Notes: FIN 303 Spring 09, Part 7 – Capital Budgeting Professor James P. Dow, Jr. Part 7. Capital Budgeting What is Capital Budgeting? Nancy Garcia and Digital Solutions Digital Solutions, a software development house, is considering a number of new projects, including a joint venture with another company. Digital Solutions would provide the software expertise to do the development, while the other company, American Financial Consultants (AFC) would be responsible for the marketing. Nancy Garcia of Digital Solutions would be responsible for assessing the financial viability of the plan. Information about the costs and revenues of the project would come from the accounting, production and marketing groups of the two companies; however, …show more content…
She (and we) will approach the problem in five steps: 1. Determine the relevant cash flows including different possible outcomes. 2. Assess the rough financial viability of the most-likely outcome. 3. Use more sophisticated capital budgeting techniques to evaluate the project. 4. Provide quantitative measures of risks the project faces. 5 Determine how these risks affect the decision to do the project. The Time-Line of a Capital Project The first step in any capital budgeting decision is to list all the relevant cash flows. This is the hardest part of the process since it depends on having a detailed understanding of the business and requires the manager to forecast what will happen with the project in the future. It is also the most important part of the process, since if the cash flows are wrong, measures of the profitability of the project will be wrong too. Many capital projects have a similar structure: An initial investment by a firm, followed by a number of periods of regular cash inflow, followed by a terminal payment that ends the project. Our methods of evaluating projects don’t depend on this structure, but it can be helpful to think of a project this way when determining cash flows in order to be sure that you don’t forget any beginning or ending payments or costs. Nancy’s project has this kind of structure. The plan is for Digital Solutions to use its own software engineers and some temporary contract workers to develop
The implementation phase is to combine the individual components of the system, verify and test, convert data and integrate system components, document and install the system. (Post & Anderson). The project’s risks and probability of its success will be based on the feasibility study that included both economic via cost-benefit analysis and legal reviews. Moreover, before the sign off a great deal of financial analysis went into this project including ROI (projected return on investment) and NPV (projected Net Present Value). The (ROI) is a calculation that measures the average rate of return earned on the money invested in the project. NPV is a basic formula to convert future cash flow to present value. (Thomson, Strickland, and Gamble)
For the personal goal aspect of the project everyone choose their own goals and we could compare our results to better understand our team members. Another aspect that the group discussed was the amount of money that should be spent on purchasing market research. We decided to go with the most expensive plan because it will have the most accurate results and one of the most important parts of starting up a business is understanding what the consumer wants. For the 3 month certification of deposit the group agreed on investing $800,000 at a quarterly interest rate of 1.50. By investing this large sum of money our company can generate 12,000 in interest revenue. Therefore, this is a brief summary of the startup quarter of the company, Speedy Solutions, and how the group members determined how to invest the company assets and come to an agreement on team
EEC calculated the amount of time involved the anticipation of its cost ($3 million). The timeline in recovering their cost of investment ($2 million) initially for the foundation of this investment any profit made in the future of this investment will be justified as a profit for the company. If EEC can anticipate a fast return on its investment it is a profitable wise decision in making the investment financial, it is considered to be an easier way of formulating investments financially. On the basis of one year all cash flows is added together equal to the sum of $2 million originally invested, then it is divided by the annual cash flow of $500,000. The calculation of the payback period would equal four years. After this time frame any financial proceeds will be considered profitable for the company. I conclude that the timeframe is adequate in comparison of the investment in this worthwhile investment financial venture for the company.
There are different types of budgeting that businesses typically use and those include Operating budgets, Capital Budgets and there are many subtypes that exist because a budget can also be created for special events, the recruitment and retention of new staff, and to manage the advertising expenses and return on investments for a business (Demand Media, 1999-2012). According to Demand Media (1999-2012), "An operating budget outlines the total operating expenses and income for the organization, typically for the period of a fiscal year. Capital budgets evaluate the investments and assets of the business, and a cash budget shows the predicted cash flow in and out of the business over a period of time” (para.2 ). According to the Cost-Benefit Analysis (2012), “Capital budgeting has at its core the tool of cost-benefit analysis; it merely extends the basic form into a multi-period analysis, with consideration of the time value of money. In this context, a new product, venture, or investment is evaluated on a start-to-finish basis, with care taken to capture all the impacts on the company, both cost and benefits. When these inputs and outputs are quantified by year, they can then be discounted to present value to determine the net present value of the opportunity at the time of the decision” ("Cost-Benefit Analysis," 2012).
CHAPTER 21 PARTNERSHIPS SOLUTIONS TO PROBLEM MATERIALS | | | | |Status: | Q/P | |Question/ |Learning | | |Present |in Prior | |Problem |Objective |Topic | |Edition |Edition | | | | | | | | | | | | 1 LO 1 Partnership definition New 2 LO 2 General partnership versus LLC New 3
Star Appliance is looking to expand their product line and is considering three different projects: dishwashers, garbage disposals, and trash compactors. We want to determine which project would be worth doing by determining if they will add value to Star. Thus, the project(s) that will add the most value to Star Appliance will be worth pursuing. The current hurdle rate of 10% should be re-evaluated by finding the weighted average cost of capital (WACC). Then by forecasting the cash flows of each project and discounting them by the WACC to find the net present value, or by solving for the internal rate of return, we should be able to see which projects Star should undertake.
Estimate the project’s operating cash flows for each year of the project’s economic life. (Hint: Use Table 2 as a guide)
1.1. Review principles of estimating project cash flows. Suggested reading: Ch. 9 “Capital Budgeting and Cash Flow Analysis” in “Contemporary Financial Management”, 11th ed. by Moyer, McGuigan, and Kretlow.
Capital planning and budgeting is a very vital piece in the Public Budgeting System process. It is an essential implement in the financial management practice and is effective in both public and private organizations. It is the method which consists of the determination and the evaluation of the investments and the possible expenses by an organization. As explicate by Lee, Johnson, & Joyce (2008), capital budgets help in determining how much of each form of investment is needed, and it supports an organization in assessing the available revenue which includes loans is required to finance those investments (p. 475). Capital budgeting is a central part of the universal
5- The approach used to calculate the value of the Joint Venture was a DCF using the APV method. Since the two companies, Jersey and Prince, have distinct characteristics and costs of capital, they value the project differently. For Prince, the Joint Venture has a total
This case study analyzed five different projects Target Corporation had to decide on capital spent for which project created the most value and the most growth for the company and its shareholders. By analyzing the financial statements and exhibits of each project, I was able to determine the positives and negatives of each of these alternatives. The alternatives were Gopher Place, Whalen Court, The Barn, Goldie’s Square, or Stadium Remodel.
The first project proposal is Match My Doll Clothing line expansion consisted of expanding matching doll and child’s clothing and accessories. The second project proposal is Design Your Own Doll by creating customizable “one of a kind” doll features through the company’s website. The project selection criteria would base on quantitative and qualitative analysis. The quantitative analysis would base on the evaluation of discounting cash flow forecasts to determining the Net Present Value (NPV), Internal Rate of Return (IRR), and the Payback period of each proposed project. The qualitative analysis would include the potential project value of the company’s overall strategy, innovation, key project risks, and the project interdependencies to the whole company.
Capital budgeting is the most important management tool that enables managers of the organization to select the investment option that yields comprehensive cash flows and rate of return. For managers availability of capital whether in form of debt or equity is very limited and thus it become imperative for them to invest their limited and most important resource in perfect option that could prove to beneficial for the organization in the long run (Hickman et al, 2013). However, while using capital budgeting tool managers must understand its quantitative and qualitative considerations that are discussed below.
Cost Analysis: Finance will develop an investment plan spread over the projected timeline and secure capital investment to fund the plan.
The foremost consideration for any firm and organization is to consider a resource’s budget, and here too it should be kept in mind that the project is within the available budget which will be £3000 to create the software.