Final Report

Yasir Mir
Arif Hussain
Haroon Nasir
M. Asad Naeem
M. Nouman Ameen
Ramish Hassan
M. Abdullah Afridi

16110188
16110220
16110221
16110263
16110209
16110211
16110166

EXECUTIVE SUMMARY
The textile Industry is the largest industry of Pakistan, contributing about 9.5% to the
GDP and providing employment to about 30% of the workforce of the country. Among the
textile industry exports, the export of cotton denim fabrics has increased from 45 million square
meters worth PKR 4.37 billion in 2005-06 to 229 million square meters worth PKR 20.49 billion
in 2009-10, thus showing an average increase of 74% per annum in terms of value. Besides
foreign demand, local market demand of denim jeans is also increasing day by day, creating
investment and job opportunities in this sector. Fashion is today incomplete without denim.
Denim comes in all forms, looks and washes to match with every dress. So we are taking
initiative to setup a denim jeans manufacturing plant and the proposed location for our business
will be Lahore. This sector is involved in the weaving of denim fabric into jeans which is used
locally as well as exported to foreign countries. The process will include dyeing, pre- shrinkage
of jeans, acid wash, Sandblasting or abrading with sandpaper, finishing and then quality control.
The denim jeans sector consists of many large companies such as the Siddiqsons Denim Mills
Limited, Pak Denim Limited, Ali Murtaza Associates (Pvt) Ltd.
We are planning to form a Private Limited Company named Dhaaga Saaz- Denim Jeans
(Pvt) Ltd, with sole proprietorship. The capital structure will comprise of both equity as well as
debt financing, with the major portion being of debt capital. We have planned to raise finance
from commercial banks, venture capitalists as well as government grants for new startups. Our
initial expenditure will mainly comprise of the plant, machinery cost and land.
We will use both primary and secondary research methods to find out the relevant data
and information. The secondary data sources will include Pakistan Economic Surveys, reports of
the State Bank of Pakistan, reports of Federal Bureau of Statistics, chambers of commerce as
well as World Bank Reports on the growth in specific industries in Pakistan. These will be used
to gain the basic insights relating to the industry in general and the business processes in
particular. Apart from this, primary research methods will also be used to gain specific insights
relating to the financial and operational feasibility of our business idea. These will include visits
to jeans manufacturing plants currently operating in nearby areas, and other businesses operating
in the textile sector such as cotton yarn suppliers and textile mills.
The operations and performance of our business will be affected by many different factors. These
include some macroeconomic variables such as the GDP growth rate of the economy, which will
determine the change in aggregate demand in the economy and hence the demand for fashion
apparels. Apart from this inflation rates will affect the raw material cost of our business and the
increase in wage rates. Moreover, the trade policies of the government will also be an important
factor, as much of the output of this sector is exported. The number of firms in the denim jeans
manufacturing industry will also affect our business as it will determine the demand of our
products i.e. denim jeans. Another factor which can affect our business can be increasing demand
for other apparels i.e. bottom wears and athletic wears etc. Minimum wage rate from the
government can also be an affecting factor. As we have a huge number of workers working in
different departments so if government increases minimal wage rate then our cost may
significantly increase reducing our marginal profits.

INDUSTRY ANALYSIS
Pakistan has always been strong in textile industry due to huge investments in this sector
and abundance of cotton. In the last decade, weaving of denim fabrics had increased to a great
extent. The export of cotton denim fabrics from Pakistan has increased from 45 million square
meters worth PKR 4.37 billion in 2005-06 to 229 million square meters worth PKR 20.49 billion
in 2009-10, thus showing an average increase of 74% per annum in terms of value. Other than
foreign market local demand for denim jeans is also increasing day by day, creating investment
and job opportunities in this sector. Almost all the leading manufacturers are mainly focusing on
the export market where A-class product is demanded and exported, whereas B- class product is
being sold in the local market. Manufacturers which are working primarily for domestic market
are very few. Major known manufacturers are in Karachi and Lahore. Other important hubs are
Sialkot, Faisalabad and Gujranwala.
SWOT Analysis
Strengths

Weaknesses

>Low cost labor (usually piece rate system)

>Less concentration on domestic market

>Abundant raw material available (particularly Cotton)

>Power and Gas shortages

>Availability of low-cost machinery

> lack of capital and finance to small

>High market demand

enterprises.

> Huge Available work force

> Low differentiation

>Progressive increase in capacity (as units are small and

> Lack of trained and skilled machinists and

Can be installed when needed)

technicians

> Well-situated industrial estate with all major facilities

available

Opportunities
> Local customers are willing to pay high prices for
. high quality

Threats
> As cost of energy is increasing day by day
so cost of manufacturing may increase

>Export (accessibility in Global market)

>New entrants can enter the market easily

>Government subsidies in future

>Political & social volatility in country

>Research & Development potential (processes can be

efficient)

> International competition from India

> Restrictive policies regarding exports

>Build a brand

>Increase in minimum wage of labor

>Mass production (economies of scale)

Porters Five Forces Analysis

Porter five forces analysis is a framework for industry analysis and business strategy
development. This is useful, because it helps understand both the strength of current competitive
position, and the strength of a position one is considering moving into. With a clear
understanding of where power lies, we can take fair advantage of a situation of strength, improve
a situation of weakness, and avoid taking wrong steps. The following are the five forces that
drive competition in an industry.
1
2
3
4
5

Industry Rivalry (competitors)

Availability of Close Substitutes
Threats of New Entrants
Bargaining Power of Suppliers
Bargaining Power of Customers

1. Industry Rivalry
Major denim Jeans stitching units are located in the upper Punjab so building our unit here will
increase competition. But domestic need-focused manufacturers are very few and are also in
small size. Major manufacturers are primarily focusing on export market. This means that
although there will be competitive rivalry in the industry, the competition from large producers
will be less. As the product has less differentiation so marketing expenditure will be high and
competitors will be spending comparatively. Hence, overall the competitive rivalry in this
industry is lower than many other industries in Pakistan.
2. Availability of Close substitutes
Despite high consumer favor, jeans are losing a significant amount of retail floor space to other
bottoms wear items like dresses and athletic pants. The popularity of womens dresses has
increased in the past five years, while athletic wears presence at retail has grown, in recent
years, due to its popularity as a multifunctional apparel item among men and women. The
competition that denim jeans are facing from other substitutes is intensified because of changing
trend. So, there is need to introduce new designs with high quality because other substitutes are
eating up its sales.
3. Threat of New entrants
This industry has somewhat in between of high and low barriers to entry. There are bright future
prospects in this business because of high demand in local and foreign markets but cost of
building up a unit is high which may restrict small investors to enter in this market. Also
many government incentives exist in this industry such as tax exemptions on exporting cotton
products. So overall, there is a threat of new entrants in the industry.
4. Bargaining Power of Suppliers
Like any manufacturing industry, we also face the power of supplier as we have to buy our raw
materials viz. denim fabric etc. from them. Our tentative suppliers would be Sapphire Group,
Nishat Spinning, Gulistan Textiles and the Bhanero Group. Our stand in this category is almost
in safe position as we have more number of suppliers with no or very less switching costs

associated with them as prices of our raw materials remain nearly constant in short term due to
the easy availability and various number of suppliers in the market. However, there are many
buyers of denim fabric in the market since the textile industry is very developed in this region of
upper Punjab. So the suppliers will have some degree of bargaining power, but since the
suppliers are also in a large number, this power will not be very significant.

5. Bargaining Power of Customers

The presence of powerful buyers reduces the profit potential in an industry as they can affect
prices. But in our industry, buyers have relatively low bargaining power and we enjoy relatively
more power than our buyers as our products are bought in low volumes and there are many
buyers in the market. Also there are many suppliers in the market too; so neither of us, company
nor buyers, can affect prices.
PESTLE Analysis
PESTLE is an industry analysis used to analyze the microenvironment within which a business
operates. It includes an analysis of the major external forces which affect a business and its
performance.
Political:
This refers to the ways in which government can intervene in terms of environmental and
labor laws, tariffs, trade restriction and tax policies. The political situation in Pakistan is not
satisfactory. There is an uncertainty in governments structure and we all know when a ruling
party faces this sort of uncertainty they fail to do well for public. The policies regarding foreign
exchange, imports, exports and investments have been consistently unpredictable due to political
instability in the country. Instability in Gas and Electricity are adversely affecting the textile
sector while government has hardly taken any steps to give some reliefs or incentives to the
businessmen operating in this industry. It was also witnessed that due to prices increase in gas
has not only adversely affected the productivity of the weaving industry but has also caused
sudden increase in the production cost and has badly affected the economy of the country. Due to
increase in production cost, denim jeans sector of Pakistan is facing challenges in operating in
local and international market. Tight monetary policy is also creating a lot of hurdles for this
sector and exporters. Also rapidly growing interest rates of the banks is causing small
manufacturers to shut down their business. Sometimes government also fails to decrease every
day trade deficit. In short, the constantly changing regulations and instability in the policies of
the government can greatly hamper the overall apparel industry in achieving its optimum
potential.
Technological:
This refers to how technology can change and includes automation, Research and
development and activity and technological incentives that are available. Technological can also
have an impact on efficient production levels and influence decisions on outsourcing. In addition
to this there are some changes in technology that can affect the costs that a business needs to
meet and improve the quality of product or service that a business offers. Rapid changes in

technology and development have increased the compaction. Pakistan is lagging in the
technology. The machinery used by the industries in Pakistan is obsolete and outdated. The main
reason for this is that he cost of replacing the obsolete machinery is quite high. Also nowadays
lack of R&D results in the low quality of cotton as well as low profitability in cotton crops
therefore farmers are shifting to other crops.
Economic
This refers to how exchange rates, inflation rates, interest rates and economic growth will
impact a business and how it can grow, develop and make various decisions. From 1998-2008
inflation rate has increased almost 100%. With this much increase in inflation, investors are
expecting high returns for the risk inherited in the system. After 2008, Government pulled back
the incentives like R & D (research and development) and subsidies on utilities from the textile
industry due to which this industry suffered a lot. The prices in weaving sector have also
increased because of shortages of electricity, petroleum and gas. The labor in Pakistan is cheaper
than that of foreign countries so there is a huge market for exported goods. The export of cotton
denim fabrics from Pakistan has increased from 45 million square meters worth PKR 4.37 billion
in 2005-06 to 229 million square meters worth PKR 20.49 billion in 2009-10, thus showing an
average increase of 74% per annum in terms of value. This market has capability of increasing if
provided with incentives and subsidies. Because of modernization and the improvement of the
production base, textile industry has shown huge investments in the last five years. So, there is a
chance of attracting foreign investors towards this industry which can enhance e the image of the
industry in international markets and would help to boost of exports of Pakistan in Textile
industry.
Legal
Small manufacturers who are working primarily on domestic level are not facing strict
legal bounds. However, reputed firms have to comply with the rules set by the government e.g.
to protect rights of workers government has set this rule for wage that workers should be paid at
least the minimum legal wage or the local industry standard, whichever is greater. Also the firms
are required to get certification from ISO 9000 to ensure better quality. Also environmental
agency has put restriction on it regarding the environment protection. Some foreign countries
have released their tariffs on textile products increasing our chance of greater exports and in turn
increasing GDP.
Social
Some of the most important social factors related to the weaving industry of Pakistan are
Child Labor, Low Wages unhealthy environment for workers. These factors have a significant
effect on the quality and cost for the industry as well as some concerns relating to
human rights. Due to high rates of inflation in the country, it is costly for the textile industry to
hire skilled labor. Therefore, to minimize the variable costs, it is taking more of unskilled child
labor in the factory which is creating a lot of social and ethical concerns. The unskilled young
labor has to give up the same effort as a skilled labor at work and most of the time has to work
longer in order to eliminate the errors undergone in production, but he is compensated with a
meager wage. At the same time, some of the skilled labor is employed at a minimal wage per
hour to reduce costs further.

Environmental
Similarly, textile industry is also responsible for environmental pollution caused by the
industrial waste. Majority of these concerns arise from the solid wastes and residues from the
units. These wastes include yarn, fabrics, paper and wasted sludge. The cotton dust and fiber
dust particulates from the dry processes of the machines and pollute the surrounding air. In
addition to this, noise pollution created by the machinery is also a source of great environmental
concern. The machines operate at very high speeds and the noise produces by it exceeds the
allowed noise level. Therefore, it is pertinent to eliminate environmental pollution and if possible
reduce the resource consumption as much as possible and finding a balance between production
and a safe and clean environment for the population.
ASSUMPTIONS OF THE MODEL
There will be a constant inflation rate of 13% per year throughout the forecast period. This figure
is based on the average inflation rate of the last 5 years in Pakistan.
Sales Model
1

2
3

The regression model is based on the sales volume and advertisement expenditure figures
of Artistic Denim Mills which is a jeans manufacturer and similar in characteristics to
our business. The other independent variable is the population figures of Pakistan for the
last 10 years. Population is considered a demand driver based on the rationale that a
higher population will lead to an increase in our target segment and hence increase the
demand. Advertisement/promotion plays an important role in the apparel industry to
boost sales; hence it is used as the second demand driver.
The population projections for the forecast period are based on an average growth rate for
the last 10 years i.e. 1.8%.
The selling price per jeans will be Rs. 500, 570, 640, 720 and 810 respectively in the five
years from 2014-2018.

Production Schedule
1
2

Closing inventory will be equal to 10% of next years expected sales.

There will be a rejection margin of 3% in the production of jeans i.e. the production of
jeans in each year will be 3% more than the sales expected to account for rejection of
some units at the time of delivery.

Procurement Schedule
1
2

The Closing Inventory of raw material (Denim) will be 20,000 meters in each year, as a
safety measure against a shortage of materials.
1.2 meters of denim is used to produce each pant. This amount allows for the wastage and
shrinkage of cloth during processing.

Cost Model

1
2

All costs increase with the assumed inflation rate of 13%.

Costs are calculated for each Process. Some Overheads are directly traceable to each
process, so they are included as part of the process cost e.g. salaries of machine operators
of the cutting process are traceable to the cutting process. Other Overheads are not
traceable so they are added in the total manufacturing cost.

Depreciation Calculation
1

Equipment and Computer Systems are depreciated using the diminishing balance method,
and their depreciation in the earlier years will be higher than the later ones because they
will contribute more to the profit-generating potential of the business in the earlier years.
In the later years their contribution will be less due to obsolescence. Their depreciation
rates are 20 and 10 percent per year respectively.
Transportation vehicle and Fixtures and Fittings are depreciated using straight line
method and their depreciation along all years will be same. This is due to the reason that
there is no obsolescence involved in the use of the vehicle or the fixtures, and their value
will be decreased due to wear and tear, which will be more or less same across the years.
They will both be depreciated at 15% per year.
The depreciation for Equipment, Transportation Vehicle and Computer Systems will be
charged to the factory, while that of the fixtures and fittings will be charged to the office.

Credit Purchases and Sales

1

30% of the purchases of raw material will be on credit, and will be payable within 1 year.
Closing balances of accounts payable are calculated through an Accounts Payable
Budget.
70% of the sales will be on credit, and customers will be allowed a payment period of 1
month. Closing Balances of Accounts Receivable are calculated through an Accounts
Receivable Budget.

Financial Statements
1
2
3

Forecasted Financial Statements are prepared for 5 years, 2014 through 2018.
Forecasted statements include Income Statement, Statement of Changes in Equity,
Balance Sheet and Cash Flow Statement.
All financial statements are prepared in accordance with the International Financial
Reporting Standards (IFRS).

Financing

1
2
3
4
5

An initial investment of PKR 51,495,000 will be required, which will be financed 50%
through debt and 50% through equity.
Debt includes a long term loan of PKR 25,747,500 at an annual interest rate of 14%. It
will be repaid in equal annual payments of PKR 6,004,121.
Equity will involve an issue of 1,494,200 common stocks at a price of Rs. 17.23 each.
The face value of each common stock is Rs. 10.
Dividends in 2014 are paid at Re. 1 per share. They will increase in each year at a
constant rate of 10%.
Corporation Tax is paid at a rate of 34% each year. Taxation of each year is paid in the
subsequent year.

WACC Calculation
1.
2.
3.
4.

The Weighted Average Cost of Capital (WACC) is calculated using the CAPM Approach.
Weightage of Debt and Equity is 50:50.
The Market Risk Premium is taken from World Bank figures for Pakistan, which is 2.5%.
The beta is taken from the website of Pakistan Institute of Development Economics
(PIDE).

RATIO ANALYSIS
Profitability Ratios

1. Gross profit Margin:

Gross-Profit Margin
25.50%
25.00%
24.50%

gross-profit margin

24.00%
23.50%
23.00%
22.50%
22.00%
2014 2015 2016 2017 2018

The gross profit margin of a company measures the percentage of each sales dollar
remaining after deducting the cost of goods sold. The gross profit margin of our company is
23.25% , 24.84%, 24.83%, 24.95%, 24.99% in year 2014 2015 2016 2017 2018 respectively.
There is very less difference between the gross profit margins throughout the 5 years this is
because the cost and price are almost increased by the same assumed inflation rate.
2. Net profit Margin:

Net-Profit Margin
12%
10%
8%

net-profit margin

6%
4%
2%
0%
2014

2015

2016

2017

2018

The net profit margin measures the percentage of each sales dollar remaining after all
cost and expenses including interest and taxes have been deducted.
Thus our companys net profit margin is steadily increasing, it is 8%, 9%, 10%, 10%, 11% in
years 2014 2015 2016 2017 2018 respectively. Two elements contribute greatly to this trend

firstly; the depreciation is high in the earlier years and low in the later year i.e. reducing balance,
secondly, finance cost is reducing in the later years because some principal is being paid.
3. Operating profit Margin:

Operating Profit Margin

20%
15%
operatin profit margin
10%
5%
0%
2014

2015

2016

2017

2018

Operating profit margin measures the percentage of each sales dollar remaining after all
costs and expenses other than interest, taxes and preferred stock dividends are deducted.
Thus our companys operating profit margin is constantly increasing, it is 13.58%, 15.53%
15.79%, 16.14%, 16.40% in years 2014 2015 2016 2017 2018 respectively. This is solely
because of high depreciation in earlier years and low depreciation in later years i.e. reducing
balance method of depreciation.
4. Return on Asset:

ROA
40.00%
30.00%

roA

20.00%
10.00%
0.00%
2014

2015

2016

2017

2018

It measures the overall effectiveness of management in generating profits with its

available assets. Our companys operating profit margin is constantly increasing; it is 23.48%,

30.21%, 32.71%, 34.98%, 36.67% in years 2014 2015 2016 2017 2018 respectively. This is
because our sales are increasing whereas there is no capital expenditure, hence, asset utilization
is increasing therefore ROA is increasing.
5. Return on Equity:

ROE
70.00%
68.00%
66.00%
64.00%

ROE

62.00%
60.00%
58.00%
56.00%
54.00%
2014

2015

2016

2017

2018

It measures the return earned on common stockholders investment in the firm. Our company
has less ROE in the beginning but it increases in the later years this is because sales are
increasing and so do the profits but the common stockholders equity has increased
proportionately less i.e. 30% retained earnings and no new issue of shares.
6. Contribution Margin Ratio:

Contribution Margin ratio

30%
25%

Contribution
Margin ratio

20%
15%
10%
5%
0%
1

Contribution margin ratio is contribution margin as the percentage of sales. Contribution

margin ratio is approximately 26% throughout the years span. This is because the increase in
variable cost and the selling price is both increased by the assumed inflation rate; hence, the ratio
is fairly consistent.
Liquidity Ratios
1. Current Ratio:

Current Ratio
2.21
2.20
2.19
CURRENT RATIO

2.18
2.17
2.16
2.15
2.14
2014

2015

2016

2017

2018

It tells about the firms ability to meet its short term obligations. Our current ratio is 2.16,
2.18, 2.18, 2.19, 2.20 in years 2014 2015 2016 2017 2018 respectively. The ratio is quite
favorable and is stable over the years.
2. Quick Ratio:

Quick Ratio
1.45
1.40
QUICK RATIO

1.35
1.30
1.25
1.20
2014

2015

2016

2017

2018

It gives the measure of overall liquidity of the firm when a firms inventory cannot be
easily converted into cash. Our liquidity ratios in years 2014 2015 2016 2017 2018 are 1.30,
1.33, 1.36, 1.39, 1.42 respectively. This ratio shows that the firm is holding quite a lot of
inventory, nevertheless, the liquidity condition of the company is still good as it is still able to
cover its short term obligations.
Activity Ratios
1. Inventory Turnover:

INVENTORY TURNOVER
12.00
10.00
8.00

INVENTORY
TURNOVER

6.00
4.00
2.00
0.00
2014

2015

2016

2017

2018

It measures the liquidity of firms inventory. Our inventory turnover ratios in years 2014
2015 2016 2017 2018 are 9.60, 8.69, 8.67, 8.71, 8.74. it is high in the first year due to no opening
inventory, whereas in later years it is slowly increasing.

2. Receivable Turnover:

RECEVABLE TURNOVER
8.00
7.00
6.00
5.00
4.00
3.00
2.00
1.00
0.00

RECEVABLE
TURNOVER

2014

2015

2016

2017

2018

It is an activity ratio which estimates the number of times a business collects its average
accounts receivable balance during a period. Our values of receivable turnover is 6 in all years
2014 2015 2016 2017 2018 respectively. It is because we have kept debtor time period of 60
days to recover. On average company collects its accounts receivable 6 times.
3. Payable Turnover:

Payable Turnover
8.00
7.00
6.00
5.00

Payable Turnover

4.00
3.00
2.00
1.00
0.00
2014

2015

2016

2017

2018

The accounts payable turnover ratio is a liquidity ratio that shows a company's ability to
pay off its accounts payable by comparing net credit purchases to the average accounts payable
during a period. Our values are 6 in all years 2014 2015 2016 2017 2018 respectively. They are

fixed because we have kept fixed time period of 60 days to pay the accounts payable. Thus in a
single year there are 6 payments.
4. Total Asset Turnover:

Total Asset Turnover

3.60
3.40
total asset turnover

3.20
3.00
2.80
2.60
2014 2015 2016 2017 2018

The amount of sales or revenues generated per dollar of assets. The Asset Turnover ratio
is an indicator of the efficiency with which a company is deploying its assets. Our values of total
asset turnover are 2.96, 3.18, 3.32, 3.41, 3.47 in years 2014 2015 2016 2017 2018 respectively.
They are increasing over time because of our increase in sales.
5. Fixed Asset Turnover:

Fixed Asset Turnover

40.00
35.00
30.00
25.00

fixed asset turnover

20.00
15.00
10.00
5.00
0.00
2014

2015

2016

2017

2018

It is a financial ratio of net sales to fixed assets. The fixed-asset turnover ratio measures a
company's ability to generate net sales from fixed-asset investments - specifically property, plant
and equipment (PP&E) - net of depreciation. A higher fixed-asset turnover ratio shows that the

company has been more effective in using the investment in fixed assets to generate revenues.
Our values of fixed asset turnover are 11.07, 15.20, 20.55, 27.87, 37.89 in years 2014 2015 2016
2017 2018 respectively. They are increasing due to the efficient use of fixed assets and increase
in sales.
DEBT RATIOS
1. Debt Ratio:

Debt ratio
70%
60%
50%
debt ratio

40%
30%
20%
10%
0%
2014

2015

2016

2017

2018

It is a financial ratio that measures the extent of a companys or consumers leverage and can
also be interpreted as the proportion of a companys assets that are financed by debt. Our values
of debt ratios are 60%, 56%, 52%, 48%, 45% in years 2014 2015 2016 2017 2018 respectively.
They are decreasing over the years because long term loan principal is being paid each year,
hence, the debt ratio is decreasing over time.

2. Times Interest Earned Ratio:

Times Interest Earned Ratio

45.00
40.00
35.00
30.00

time interest ratio

25.00
20.00
15.00
10.00
5.00
0.00
2014

2015

2016

2017

2018

It is a metric used to measure a company's ability to meet its debt obligations. It is

usually quoted as a ratio and indicates how many times a company can cover its interest charges
on a pretax basis. Failing to meet these obligations could force a company into bankruptcy. It is
also referred to as "interest coverage ratio" and "fixed-charged coverage. Our values are 8.75,
13.51, 18.68, 27.00, 41.19 over the years 2014 2015 2016 2017 2018 respectively. They are
increasing because our operating profits are increasing due to increasing sales and finance cost is
decreasing.
3. Debt to Equity Ratio:

Debt to Equity Ratio

70%
60%
50%
debt to equity ratio

40%
30%
20%
10%
0%
2014

2015

2016

2017

2018

Debt-to-Equity ratio is the ratio of total liabilities of a business to its shareholders' equity. It
is a leverage ratio and it measures the degree to which the assets of the business are financed by
the debts and the shareholders' equity of a business. Our values are 60%, 56%, 52%, 48%, 45%
in years 2014 2015 2016 2017 2018 respectively. They are decreasing because our total liabilities
and equity are increasing at a rate greater than total liabilities.

INVESTMENT APPRAISAL
Investment Appraisal is the process of evaluating different investment alternatives, with
the objective of choosing those which maximize the wealth of shareholders. The financial
feasibility of Dhaaga Saaz has been evaluated using multiple investment appraisal techniques.
The Net Present value (NPV) of our business is about PKR 46 million, which is quite an
attractive NPV for a medium size business. This shows the present value of all expected future
cash flows till perpetuity. Cash flows to perpetuity are considered because our business is a going
concern and hence expected to operate for the foreseeable future. The time horizon for NPV
calculation if 5 years, however the terminal value of the business is included in the cash flow of
the 5th year to account for the present value of the business after that. Taxes are assumed to be
paid one year in arrears. Although the NPV shows an attractive investment, a more meaningful
interpretation of the figure will be possible when it is compared with NPVs of alternative
investments. The terminal value of the business is based on a terminal value multiple of 2 (on the

after-tax Operating Cash flows of the 5th year). The present values of the cash flows for the 5
years are shown in the graph below.

The Weighted Average Cost of Capital (WACC) of our business is 10.43%. The WACC is
calculated using the CAPM approach. The market risk premium figure of 2.5% is the World
Bank risk premium for Pakistan. The risk free rate of return is based on the market yield of a 6month T-Bill of the Government of Pakistan. Furthermore, the beta figure of 0.661 is the beta of
the textile industry taken from the statistics of Pakistan Institute of Development Economics
(PIDE).
The Internal rate of return (IRR) of our business is 30%. IRR shows the return from a
project based on cash flows. An IRR of 30% shows a very attractive investment and
complements the previous interpretation of the NPV figure. This is higher than our Weighted
Average Cost of Capital (WACC) which is 10.43%, hence this investment opportunity should be
accepted and is expected to generate high returns. The IRR figure of 30% also signifies that the
maximum cost of capital for Dhaaga Saaz is 30%, after which it will lead to a negative NPV. So
this IRR is far away from our current WACC of 10.43% and shows a safe position that small
changes in WACC will not render this project infeasible.
The Payback Period shows the amount of time in which the initial investment of the
project can be recovered. For our business, the initial investment can be recovered in 3 years and
6 months, which is a short period and hence very attractive for investors. The payback period
based on discounted cash flows is 4 years and 1 month. This increase is due to the discounting of

cash flows, and still indicates a short payback period. The discounted payback period is
graphically represented in the figure below.

The Average rate of

Return (ARR) shows the average profitability of the business in each year. For our business it is
190%. This is a very high rate of return and adds to the attractiveness of the investment
opportunity. This is very high due to the fact that in the five years no new capital investment is
done and the present value of the investment has almost halved in the five years, averaging out a
fairly high rate of return on the average investment. Another reason is the high growth rate of the
profits of the business. There is a huge potential for profit growth in the textile sector of Pakistan
and high growth rates are not uncommon. This potential is expected to be realized by our
business and a high ARR is expected.
Hence, according to the different techniques of Investment Appraisal used to evaluate this
investment, it has proven to be an attractive investment which is expected to generate high
returns I the future.
COMMON SIZE INCOME STATEMENT
As the company is started as an entrepreneurial venture and new in the market, that is
why we have no opening stock. We have assumed that the closing stock at the end of the year
will be same (8% of the sales revenue). Sales are increasing throughout the five years because
the variables (Population and Advertisement expenditure) we have selected for regression
analysis are increasing over the five years period. Also the price is increasing due to inflation.

These two effects (Regression and Inflation) collectively increase the sales revenue. Coming to
the cost of production, it is increasing from 2014 to 2015, and then it remains constant
throughout the next three years. The reason for this fluctuation in the cost of production is the
rapid growth in sales in the first two years. After the first two years, company is witnessing a
steady growth in sales which ultimately relaxes the growth in cost of production.
As far as Gross profit is concerned, after increasing in the first year it remains constant
for the next four years. This is due to the fact that the sales and cost of production are increasing
at the same rate. Also beginning stock and ending stock are same over the five years. These same
beginning and ending stock results in same cost of goods sold which ultimately leads to constant
gross profit.
Fixed expenses are increasing only because of inflation effect while sales have both
regression and inflation effects. Thats why the ratio of fixed cost to sales revenue is decreasing
over the 5-years period. Gross profit is constant over the 5-years period and the operating
expenses are decreasing. So, the operating income has an increasing trend as it is net of gross
profit and operating expenses.
10.000%
8.000%
6.000%
4.000%

2014

2017

Co
m

2018

Sa
le
s

O
f
ce

Ad
ve
rt
is
em
en
ta
nd

m
is
si
on

2016
In
su
ra
nc
e

0.000%
Re
nt

2015

Pu
bl
ic
ity

2.000%

Coming to the tax, it is constant throughout the 5-years period. As, operating profit are
increasing, the absolute value of taxes are increasing as we go from 2014 to 2018.

Common stocks are issued at the beginning of first year and are same in the following 4
years. As net income is increasing and the stocks are constant, earning per share (EPS) is
increasing.

COMMON SIZE BALANCE SHEET

In the beginning year, 73% of the total assets are composed of current assets and the other
27% of total assets are of non-current or fixed assets. This ratio is increasing throughout the 5years. We will see individual elements of total assets to analyze the reasons for this increase.

Total Assests
Total Current Assets

Total Non-Current Assets

27%

21%

16%

12%

9%

73%

79%

84%

88%

91%

2014

2015

2016

2017

2018

First of fall, the cash is increasing due to the increase in the operating profit. Accounts
receivables are increasing during the five years which indicates that our receivable turnover is
decreasing over time. This means that customers are taking more time to pay their payments

which is ultimately increasing average collection period. The finished good inventory is quite
high in the first year and this tails in the following years as well. This shows that we are keeping
too much finished good inventory in the warehouses. Raw material inventory is constant
throughout the five years. Although the absolute values of raw material inventory is increasing as
the production is increasing. But the ratio of raw material inventory to total assets is almost
constant.
Coming to the values of non-current assets like equipment, transportation vehicle,
computer systems and fixture & fittings, these values are decreasing from 2014 to 2018. The
reason is that no fixed asset is purchase in the four years other than the beginning year. The
values of these assets are absorbing depreciation and are declining in the following years.
The equity to liability ratio in the first year is 40% to 60%. It is increasing in the coming
years. We will see the details of individual elements for this increment.

Liabilities and Equity

Total Liabilities

Total Stockholders' Equity

40%

44%

48%

52%

55%

60%

56%

52%

48%

45%

2014

2015

2016

2017

2018

First of all accounts payable are constant which indicates that there is no change in the
creditors policy over the five years. Payable turnover is almost same and so is the average
payment period. Loan payments are constant because no loan has been taken in the next four
years other than the beginning year. Tax payments are increasing as the operating income is
increasing. Principal amount of loan is decreasing because of annual loan payments. The rapid

increase in retained earnings in the following years is because of quick growth in net operating
income.

SENSITIVITY ANALYSIS
Sensitivity of the model will be analyzed through optimistic, base and pessimistic approach.
Analysis will be based on the effect of changes in different variables on NPV of the model. First
of all, increasing sales price by 5% from its base case increases NPV from 1269177 to 43383462.
The reason for this is that by increasing the sale price assuming everything else constant, cash
flow increases over the next five years which results in increased present value. The result of
these changes will be an increased NPV value.
-5%
Pessimistic
475
Pessimistic

5%
Same

Optimistic
500
525
Most likely
Optimistic

(27,853,061)
1,269,177
43,383,682
Similarly a 5% decrease in sale price will reduce the NPV value to (27853061).
Fixed Cost

2014
-5%

5%
Pessimisti

Same

Optimistic
10317000

10860000

c
11403000
Pessimisti

Optimistic

Most likely

Range

2,691,157

1,269,177

(152,804)

2,843,960

As it is depicted in the above table that increasing the fixed costs by 5%, NPV value falls down
to (152804). The reason is that the increase in cost decreases net cash inflows which results in
low NPV value. The same logic applies when fixed cost is reduced by 5%.

Variable Cost
2014
-5%

5%
Same
Optimistic
Pessimistic
169405851.2 178321948.6
187238046.1
Optimistic
Most likely
Pessimistic
Range
5,147,383

1,269,177

(2,609,030)

7,756,412

As depicted in the above table, increasing the variable cost by 5% changes the NPV value from
1269177 to (2609030). The reason for this reduction is that by increasing the variable cost, the
net cash flow decreases. This will ultimately result in reduced value of NPV. Same is true when
variable cost reduces.
Inflation
2014
-5%
Optimistic

Same

5%
Pessimistic

8%

13%

18%

8,671,329.0
(1,267,171) 1,269,117.00 0

As it is clear from the above table that increasing the inflation by 5%, the NPV will change from
1269117 to 8671329. The reason for this shift in NPV is that when inflation increases the overall
cash flows of the company increases and the incremental cash inflow is greater than the
incremental cash outflow. Thats why NPV is greater than the base case. The same logic holds
when inflation decreases.

WAAC
WAAC
NPV

6.78%

10.43%

7.497%

1886962

45,936,770

660337

Percentage
Change

49%

-48%

As depicted from the table, it is clear that increasing the WAAC from 7.14% to 7.497% will
result in increase in NPV from 1269177 to 660337. As the cash flows are discounted at WAAC,
so when we increase the WAAC the present value of cash flows reduced. This is the reason why
NPV reduces when WAAC increases. Similarly if we reduce WAAC, the present value of cash
flows increases, which results in high value of NPV.
SCENARIO ANALYSIS
Scenario Analysis is a process to ascertain and analyze possible future events that can take place
in the future given certain assumptions. This is an important tool in the world of finance and
economics, and is used extensively to make projections for the future. In our model, we analyzed
three scenarios namely; worst or pessimistic (Recession), most likely (Current) and best or
optimistic (Boom) scenarios. The current scenario of our model is the most likely situation

expected to happen in real business world as it is developed with much sophistication and taking
into consideration all relevant factors.
Below are few income statement items which are considered to be affected by changes in
economy based on scenarios.
Sales
Sales are determined by level of economic activity in the market. During recession economic
activity decreases while in case of economic boom, economic activity increases. But how much
the economic activity increases or decreases depend on the situation and cannot be forecasted
with much accuracy. So we assumed that sales will increase by 30% in boom and decrease by
30% during recession. Graphically, these changes are shown below.
700000000
600000000
S 500000000
a 400000000
l 300000000
e 200000000
s 100000000
0

Year
Most Likely
Recession
Boom
2014

2015

2016

2017

2018

Year

Cost of Goods Sold

As most components of COGS are variable and include salaries, cost of inventory and cost of
production. These costs tend to decrease during recession and vice versa in boom as salaries and
wages decline during recession. Also due to low economic activity during recession, inventories
pile up and manufacturers will reduce prices in order to sell inventory. So cost of inventory goes
down in recession while exactly opposite will happen in boom. We assumed here that COGS will
change by +- 15%.
Gross Profit

Based on the above projection of sales and cost of goods sold gross profit comes out be as
follows graphically. During recession, gross profit has decreased by 80%, 75%, 75%, 75% and
75% from 2014 to 2018 respectively while it increased by 80%, 75%, 75%, 75% and 75% from
2014 through 2018 respectively as compared to the current situation.
500000000
400000000
C 300000000
O
G 200000000
S
100000000

Most Likely
Recession
Boom

0
2014

2015

2016

2017

2018

Year

G
r
o
s
s
P
r
o
f
i
t

250000000
200000000
150000000
100000000

Most Likely
Recession

50000000

Boom

0
2014

2015

2016

2017

2018

Year

Selling & Admin Expenses

Selling and administrative expenses ate affected in the same way as COGS as salaries and wages
of employees tend to decrease during recession and will increase during boom. Here we again
assumed a rate of +-15% change of current expenses in both the scenarios.
Operating Profit

Based on above formulations, operating profit decreases from current scenario by 125%, 112%,
110%, 108% and 106% from 2014 through 2018 respectively and it increases from current
scenario by 125%, 112%, 110%, 108% and 106% from 2014 through 2018 respectively. As the
decrease in operating profit during recession is greater than 100% we incur losses during
recession.

Finance Cost
Interest rates determine finance cost and it decreases during recession as investors expectations
of future cash flows decreases because of low economic activity and increases in boom as
investors expectations of future cash flows increases because of high economic activity. In our
model, interest rate is 14% and we assumed it to decrease to 10% in recession and it will increase
to 18% in boom. Based on these assumptions, finance cost decreases by 29%, 30%, 31%, 32%
and 33% from 2014 through 2018 respectively.

S
e
l
l
i
n
g

60000000

&

A
d
m
i
n
C
o
s
t

50000000
40000000
30000000
20000000

Most Likely

10000000

Recession
Boom
2014

2015
Year

2016

2017

2018

F
i
n
a
n
c
e

5000000
4000000
3000000
2000000

Most Likely

1000000

Recession

C
o
s
t

Boom

0
2014

2015

2016

2017

2018

Year

Taxation
Tax rate also changes with changes in economic activity but it is a slow and passive process and
not as much responsive to market level of activity as that of interest rates. Tax rates are primarily
determined by governments and its variability depends on government policies. Usually
government decide tax rate taking into consideration the economic level of activity. In the model,
we have set a tax rate of 34%. In the two scenarios, we assumed that government will realize the
economic situation after two years and decrease tax rate to 30% in recession in order to increase
disposable income and bring the economy out of recession. While in the case of boom in market,
government, realizing the greater disposable income, will increase tax rate to 40%. But in case of
recession, we will incur losses as given above, no taxation will be charged. However when there
is a boom in the economy, taxation increases from the current case.

Profit after Tax

In case of boom, profit after tax is 138%, 118%, 95%, 92% and 89% more than the current profit
after tax from 2014 through 2018 respectively and are all positive. While during recession, as we

incurred operating losses, profits after tax are also negative and are decreased by 158%, 128%,
122%, 116% and 113% from current situation from 2014 through 2018 respectively.
70000000

T
a
x
a
t
i
o
n

60000000
50000000
40000000
30000000

Most Likely

20000000

Recession
Boom

10000000
0
2014

2015

2016

2017

2018

Year

Earnings per Share (EPS)

Earnings per share are average amount per share available to shareholders after tax payments. In
case of recession, we incur an operating loss, so no amount available to shareholders while in
case of boom in the market, more cash become available to shareholders and earnings per share
increased by 138%, 118%, 95%, 92% and 89% from current EPS from 2014 through 2018
respectively.

70.00
60.00
50.00
E 40.00
P 30.00
S
20.00

Most Likely
Boom

10.00
0.00
2014

2015

2016

Year

2017

2018