I. Introduction

Having already established the technical and marketing aspects of the study, EALA

Inc. will now try to incorporate all pertinent information gathered to determine the

financial feasibility of PantSaloon.

A comprehensive discussion of key quantitative indicators will be presented in this

part of the study. This section will start off by presenting information regarding the

project’s total cost, initial capital requirements, the correct mix of financing as well

as sources for such. Assumptions were already made regarding several factors

concerning the financial projections. Financial statements and analysis of such will

also follow. This will provide insight regarding the financial potential of PantSaloon

as a business.

The analysis and detailed evaluation of all generated projections is the basis for

EALA Inc.’s conclusion that PantSaloon is financially sound and capable of

competing in the industry.

A. Executive Summary

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At this stage of the feasibility study PantSaloon has already proven to be of

attractive demand and doable production. This is now the section of our study

where we push that further into determining the financial feasibility of this whole

business.

To arrive at the decision of whether to go or not to go with this business the group

did a financial analysis starting of with calculating the total investment needed to

start it all up. This amounted to Php 1,948,965. This figure already includes all the

necessary registration expenses, fixed assets like sewing machines, initial

marketing expenditure and as well as the initial working capital needed for

operation.

Based on the resulting projections as reflected by the financial statements,

particularly the Income Statement, it turns out that EALA Inc. stands to earn a

positive net income in its first year of operations. Though the amount is relatively

small, it signals that the business can stand to gain more as it continues its

operations despite the additional cost of the 12% VAT and corporate taxes.

In addition, the net present value, computed for the operating cash flows for Years 1

to 10 is found to be positive and greater than zero. The internal rate of return

computed for resulted to 283%, and the payback period for the business is 1 year.

As such, it is determined that the company would earn a return greater than 22%,

communicating an attractive market value to the investors and increased wealth for

the owners.

Financial Ratios were derived to assess the performance of PantSaloon. Based from

the resulting liquidity, activity, debt, and profitability ratios, PantSaloon’s business

operations are indeed efficiently and effectively managed.

It can be concluded based on the results of the financial analysis that PantSaloon is

a promising business venture.

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II. Financial Study

A. Initial Investment (see Table 1)

Total initial investment required to start the business is estimated to be Php

1,948,965. This amount includes registration fees, fixed assets,

pre-operating/promotion expenses, as well as initial working capital requirements

necessary to start up the business.

Payments for legal transactions with the SEC, BIR, DTI and Local City Government

comprise the registration fees. Purchases made for the equipments, furniture and

fixtures for the office, plant and the store as well as the delivery van are also

included in the initial investment. Renovations and construction works of the office

as well as the store site is also part of the initial costs.

The pre-operating costs consist of outlays for promotional activities, most

specifically the initial print materials and the expenses for the launching of the store

which will be conducted through a ribbon cutting ceremony. The required initial

working capital is composed of payments for supplies and purchases of materials

for initial production runs. A month’s worth of salary payments and a two-month

deposit for the store rent will also form part of the initial investment. Cash on hand

(set at 500,000) will also be required for other pre-operating expenses which will arise prior to

start of business.

Table 1| Initial Investment CostsRegistration Fees SEC   3,189 BIR   500 DTI   515 Business Permit   7,472 Total Registration Fees 11,676Fixed Assets Office     Equipment     4 in 1 machine 12,000   Computer Set 60,000   Furniture and Fixtures     Cabinets 2,500  

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Chairs and table 29,000   Sofa 4,000   Fire extinguisher 1,700   Leasehold Improvements 15,000   Total Office Assets 124,200 Store     Equipment     Sewing machine 30,000   Edging machines 15,000   Buttonholers 5,000   Jeans software 20,000   Computer set 30,000   Chairs and worktables 5,710   Phone 2,000   Safety deposit box 1,700   Furniture and Fixtures     Display materials 15,000   2-seater sofa 6,000   Chair 2,000   Center table 4,000   Floor lamp 1,500   Lighting system 8,000   Fire extinguisher 1,700   Air conditioning unit 17,000   Leasehold Improvements 293,629   Vehicle 300,000   Total Store Assets  758,239Total Fixed Assets 882,439Initial Advertising Costs Print Materials   80,500 Ribbon Cutting   30,000Total Initial Advertising Costs 110,500Initial Working Capital Current Assets     Cash on Hand 500,000   Supplies 53,500   Materials 39,885   Prepaid Rent 75,000   Total Current Assets 668,385 Production Costs     Variable     Indirect Labor (Washing: Outsource) 15,000   Total Variable Costs 15,000   Fixed     Direct Labor (wages) 48,000   Indirect Labor (Designer) 20,000   Rent Expense 12,500   Utilities 9,090  

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Transportation 3,000   Repair and Maintenance 0   Total Fixed Costs 92,590   Total Production Costs 107,590 Administrative Costs     Office Supplies 1,000   Salaries 162,000   Insurance 1,875   Communications 1,500   Utilities 2,000   Total Administrative Costs 168,375Total Initial Working Capital 944,350TOTAL INITIAL INVESTMENT COST 1,948,965

B. Assumptions for Financial Projections

Rates

Growth rate. The group will assume an annual 2 percent growth rate on sales

based on a professional opinion of Mr. Victorino Caluza, the owner of Viktor Jeans.

Corporate income tax rate. Income tax is set at a constant rate of 32 percenti.

Cost of debt. For this study, we used the following as the cost of debt:

Cost of debt = 15%

Direct from the PNB loan application for start-up businesses, the lending rate would

range from 13% - 15% depending on how risky is the proposed business. In the case

of PantSaloon a pessimistic standpoint was taken and therefore would be applying

the 15% rate on the loan.

Cost of equity. The group used the following formula to determine the cost of

equity:

Cost of Equity = Cost of Debt + Risk-free Rate

= 15% + 7%

= 22%

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The cost of equity is estimated to be higher than the cost of debt due to the

increased required return desired by investors. As such, to determine the cost of

equity, risk-free rate is added to the after-tax cost of debt. Risk-free rate is found by

averaging the 90-day T-bill rates for the past five years (2001-2005).ii

Inflation rate. For selected items in the financial statements, the projected

national inflation rate of 7.5%iii is used; the inflation rate of the clothing industry,

pegged at 1.02% is also used.

Dividend policies. Dividends amounting to P100, 000 is distributed to

stockholders starting from the 6th up to the 10th year of operations as income is seen

to be at a considerably favorable level.

D. Projected Financial Statements

1. Income Statement Accounts (see Appendix 1 for the Pro-forma Income

Statements)

Sales. The selling price of the PantSaloon jeans was determined through the survey

conducted. The pre-determined average regular selling price of Php 1000.00 per

shirt will remain constant throughout the ten-year projection. The discount price

(50% of regular price) of Php 500 shall also be kept constant. Net sales is computed

by dividing Gross Sales by 1.12 (at 12% VAT rate)

Sales Forecast. The sales forecast is based on the estimated production capacity

that PantSaloon has, the percentage of which was shown in the Market Study. The

percentage of the effective demand that will be targeted will be kept at a constant

rate.

EALA Inc. estimates that 95% of the items offered for sale at regular price will be

sold. The remaining unsold items shall be offered for sale throughout the year at a

50% discount. It is estimated that 99% of these will be sold within the year.

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Unsold items will be passed on to the following year and will be included in the

items to be offered for discount sale for that year.

All sales are made on cash basis. It is also assumed that there will be no sales

returns.

Cost of Goods Sold. The Product Costing Schedule shows the computation of each

unit of jeans produced. The direct material cost component of each unit has been

adjusted for inflation for the ten-year projection.

The cost of goods sold for the promotional discount sale shall be based on First in

First out (FIFO) basis. Wherein, the unsold items from the previous year will first be

exhausted before the unsold items from regular sales of the present year.

Advertising Expenses. Advertising expenses will be set at Php 30,000 on years 2,

3, 5, 7, 8, 9, 10; Php 110,500 at year 1 and Php 100,500 on year 6. This amount will

be allocated to the various promotional activities that EALA Inc. plans to implement

annually.

Depreciation Expense. The straight-line method of depreciation was used to

depreciate each fixed asset owned by PantSaloon. It was assumed that all of these

very fixed assets have a salvage value equal to zero.

The estimated useful life of the fixed assets are based on information provided on-

line sources and vendors of the corresponding fixed assets.

Repair & Maintenance. Annual Repair and Maintenance cost shall be set at

PhP35, 000 annually. This assumption was approved as by Lorenzo Sison, Jr., a

Certified Public Accountant, based on the analysis he made on the nature and

estimated life of the fixed assets.

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Rent Expense. This cost will only include the rental fees charged by the J & R

Commercial Center to its tenants. The ten-year projections were adjusted to reflect

the national economy’s inflation (pegged at 7.5%).

Administrative Expense. Position in the company and the level of responsibilities

that each job entails make salaries and wages vary from one employee to another.

Employees are paid every 15th and 30th of the month.

EALA Inc. will give wage increase starting on the 3rd year on the basic pay of all its

employees. These salary increases are meant to offset the effects of increases in

the inflation rate.

SSS Contribution. EALA Inc. will pay SSS contributions for its employees,

contribution will vary depending on the salary bracket that each employee belongs

to.

PhilHealth Contribution. As mandated by law, EALA Inc. will give PhilHealth

benefits to its employees and his/her legal dependents to cover part of

hospitalization cost and other medical expenses. The company’s contribution for

each employee is based on Phil Health Premium Rates.

Employee Benefits. As mandated by P.D. 851, employees shall be entitled to

receive 13th month pay which should amount to not less than 1/12 of the total basic

salary he/she receives within a calendar year provided he/she has already worked in

the company for at least one month. The 13th month pay of all EALA Inc. employees

will amount to the same monthly salary they receive.

Utilities Expense. Expenses for utilities consist of total costs incurred annually for

gasoline, telephone, and electricity usage in the plant and office.

Supplies Expense. The items under this account consist of office supplies such as

paper, pens, ink and cleaning materials for the office, plant and stores.

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Miscellaneous Expense. Annual miscellaneous expense will consist of fees paid

for renewal of legal permits from the local government and other regulatory

agencies.

2. Balance Sheet Accounts

Current Assets

Inventory. The cost of ending inventory for the each succeeding years shall consist

of unsold items from the previous year and purchases made for materials for the

beginning of the next year.

Supplies on Hand. Supplies on hand are remainders from last month’s supplies.

Prepaid Rent. At the pre-operation period, prepaid expense refers to the payments

made for rent. There will no longer be pre-payments at the succeeding years

because raw materials and other inputs to production will be paid as they are

picked up from the suppliers.

Fixed Assets

Office Assets. Office assets include 4-in-1 office machine, personal computer,

fire extinguishers; furniture and fixtures such as chairs and tables, sofa, and

filing cabinets.

Store Assets. Store assets include sewing machines, edging machines,

buttonholers, jeans software, computer set, chairs and worktables, phone,

safety deposit box, display materials, 2-seater sofa, chair, centertable,

floorlamp, lighting system, fire extinguisher, and airconditioning unit.

Vehicle. EALA Inc. will use a light commercial van for delivery. The market value of

the said vehicle at the time of acquisition is quoted at 300,000 and has 10 years

remaining usable life and it will be depreciated using the straight-line method.

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Intangibles. The cost of leasehold improvements is listed under these Leasehold

improvements accounts for the renovation of the store. This will also be

depreciated over its estimated useful life.

Current Liabilities

Interest Payable. The interest at year end for the first two years of projection

amounts to the monthly interest payment of the annual 15% interest on the loan

principal of Php 198,965.

VAT Output Tax Payable. This account, at year-end consists of the output tax for the

last month of the year.

Long-term Loan. The principal amount of the loan is Php 198,965. The interest rate

is 15% per annum and the maturity is set at Year 2.

Stockholder’s Equity

Capital Stock. Total capital stock is equals to Php 1,315,270.90 with P10 par value

per share.

E. Sources of Financing

Having a total initial investment cost of Php 1,948,965, the initial contribution of the

incorporators of EALA Inc. will not be sufficient to fund the project. As such,

additional investments from potential investors as well as from institutions are

necessary to execute the said project.

With the contribution of EALA Inc. proponents amounting to Php 1,000,000, the

company still needs Php 948,965 to finance the PantSaloon project. Fortunately,

some venture capitalists are supportive of EALA Inc.’s business venture.

1. Leonila T. Amposta

Vice-President for Operations, Bank of the Philippine Islands

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An Economics graduate, Leonila T. Amposta has been in the banking industry for

30 years. Her work has landed her positions in banks like Far East Bank, Asian

Development Bank and Bank of South East Asia, before joining BPI as its VP for

Operations. Apart from her expertise in banking, she is interested in starting her

own business, particularly in the clothing industry. Hence, PantSaloon’s idea of

custom-fit jeans production is indeed appealing to her. She is willing to buy

shares of stocks of EALA Inc. amounting to Php 500,000.

2. Atty. Cristina A. Mortel

Assistant General Manager for Admin & Chief Legal Counsel, Public Estates

Authority

Project Manager - CBP1, Macapagal Boulevard

Atty. Mortel graduated from Ateneo de Manila University with undergraduate

degree of Bachelor of Science major in Mathematics magna cum laude and

Bachelor of Laws. She is presently the Assistant General Manager for Admin and

Chief Legal Counsel of Public Estates Authority. Like Ms. Leonila T. Amposta,

Atty. Mortel is interested in starting her own business or being part of a clothing

company. Hence, she is willing to invest Php 250,000 for PantSaloon.

Though there are two additional shareholders, the total investing amount is still not

enough to finance the project. Thus, EALA Inc. has to find a financial institution that

will lend the company enough money to support the project. However, finding a

bank that provides a loan for a start-up business like PantSaloon will be difficult

hence the incorporators deem it necessary to have a guarantor to help with loan

needs. EALA Inc. is fortunate to have a guarantor to support its business venture.

1. Atty. Peter Suchiangco

Chief Executive Officer, CyberBay Corporation

Atty. Suychiangco is an entrepreneur himself that is why he is supportive to

those entrepreneurs who lack financial resources.

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As such, EALA Inc. can now loan a total of Php 198,965 at 15% iv, payable for 2

years. Since the loan is quite small, EALA Inc. decided to borrow it from one bank,

specifically Philippine National Bank (PNB).

F. NPV Computation

The net present value is computed by subtracting the initial project cost from the

present value of the operating cash flows for years 1 to 10, discounted at the

company’s cost of capital of 20%. The year-end operating cash flows are computed

as provided by the cash flow provided from operating activities as indicated by the

Statement of Cash Flows.

Net Present Value computed for the operating cash flows for years 1 to 10,

P146,946,533.77 , is found to be positive and greater than zero. As such, it is

determined that the company would earn a return greater than 22%,

communicating an attractive market value to the investors and increased wealth for

the owners.

G. IRR Computation

The Internal Rate of Return is the discount rate that equates the NPV of an

investment opportunity with Php0 because the present value of cash inflows equals

the project cost or initial investment. The Internal Rate of Return computed for EALA

Inc. is 283%. This is the compound annual rate of return that EALA Inc. will earn if it

invests in the business and receives the given cash inflows. Since the IRR of 283% is

greater than the cost of capital of 22%, EALA Inc.’s business seems to be

acceptable.

H. Payback Period

The payback period is computed to determine the amount of time required for EALA

Inc. to recover its initial investment in the business, as calculated from the cash

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inflows from operating activities indicated by the Statement of Cash Flows. The

yearly cash inflows are accumulated until the initial investment is recovered. EALA

Inc.’s payback period is 1 year.

I. Financial Ratio Analysis

The information contained in the four basic financial statements (Balance Sheet,

Income Statement, Statement of Retained Earnings, and Statement of Cash Flows)

is important to many interested parties who regularly need to have relative

measures of EALA Inc.’s operating efficiency. Conducting a ratio analysis involves

methods of calculating and interpreting financial ratios to analyze and monitor EALA

Inc.’s performance.

1. Liquidity Ratios

Liquidity ratios measure the ability of a company to pay short term liabilities. This

includes the current ratio and quick ratio

Current Ratio. The current ratio measures EALA Inc.’s ability to meet its short

term obligations. It is computed as follows:

Current Ratio= Current Assets

Current Liabilities

Generally, the higher the current ratio, the more liquid a firm is deemed to be. As

for EALA Inc., its current ratio has been increasing throughout the years, thus

enabling it to become more liquid in the long run.

Quick Ratio. The Quick Ratio is sometimes called the "acid-test" ratio and is one of

the best measures of liquidity. It is figured as shown below:

Quick Ratio = Current Assets - Inventory

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Current Liabilities

The Quick Ratio is a much more exacting measure than the Current Ratio. By

excluding inventories, it concentrates on the really liquid assets, with value that is

fairly certain. EALA Inc.’s quick ratios are fairly high because of low levels of

inventory during those years. In addition, the low variance between the current

ratio and quick ratio of EALA Inc. is caused by low inventory asset balances in the

balance sheet.

2. Activity Ratios

Activity ratios measure the speed with which accounts are transformed into sales or

cash. Regarding current accounts, measures of liquidity are not enough because

differences in the structure of a company’s current assets and current liabilities can

considerably affect its “true” liquidity.

Inventory Turnover. Inventory turnover measures the number of times that

inventory is replaced during the period. It can be computed as follows:

Inventory Turnover= Cost of Goods Sold

Average Inventory

EALA Inc.’s inventory turnover increases to a great extent through the its operating

years. This means that EALA Inc. is transforming its inventory into sales faster. This

is acceptable considering the nature of the company’s business which involves

products (clothes) that are highly affected by changes in fads or styles and other

clothing materials.

Total Asset Turnover. The asset turnover is used to measure the ability of the

firm to use its assets efficiently by turning it into cash. The computation for this

ratio is:

Total Asset Turnover= _______Sales________

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Average Total Assets

EALA Inc.’s total Asset Turnover has been decreasing. Though this may be the case,

the changes in this ratio from year-to-year are not that critical.

3. Debt Ratios

Debt ratios indicate the company’s ability to pay its debts. This is somewhat similar

to liquidity except that solvency involves longer time periods. Long-term creditors

and stockholders are particularly interested in these ratios. The debt position of a

company also indicates the amount of other people’s money being used to generate

profits.

Debt Ratio. The debt ratio measures the proportion of total assets financed by

EALA Inc.’s creditors. The higher this ratio, the greater the amount of other people’s

money being used to generate income. This ratio can be computed as follows:

Debt Ratio = Total Liabilities

Total Assets

EALA Inc.’s Debt Ratio experiences a significant decrease in Year 3 because it no

longer pays interest on the money it loaned. Therefore, EALA Inc. has a lesser

degree of financial indebtedness and less financial leverage.

4. Profitability Ratios

Profitability ratios help people analyze the firm’s profits. The firm is very much

concerned with earning enough revenue that can satisfy its obligations and at the

same time provide a satisfactory return on its stockholder’s investments.

Gross Profit Margin. The gross profit margin measures the firm’s mark up on its

products. It can be gauged by the following formula:

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Gross Profit Margin= Gross Income

Sales

The relatively stable and consistent figures in EALA Inc.’s Gross Profit Margin is a

good sign that the company is maintaining a stable gross profit. This also shows

that there is no significant change in the company’s pricing policies.

Operating Profit Margin. The operating margin represents the pure profits that

are left to the company. This can be determined by the formula below:

Operating Profit Margin= Operating Income

Sales

The Operating Profit Margin in relatively stable for EALA Inc.

Net Profit Margin. The return on net sales measure the income provided by sales.

It can be measured by computing this formula:

Net Profit Margin= Net Income

Sales

The Net Profit Margin for EALA Inc. has been increasing. The low net profit margins

on particular years were due to lower gross income matched with increasing

operating expenses.

i In General – Except as otherwise provided in this code, a corporation organized, authorized, or existing under the laws of any foreign country, engaged in trade or business within the Philippines, shall be subject to an income tax equivalent to thirty-five percent (35%) of the taxable income derived in the preceding taxable year from all sources within the Philippines: Provided, That effective January 1, 1998, the rate of income tax shall be thirty-four percent (34%); effective January 1, 1999, the rate shall be thirty-three percent (33%) and effective January 1, 2000 and thereafter, the rate shall be thirty-two percent (32%). - Section 28, paragraphs (A)(4) of the National Internal Revenue Code http://www.chanrobles.com/republicactno9294.html

ii 20012002200320042005T-bill rate (91 days)9.86%5.43%6.03%7.34%6.45%iii

“Economic Statistics.” [Online] Availablehttp://www.philippinebusiness.com.ph/economic_stats/economy.htm, August 2005

iv PNB’s interest rate is 15%. The rate may change depending on the bank of choice.

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ENDNOTES

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