Your company Portfolio Manager is convening a review board in the first calendar quarter to consider three projects. You have been asked to provide recommendations with respect to the capital budgeting aspects of these projects. Your recommendations will be considered by the review board along with other non-financial aspects of the projects. Initial (year 0) funding will be provided in the current year for the single project selected.
Project sponsors have provided the following estimated cash flow projections:
The company has not yet decided how the selected project will be financed. The cost of capital or hurdle rate will vary depending upon how the company decides to finance the project. You decide to compare projects in three areas: (1) payback period (not considering the cost of capital); NPV sensitivity (see note 1 below); and (3) Internal Rate of Return (IRR). Conduct each analysis and interpret the results.
Based on your analysis, which project would you recommend and why? Your recommendation must be based on the combination of all three factors.
Show all calculations supporting your recommendation. Calculate NPV to the nearest dollar, IRR to three decimal places, and payback period to one decimal place.
Note 1: Project NPV varies inversely with the cost of funds to perform the project (expressed as the hurdle rate or k in the NPV discount factor formula). Some project NPVs are more sensitive to changes in k than others. See the NPV Profile discussion in Gallagher, Chapter 10, pages 278-279 (Reserved Readings) for information on determining NPV sensitivity.
The below responses only need to be a paragraph, please use PMBOK and the book mentioned above.
Topic 8a: Debt or Equity Finance, or a Combination?
Actions for Topic 8a: Debt or Equity Finance, or a Combination?
Should a project or an ongoing business use debt or equity financing? What are the pros and cons of each? If a project uses both equity and debt finance, what is the appropriate mix? What types of financing are used by your current organization (or a previous organization)? [If you don’t know, please try to find out.]
Topic 8b: Sources of Funding for Projects
Actions for Topic 8b: Sources of Funding for Projects
Identify and describe three to five possible sources of funding for projects. What are the relative advantages and disadvantages of each? What sources of capital are used for projects in your current organization (or a previous organization)? [If you don’t know, please try to find out.]
Topic 8c: Weighted Average Cost of Capital
Actions for Topic 8c: Weighted Average Cost of Capital
What is the weighted average Cost of Capital (WACC)? Why is it important for organizations that use both debt and equity financing?
