Evaluation of Capital Projects Assignment

Anonymous
timer Asked: Feb 4th, 2019
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Question Description

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:

  1. 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.
  2. 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.

Tutor Answer

Richardweir
School: Boston College

Attached.

Running head: EVALUATION OF CAPITAL PROJECTS

EVALUATION OF CAPITAL PROJECTS
Name
Institution

1

EVALUATION OF CAPITAL PROJECTS

2

Evaluation of Capital Projects
Introduction
Capital budgeting is a critical tool for the evaluation of various investment opportunities/
projects available for an organization in a bid to select the most viable project. The concept of
capital budgeting is centered on various methods, including the Net Present Value (NPV),
Internal Rate of Return (IRR), and Pay Back period (PB). The different techniques are useful in
determining the worth of a prospective project before the commitment of resources into the same
(Shaban, Al-Zubi & Abdallah, 2017). As such, this paper will evaluate three projects, A, B, and
C, to assist in identifying the most feasible investment option for Drill Tech Inc. The proposed
advice in this paper will be based on objective and critical data analysis and evaluation of the
three projects using NPV, IRR, PI, and PB.
Project Cash Flows against the Upfront Costs
Imegi and Nwokoye (2015) quote the reasons identified by Gitman in 1974 for investors’
commitment of their resources into investments, including cost reduction, revenue growth, and
legal requirements. In the case of Drill Tech Inc., the drivers for the commitment of resources
have to be cost reduction and revenue growth in a bid to increase the shareholder value.
Therefore, the three projects under review exhibit specific characteristics regarding their cash
flows. The incremental cash flows realizable from project A can be presented in the table below.
Yr 1

Yr 2

Yr 3

yr 4

Yr 5

Yr 6

yr 7

Yr 8

$

$

$

$

$

$

$

$

EVALUATION OF CAPITAL PROJECTS
7,089,388

7,331,638

7,165,388

7,046,638

3
6,962,088

6,961,850

6,962,088

6,855,925

From the table, it is evident that the total cash flow to be generated by the project A over its
lifespan will amount to $56,375,000 against an initial cost outlay of $10,000,000. Project B will
generate incremental cash flows as follows:
Yr 1

Yr 2

Yr 3

yr 4

Yr 5

6,160,000

6,776,000

7,453,600

8,198,960

9,018,856

The project will generate cumulative cash flows amounting to $37,607,416 against an initial cost
outlay of $8 million. Project C will, on the other hand generate the following cash flows over its
lifetime.
Yr 1

Yr 2

Yr 3

yr 4

Yr 5

Yr 6

5,400,000

6,435,000

7,625,250

8,994,038

10,568,143

12,378,365

The total incremental cash flows realizable from the project will be $51,400,795 over the six
years against the annual cost of $2 million.
Decision Recommendations
The decision recommendations for the three projects will aim at identifying the best and
most viable project for implementation by the organization. The basis of the decision
recommendations will be factual data findings and calculations conducted (see appendix) to
highlight the most feasible investment opportunity. Various capital budgeting will be useful in

EVALUATION OF CAPITAL PROJECTS

4

the determination of the most viable project for Drill Tech Inc. and which will significantly
improve the business' commitment to increasing its sharehold...

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Review

Anonymous
Tutor went the extra mile to help me with this essay. Citations were a bit shaky but I appreciated how well he handled APA styles and how ok he was to change them even though I didnt specify. Got a B+ which is believable and acceptable.

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