1. 1 ESMBA06 Finance 5405 Financial Management

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

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

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

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

6. 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. 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. 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. 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. 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. 11 III. Analysis Overview Summary of case information Alternatives’ analysis

12. 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. 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. 14 Cost of capital (Given) Dixie Holdings (Overall corporate)10% Dixie Support8% Dixie Properties7% Dixie Air12%

15. 15 Case assumptions Projected general inflation rate 3.0% Projected printing volume increase2.0% Supplies as % of billing30.0% Tax rate40.0%

16. 16 Current costs and values for alternatives 1, 2 and 3 – Yr (2003) Annual lease costs$7,125 Annual utilities/insurance$2,400 Annual labor$50,000 Annual material costs$42,837 Annual depreciation exp$20,000 Market value of existing equipment$230,000

17. 17 New costs for Alt. 2 and 3 – Yr 2003 Incremental annual lease expense$13,125 Building remodeling$50,000 Equipment investment$212,600 Depreciation on new equipment$25,000 Added annual labor costs$90,016 Added annual utilities/insurance$3,600 Annual vehicle expense$2,060

18. 18 Incremental savings for alternatives 2 and 3 – Yr 2003 Graphics printing$118,839 Forms printing$174,540

19. 19 External Revenues for alternative 3 Pre-tax earnings for 2004$50,000 Pre-tax earnings for 2005$75,000 Revenue growth rate after 20055.0%

20. 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. 21 Alternative 2 – Cash flows

22. 22 0 $77 1 $82 2 $87 3 ($266) Net cash flows (000s) NPV = $80. IRR = 18.3%. MIRR = 13.8%. 8% 45 $101$92

23. 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. 24 Alternative 1 – Cash flows

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

26. 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. 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. 28 Alternative 3 – Cash flows

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

30. 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. 31 Sensitivity Analysis – Most likely case

32. 32 Sensitivity Analysis – Most likely case

33. 33 Sensitivity Analysis – Most likely case

34. 34 Sensitivity Analysis – Worst case

35. 35 Sensitivity Analysis – Worst case

36. 36 Sensitivity Analysis – Worst case

37. 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. 38 Real world

39. 39 V. Recommendations 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%)

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

41. 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. 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. 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. 44 Questions and Answers Any questions