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ESMBA06 Finance 5405 Financial Management

ESMBA06 Finance 5405 Financial Management. Team 07 Sushil Bhattachan Christina Danver Ben Gumpert Adan Montoya Gurinder Virdi. Case 7 Make or Buy Analysis Dixie Holdings. Introduction Assumptions Analysis Conclusions Recommendations. I. Introduction. Company Overview

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ESMBA06 Finance 5405 Financial Management

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  1. ESMBA06 Finance 5405 Financial Management

  2. Team 07 Sushil Bhattachan Christina Danver Ben Gumpert Adan Montoya Gurinder Virdi

  3. Case 7Make or Buy Analysis Dixie Holdings • Introduction • Assumptions • Analysis • Conclusions • Recommendations

  4. I. Introduction • Company Overview • Current Situation • Analysis’ Objectives • Financial theory applied in case

  5. Company Overview • Dixie Holding • Dixie Air • Dixie Properties • Dixie Support • Dixie Support provides support services to Holding, including print services

  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)

  7. Analysis’ Objectives • Should Dixie Support outsource or expand print shop? • 3 Alternatives for Dixie Support • Close 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.

  8. Financial Theory • Make vs. Buy Analysis • Purpose • Choosing a discount rate (riskiness) or cost of capital (CC) • Project financial indicators • NPV (dollar contribution of project) • IRR (expected rate of return) • MIRR (forces reinvestment at cost of capital)

  9. Financial Theory • Risk Assessment • Sensitivity Analysis (used in this case) • Scenario Analysis • Monte Carlo Simulation • Cash Flows • Estimating • Discounting • Investment project vs. Borrowing project • Differences

  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

  11. III. Analysis • Overview • Summary of case information • Alternatives’ analysis

  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.

  13. Case Information • General • Cost of Capital • Assumptions • 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

  14. Cost of capital (Given)

  15. Case assumptions

  16. Current costs and values for alternatives 1, 2 and 3 – Yr (2003)

  17. New costs for Alt. 2 and 3 – Yr 2003

  18. Incremental savings for alternatives 2 and 3 – Yr 2003

  19. External Revenues for alternative 3

  20. Alternative 2 • Risk Analysis • Most conservative alternative • Extension of work performed by the Dixie Support subsidiary • Control in house • Cost of Capital • Use Dixie Support CC (8%)

  21. Alternative 2 – Cash flows

  22. Net cash flows (000s) 4 5 2 3 0 1 8% $92 $101 ($266) $77 $82 $87 NPV = $80. IRR = 18.3%. MIRR = 13.8%.

  23. Alternative 1 • Risk Analysis • Second most conservative alternative. Higher risk than alternative 1 • All work performed by vendors • No control in house • Cost of Capital • Penalize the Dixie Support CC (8%) by 2% to incorporate higher risk • It is a borrowing project. CC = 8% – 2% = 6%

  24. Alternative 1 – Cash flows

  25. Net cash flows (000s) 4 5 2 3 0 1 6% ($45) ($52) $234 ($38) ($41) ($43) NPV = $51. IRR = -2.3%. MIRR = 11.3%.

  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

  27. Alternative 3 • Cost of Capital • Lower EBIT and ROA in Louisiana • Penalize 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

  28. Alternative 3 – Cash flows

  29. Net cash flows (000s) 4 5 2 3 0 1 8% Internal $92 $101 ($266) $77 $82 $87 4 5 2 3 0 1 11% External $50 $53 $30 $45 $47 4 5 2 3 0 1 Net $142 $153 ($266) $107 $127 $134 NPV = $242. IRR = 37.6%. MIRR = 23.6%.

  30. Sensitivity Analysis - Overview • Most likely case • NPV and MIRR vs internal cost of capital • External CC = Internal CC + 3% • Worst case • NPV and MIRR vs internal cost of capital • External CC = Internal CC * 2

  31. Sensitivity Analysis – Most likely case

  32. Sensitivity Analysis – Most likely case

  33. Sensitivity Analysis – Most likely case

  34. Sensitivity Analysis – Worst case

  35. Sensitivity Analysis – Worst case

  36. Sensitivity Analysis – Worst case

  37. IV. Conclusions • Summary • Alternative 3 • Higher NPV and MIRR under assumed conditions. • Best alternative in sensitivity analysis. It has the higher NPV and MIRR under different scenarios.

  38. Real world

  39. Alternative 3 Expand 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%) V. Recommendations

  40. Centrally control printing contracts Reduce the list of printing vendors from 9 to 2 Get better prices and payment conditions

  41. Improve assumptions by using industry or historic data Expand cash flow analysis to more than 5 years Pro: 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.

  42. Perform lease vs. buy analysis for building for equipment Buy additional equipment to perform 100% of work in-house instead of 90% of graphics printing 25% of forms printing Explore ways to reduce cost and improve productivity Recycling cartridges and paper Print same colors in batch to reduce rollers’ wash-up charges

  43. Perform additional analysis as part of business plan for alternative 3 Window of opportunity Market environment (demand and supply) Competitor analysis Market positioning Risk recognition Risk reduction strategies Financial Plan

  44. Any questions Questions and Answers

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