Posted: September 12th, 2024

Strayer-FIN534 fin534-Capital Budgeting and Risk Analysis

FIN
534 DQ Week#6
"Capital
Budgeting and Risk Analysis" Please respond to the following:

*
From the e-Activity (Use the Internet to research
two (2) mutually exclusive investment projects to compare. The projects
may involve any kind of investment, as long as the time frame for one (1)
of the investments is a maximum of one (1) year (short term) and the time
frame for the other investment is five (5) years minimum (long term). Be
prepared to discuss. ), analyze the reasons why the short-term
project that you have chosen might be ranked higher under the NPV
criterion if the cost of capital is high, while the long-term project
might be deemed better if the cost of capital is low. Determine whether
or not changes in the cost of capital could ever cause a change in the
internal rate of return (IRR) ranking of two (2).
*
From the scenario (The Week 6 Scenario covers the
following topics: How to use the different capital budgeting
methods; and Identifying relevant cash flows. Script also list below this
bullet in full), take a position for or against TFC’s decision
to expand to the West Coast. Provide a rationale for your response in
which you cite at least two (2) capital budgeting techniques (e.g., NPV,
IRR, Payback Period, etc.) that you used to arrive at your decision.

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Scenario Script, from bullet #2 above:

FIN534 Week 6
Scenario Script: How to use the Different Capital Budgeting Methods, and
Identifying Relevant Cash Flows

Slide
#

Scene/Interaction

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Narration

Slide 1

Intro Slide

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Slide 2

Scene 2
•
In Don’s office
•
Maybe Fitness Olympic banner
•
Situation room
•
End of scene

Don: Hi Linda,
how was your workout? I knew I would
see you exercising before work.

Linda:That is right
Don. Our annual Fitness Olympics challenge is coming up and
I want to be in shape for it.

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Don: I forgot about the company Fitness Olympics.

Linda: Well, I did not forget. Last year our department just missed out on
the top honors. This year we are
planning on being the winning department. I may even try to recruit our
intern!

Don: Great attitude, Linda.

Don: Before the Fitness Olympics, we still have
a lot of work to do concerning this expansion project and whether or not we
should go with it. Things are starting
to move quickly. Recently, I heard
from Joe and he wants us to do some capital
budgeting analyses on the project.
This analysis may be our make or break analysis for the project so we
really need to be detailed.

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Linda: Okay
Don. The intern and I are right on
it. I plan on meeting the intern in
the “Situation Room”. We dubbed the
conference room that name as we are constantly making informed decisions.

Slide 3

Scene 3
•
Linda in conference room
•

•
Go to next slide

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Linda: We have our hands full. The project is getting close to decision
making time. Joe and Don want us to
analyze the proposed expansion project from a capital budgeting standpoint. Currently, we have completed many
internal analyses on TFC. Now, we must
look at the viability of the expansion project. Capital budgeting does just that. At the end of it, we should have a better
idea of what our recommendation would be.

Linda: Capital
budgeting can be done whenever there is an initiative to invest in assets for
the long term. Our project is doing
just that. We want to be confident in
our decision as this project is for the long term and is costly. Don is going to be joining us with the
expected cost of the project.

Slide 4

Scene 4
•
Don in conference room with
papers in hand?
•
Show on the papers - seven
hundred fifty million dollars
•
Go to next slide

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Don: Hello all.
With this expansion project we will double in asset size. But it comes with a price. The Accounting Department told us that the
projected price to expand out West is seven
hundred fifty million dollars. I also have the projected cash flow numbers.
Now, I need the both of you to determine if we should proceed with the
expansion. To do so you will need to
use many capital budgeting techniques
to arrive at a highly confident decision.
Good luck! The faith of this expansion and the future
success of TFC depend on your analysis.

Linda: Don, the Intern and I will begin working on
this now!

Slide 5

Scene 5
•
Linda In conference room (Don not
in room)
•
Net Present Value
•
WACC =10.92%
•
Go to next slide

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Linda: We have our assignment so let’s starting
working through this analysis. There
are many capital budgeting techniques and the plan is to use some of them for
our project as Don said. But, it
ultimately comes down to money. If the
project is expected to bring in more cash than its costs, the project is a
go, within reason, that is.

As we have been saying all along, cash
is the driving force behind our decision-making. To analyze our cash flows ,we need to look
at the net present value of our future
cash inflows and outflows including the cost of the project. Since these cash flows are being expected
over time, we need to discount them back to today so we are valuing
everything at the same point in time.
Since we do not know the actual cost for undertaking the project, we will
use our WACC, which is ten and
ninety-two hundredths percent, as our discount rate. We also need our anticipated cash flows in
the future years. This can be
difficult to project, but it is extremely important that these numbers are as
realistic as possible.

From what I was told, the Accounting Department expects cash flows
for this project only to be negative ten million in projected year one as the
company will still be opening up fitness centers at a high rate. In year two, the cash flow is projected to
be two hundred million, then two hundred fifty million, three hundred
million, and four hundred million, respectively, for years two through five.
A five-year projection will enable us to see where we will be in the
immediate future. Anything after five
years may be difficult to estimate as things change over time..

Linda:Now that we
know all the inputs to our calculation, we can determine if this expansion
project will have a positive net present value.

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While I gather data for our second cash budgeting technique, can you
run the numbers to see what the outcome is?

Slide 6

Scene 6
•
CYU
Linda would
like you to determine the Net Present Value of the expansion project. Using a 10.92% discount rate and the cash
flows as follows:

Cash Flow Year
0 = $-750,000,000
Cash Flow Year
1 = $ - 10,000,000
Cash Flow Year
2 = $+200,000,000
Cash Flow Year
3 = $+250,000,000
Cash Flow Year
4 = $+300,000,000
Cash Flow Year
5 = $+400,000,000

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Using present
value calculations for an uneven stream of cash flows what will the Net
Present Value of the project be?
(Round to whole dollars)

Answer:
$23,164,711 (can you put a variance in there of $20?)

If right –
Great job. This project will generate
cash for TFC

If
wrong – Nice try. Remember to discount
each cash flow back at 10.92% and then sum all the amounts including the
-$750,000,000

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Slide 7

Scene 7
•
Net Present Value
•
Go to next slide

Linda: Nice work! From the calculations, the net
present value of the project is expected to be over twenty-three million dollars. Now, that is some great news. But,
we have to be careful here. We are
assuming our discount rate to be ten
and ninety-two hundredths, which is in line with our required rate of
return under the WACC. If this rate
changes, it can affect the project’s value.

Linda: Having a positive expected net present
value indicates that we should proceed with the project. The capital
budgeting technique is the best choice to use as it tells us the expected cash value of the project. If the numbers that came back were
negative, we would suggest that we should not proceed with the project. As
you can see, it all depends on cash.

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Linda: Even though
the Net Present Value measure is
the best one to use, it is good practice if we look at a few of the other ones.

Slide 8

Scene 8
•
Conference Room
•
Show calculation from excel
•
IRR =11.84%
•
Next slide

Linda: Another measure is the Internal Rate of Return, or the IRR for short. It is the discount
rate that makes all the future cash flows equal to the beginning cash
outlay. Basically, it measures the
expected rate of return on the project.
If the IRR is greater than the project’s cost of capital, the
shareholders will benefit by the project.

The calculation can be quite involving if done by hand. Luckily at TFC, we have a financial
calculator that handles the calculation and leaves the decision making up to
us. Our calculator is showing eleven and eighty-four hundredths percent as
the IRR. This is above our cost of
capital of ten and ninety-two
hundredths percent which shows a return higher than cost.

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So far everything is pointing toward proceeding with the project.

Slide 9

Scene 9 –
·
Linda in room
·
Cost of debt

Linda: The third
measure, called the Modified Internal
Rate of Return or MIRR is similar to the IRR but it looks at cash inflows and outflows separately and then together. What I mean by that is, in order to do the
calculations:

First, take all negative cash flows and discount them back to
today.

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Then, take all positive cash flows and compound them at our WACC to
our last projected year, which is year five.

At that point we have a present value amount and a future value
amount.

The MIRR is the rate that links the two cash flows, the present value
and future value.

Keep in mind, the present value cash flows are all the negative cash
flows discounted, including today,
while the future cash flows are all the positive cash flows compounded to the
future, which is year five for TFC.

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Linda: Let’s now calculate the MIRR.

Slide 10

Scene 10
•
CYU
Linda would
like you to determine the MIRR of the expansion project. Using a 10.92% as the discount and
compounded rates to rate and the cash
flows as follows:

Cash Flow Year
0 = $-750,000,000
Cash Flow Year
1 = $ - 10,000,000
Cash Flow Year
2 = $+200,000,000
Cash Flow Year
3 = $+250,000,000
Cash Flow Year
4 = $+300,000,000
Cash Flow Year
5 = $+400,000,000

Answer: 11.56%

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•
(If they get it wrong. ) Nice try
but remember to compound the positive cash flows in Years 2,3,4,5 and
discount the negative cash flow in year 1.
Add that amount to the beginning cash outlay. Then find the rate over 5 years
Correct, Theformula is to discount
negative cash flow in year 1 to year zero and add it to that amount to get
$759,015,506.67. Year 5 total cash
flows would be $1,313,276,378.14.
Discounting that back at 5 years would give 11.56%

Slide 11

Scene 11
•
Set up the cash flows on a clip
board
Cash Flow Year
0 = $-750,000,000
Cash Flow Year
1 = $ - 10,000,000
Cash Flow Year
2 = $+200,000,000
Cash Flow Year
3 = $+250,000,000
Cash Flow Year
4 = $+300,000,000
Cash Flow Year
5 = $+400,000,000

·
Show $10,000,000/$400,000,000 =.025 of a year for
a total of 4.025 years

•
Next Slide

Linda:Great
job! Another measure is the Payback Period. We like to say that
this is our most straightforward measure but we need to be careful with it as
it does not assume any rates.

We use this measure when we think our cash balance for the project
will be positive.

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To do this, we look at the initial cash outlay of seven hundred fifty million dollars. We also anticipate another cash outlay of
ten million in the first year. In year
two is when we plan on generating some positive cash flows of two hundred million dollars.

If we just look at it from a net cash perspective after year two we
would have negative five hundred sixty
million. The cash outlays from the
beginning of the project and year one would put us in a deficit of seven hundred sixty million.

By adding the two hundred
million in year two our deficit would be five hundred sixty million. With that same approach, after year
three we would still be at a three
hundred ten million dollar deficit.

After year four we are almost there at a deficit of ten million dollars. In year five, we anticipate the deficit to
go away with the first ten million
of the anticipated four hundred million
in positive cash flows.

When you take that ratio of what is needed to break even or ten million dollars over the expected
cash flow in year five of four hundred
million, the result is point zero
two five of a year.

When we put it all together, we can expect to be in the positive for
the project in four point zero two five years.

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So, the project will pay for itself in just over four years.

Linda:This payback
period measure has some drawbacks especially in the area of discounting. We are not factoring in time but for a
quick measurement it is a good one to use.
Also, this measure is not our deciding factor. As you know by now, our deciding factor is
the net present value calculation.

Slide 12

Scene 12
• Don in room
• Show results
on screen
• Thumbs up!

Don: I left you with the most critical piece of
the project. What were you able to
find out?

Linda: Don, I think you will be pleased by our
analysis. We did a number of capital
budgeting measures and the results are as follows:

Net Present Value is positive twenty
three million, one hundred sixty-four thousand, seven hundred eleven dollars.

Internal Rate of Return is eleven
and eighty-four hundredths percent, which is greater than our discount
rate.

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Modified Internal Rate of Return is eleven and fifty six hundredths percent.

And the Payback Period is four
point zero two five years.

Don: Wow. Great job. I can’t wait to
share the results with Joe. But,
before I do. Are you giving us thumbs
up on the project?

Linda: Of course
from a financial standpoint we would always like to do some more analyses,
but based on our numbers to date, Yes!
A double thumbs up!

Slide 13

Scene 13

•
Linda talking about cash flows
•
Put words “Relevant Cash Flows”
on board
•
Don enters

Linda: Great job
with the capital budgeting analysis.
While we do four different measures here at TFC, there are others,
such as the Profitability Index
and using the discount rate on the payback period measurement. But in our decision making, it all comes
down to cash flow and the net
present value tells us the cash outlook for the project.

Linda: So I’ve been mentioning cash a
lot...... When we started on the cash
budgeting, we were given projected amounts from the Accounting Department. I’ve even mentioned that there was much
debate on the cash flows. Keep in mind
these are projected cash flows, so a lot of analysis and decision making goes
into it. Probably the most critical
part of our expansion project is projecting the cash flows from it. Our Accounting Department spent countless
hours discussing what should be included in the analysis and what is not
relevant.

Don: That is right
Linda. I spent some time in the
Accounting Department when this analysis was being done and some of the
points that were being considered included the following.

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First, there is a distinction
between free cash flows and
accounting income. Typically
accounting income is on an accrual basis which is different from actual cash
flow. Remember for this project we are
only concerned with the cash flows related to this project and not other
areas of TFC.

Second, depreciation needs
to be added back into the project. It
is a not cash item that needs to be added back when estimating cash
flows. In fact all non cash charges
related to the project should be added back for cash flow purposes.

Third, we do not deduct any
interest charges related to the project as this was already considered
when we determined the WACC, which is the rate we use to discount all the cash
flows.

Fourth, change in net operating working capital is a factor. Any activity related to this expansion
project, whether assets or liabilities, need to be considered. This is one of the areas that really need
to be looked at closely.

Another area involves sunk
costs, which are cash outlays that occurred prior to moving forward with
the project and should be ignored. The
Accounting Department determined that all of the research on the different
locations to expand into are sunk costs and are not included in the net cash
flow.

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Slide 14

Scene 14
•
Don and Linda in room

Next
Slide

Don: These are just a few of the areas that need
to be considered. For the most part,
if it is a cash transaction and it is part of the project, then it should be
included in determining cash flows.

Linda: That is true. And at TFC we have many computer tools and
spreadsheets that we use to aid us in making these cash flow decisions. That is why we were confident in our
analysis.

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Don: And I passed that on to Joe. Working together as a team really helps in
decision making.

I can’t wait to see this project move forward. But like any hard day
at work, it is always good to finish it with a workout. Before we head to the gym, let’s briefly go
over what we accomplished today.

Slide 15

Scene 15
•
Summary Slide –

I received some comments from my teacher. Can you help me with them?

Absolutely! If your teacher’s got feedback, you can request a free revision within 7 days of approving your paper—just hit the revision request button on your personal order page. Want a different writer to take a crack at it? You can ask for that too, though we might need an extra 12 hours to line someone up. After that 7-day window, free revisions wrap up, but you can still go for a paid minor or major revision (details are on your order page). What if I’m not satisfied with my order? If your paper needs some tweaks, you’ve got that free 7-day revision window after approval—just use the “Revision” button on your page. Once those 7 days are up, paid revision options kick in, and the cost depends on how much needs fixing. Chat with our support team to figure out the best way forward. If you feel the writer missed the mark on your instructions and the quality’s off, let us know—we’ll dig in and sort it out. If revisions don’t cut it, you can ask for a refund. Our dispute team will look into it and figure out what we can offer. Check out our money-back guarantee page for the full scoop.

Linda: Another great job by the team at TFC. We covered many capital budgeting
techniques when looking at a project’s cash flows including the Net Present
Value, Internal Rate of Return, Modified Internal Rate of Return, and Payback
Period. While all are important, the Net present Value should be used at
the final deciding factor.

We also looked at identifying relevant cash flows. They should be those activities that are
related to the project now. There are
many software packages that can help in the decision making.

Don: Linda, you and the intern are doing fabulous work. You two made the determination to proceed
with the project but your work is not done.
Enjoy your workout as I have another project when you are finished.

Slide 16

Scene 16
•
Closing slide

Closing slide

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