APIX ANALYSIS OF COFFEE PACKAGING PROJECT PHASE 5 INDIVIDUAL PROJECT KENNETH C HOLMES FINC615-1504A-02 PROFESSOR EDWARD HARTMANN NOVEMBER 9, 2015

PROJECT SPREADSHEET Project parameters (Hartmann, Live Chat 5, 2015): Initial investment = $40 mill ($35 mill equipment and $5 mill net working capital (NWC)), NWC accounted for in year 5 Project and equipment life = 5 years Revenue = $27 mill for five years Gross profit margin (GPM) = 50% (does not include depreciation) Depreciation = straight line SG & A = 10% of revenue Tax rate = 35% WACC = 10% NPV: ($996,643) IRR: 9.08%

PROJECT EVALUATION WACC NPV IRR Evaluation WACC: For APIX, the weighted average cost of capital (WACC) determines the lowest after-tax (required rate of return) for the coffee packaging project to be profitable for all stakeholders, as well as the risk level associated with the project (N.A., Weighted Average Cost of Capital, 2015). In simple terms, the WACC provides the baseline for the projects profitability, is used to calculate the NPV, and is compared to the IRR for determining whether the project is a go or no go (Hartmann, Live Chat 3, 2015). A low WACC and a high ROE provides APIX the ability to pursue other ventures. When the projects cost is higher than the return, it is a no go, and when the projects cost is lower than the return, it is a go. In simpler terms, the higher the IRR above zero, the more profitable and acceptable the coffee packaging project will be, if the IRR falls below zero, the coffee packaging project will not cover the costs of the project, and will be unacceptable (Hartmann, Live Chat 3, 2015). WACC equation factors (Hartmann, Live Chat 3, 2015): (The following parameters pertain to the equation on the screen) Re = cost of equity Rd = cost of debt E = market value of the firm's equity D = market value of the firm's debt V = E + D = total market value of the firm’s financing (equity and debt) E/V = percentage of financing that is equity D/V = percentage of financing that is debt Tc = corporate tax rate The project WACC of 10% means the IRR must be over 10% for the project to be acceptable. The projects IRR is 9.02%, which is .98% below the WACC. NPV: The NPV discounts future cash flows by the expected rate of return to translate them into today’s dollar value, and provides the baseline for future cash flows (N.A., Net Present Value, 2015). The NPV is based on estimates of the initial investment, discount rate, and estimated returns, so any changes to the project parameters require the recalculation of the NPV. The NPV does not account for risks associated with the project such as market uncertainty, and estimates should never be over ambitious as to not provide a heightened expected project return on investment (Hartmann, Live Chat 3, 2015). The NPV equation factors (Hartmann, Live Chat 3, 2015): Ct = net cash inflow during the period t Co = total initial investment costs r = discount rate t = number of time periods  The NPV of the project must be above zero for the project to be profitable, and an NPV below zero indicates a loss on the project investment. The higher the NPV over zero, the more profitable and acceptable the project. The project NPV of ($996,643) indicates a negative value. With a project cost of $40 mill, the project would only generate $39,003,357 in revenues, providing APIX a loss of almost $1 million. IRR: The Internal Rate of Return (IRR) calculates a projects profitability based on the estimated cash flows, the cost of capital, and the cost associated with the project. It uses the NPV equation, and sets the NPV value to zero, then determines the discount rate by trial and error, or by using BI software (N.A., Internal Rate of Return - IRR, 2015). In simple terms, if the IRR is greater than the WACC, the project will be profitable, and if the IRR is lower than the WACC, the project will provide a loss. The higher the IRR above the WACC, the more profitable the project, and indicates a go for the project (Hartmann, Live Chat 3, 2015). The IRR is used in conjunction with the NPV and the WACC, and is commonly used when comparing projects with similar parameters. The projects IRR is 9.08%. Evaluation: The calculation results are as follows: WACC of 10%, an IRR of 9.08%, and an NPV of ($996,643). Based on the results, the IRR is .92% lower than the WACC, indicating an insufficient return to cover the cost of the project, and the NPV indicates a loss of almost $1 million, clearly indicating a bad investment for APIX, and a no go on the project.

RISK ASSESSMENT METHODS Vertical Analysis Horizontal Analysis Benchmarking Payback Period Return on Investment Vertical Analysis (Common Size Analysis): Vertical analysis states the amounts for a given period (quarter, year) in dollars and percentages of each category. It can be used with any financial statement, divides the financial statement by category (total assets, total liabilities, stockholders equity, gross sales, and so on), states the category as 100 percent, and each element of that category as a percentage totaling 100% (N.A., Vertical Analysis, 2015). For example: For 2013: APIX’s total assets = $157,600,000 or 100%, and each asset is calculated as a percentage of total assets where cash = $6,000,000 or 3.8%, inventory = $12,100,000 or 7.7%, accounts receivable = $2,350,000 or 1.5%, land = $25,000,000 or 15.9%, and building and equipment = $112,150,000 or 71%. Application of vertical analysis enables APIX to determine account balance proportions in a specific time period, and can be used for a timeline analysis (quarter to quarter, year to year), to monitor changes on the financial statements (N.A., Vertical Analysis, 2015). Comparing long term liabilities for the years 2013 and 2014, and observing a 40% increase in long term debt, should trigger concern, and an evaluation of why. Horizontal Analysis (Trend Analysis): Horizontal analysis compares data from past financial statements and/or ratios over two or more years, can be used for future projections, and states the changes between years in dollars and percentages, starting with the base year. In simple terms, the base year equals 100%, and all other years are stated as a percentage increase or decrease of the base year (N.A., Horizontal Analysis, 2015). APIX total long-term liabilities for 2012 = $100,000,000 or 100%, and for 2013 = $54,950,000 or 54.95%, which translates to a 45 percent reduction in total long-term liabilities. APIX Net Income for 2012 = $6,500,000 million or 100%, and for 2013 = $26,250,000 or 404%, translating to an over 400 percent increase in Net Income. The purpose is to view the percentage changes, and look for trouble spots that require investigation, or to locate the periods of best performance, and use them as a benchmark for good productivity. It is preferable to perform horizontal analysis on all financial statements at the same time to enable APIX to view the overall picture of each period (N.A., Horizontal Analysis, 2015). When analyzing with horizontal analysis, it is necessary to understand that events from period to period will change account balances. Benchmarking: Benchmarking provides an industry comparison by comparing the financial statements of one company to another within the same industry. For APIX, the process enables the comparison of assets, liabilities, stockholders equity, revenue, costs, net income, and capital structure, and provides data to improve efficiency, standards of performance, and business practices. Benchmarking will also help APIX determine the best combination of debt and equity that works for them (N.A., Financial benchmarking - What is financial benchmarking? , 2015). Note: Vertical analysis, horizontal analysis, and benchmarking can be applied to evaluating the financial statements of other companies in the same industry, as well as companies earmarked for acquisition, enabling analysis of their financials. It is important to know how the financials of the competition, and prospective investments has changed over the years. Payback Period: Payback period is the length of time it will take for APIX to recover their investment, and is based on the initial investment in the project, the annual cash flows after deducting all annual costs, taxes and depreciation (Hartmann, Live Chat 5, 2015). Payback period should never be used alone for several reasons including: it only indicates the time frame for APIX to recover their initial investment, it does not account for the time value of money, or any financial benefits after the payback period, and does not measure a projects profitability (Hartmann, Live Chat 5, 2015). Formula: Payback Period = Cost of Project/Annual Cash Inflows APIX’s Payback Period = $40,000,000/$9,470,000 = 4.22 years or just over 4 years. Return on Investment (ROI): The ROI determines a ventures return based on the amount invested in the venture, and is useful for evaluating one, or multiple investments. The ROI is accurate, and simple to compare to the IRR, and provide additional financial data to cross check results (N.A., Return On Investment - ROI, 2015). ROI = (Gain or loss from the investment – Cost of Investment)/Cost of Investment For Example: APIX’s ROI = (($996,643) - $40,000,000))/$40,000,000 = - $40,996,634/$40,000,000 = -1.03 % or a loss of 1.03% The ROI -1.03% easily compares to the variation in the WACC and IRR of -.92%, providing an accurate cross check of results, as well as reassuring APIX they will lose money on the project.  

CAPITAL BUDGETING ASPECTS What is capital budgeting? Potential capital projects for APIX. Phases of capital budgeting. What is capital budgeting? Capital budgeting is the process of determining whether a project is worth pursuing based on its risks and rewards, and includes determining a company’s needs based on level of priority, which expenditures are needed, and which expenditures must be accomplished first. Capital budgeting encompasses the effects on APIX’s cash flow, debt and equity, efficiency of daily operations, financial statements, income taxes, and the decision to pursue a long term venture, new plant and equipment, new products or research and development (Hartmann, Live Chat 4, 2015). The effects of capital budgeting on financial statements reflect APIX’s ability to utilize their resources to best benefit the stakeholders. Lenders review financial statements to determine whether APIX should be approved or not for financing, and stockholders review this information to determine whether APIX is a good investment, as well as provide a suitable return on their stock investment (Hartmann, Live Chat 4, 2015). No matter the size of the company, capital budgeting decisions will effect the short-term and long-term health, and will potentially impact their very existence. Potential capital projects for APIX: Since APIX is in the printing industry, there are a vast array of options. Choices can potentially include: Frozen food packaging Dry goods packaging Printing labels for bottled beverages, nonalcoholic and alcoholic Printing labels and packaging for the health and beauty products Printing labels and packaging for soft lines and hard lines Establish contracts with startup companies to create and print the packaging for their products Phases of capital budgeting (Wilkinson, 2013): Determine APIX’s needs, and possible projects based on their goals, vision, strategy and mission Determine potential alternative projects based on the same goals, vision, strategy and mission Compare the projects based on solid financial analysis Choose the project that best fits APIX’s values, goals, strategy, objectives, and financial capability Perform a full audit when the project is completed

CAPITAL BUDGETING ASPECTS Evaluating capital budgets. Soft costs and benefits. Post completion evaluation. Evaluating capital budgets: The capital budget should be based on APIX’s values, goals, mission, priorities, their financial capabilities, and the company’s needs. It should account for its effects on financial statements, all stakeholders, and the target products and consumers. It should include resources from the entire organization including: market trend research on revenues, product demand, and new product ideas; input from all departments to establish needs, and potential use of current production facilities to take advantage of potential opportunities; evaluation of all costs, projections, and analysis associated with a project; and if necessary, be evaluated by an impartial outside service (Wilkinson, 2013). When evaluating multiple projects it is necessary to determine the NPV, IRR, and the payback period. It will also be wise to determine the effects the project will have on APIX’s financial statements by performing a vertical analysis, horizontal analysis, and benchmarking. If the project involves acquiring an existing business it is necessary to perform a vertical analysis, horizontal analysis, and benchmarking to determine how the business compares to other companies in the industry, as well as determining whether their account balances are healthy, or are higher than acceptable. In addition, when comparing multiple project, there will likely be variations in the results. For example: one project may have a higher IRR, but have a higher investment cost; and another project may have a lower IRR, but have a lower investment cost. It is necessary to determine the amount of cash, debt and equity APIX can assemble to determine the limit to how much APIX can invest. This will be a major determinant regarding what projects APIX can pursue. Soft costs and benefits: Soft costs and benefits are side effects of a project that can either be positive or negative. For example: a change in an APIX printing ink may incidentally contain toxins that are absorbed in the skin when touched; a change in the production process may incidentally contaminate the air with greenhouse gasses; or may increase instead of decrease production efficiency, causing more power consumption. There may also be benefits including: embracing new printing technology may improve efficiency, eliminate toxins, reduce greenhouse gasses, energy consumption, and improve the air quality. It is important soft costs and benefits be addressed as they can be advantageous in winning clients and consumers loyalty (Wilkinson, 2013). Post completion evaluation: A full evaluation of the project should be performed by an unbiased, independent outside party. The results of the evaluation will determine: whether the actual results meet APIX’s expectations; pinpoint areas that require improvements, such as a reduction in costs or an increase in efficiency; whether the project should be discontinued, based on results indicating APIX’s expectations are not being met. This could mean the project falls short of projected revenues, the costs of the project are higher than expected, or both. Both would be the result of over ambitious project estimates, and require a rework of the NPV and IRR. The lessons learned from the evaluation will provide invaluable information that can be applied to future ventures, help APIX to prevent such issues from recurring, as well as a learning experience for all parties involved (Wilkinson, 2013).

ADDITIONAL CRITIQUE Were financials provided sufficient for proper decision? Missing financial information. The determining factors. Applying financial information to other situations. Were financials provided sufficient for a proper decision? In this case, the financials provided were sufficient to determine whether the coffee packaging project would be acceptable or not. Based on the financials provided the project is not acceptable, and APIX would be foolish to pursue it. Is there any missing financial information? It would be wise to perform a vertical analysis, horizontal analysis, and benchmarking, to determine the effects the project would have on APIX’s financial statements. The only additional equations would be the Payback Period, and Return on Investment, but neither would have changed the outcome of the decision. The determining factors: In this case, the determining factors are the NPV, IRR, and the WACC. Because the NPV is ($996,643), the annual cash flows will provide a loss for APIX of almost $1 million, and the IRR of 9.08% is .92% less than the WACC of 10%, translating to a 1% loss for APIX. In this case, all calculations ensure APIX will lose money on this project, and dictate a no go. Applying financial information to other situations: The NPV, IRR and payback period apply to any project, and if the project involved the acquisition of an existing business, the addition of vertical analysis, horizontal analysis, and benchmarking would be appropriate and necessary. APIX can apply risk assessment and financial analysis for many business applications. For example: performing vertical, horizontal, and benchmarking on APIX’s own financial statements will help determine how well APIX’s figures compare to the competition, and the industry; financial analysis can help APIX identify weak areas that require attention, as well as areas of strength; financial analysis can help APIX refine their overall financial structure, improve manufacturing efficiency, refine their goals and standards, and determine whether their financing strategy enhances their financial statements, or if it needs adjusting; and ultimately determine the optimal capital structure for APIX (Hartmann, Live Chat 5, 2015). Simply put, risk assessment and financial analysis will help identify where adjustment needs to be made internally, as well as project evaluation.

REFERENCES Hartmann, E. (2015, October 20). Live Chat 3. Retrieved from CTU Online Campus: campus://ctuonline.edu/finc_615_03 Hartmann, E. (2015, October 28). Live Chat 4. Retrieved from CTU Online: http://campus.ctuonline.edu Hartmann, E. (2015, November 5). Live Chat 5. Retrieved from CTU Online: http://campus.ctuonline.edu/live chat 5 N.A. (2015). Financial benchmarking - What is financial benchmarking? . Retrieved from Reviso: e-conomic Accounting ...: https://www.e-conomic.co.uk/.../glossary/financial-benchmarking N.A. (2015). Horizontal Analysis. Retrieved from Accounting Tools: www.accountingformanagement.org/horizontal-analysis-of-financial... N.A. (2015). Internal Rate of Return - IRR. Retrieved from Investopedia: www.investopedia.com/terms/i/irr.asp N.A. (2015). Net Present Value. Retrieved from Investopedia: www.investopedia.com/terms/n/npv.asp N.A. (2015). Return On Investment - ROI. Retrieved from Investopedia: www.investopedia.com/terms/r/returnoninvestment.asp N.A. (2015). Vertical Analysis. Retrieved from Accounting Tools: www.accountingtools.com/vertical-analysis N.A. (2015). Weighted Average Cost of Capital. Retrieved from Investopedia: www.investopedia.com/terms/w/wacc.asp Wilkinson, J. (2013, July 23). Capital Budgeting Phases. Retrieved from The Strategic CFO: strategiccfo.com/wikicfo/capital-budgeting-phases