Use capital budgeting tools to compute future project cash flows and compare them to upfront costs.

Introduction

This portfolio work project is about one of the basic functions of the finance manager: allocating capital to areas that will increase shareholder value. There are many uses of cash managers can select from, but it is essential that the selected projects are ones that add the most value to the company. This means forecasting the projected cash flows of the projects and employing capital budgeting metrics to determine which project, given the forecast cash flows, gives the firm the best chance to maximize shareholder value. As a business professional, you are expected to:

•Use capital budgeting tools to compute future project cash flows and compare them to upfront costs.

•Evaluate capital projects and make appropriate decision recommendations.

•Prepare reports and present the evaluation in a way that finance and non-finance stakeholders can understand. 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%.