash flows
Investment opportunity is only 27%
MIRR gives better and realistic results
MIRR is 30.253%
It would be better not to select project B because anything
above the MIRR rate would be uncertain and risky.

37

MIRR= 25% + 89,497.96/ (89497.96+66,655.68)*(35-25)

= 30.73%

Answer to question 5:
Year

Cash Inflows

FVIF @ 27%

FV of Inflows

$370,000.00

2.0483

$757,871.00

$270,000.00

1.6129

$435,483.00

$155,000.00

1.27

$196,850.00

$49,000.00

$49,000.00

Terminal Value of Cash Inflows

$1,439,204.00

MIRR is calculated to determine the rate at which the present value of a projects outflow equals the terminal value
of the projects inflows. Trying at 35% and 25%, we get

Present

Value

PVIF @ 35%

PV @ 35%

PVIF @ 25%

PV@ 25%

of $1,439,204

0.3011

$433,344.32

0.4096

$589,497.96

Terminal Cash Inflow

Present

Value

of $500,000

$500,000

$500,000

Outflow
Present

Value

of $500,000

$500,000

$500,000

Outflow
NPV

$(66,655.68)

$89,497.96

Question no.6
If Mr. Hill is confident that he will be able to generate more and better projects in
the years to come, but relatively doubtful that he will be able to persuade the
Belford brothers to employ debt financing, how might this influence his
recommendations? Could there ever be a situation in which Project D would be
advisable? Explain

Egret Printing and Publishing Company, owned by the Belford brothers who possess
extreme conservative nature .
Patrick Hill who was responsible for managing the internal as well as the external
financial operations of the company has been trying to change the firms policy of not
using any debt.
He puts forward a proposal to the Belford brothers in which he states that he would
complete the current task .
Earlier when the company did not make use of debt, it could only invest in Projects
A & C, but if the company takes debt.
But by making use of debt financing the cost of capital would only be 12% and this
would help in lowering the WACC which in turn would improve the companys
current NPV.
Use of debt would increase the level of investments by $500,000.

Question no.7
Source of
capital

Amount ($)

Weight

After tax cost

Percent

Long term debt

500,000

0.25

6.48 %

1.62

Common equity

1,500,000

0.75

15%

11.25

Weighted average cost of capital

12.87%

Profitability Index
Discount rate

Combination of Projects

Initial Investment

NPV

PV of Inflow

Profitability
Index(PI)

12.87%

A, C & D

2 million

1,082,314.28

3,082,314.28

1.54

12.87%

B, C & D

2 million

1,056,987.10

3,056,987.10

1.53

Value addition in NPV after changes in capital structure

Particulars

Amount

($)
Net present value of selected projects after inclusion of debt in capital 1,082,314.74
structure (A,C&D)X
Less: Net present value of selected projects before inclusion of debt in
capital structure (A,C)Y

Extra value additional due to use of debt financing (X-Y)

785,417.04

296,897.70

New capital structure yield more return than without using debt in capital
structure due to low cost of capital .

Question no.8
Assuming that the $1.5 million of internal funds available to
finance new investment is after paying a dividend of $300,000
and represents an average addition to retained earnings; do
you consider the use of $500,000 of debt to increase the risk
to the Belford's by very much? Explain by considering times
interest earned ratio.

Solution no. 8

EBIT

$3,393,333.33

Less: Interest (12%)

$60,000.00

EBT

$3,333,333.33

Less: Tax @ 46%

$1,533,333.33

EAT

$1,800,000.00

Less: Dividends

$300,000.00

Retained Earnings

$1,500,000.00

Times Interest Earned= EBIT / Interest

Expense
= $ 3,393,333.33/60,000
= 56.5555 times

The case stated that Project C would be feasible unless

either Project A or B was also accepted. What is the
implication of this statement on the current capital
budgeting analysis? Is the way Project C handled earlier in
the case 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.

2. In case of independent project, having higher
positive NPV should be selected.
3. In case of mutually exclusive, project with highest
NPV is selected.
1.

 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.

 No,

-Quantitative Factors

Pay back period

Net present value
Profitability index
Internal rate of return
Modified Internal Rate of Return
Equivalent annual annuity

SWOT analysis
PEST analysis

Competitors analysis Alignment with mission,

vision, corporate strategies and strategic fit

Effect on capital structure, dividend policy and
working capital
Management ability to carry out the project
-Both quantitative and qualitative technique helps manager for
good decision.
-Quantitative factors review the past whereas qualitative factors
forecast the future.

Conclusion:
The objective of each firm is maximizing
shareholders wealth
A firm adopting an all-equity structure faces

certain drawbacks
It would be an asset to a firm to consider the
qualitative factors as well to make effective
decisions

Lesson learnt from case

Debt financing is important for any company .
A positive NPV is the best criteria.
Profitability index helps in deciding the combinations

of projects to be undertaken.
Equity holders have ultimate authority over
investment decisions.
Both quantitative and qualitative factors need to be
considered to decide the undertaking of projects.

Thank You