MBA FPX 5014 Assessment 2

Executive Report

This capital project analysis provides a review of three potential projects to determine which one Drill Tech, Inc., should pursue. Capital budgeting methods were employed to examine a large equipment purchase, an expansion into Europe, and a campaign of marketing and advertising. After comparing the incremental cash flow changes, the net present values (NPV) of the three projects were calculated: the NPV of the purchase of major equipment was 28.77, the NPV of the European expansion project was 17.1, and the NPV of the marketing/advertising campaign was 32.4. From these, it is evident that the most profitable capital project in the long term is the marketing/advertising campaign.

Evaluation of Capital Projects: Drill Tech, 

Drill Tech, Inc. is a mid-sized Minnesota manufacturing company (Saunders, 2000). For the upcoming fiscal year, the company has placed three capital projects up for approval. A capital project is a long-term endeavor designed to improve, build, maintain, or produce a company’s capital assets (Marshall, McManus, & Viele, 2017). Such projects can have significant investments that are repeated again and again for the project’s duration (Brigham & Houston, 2012). Therefore, it is crucial that Drill Tech, Inc., selects that project that will generate maximum shareholder value upon completion. Shareholder value refers to the inherent value obtained by a shareholder as a result of holding an ownership interest in a company. In publicly traded companies, shareholder value is part of the equity, as well as long-term debt, to consider the capitalization of the company (Saunders, 2000).

A firm’s shareholder value grows with an increase in its earnings, which makes it more valuable (Gibson & Dunn, 1989).

Choosing the project most likely to maximize shareholder value is the most critical factor in determining what project Drill Tech, Inc. should pursue.

Capital Projects Backgrounds Project A: Major Equipment Purchase 

The first likely project involves purchasing major equipment, such as heavy machines, to boost the production process. The first time investment amounts to $10 million, and the project reduces the cost of sales by 5% annually over eight years.

After eight years, the equipment will have a salvage value of $500,000.

This is a low-risk project, and the rate of return needed is 8%. The equipment will be depreciated using a MACRS 7-year schedule (Brigham & Houston, 2012). The marginal corporate tax rate applicable for this project is 25%.

Project B: Expansion into Europe

The second option is to expand in Western Europe, with estimated growth in sales of 10% annually over five years and a 10% growth in the cost of sales. The initial investment is $7 million, with an initial net working capital (NWC) of $1 million, which is expected to be recovered after five years. The project has higher risk, with a 12% mandated rate of return and a 30% marginal corporate tax, as the European tax rates are higher.

Project C: Marketing/Advertising Campaign 

The final suggested project is a marketing/advertising campaign with zero initial investment but $2 million annually for six years, totaling $12 million. The campaign will increase sales and the cost of sales 15% each year over the six-year project duration. The project is relatively risky, with a 10% required rate of return and a 25% marginal corporate tax rate.

Capital Budgeting Methods 

Capital budgeting methods are used to analyze long-term, high-cost projects, which usually last several years or decades and involve high financial risks (Saunders, 2000). Capital budgeting methods assist in considering projects by reducing risks, aiding in decision-making, and avoiding under- or overinvestment (Saunders, 2000). Some of the most commonly used capital budgeting methods include the payback period, internal rate of return (IRR), and profitability index (PI).

Payback Period 

The payback period calculates the duration of repayment for the initial investment (Phillips et al., 2012). Project A will take two years, Project B will take three years, and there is no initial investment for Project C, so no payback period can be determined.

Internal Rate of Return (IRR) 

IRR calculates the percentage at which an investment’s net present value will become zero (Phillips et al., 2012). The IRR for Project A is 0.70, Project B’s IRR is 0.81, and there is no IRR for Project C, as there is no initial outlay.

Profitability Index (PI) 

PI is a budgeting technique used to calculate the value generated per investment unit (Brigham & Houston, 2012). PI for Projects A and B can be determined, but there is no initial investment for Project C, and hence it cannot be evaluated similarly.

Net Present Value (NPV)

NPV is commonly utilized to assess capital projects by measuring the present value of projected cash flows against the initial investment (Brigham & Houston, 2012). In the analysis, Project A’s NPV is 28.77, Project B’s NPV is 17.1, and Project C’s NPV is 32.4, and thus the marketing/advertising campaign is the most lucrative.

Conclusion

By evaluating the potential projects using capital budgeting techniques, it is evident that Project C, the advertising/marketing campaign, holds the greatest promise to enhance shareholder value, given its higher NPV. Hence, Drill Tech, Inc. must undertake Project C.

 MBA FPX 5014 Assessment 2 Evaluation of Capital Projects 

Marshall, D., McManus, W., & Viele, D. (2017). Accounting: What the numbers mean (11th ed.). New York, NY: McGraw-Hill Education. https://www.investopedia.com/terms/t/trendanalysis.asp.

Phillips, F., Libby, R., Libby, P. A., & Mackintosh, B. (2011). Fundamentals of Financial Accounting. New York, NY: McGraw-Hill Irwin. https://www.investopedia.com/terms/b/bvps.asp.