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

1
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.

2
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 Costs
Registration Fees
SEC 3,189
BIR 500
DTI 515
Business Permit 7,472
Total Registration Fees 11,676
Fixed Assets
Office
Equipment
4 in 1 machine 12,000
Computer Set 60,000
Furniture and Fixtures
Cabinets 2,500
Chairs and table 29,000

3
 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 758,239
Total Fixed Assets 882,439
Initial Advertising Costs
Print Materials 80,500
Ribbon Cutting 30,000
Total Initial Advertising Costs 110,500
Initial 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
Transportation 3,000

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 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 168,375
Total Initial Working Capital 944,350
TOTAL 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

th th
stockholders starting from the 6 up to the 10 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.

6
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.

8
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.

9
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.

11
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

12
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

13
 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________

Average Total Assets

14
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:

15
 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.

ENDNOTES

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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] Available
http://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.