MBA-FPX 5014_Applied Managerial Finance_Assessment 2

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May 27, 2024

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1 ABC Healthcare: Evaluation of Capital Projects Paul Ujadughele Capella University MBA-FPX 5014 Applied Managerial Finance Dr. Keith Wade May 21, 2024

2 Executive Summary ABC Healthcare Corporation, a prominent healthcare entity committed to delivering exceptional services to the community, is overseen by Maria Gomez, the organization’s founder, and President. Maria’s primary objective is to ensure the sustained success and expansion of the company through strategic capital investments. To achieve this, Maria has delegated the evaluation of three proposed capital projects to me, the financial analyst manager, to assess their viability based on projected cash flow. Our approach involves the utilization of various capital budgeting methodologies to scrutinize the future cash inflows of each project and compare them against the initial outlay (Pinkasovitch, 2023). Through the application of tools such as net present value (NPV), internal rate of return (IRR), payback period, and profitability index (PI), our aim is to deliver a comprehensive analysis that facilitates informed decision-making in the selection of the most profitable projects for ABC Healthcare Corporation. By meticulously employing capital budgeting techniques to evaluate the proposed capital projects of ABC Healthcare Corporation, our objective is to pinpoint the most financially sound investment opportunities. Through an exhaustive examination of anticipated cash flows, initial expenditures, and profitability indicators for each project, our recommendations will be tailored to enhance shareholder value and steer the strategic growth of the organization (Palmer, 2021).

3 Capital Budgeting Tools Capital budgeting is a critical process that helps businesses make informed decisions about potential investment projects. By applying various capital budgeting tools, companies can analyze the future cash flows generated by a project and compare them to the upfront costs. In this report, we will explore different capital budgeting tools, including net present value (NPV), internal rate of return (IRR), payback period, and profitability index (PI), and demonstrate how they can aid in decision-making (Pinkasovitch, 2023). Net present value (NPV) is a popular capital budgeting tool that calculates the present value of future cash inflows and outflows of a project. The NPV of a project is calculated by subtracting the upfront investment cost from the present value of the expected cash inflows. A positive NPV indicates that the project is expected to generate more cash inflows than outflows and, therefore, is considered a financially viable investment (Palmer, 2021). Another important capital budgeting tool is the internal rate of return (IRR), which represents the discount rate at which the NPV of a project is equal to zero. In simpler terms, the IRR is the rate of return a project is expected to generate over its lifetime. Generally, a higher IRR indicates a more profitable investment opportunity (Palmer, 2021). The payback period is a simple capital budgeting tool that calculates the time it takes for a project to recover its initial investment. Projects with shorter payback periods are generally preferred as they allow for quicker capital recovery and reduced risk (Kegan, 2023). Profitability Index (PI) is a ratio that compares the present value of future cash inflows to the upfront investment cost. A PI greater than 1 indicates that the project is expected to generate positive returns, while a PI less than 1 suggests that the project may not be economically feasible (Chen, 2021). When analyzing a potential investment project, it is essential to consider multiple capital budgeting tools to gain a comprehensive understanding of its financial viability. For example, a project may have a positive NPV, but a low IRR, indicating that although the project generates positive cash inflows, the return on investment may not be as high as expected. In such cases, incorporating multiple tools like the payback period and profitability index can provide a more well- rounded analysis and help in making an informed decision (Palmer, 2021). In summary, capital budgeting tools play a crucial role in evaluating investment projects and guiding decision-making processes in businesses. By utilizing tools like NPV, IRR, payback period, and profitability of potential projects. It is imperative for businesses to conduct thorough analyses using these tools to ensure successful investment decisions and maximize returns on capital investments. Evaluation on Capital Projects

4 ABC Healthcare is currently reviewing several projects for potential investment using capital budgeting tools. Appendix A, B, and C contain detailed data for further analysis. The key metrics being evaluated for these projects include Net Present Value (NPV), Internal Rate of Return (IRR), payback period, and Profitability Index (PI). The projects range from five to eight years in duration, each with different initial and subsequent investment costs. Project A: Major Equipment Purchase ABC Healthcare is considering purchasing new major equipment at a cost of ten million dollars, with projected cost savings of five percent per year for eight years. Additionally, the equipment is estimated to be sold for salvage value of five hundred thousand dollars at the end of the eight-year period. With a required rate of return of 8 percent, Project A is deemed a relatively safe investment. Furthermore, the equipment will be depreciated on a MACRS seven-year schedule, and annual sales are projected to remain constant at twenty million dollars for eight years. Before the implementation of Project A, the cost of sales stood at sixty percent, indicating potential for significant cost savings through this investment. Moreover, considering the marginal corporate tax rate of twenty-five percent, it is essential to incorporate these financial factors into the evaluation process. In assessing the feasibility and profitability of Project A, various capital budgeting tools have been utilized. The net present value (NPV) of the project is calculated as $44,262,269, indicating a positive return on investment. The internal rate of return (IRR) is an impressive 79.79%, suggesting the project’s profitability. The payback period is estimated at 1.36 years, highlighting the quick return on the initial investment. Additionally, the profitability index (PI) of 5.43 further reinforces the financial attractiveness of Project A (Chen, 2021). While the quantitative analysis provides valuable insights into the financial viability of Project A, it is also essential to consider potential non-quantitative factors that could influence decision-making. Factors such as technological advancements, market trends, and regulatory changes should be considered to ensure the long-term sustainability and success of the project. Project B: Expansion into Three Additional States ABC Healthcare is considering an expansion into three additional states outside of the current location. Project B presents a significant opportunity for growth, with a forecasted increase in sales and revenues of ten percent per year for the next five years. The annual sales for the previous year were twenty million dollars, and with the expansion, there is potential for substantial revenue growth. However, it is also important to consider the associated costs and investments involved in this project. The start-up costs for Project B are projected to be seven million dollars, with an additional upfront investment in working capital of one million dollars. It is

5 essential to note that the working capital amount invested will be recouped at the end of year five. Considering the marginal corporate tax rate of twenty five percent and the project’s required rate of return of twelve percent, we can utilize various capital budgeting tools to analyze the feasibility of Project B. The Net Present Value (NPV) of Project B is calculated as $20,616,672, indicating a positive value and potential profitability for the project. The internal Rate of Return (IRR) is determined to be 86.34%, which surpasses the required rate of return, highlighting the attractiveness of the investment. The payback Period of 1.14 years suggests that the initial investment will be recovered relatively quickly. Additionally, the Profitability index (PI) of 3.78 demonstrates the value created by the project relative to the investment made (Chen, 2021). While the quantitative analysis provides valuable insights into the financial viability of Project B, it is also essential to consider potential non-quantitative factors that could impact the decision-making process. Factors such as market volatility, regulatory changes, and competitive landscape should be considered when evaluating the risks and rewards associated with the expansion project. Project C: Marketing or Advertising Campaign ABC Healthcare is considering a new marketing and adverting campaign to increase revenue. Project C entails a major new marketing/advertising campaign with an annual cost of two million that will span over six years. The forecast suggests that the campaign will increase sales and costs by fifteen per cent each year, with annual sales of twenty million in the previous year. Considering a moderate risk investment, the required rate of return for the project is set at ten percent. Utilizing capital budgeting tools, the Net Present Value (NPV) of Project C is calculated to be $33,470,904, indicating that the project is expected to generate significant value. The Internal Rate of Return (IRR) stands at an impressive 90.36%, showcasing the project’s potential for high returns. The Payback Period is estimated at 1.23 years, indicating that the initial investment will be recouped relatively quickly. Moreover, the profitability Index (PI) of 4.84 confirms that the project’s returns outweigh the costs, making it a financially viable option. When evaluating capital projects, it is essential to not only focus on quantitative metrics but also consider non-quantitative factors that could impact the project’s success. Factors such as brand reputation enhancement, competitive positioning, and customer loyalty resulting from the marketing/advertising campaign must be considered. These qualitative aspects can add significant value to the project and influence the decision-making process. Comparison of Capital Projects

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