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Use capital budgeting tools to determine the quality of three proposed investment projects, and prepare a 4-6 page report that analyzes your computations and recommends the proj

Use capital budgeting tools to determine the quality of three proposed investment projects, and prepare a 4-6 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 4-6 pages of content beyond the title page, references, and any appendices.
  • Use 12 point, Times New Roman.

ProjectA

Project A Major Equipment Purchase
Purchasing cost $10,000,000
Life of project in years 8
Reduction in cost per year 5%
Salvage value $500,000
Required rate of return 8%
Depreciation MACRS-7 years
Annual sales $20,000,000
Earlier Cost of sales (60% of sales)
: 60% of Annual Sales i.e of 20 million =C9*0.6
$12,000,000
Tax rate 25%
Year 0 1 2 3 4 5 6 7 8
Purchasing Cost $10,000,000
Annual Sales $20,000,000 $20,000,000 $20,000,000 $20,000,000 $20,000,000 $20,000,000 $20,000,000 $20,000,000
Cost of the goods sold
: Cost of sales reducing by 5% per year for 8 years
$11,000,000 $10,000,000 $9,000,000 $8,000,000 $7,000,000 $6,000,000 $5,000,000 $4,000,000
MACRS – 7 years rates 14.29% 24.49% 17.49% 12.49% 8.93% 8.92% 8.93% 4.46%
Annual Depreciation $1,429,000 $2,449,000 $1,749,000 $1,249,000 $893,000 $892,000 $893,000 $446,000
Earnings before interest and taxes (EBIT) / Gross Income
: EBIT = Sales – Cost of Sales – Operating Expenses https://www.investopedia.com/terms/e/ebit.asp
$7,571,000 $7,551,000 $9,251,000 $10,751,000 $12,107,000 $13,108,000 $14,107,000 $15,554,000
Taxes (25%) / Income Taxes
: EBIT * Tax rate of 25%
$ 1,892,750 $ 1,887,750 $ 2,312,750 $ 2,687,750 $ 3,026,750 $ 3,277,000 $ 3,526,750 $ 3,888,500
Earnings after taxes / Net Income
: EBIT – Taxes
$5,678,250 $5,663,250 $6,938,250 $8,063,250 $9,080,250 $9,831,000 $10,580,250 $11,665,500
Add Depreciation $1,429,000 $2,449,000 $1,749,000 $1,249,000 $893,000 $892,000 $893,000 $446,000
Add: After tax salvage value
: Salvage value on 8th year – (Salvage Value * Tax rate 25%)
: 60% of Annual Sales i.e of 20 million =C9*0.6 $375,000
Cash Flows ($10,000,000) $7,107,250 $8,112,250 $8,687,250 $9,312,250 $9,973,250 $10,723,000 $11,473,250 $12,486,500
Cummulative Cash Flows ($10,000,000) ($2,892,750) $5,219,500 $13,906,750 $23,219,000 $33,192,250 $43,915,250 $55,388,500 $67,875,000
Present Value factor (8%)
: PV https://www.accountingtools.com/articles/what-is-the-present-value-factor.html
1 0.93 0.86 0.79 0.74 0.68 0.63 0.58 0.54
Present value of cash flows
: Ref: Bradford, R.S.W.R.J.J. J. (2017). Corporate Finance: Core Principles and Applications. [Capella]. Retrieved from https://capella.vitalsource.com/#/books/1260384357/ Page 115 (Ch4), 197 (Ch7)
: Cost of sales reducing by 5% per year for 8 years ($10,000,000) $6,580,787 $6,954,947 $6,896,219 $6,844,782 $6,787,626 $6,757,309 $6,694,531 $6,746,067
Present value of cash inflows $54,262,269
Present value cash outflows $10,000,000
Net present value = Present value of cash inflows – Present value of cash outflows $44,262,269 NPV Formula: $44,262,269
Internal rate of return (IRR) IRR: 79.79%
Payback period
: https://www.investopedia.com/ask/answers/051315/how-do-you-calculate-payback-period-using-excel.asp https://www.elearnmarkets.com/blog/calculation-of-payback-period/
1.36
profitability Index (PI) + present value of cash inflows/ present value of cash outflows 5.43

ProjectB

Project B: Expansion Into Three Additional States Expansion Into Three Additional States
Start up Cost $7,000,000
Life of a project in years 5
Annual Depreciation (using straightline)
: Using straight line depreciation Annual Depreciation= (Asset Cost – Salvage Value)/Asset Life https://corporatefinanceinstitute.com/resources/knowledge/accounting/straight-line-depreciation/
$1,400,000
Net working capital $1,000,000
Required rate of Return 12%
Earlier annual sales $20,000,000
Earlier Cost of sales (60% of sales) $12,000,000
Increase in sales and revenue per year 10%
Tax rate 25%
Year 0 1 2 3 4 5
Purchasing Cost $7,000,000
Annual Sales $22,000,000 $24,200,000 $26,620,000 $29,282,000 $32,210,200
Cost of goods sold $13,200,000 $14,520,000 $15,972,000 $17,569,200 $19,326,120
Annual Depreciation $1,400,000 $1,400,000 $1,400,000 $1,400,000 $1,400,000
Earnings before interest and taxes (EBIT) $7,400,000 $8,280,000 $9,248,000 $10,312,800 $11,484,080
Tax (30%) $1,850,000 $2,070,000 $2,312,000 $2,578,200 $2,871,020
Earnings after tax $5,550,000 $6,210,000 $6,936,000 $7,734,600 $8,613,060
Plus Depreciation $1,400,000 $1,400,000 $1,400,000 $1,400,000 $1,400,000
Net working capital ($1,000,000) $1,000,000
Cash flows ($8,000,000) $6,950,000 $7,610,000 $8,336,000 $9,134,600 $11,013,060
Cummulative Cash flows ($8,000,000) ($1,050,000) $6,560,000 $14,896,000 $24,030,600 $35,043,660
Present value factor (12%) 1.00 0.89 0.80 0.71 0.64 0.57
Present value of cash flows ($8,000,000) $6,205,357 $6,066,645 $5,933,400 $5,805,203 $6,249,106
Present value of cash inflows $30,259,712
Present Value of Cash outflows $8,000,000
Net Present Value = Present Value of cash inflows – Present Value of cash outflows $22,259,712 NPV Formula: $22,259,712
Internal rate of return IRR: 91.48%
payback period 1.14
Profitability Index (PI) 3.78

ProjectC

Project C Marketuing/ Advertising Campaign
Annual cost $2,000,000
Life of project in years 6
Required rate of return 10%
Earlier Annual sales $20,000,000
Earlier Cost of Sales (60% of sales) $12,000,000
Increase in sales and revenue per year 15%
Tax rate 25%
Year 0 1 2 3 4 5 6
Marketing / Advertising cost $2,000,000 $2,000,000 $2,000,000 $2,000,000 $2,000,000 $2,000,000
Present value of Annual marketing cost $8,710,521
Annual sales $23,000,000 $26,450,000 $30,417,500 $34,980,125 $40,227,144 $46,261,215
Cost of the Goods sold $13,800,000 $15,870,000 $18,250,500 $20,988,075 $24,136,286 $27,756,729
Earnings before interest and taxes (EBIT) $9,200,000 $10,580,000 $12,167,000 $13,992,050 $16,090,858 $18,504,486
Taxes (25%) $2,300,000 $2,645,000 $3,041,750 $3,498,013 $4,022,714 $4,626,122
Earnings after taxes $6,900,000 $7,935,000 $9,125,250 $10,494,038 $12,068,143 $13,878,365
Cash Flows ($8,710,521) $6,900,000 $7,935,000 $9,125,250 $10,494,038 $12,068,143 $13,878,365
Present value factor (10%) 1.00 0.91 0.83 0.75 0.68 0.62 0.56
Present value of cash flows ($8,710,521) $6,272,727 $6,557,851 $6,855,935 $7,167,569 $7,493,367 $7,833,975
Cummulative Cash flows ($8,710,521) ($1,810,521) $6,124,479 $15,249,729 $25,743,766 $37,811,909 $51,690,274
Present value of cash inflows $42,181,425
Present value of cash outflows $8,710,521
Net Present Value = Present Value of cash inflows – Present value of cash outflows $33,470,904 NPV Formula: $33,470,904
internal rate of return IRR: 90.36%
Payback periodd 1.23
Profitability Index (PI) = present value of cash inflows/ present value of cash outflows 4.84

Comparison

Projects Net Present Value Payback Period Profitability Index Internal Rate of Return
Project A: Major Equipment Purchase $44,262,268.65 1.36 5.43 79.79%
Project B: Expansion Three Additional States $22,259,712.14 1.14 3.78 91.48%
Project C: Marketing or Advertising Campaign $33,470,903.72 1.23 4.84 90.36%

Combined_EvaluateCapProjects

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Project A Major Equipment Purchase
Purchasing cost $10,000,000
Life of project in years 8
Reduction in cost per year 5%
Salvage value $500,000
Required rate of return 8%
Depreciation MACRS-7 years
Annual sales $20,000,000
Earlier Cost of sales (60% of sales)
: 60% of Annual Sales i.e of 20 million =C9*0.6
$12,000,000
Tax rate 25%
Year 0 1 2 3 4 5 6 7 8
Purchasing Cost $10,000,000
Annual Sales $20,000,000 $20,000,000 $20,000,000 $20,000,000 $20,000,000 $20,000,000 $20,000,000 $20,000,000
Cost of the goods sold
: Cost of sales reducing by 5% per year for 8 years
$11,000,000 $10,000,000 $9,000,000 $8,000,000 $7,000,000 $6,000,000 $5,000,000 $4,000,000
MACRS – 7 years rates 14.29% 24.49% 17.49% 12.49% 8.93% 8.92%