Capella University
March 2nd, 2024
Evaluation of Capital Projects Report
Abstract
This comprehensive analysis explores the strategic capital investment decisions facing ABC Healthcare Corporation regarding these three capital projects: Project A (Major Equipment Purchase), Project B (Expansion into Europe), and Project C (Marketing/Advertising Campaign). Utilizing capital budgeting techniques such as NPV, IRR, Payback Period, and Profitability Index, the financial viability and potential shareholder value of each project are evaluated. The analysis reveals that while each project offers unique advantages, Project A demonstrates the highest NPV and IP, and Project B showcases highest IRR. However, Project C emerges as the optimal choice for maximizing shareholder wealth due to its competitive financial performance, steady cash flows, and strong potential for long-term profitability and stock price impact. A recommendation is made for a balanced portfolio approach, combining the strengths of all three projects to mitigate risks and enhance overall financial performance. The importance of considering potential constraints such as mutual exclusivity is emphasized to ensure informed decision-making. Ultimately, selecting Project C for the marketing and advertising campaign is recommended, as it promises to increase shareholder wealth and contribute positively to the company’s long-term success.
Introduction
Strategic capital investments play a crucial role in corporate decision-making, influencing
the ABC Healthcare Corporation must conduct a thorough analysis of three capital projects:
Project A, the company’s expansion into Europe; Project B, the purchase of key equipment; and
Project C, the marketing and advertising campaign. Assigned this duty, the top-performing
manager of financial analysis performs an extensive analysis using capital budgeting instruments
including PI, IRR, Payback Period, and NPV (Brealey et al., 2017). This paper explores the
details of each project, with a focus on Project C’s increased brand visibility, Project B’s
accelerated returns, and Project A’s cost reductions (Gitman & Zutter, 2015). The insights are
intended to support strategic decision-making for ABC Healthcare Corporation as it navigates
the ever-changing financial landscape. They include recommendations for minimizing risk,
maximizing shareholder value, stable growth, and optimal potential capital allocation (Pike &
Neale, 2003). The goal is to provide the business with a roadmap so that it can make educated
and strategic decisions in the pursuit of long-term success (Block & Hirt, 2005).
Capital Projects Backgrounds
Project A: Major Equipment Purchase
The first project alternative (A) calls for the purchase of sizable machinery, which would
be beneficial for the production procedures. Ten million dollars is the initial cost of this
equipment. Nonetheless, it is anticipated to pay off by lowering the cost of sales by 5% every
year for eight years. The equipment is expected to have a $500,000 salvage value after the eight
years. This project needs a minimal rate of return of 8% because it is deemed low risk. The
equipment will be written down using a seven-year MACRS schedule, which divides fixed assets
into groups based on pre-established Internal Revenue Service depreciation calculations. The
company expects to generate $20 million in revenue in its first year, with constant yearly sales
over the next eight years. Prior to starting this project, the cost of sales was 60%, and the
predicted 5% reduction would bring it down to 55% per year. The projected marginal
corporation tax rate for this project is 25%, which is the percentage of tax levied on a company’s
income based on its tax bracket. This rate is set by the federal government and stays constant.
When undertaking financial planning, the marginal tax rate must be considered in order to
establish the net amount of money retained after taxes (Knoll, 2000).
Project B: Expansion into Three Additional States
The second project option (B) entails the company expanding into three more states. This
capital project is expected to boost revenues by 10% each year for the next five years. During the
same period, the cost of sales is predicted to climb by 10% annually. The prior year’s annual
revenues totaled $20 million USD. To begin the project, the company will need a $7 million
investment and an initial net working capital of $1 million. After deducting any outstanding
liabilities, a company’s current liquid assets are calculated as net working capital, or working
capital (Hill et al., 2010). In other words, during the first year of expansion, the company cannot
have more liabilities than assets, and net working capital must be at least $1 million. But by year
five, it’s expected that the working capital would be paid back. The marginal corporate tax rate
for this project is set at 25%, same as the big equipment acquisition project, due to the higher tax
rates in the three extra states. The project’s rate of return is set at 12% due to the higher risk
associated with this investment.
Project C: Marketing/Advertising Campaign
The last capital project (C) suggests setting aside money for a marketing/advertising
initiative. This project doesn’t need a $2 million USD start-up cost; however, over the course of
its six-year duration, it will cost $2 million USD year in marketing costs. According to the
project’s estimated results, throughout the course of the project’s six years, the marketing
campaign will raise sales by 15% annually and boost sales/revenues and cost of sales by a similar
15%. The company’s prior yearly sales were $20 million USD, and Project A’s anticipated
marginal corporate tax rate of 25% is accurate. Project C is deemed to have a moderate amount
of risk, with a 10% necessary rate of return.
Capital Budgeting Methods
There are hazards associated with every sizable and long-term financial investment.
Major expenditures typically take years or even decades to complete, creating significant
financial uncertainty. In order to determine which project has the highest potential to increase
shareholder value, capital budgeting methods must be utilized for understanding and strategic
planning. Techniques for capital planning reduce cost risks, enable decisions that cannot be
reversed, and guard against making unnecessary or excessive investments (Schall & Sundem,
1980).One can employ a variety of capital budgeting techniques.
Pay Back Period
A financial term called the payback period is used to assess how long it will take an
investment to produce enough cash flows to cover its initial cost. The focus of this strategy is the
project’s potential for revenue generation (Boardman et al., 1982). But it ignores the money’s
temporal worth (Lefley, 1996).
