Use capital budgeting tools to determine the quality of three proposed investment projects, and prepare a 6-8 page report that analyzes your computations and recommends the project that will bring the most value to the company.
Introduction
This assessment is about one of the basic functions of the finance manager, which is allocating capital to areas that will increase shareholder value and add the most value to the company. This means forecasting the projected cash flows of the projects and employing capital budgeting metrics to determine which project, given the forecast cash flows, gives the firm the best chance to maximize shareholder value. As a finance professional, you are expected to:
Use capital budgeting tools to compute future project cash flows and compare them to upfront costs.
Evaluate capital projects and make appropriate decision recommendations.
Prepare reports and present the evaluation in a way that finance and non-finance stakeholders can understand.
Scenario
Senior leadership has now called upon you to analyze three capital project requests based on forecasted cash flow as they relate to maximizing shareholder value.
Your Role
You are one of Maria’s high-performing financial analyst managers at ABC Healthcare Corporation and she trusts your work and leadership. Senior leadership was impressed with your presentation in Assessment 1 and they are tasking you with the analysis of these three proposed capital projects based on forecasted cash flow. You have completed forecasting the projected cash flows of the projects as reflected in the attached spreadsheets, Projected Cash Flows [XLSX]. You now need to conduct your analysis recommending which will provide the most shareholder value to the organization.
Requirements
Use capital budgeting tools to compute future project cash flows and compare them to upfront costs. Remember to only evaluate the incremental changes to cash flows.
Employing capital budgeting metrics, determine which project, given the forecast cash flows, gives the organization the best chance to maximize shareholder value.
Demonstrate knowledge of a variety of capital budgeting tools including net present value (NPV), internal rate of return (IRR), payback period, and profitability index (PI). The analysis of the capital projects will need to be correctly computed and the resulting decisions rational.
Evaluate capital projects and make appropriate decision recommendations. Accurately compare the indicated projects with correct computations of capital budgeting tools and then make rational decisions based on the findings.
Select the best capital project, based on data analysis and evaluation, that will add the most value for the company. Provide a rationale for your recommendations based on your financial analysis.
Prepare reports and present the evaluation in a way that finance and non-finance stakeholders can understand.
Project A: Major Equipment Purchase
A new major equipment purchase, which will cost $10 million; however, it is projected to reduce cost of sales by 5% per year for 8 years.
The equipment is projected to be sold for salvage value estimated to be $500,000 at the end of year 8.
Being a relatively safe investment, the required rate of return of the project is 8%.
The equipment will be depreciated at a MACRS 7-year schedule.
Annual sales for year 1 are projected at $20 million and should stay the same per year for 8 years.
Before this project, cost of sales has been 60%.
The marginal corporate tax rate is presumed to be 25%.
Project B: Expansion Into Three Additional States
Expansion into three additional states has a forecast to increase sales/revenues and cost of sales by 10% per year for 5 years.
Annual sales for the previous year were $20 million.
Start-up costs are projected to be $7 million and an upfront needed investment in net working capital of $1 million. The working capital amount will be recouped at the end of year 5.
The marginal corporate tax rate is presumed to be 25%.
Being a risky investment, the required rate of return of the project is 12%.
Project C: Marketing/Advertising Campaign
A major new marketing/advertising campaign, which will cost $2 million per year and last 6 years.
It is forecast that the campaign will increase sales/revenues and costs of sales by 15% per year.
Annual sales for the previous year were $20 million.
The marginal corporate tax rate is presumed to be 25%.
Being a moderate risk investment, the required rate of return of the project is 10%.
Deliverable Format
In this assessment, you will prepare an appropriate evaluation report to senior leadership using sound research and data to defend your decision.
Report requirements:
Your report should follow the corresponding MBA Academic and Professional Document Guidelines, including single-spaced paragraphs.
Ensure written communication is free of errors that detract from the overall message and quality.
Format your paper according to APA style and formatting.
Use at least three scholarly resources.
Length: Between 6–8 pages of content beyond the title page, references, and any appendices.
Use 12 point, Times New Roman.
Evaluation
By successfully completing this assessment, you will demonstrate your proficiency in the following course competencies through corresponding scoring guide criteria:
Competency 1: Apply the theories, models, and practices of finance to the financial management of an organization.
Use capital budgeting tools to compute future project cash flows and compare them to upfront costs. Demonstrate knowledge of a variety of capital budgeting tools, including net present value (NPV), internal rate of return (IRR), payback period, and profitability index (PI).
Competency 2: Analyze financing strategies to maximize stakeholder value.
Evaluate the capital projects using data analysis and applicable metrics that align to the business goals of maximizing shareholder value. Accurately compare the indicated projects with correct computations of capital budgeting tools and then make rational decisions based on the findings.
Competency 3: Apply financial analyses to business planning and decision making.
Select the best capital project, based on data analysis and evaluation, that will add the most value for the company. Provide a rationale for your recommendations based on your financial analysis.
Competency 5: Communicate financial information with multiple stakeholders.
Prepare an appropriate evaluation report for senior leadership, using sound research and data to defend the decision. Present the evaluation in a way that finance and non-finance stakeholders can understand.
Your course instructor will use the scoring guide to review your deliverable in the role of your boss and stakeholders. Review the scoring guide prior to developing and submitting your assessment.
resources
The following resources may be useful in learning about time value of money (TVM) and how to calculate TVM in Excel:
Alexander, M., & Kusleika, D. (2016). Excel 2016 formulas. Indianapolis, IN: John Wiley & Sons, Inc.
You will find explanations on using Excel to calculate financials in these chapters:
Chapter 11, “Borrowing and Investing Formulas.”
Chapter 12, “Discounting and Depreciation Formulas.”
Chapter 13, “Financial Schedules.”
Ross, S. A., Westerfield, R. W., Jaffe, J. F., & Jordan, B. D. (2018). Corporate finance: Core principles and applications (5th ed.). New York, NY: McGraw-Hill. Available from the bookstore.
Chapter 4, “Discounted Cash Flow Valuation,” pages 83–129.
Schmidt, C. E. (2016). A journey through time: From the present value to the future value and back or: Retirement planning: A comprehensible application of the time value of money concept. American Journal of Business Education, 9(3), 137–143.
Time Value of Money | Transcript.
This presentation discusses the components that make up time value of money. The presenter also provides examples to compute and read the computations.
Mayes, T. R. (n.d.). Microsoft Excel as a financial calculator part I. Retrieved from http://www.tvmcalcs.com/index.php/calculators/excel_tvm_functions/excel_tvm_functions_page1/
Skillsoft. (n.d.). Financial statement analysis for non-financial professionals.
Go to the Analyzing the Financial Statement section in the Table of Contents menu, and select The Time Value of Money.
Seeking Alpha. (2016, March 28). Does Warren Buffett use discounted cash flow? Retrieved from https://seekingalpha.com/instablog/5969741-the-value-pendulum/4868716-warren-buffett-use-discounted-cash-flow
Ross, S. A., Westerfield, R. W., Jaffe, J. F., & Jordan, B. D. (2018). Corporate finance: Core principles and applications (5th ed.). New York, NY: McGraw-Hill. Available from the bookstore.
Chapter 4, “Discounted Cash Flow Valuation,” pages 83–129.
Ross, S. A., Westerfield, R. W., Jaffe, J. F., & Jordan, B. D. (2018). Corporate finance: Core principles and applications (5th ed.). New York, NY: McGraw-Hill. Available from the bookstore.
Chapter 6, “Stock Valuation,” pages 165–194. Find out how the valuation of these securities determines the ultimate value of the entire enterprise.
Edspira. (n.d.). Capital stock (common stock and preferred stock) [Video] | Transcript Retrieved from https://www.youtube.com/watch?v=TZ2uWgtQXBo
TheFinCoach. (2012). Session 08: Objective 1 – common stock valuation [Video] | Transcript Retrieved from https://www.youtube.com/watch?v=uajW4BWh_zY
Harper, D. (2018, February 18). Forces that move stock prices. Retrieved from https://www.investopedia.com/articles/basics/04/100804.asp
Ross, S. A., Westerfield, R. W., Jaffe, J. F., & Jordan, B. D. (2018). Corporate finance: Core principles and applications (5th ed.). New York, NY: McGraw-Hill. Available from the bookstore.
Chapter 5, “Interest Rates and Bond Valuation,” pages 130–164. This chapter illustrates the employment of time value of money concepts to determine the value of corporate debt/bonds and common/preferred stock.
McCracken, M. (n.d.). Bond valuation [Video] | Transcript Retrieved from http://www.teachmefinance.com/bondvaluation.html
Ross, S. A., Westerfield, R. W., Jaffe, J. F., & Jordan, B. D. (2018). Corporate finance: Core principles and applications (5th ed.). New York, NY: McGraw-Hill. Available from the bookstore.
Chapter 7, “Net Present Value and Other Investment Rules,” pages 195–229. This chapter introduces the process of capital budgeting, which determines the value of a potential investment/project to a firm. That is, it weeds out good investments from the bad. Evaluating capital budget projects is a critical function for any business professional involved with finance decisions.
Chapter 8, “Making Capital Investment Decisions,” pages 230–261. The key to valuation of investments and projects is the cash they generate. This chapter illustrates the way to figure the all-important cash flows from investment projects.
Van Dalsem, S. (2017). Capital budgeting cash flows tutorial [Video] | Transcript Retrieved from https://www.youtube.com/watch?v=X6HvKl__rLY&t=19s
View the segment, 12:36–27:36.
