Running head: LEARNING TEAM DELIVERABLE

Pontrelli Recycling Sara Doyle, Kevin Jackson, and Ali Lakhani FIN/575 Michael Plesko January 20, 2014

LEARNING TEAM DELIVERABLE Pontrelli Recycling Pontrelli Recycling, Inc. has a mission to increase the efficiency of recycling usable materials in order to create a better environment for all, and to create value and a fair return on investment for shareholders (Callahan, Stetz, and Brooks, 2007). A project must always be aligned with the companys strategy and financial goals. When devising any new project, a company can refer to many available resources for the information needed for the plan by reviewing financial sheets and documents. In the upcoming project for Pontrelli Recycling the high level cost estimate for the project is $8.8 million. In the following project plan overview, the details of the project will be reviewed. Debt and equity financing are two methods that may be employed by a company to obtain necessary capital for projects. Equity financing uses investors to obtain necessary funds. Equity financing does not have to be paid back like a loan and leaves more cash on hand for a company. While this method sounds appealing for those reasons, equity financing can lead to less control and ownership of a company, higher returns to be paid out to investors in the long run, and a longer financing process. Debt financing uses loans from banks or other financial institutions to acquire funds. By using debt financing, a company is able to maintain control and ownership of their company, use interest on the loan as a tax deductible, and plan for known repayment figures. Pontrelli Recycling can take advantage of the benefits of both of these methods for financing, and reduce their disadvantages by using both methods to fund their upcoming project. They can turn to investors for a portion of their financing and use banks for the other portion of financing.

LEARNING TEAM DELIVERABLE One major part of creating a project proposal is being able to measure the value of the company. Pontrelli Recycling will need to determine the value of their company to assist in determining credit worthiness, tax purposes, and to be able to present their current status to potential lenders or investors. To measure value, a company can use either the economic value added (EVA) or the market value added (MVA)approach. Economic value added can be calculated as the difference between the companys net operating profit after tax and a portion of the amount of capital invested in the business while the market value added can be calculated as the difference between the companys market value and the amount of capital invested in the business (Hanks, n. d.). The MVA measures the operational capabilities of a companys management and the EVA measures the opportunity cost of alternative investments, and the companys efficiency of management (Hanks, n. d.). Weighted Average Cost of Capital. Weighed average cost of capital (WACC) is a composite of the individual costs of financing incurred by each capital source. The firm WACC is a function of (1) the individual cost of capital, (2) the capital structure mix, and (3) the level of financing necessary to make the investment (Titman, Keown, & Martin, 2011). WACC is calculated by multiplying the after cost of debt to the proportion of capital raised by debt. Multiply the cost of preferred stock to the proportion of capital raised by preferred stock, and then multiply the cost of common stock to the proportion of capital raised by common stock. The formula for WACC is: WACC= (after tax cost of debt X proportion of capital raised by debt)+(Cost of preferred stock X proportion of capital raised by preferred stock)+(Cost of common stock X

LEARNING TEAM DELIVERABLE proportion of capital raised by common stock). The advantage of using the WACC method is it is familiar to mot business executives. The WACC minimizes estimation cost, as there is only one cost of capital calculation for the firm. In addition, using WACC reduces the problem of influence cost issues (Titman, Keown, & Martin, 2011). However the weaknesses of a firm using the WACC method is (Titman, Keown, & Martin, 2011): WACC does not adjust discount rates for differences in project risk WACC does not provide for flexibility in adjusting for differences in project debt in the capital structure. WACC is used to value the entire firm, it used as a starting point to determine the discount rate for project investments. In addition, the WACC is the appropriate rate to use when evaluating the firm performance to determine if the firm has created value for its shareholders. Project Viability To calculate the cash flows for the project a cash flow statement has to be created for Pontrelli Recycling Inc. The cash flow statement shows the projected cash flows for Pontrelli Recycling Inc. project (Callahan, Stetz, & Brooks, 2007): Cash Flow Statement 2007 2,205,535 (7,500,000) 2008 3,413,387 0 2009 5,296,138 0 2010 8,532,792 0

Net Income Depreciation and Amortization Acct. Receivable Inventory Prepaid Expenses

(86,406) 60,759 0

(90,726) 63,580 0

(95,263) 66,767 0

(100,026) 70,105 0

LEARNING TEAM DELIVERABLE Acct. Payable Taxes Payable Customer Deposit Net Cash Flow Provided by Operating Activities Net Property, Plant, and Equipment Other Assets Net Cash Flow Provided by Investing Activities Borrowings 27,265 31,402 0 (5,261,798) 29,991 66,332 0 3,455,564 49,485 103,404 0 5420531 56,908 177,682 0 8737461

(19,791) (19,791)

(21,769) (21,769)

(35,920) (35,920)

(41,308) (41,308)

7,522,016

(839,806) 0 (839,806)

(752,358) 0 (752,358)

(673,482) 0 (673,482)

Common 0 Stock/Equity Net Cash Flow 7,522,016 Used by Financing Activities Change in Cash 2,258,247 Beginning Cash 5,402,551 Ending Cash 7,660,798

2,593,989 7,608,086 10,202,075

4,632,253 11,021,473 15,653,726

8,022,671 16,317,611 24,340,282

The projected cash flows for Pontrelli Recycling Inc., project is as followed: 2007 Cash Flow- 7,660,798 2008 Cash Flow- 10,202,075 2009 Cash Flow- 15,653,726 2010 Cash Flow- 24,340,282

Using these projected cash flows the financial manager can calculate the net present value (NPV) of the project to obtain the present value of future cash flows. The initial cash outflow is 8.8 million dollars, and the discount rate is 18% (8% loan financing + 10% equipment amortization). NPV is calculation is:

LEARNING TEAM DELIVERABLE -Cash outflow+ Cash inflow1/(1+discount rate)+Cash inflow2/ (1+discount rate)2+Cash inflow3(1+discount rate)3+Cash inflow4(1+discount rate)4. To calculate the profitability index Pontrelli Recycling Inc. will take the present value of future cash flow from calculating NPV and divide by the cash outflow of 8.8 million dollars: 2007 present value-6,492,202 2008 present value-7,326,971 2009 present value-9,527,341 2010 present value-12,554,447

The total present value of future cash flow is 35,900,961 divide this amount by the cash outflow of 8.8 million, and the profitability index is 4.08. According to Titman, Keown, and Martin (2011), When the profitability index is greater than one, the NPV will be positive, so the project should be accepted. When the profitability index is less than one, which indicates a bad investment, NPV will be negative, and the project should be rejected. Because the profitability index for Pontrelli Recycling Inc. is 4.08 the project should be accepted. Alternate Capital Structure Pontrelli Recycling Inc. can use economic value added as an alternate capital structure instead of the traditional WACC. The economic value added is the difference of net operating profit after taxes (NOPATO) minus the capital charge (CC). However, to obtain the capital charge, Pontrelli Recycling Inc. would use the product of WACC and multiply the beginning balance of the firms capital or equity (Callahan, Stetz, & Brooks, 2007). According to Callahan, Stetz, and Brooks (2007) economic value added shows

LEARNING TEAM DELIVERABLE the amount of value that is created or destroyed by Pontrelli Recycling Inc. for the period of operations. Pontrelli Recycling Inc. can use the EVA to see if the project would increase or decrease value to the firm for years the project is initiated. Alternate Project Budget The budget made by Pontrelli and the actual projections of what the project is going to be over by almost six percent. In creating an alternative budget it is important to first see where the pervious budget was and where the actual projection costs of the project are. Then a new budget can be made that takes that into account so that the projections and budget are not too far off from one another. The current budget takes into account: Project Initiation and Planning, Plant Equipment, New Trucks, Construction, Installation, Process Review and Change, Project Management, Training, New Equipment, Construction and Renovation, and Training and Change Management. All together, there is roughly 7.5 million dollars budgeted for this specific project. However, the project is estimated actually cost 8.8 million dollars. When creating an alternate budget it is important to take this into account. Currently, there is $100,000 budgeted for Project Initiation and Planning. The new budget will allocate $150,000 for Project Initiation and Planning. Next, Plant Equipment is budgeted at $ 5 million, so now it will be taken up a bit to 5.5 million dollars. New Trucks have a budget of $750,000 so to take into account the high costs, the new budget will be $850,000. Construction is currently budgeted at $800,000 and now the new budget will be 1 million dollars.

LEARNING TEAM DELIVERABLE Next for Installation, the budget is $450,000, but now since the project estimate is going to be higher, the company needs to allocate $525,000 as a new budget for Installation. Process Review and Change is currently budgeted at $162,000, but now the company needs to increase that budget to $200,000. Project Management can be increased to $200,000 as well to account for the new project estimates. Training is budgeted for $125,000, and now it will be changed to $200,000 to include the new high cost project estimates. So now, the budget for the project has actually increased to $8,625,000 and the Project Estimate remains at $8.8 million. Now there is only one percent to two percent difference between the Project Estimate and the Budget Estimate. There are still constraints to this. The constraints to this budget are that the project estimate is still way over the actual budget that Pontrelli has sent. When it comes to any one of these categories, if corners are cut the entire project could suffer. Planning and Project Initiation is one place where costs can be cut. However when it comes to construction, installation, and training the full resources of money are going to be needed or the staff will not be trained and equipment will not be installed properly. In the long run, this could have affects on the customer experience, which could lead to a loss in sales for the company. Project Budget Plan An alternative plan to manage the project budget can include using budgeting as a control tool instead of overestimating or underestimating the project (Eichenbeger, 1998, p. 269). When using the budget as a control method, it allows the project manager to be able to manage the costs of the project more

LEARNING TEAM DELIVERABLE closely and not allowing the actual cost of the project to be that much higher than the projected budget. This can keep the project from becoming a risk factor the company.

LEARNING TEAM DELIVERABLE References Callahan, K.R., Stetz, G.S., & Brooks, L.M. (2007). Project Management Accounting:Budgeting, Tracking, and Reporting Cost and Profitability . Hoboken, N.J.: John Wiley & Sons, Inc. Eichenberger, J. (1998). Project management, part III budgets for projects. AAOHN Journal, 46(5), 268-70. Retrieved from http://search.proquest.com/docview/1013462577?accountid=35812 Hanks, G. (n.d.). Market Value Added Vs. Economic Value Added Chron.com. Retrieved January 18, 2014, from http://smallbusiness.chron.com/market-valueadded-vs-economic-value-added-72854.html Titman, S., Keown, A.J., & Martin, J.D. (2011). Financial Management:Principles and Applications (11th ed.). Boston, M.A.: Prentice Hall

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