MBA-FPX5014_VitosGarciaJavierAndres_Assessment2_1

docx

School

EDP University of Puerto Rico *

*We aren’t endorsed by this school

Course

BA 2321

Subject

Business

Date

Feb 20, 2024

Type

docx

Pages

Uploaded by javiervitos88

1 Evaluation of Capital Projects (Javier A Vitos Garcia) Capella University Keith Wade Dec 11, 2023 MBA-FPX5014

Evaluation of Capital Projects 2 Introduction ABC Healthcare is committed to managing and overseeing a range of healthcare facilities, including hospitals, medical clinics, and outpatient centers. In its ongoing efforts to enhance shareholder value and bolster financial performance, the company has undertaken the development of three potential capital projects. These projects represent strategic initiatives aimed at advancing the organization's mission and contributing to its overall growth. In the subsequent analysis, this report will extensively explore the utilization of cash flow forecasting and budgeting tools. By employing these tools, the objective is to discern the most lucrative project that aligns with the company's goals, ensuring a judicious investment that fosters sustained business expansion and profitability. Capital Budgeting Tools Capital budgeting serves a critical role in fostering accountability and measurability within businesses. For enterprises contemplating resource allocation to various projects, a comprehensive understanding of associated risks and returns is imperative to avoid being perceived as irresponsible by stakeholders (Pinkasovitch, 2022). Financial analysis employs metrics such as the internal rate of return (IRR) to assess the potential profitability of investments (Fernando, 2022). The IRR provides a percentage indicating the profit or loss for the unwithdrawn amounts from a project, complementing the Net Present Value (NPV), which measures the net benefits derived from the project. The Net Present Value rule, advocated by Tuovila (2021), suggests that managers and investors should only undertake projects with a positive NPV. The NPV, calculated by comparing money inflows to outflows adjusted for an interest rate, is crucial in evaluating the feasibility and

Evaluation of Capital Projects 3 desirability of an investment. This approach aids in making informed decisions about the financial viability of a project. In addition to NPV and IRR, the profitability index (PI), also referred to as the profit investment ratio (PIR) or value investment ratio (VIR), offers another valuable tool for capital budgeting (Carlson, 2020). The PI assesses the potential profitability of an investment by considering the ratio of updated collections to payments. Investments with a PI greater than one are deemed effective, signaling positive returns. When faced with multiple investment options, prioritizing those with a higher rate of return becomes a prudent strategy in the decision-making process. Therefore, the integration of NPV, IRR, and PI provides a comprehensive framework for evaluating and selecting projects that align with business objectives and contribute to long-term success. Project A: Major Equipment Purchase In the case of Project A, ABC Company plans to allocate an initial investment of $10,000,000 for acquiring essential equipment. While this may appear as a substantial upfront cost, it is expected to yield significant long-term benefits. The investment is projected to result in a 5% annual reduction in the cost of sales over an 8-year period. This cost reduction is particularly impactful due to the Modified Accelerated Cost Recovery System (MACRS), which enables the company to benefit from tax advantages through depreciation. The anticipated annual sales for the initial eight years of this project are estimated at $20,000,000. Comparatively, prior to the project's implementation, the cost of sales stood at 60%, and following its execution, it is expected to decrease to 20% after 8 years. This substantial reduction represents a noteworthy 40% savings compared to the previous cost structure.

Your preview ends here

Eager to read complete document? Join bartleby learn and gain access to the full version

Access to all documents
Unlimited textbook solutions
24/7 expert homework help

Evaluation of Capital Projects 4 In the dynamic landscape of the industry, achieving business objectives necessitates ongoing process improvement and expanding the service portfolio. Consequently, substantial investments in machinery become essential. Allocating economic resources toward acquiring machinery not only enhances productivity but also catalyzes the overall development of business activities. This strategic investment in equipment underscores the company's commitment to operational excellence and positions it for sustained success in the industry. Initial Investment IRR NPV PI Payback Period $10,000,000 79,79% $44,262,269 5.43 1.36 Project B: Expansion into Three Additional States The implementation of this project marks a significant stride for ABC Healthcare as it endeavors to extend its footprint into three new states beyond its current operational reach. The strategic expansion initiative is poised to generate a noteworthy 10% increase in sales within the initial five years. The comprehensive investment for this venture amounts to $8,000,000, encompassing both project costs and an initial working capital injection of $1,000,000. It is anticipated that the capital invested will be recouped by the culmination of the fifth year. Beyond the immediate financial considerations, a successful expansion holds the potential to enhance ABC Healthcare's standing, facilitating easier access to crucial financing. Securing financing is pivotal during the expansion phase, as it can either act as a catalyst for growth or pose a significant setback if mismanaged. Companies boasting a robust financial

Evaluation of Capital Projects 5 position and a sizable presence in the stock market typically find it easier to attract favorable financing terms and catch the attention of reputable investors. However, it is imperative for the company to recognize that expansion, while offering promising opportunities, also brings forth challenges, particularly financial ones. For businesses unprepared for the complexities associated with growth, expansion can lead to severe financial repercussions. Therefore, the success of the expansion should not solely be measured by sales growth but also by its impact on profitability. The overarching goal of business growth is to enhance profitability, making it essential for the company to navigate the expansion process with a focus on sustained financial success. Furthermore, any expansion should be driven by a clear and compelling rationale, such as entering lucrative new market segments. A well-defined purpose for expansion ensures that the company is strategically positioned to capitalize on potential profitability in the chosen markets, aligning the growth strategy with long-term business objectives. Initial Investment IRR NPV PI Payback Period $7,000,000 WC 1,000,000 91,48% $22,259,712 3.78 1.14 Project 3: Marketing/Advertising Campaign With an annual budget of $2 million spanning six years, Project C is poised to significantly impact the company's sales, profits, and overall value. The project anticipates annual increments of 15%, culminating in a substantial $20 million surge in the final year. Factoring in a corporate tax rate of 25%, Project C is classified as a moderate-risk venture, with a Required Rate of Return (RRR) set at 10%.

Evaluation of Capital Projects 6 The strategic allocation for advertising investment is a crucial consideration, ranging from 2% to 30% of the company's total sales. Optimal marketing investment, commencing at approximately 6%, is contingent on the projected net return. The flexibility in the advertising budget underscores the need for adaptability, allowing the company to calibrate its marketing expenditures based on expected returns and market dynamics. Furthermore, Project C's impact on the company's overall performance extends beyond financial metrics. As it unfolds over the six-year duration, the project has the potential to enhance the company's market position, brand recognition, and customer engagement. The iterative nature of the project budgeting enables the company to strategically align its financial resources with evolving market conditions, ensuring that the investment in advertising and marketing yields the desired returns. In essence, the success of Project C hinges on a comprehensive understanding of financial dynamics, risk management, and strategic marketing decisions. As the project unfolds, periodic assessments and adjustments to the budget and marketing investments will be essential to maximize returns, navigate potential risks, and ensure sustained growth and profitability. Initial Investment Complete Investment IRR NPV PI Payback Period $2,000,000 $12,000,000 90,36% $33,470,904 4.84 1.23 Initial Investment Complete Investment IRR NPV PI Payback Period $10,000,000 $10,000,00 0 79.79% $44,262,269 5.43 1.46 $8,000,000 $8,000,000 91,48% $22,259,712 3.78 1.14 $2,000,000 $12,000,00 0 90,36% $33,470,904 4.84 1.23

Your preview ends here

Eager to read complete document? Join bartleby learn and gain access to the full version

Access to all documents
Unlimited textbook solutions
24/7 expert homework help

Evaluation of Capital Projects 7 Recommendation Upon a comprehensive examination of all presented projects, it is evident that each one carries a positive impact on ABC HealthCare, with none posing a significant risk of financial loss. While all three projects promise positive outcomes, the objective is to implement the most effective one, providing shareholders with a promising glimpse into the company's future and the potential for substantial returns on their investments. In the industrial sector, strategic investment in machinery is indispensable, given the demand for mechanization and automation in service offerings. The acquisition of machinery plays a pivotal role in influencing a company's agility and capacity to capitalize on opportunities or effectively address challenges within the dynamic market landscape. Given these considerations, I recommend the implementation of Project A for ABC HealthCare. This choice is substantiated by the Profitability Index (PI), which stands out as the highest among the projects at 5.43 when total investments are compared. Although Project A's Internal Rate of Return (IRR) is the lowest among the three projects, it remains acceptable. Notably, while Project A may not boast the highest sales figures, its cost of sales experiences a consistent 5% annual decline, resulting in significant cost savings for the company. This, in turn, contributes to enhanced profitability and overall financial gains over the course of the project's implementation. The holistic evaluation of Project A indicates that it aligns with the company's objectives, demonstrating a balanced approach between sales growth and cost efficiency.

Evaluation of Capital Projects 8 References Carlson, Rosemary. (2020). How to use the Profitability Index. Retrieved from: https://www.thebalancesmb.com /the-profitability-index-392917. Fernando, Jason. (2022). Internal Rate of Return (IRR)? Retrieved from: https://www. Investopedia.com/terms/i/irr.asp. Pinkasovitch, Arthur. (2022). An Introduction to Capital Budgeting. Retrieved from: https://www.investopedia.com/articles/financial-theory/11/corporate-project-valuation- methods.asp#:~:text=Capital%20budgeting%20is%20important%20because,by%20its %20owners%20or%20shareholders. Tuovila, Alicia. (2021). Net Present Value Rule. Retrieved from: https://www.investopedia.com /terms/n/npv-rule.asp.

MBA-FPX5014_VitosGarciaJavierAndres_Assessment2_1

Related Documents