5014_ASS 2 # DRAFT 1 # Evaluation of Capital Projects # MBA # FLEXPAH CAPELLA
************************************************** Plagiarism 61% match *****************************************************
**** First submission is final submission ***** No option for REWORK **** **** First submission is final submission ***** No option for REWORK ****
Assessment 2 Instructions: Evaluation of Capital Projects
Create an Excel spreadsheet in which you use capital budgeting tools to determine the quality of 3 proposed investment projects, as well as a 6-8 page report that analyzes your computations and recommends the project that will bring the most value to the company.
Introduction
This portfolio work project is about one of the basic functions of the finance manager: allocating capital to areas that will increase shareholder value. There are many uses of cash managers can select from, but it is essential that the selected projects are ones that 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 business 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
You work as a finance manager for Drill Tech, Inc., a mid-sized manufacturing company located in Minnesota. Three capital project requests were identified as potential projects for the company to pursue in the upcoming fiscal year. In the meeting to discuss capital projects, the director of finance (and your boss), Jennifer Davidson, gives you a synopsis of the projects along with this question: Which one of these projects will provide the most shareholder value to the company?
She also tells you that other than what is noted in each project scenario, all other costs will remain constant, and you should remember to only evaluate the incremental changes to cash flows.
The proposed projects for you to review are as follows.
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 Europe
Expansion into Western Europe 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.
Because of the higher European tax rate, the marginal corporate tax rate is presumed to be 30%.
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%.
Your Role
You are a finance manager at Drill Tech, Inc., who plays a major role in reviewing capital project requests.
Requirements
Jennifer reiterates that your report is critical for the company to select the project that will bring the most value to shareholders. Your calculations and report should address these items for her and other stakeholders:
Apply computations of capital budgeting methods to determine the quality of the proposed investments.
Use budgeting tools to compute future project cash flows and compare them to upfront costs. Remember to only evaluate the incremental changes to cash flows.
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 the capital projects using data analysis and applicable metrics that align to the business goal of maximizing shareholder value.
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.
Prepare an appropriate evaluation report for requestors, using sound research and data to defend your decision.
Justify your decision with a clear analysis showing the findings of the analysis and which project has the best chance to increase shareholder value.
Use your calculations and data to provide a clear picture of why your recommendation is the right one. This goes beyond just regurgitating the data. Think about how the data can tell the story that will be meaningful to the readers.
Deliverable Format
For this assessment, create two deliverables:
An Excel spreadsheet showing the required cash flow forecasts and capital budgeting tool calculations for each project. Use the same spreadsheet but create separate tabs for each project.
A report providing an analysis of the computations, the project selection decision, and justification for the decision, as well as its impact on the value of the firm. The project selection decision must have an analytical rationale to support it.
Report requirements:
Ensure written communication is free of errors that detract from the overall message and quality.
Use at least three scholarly resources.
Your report should be between 6 and 8 pages.
Use 12 point, Times New Roman.
Related company standards:
Your report is a professional document and should follow the corresponding MBA Academic and Professional Document Guidelines (found in the MBA Program Resources), including single-spaced paragraphs.
Use APA-formatted references.
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.
Apply computations of capital budgeting methods to determine the quality of the proposed investments.
Competency 2: Analyze financing strategies to maximize stakeholder value.
Evaluate the capital projects using data analysis and applicable metrics that aligns to the business goals.
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.
Competency 5: Communicate financial information with multiple stakeholders.
Prepare an appropriate evaluation report for requestors, using sound research and data to defend the decision.
Faculty will use the scoring guide to review your deliverables in the role of your boss and stakeholders. Review the scoring guide prior to developing and submitting your assessment.
ePortfolio
This assessment shows potential employers and clients that you can analyze capital projects to determine whether and how they can provide value to shareholders. Include this in your personal ePortfolio.
**** First submission is final submission ***** No option for REWORK ****
Running Head:1CAPITAL BUDGETING TOOLS 1
Introduction
1The Drill Tech, Inc.
4is a mid-sized manufacturing firm whose location is in Minnesota.
1The finance manager was requested to evaluate three different potential projects to determine the one Project that will give the most investor value to the company.
Capital projects must be assessed to determine whether the cost of investment will provide enough benefit and outweigh any risks associated.
While there are many various aspects in assessing the benefit or threat of a potential project, this evaluation is to determine the financial issues.
Each Project has its advantages and is very different from one another, but when taking the sales, cost of sales, tax, possible equipment depreciation and calculate the net cash flow and net present value, and informed financial decision can be made (Batra, & Verma, 2017).Therefore, it’s important to note that the net current worth is one of the capital budgeting tools, which is strongly recommended to be used when analyzing the viability of the Project. Therefore, in this paper, alongside other capital budgeting tools, the net present value will be given more priority in coming up with a project recommendation for Drill Tech, Inc.
4As per the scenario, the three projects are a significant equipment purchase, expansion into Western Europe as well as marketing/advertising campaign.It’s out of these that one Project will be recommended for the company to undertake. The recommendation of the Project to be conducted can’t be a simple task without the use of capital budgeting tools. Through this, a more profitable project will be recommended for the company as it will be determined after conducting the necessary calculations using the capital budgeting tools using the excel spreadsheet.
5Capital Projects Evaluation Background This company Drill Tech, Inc., as it has been mentioned from the introduction section, is a mid-sized manufacturing company based out of Minnesota.The company’s finance manager has been tasked to conduct projects evaluation and come up with a worthy project to be undertaken.4However, the main challenges associated with capital projects is that they increase with various markets.
6With some projects having inherent uncertainties since they encompass many moving parts, resources, and contractors that may keep changing over many years.
1It must be appreciated that capital investment projects can impact a companys value as well as increase its growth and returns on invested capital.According to (Yasotharalingam, 2016), a potential investment can either be qualitative or quantitative.1Qualitative projects are strategic, and hence they may address new mandates or regulatory requirements, on the other hand, quantitative investments have got clear financial goals.
7For this portfolio, capital budgeting tools will be used to determine future project cash flows and determine which Project will bring the most value to shareholders.
1The Capital Structure Theories
Various theories have been put forward to explain the nature of capital structures. Some of these theories include;1the trade-off theory assumes that the optimum level of the obligation is where the marginal benefit of debt finance is equal to its minimal cost (Yasotharalingam, 2016).
This theory explains that companies are financed with both debt and equity.
Secondly is the Pecking order theory states that the cost of financing increases with asymmetrical information.
Internal funding is easy to obtain and has the least amount of risk, so it is used first.
This theory posits that if domestic financing does not meet business requirements, they will borrow funds.
Equity is used as a last resort as it is least preferable and risky.
The Capital Budgeting Tools
These are the tools that are utilized in helping the company to determine whether a company should accept or reject a project.
The net present value investment rule, for instance, will tend to take a project if its net current value is greater than zero, that is NPV>0, and reject it if it is less than zero, that is NPV<0.
It must be noted that a positive NPV will benefit the stockholders.
The second tool is the Project's internal rate of return, the internal rate of return (IRR) is based on the cash flows of the Project.The cash flows calculate the actual performancethe higher the IRR, the better the investment.1The IRR is calculated by using expected cash flows, and the net present value is zero.
This calculation will give the anticipated rate of return earned on a projected investment.
The third capital tool is the payback period that tends to determines how long it takes to recover the initial investment.
An argument against this method is that capital budgeting relies on the time value of money, project profitability and additional cash flows after payback has been reached.
Finally, the profitability index tends to measures the present value of future cash flows for every dollar of investment.
The NPV and profitability index method can give contradicting results, but in general, the higher the PI, the better the Project is.
It must be noted that each of these tools should not be relied upon solely to determine whether a project should be accepted or rejected.According to (Yasotharalingam, 2016).1building on the internal rate of return can "lead to a poor decision about where to invest, especially when comparing projects that have different durations.
Using the internal rate of return with net present value will provide a complete snapshot of a project's cost and profitability.
Projects Analysis
The three projects will be analyzed about their net present value, the internal rate of return as well as the payback periods. From the provided information, all these project determinants can be calculated using an excel spreadsheet.
Project A:1Major Equipment Purchase
Making use of the information provided from the scenario, the following is the calculations of the net present value of project A as they are computed in the excel spreadsheet.
1Using the given information, the net present value, internal rate of return, payback period and profitability index are calculated as below, and the attached spreadsheet:
From the above attachment from excel, it's clear that the net present value considering the second calculation option is $31.07 with an IRR of 70% and a payback period of 1.6 years.5Therefore, in this case, the net present value of the Project is more than zero.But from the first option of calculation it was found to be less than zero, hence the reason as to why it's not recommended to only rely on one tool of capital budgeting in deciding on project recommendation. It can also be witnessed that the profitability index of this Project is 4.107. Therefore, in this Project, three parameters qualify it to be considered, that is the positive net present value, higher internal rate of return as well as the less payback period which renders the Project to be of low risk. However, this cant be taken as a conclusive option for project A, the same will have to be carried out for projects B and C, and then a comparison is made (JUSTICE et al. 2020).
Project B:1Expansion into Europe
For this Project, the calculations of the second option from excel displaying its net present value, the internal rate of return, as well as the payback period and the profitability index are as attached below.
5From the above table, it's clear that the net present value of the Project is more significant than zero.
8Also, from the Project's internal rate of return, it indicates that the Project has got a higher magnitude as well as better timing of the incoming profits.
9Its important to note that the higher the internal rate of return, the less risk is the Project.Also, it can be said that the payback period is less than one and a quarter year, which as well supports the less risk of the Project.10This indicates the between project A and B;project B has to be undertaken since it is less risk. However, project C must as well be considered (Chaudhary, 2016).
Project C:1Marketing/Advertising Campaign
For this Project, the following was extracted from option two calculation in excel.
5From the above table, it's clear that the net present value of the Project is more significant than zero.
8Also, from the Project's internal rate of return, it indicates that the Project has got a higher magnitude as well as better timing of the incoming profits.
9It's important to note that the higher the internal rate of return, the less risk is the Project.Also, it can be said that the payback period is zero, which as well supports the less risky is the Project. This indicates the between project B and C; project C have to be undertaken since it is less risk (Kengatharan, 2016).
Recommendation
NPV IRR
Project A:1Major Equipment Purchase $31.07 70%
Project B:1Expansion into Europe $19.18 81%
Project C:1Marketing/Advertising Campaign $33.65 288.69%
Its important to note that from the above analysis, all the projects have got a payback period of fewer than two years. Both projects were observed not to be risky as noted from their IRR. However, in comparison, project C was found to be less risky as compared to the other two. This project C was also more profitable and with a net present value than the other projects. Therefore this indicates that the company will much benefit from project C than the other two.
1Project C's higher net present value, higher internal rate of return, lower payback period and higher profitability index shows that it creates more cash flow than the Project uses.This indicates that the company will tend to generate more cash flow as well as increasing the value of the investment via moving with moderate risk investment of the marketing as well as advertising campaigns (Batra, & Verma, 2017).
References:
Batra, R., & Verma, S. (2017).11Capital budgeting practices in Indian companies.IIMB Management Review, 29(1), 29-44.12Retrieved from https://www.sciencedirect.com/science/article/pii/S0970389617300587
Chaudhary, D. K. (2016). CAPITAL BUDGETING PRACTICES IN BEVERAGES INDUSTRIES IN NEPAL. International Educational Applied Scientific Research Journal, 1(1). Retrieved from http://ieasrj.com/journal/index.php/ieasrj/article/view/2
JUSTICE, A., YEBOAH, E. N., & PIOUS, O. (2020). Capital Budgeting as a Tool of Management Decision Making: A Case Study of National Investment Bank Limited. Retrieved from https://www.clutejournals.com/index.php/JBCS/article/view/9794
Kengatharan, L. (2016). Capital budgeting theory and practice: a review and agenda for future research. Applied Economics and Finance, 3(2), 15-38. Retrieved from http://redfame.com/journal/index.php/aef/article/view/1261
Yasotharalingam, L. (2016). Capital budgeting theory and practices (Doctoral dissertation, Kingston University). Retrieved from https://eprints.kingston.ac.uk/34118/
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