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Capital Budgeting Analysis for Supplemental Material for Short Course 3: C

Medical Services USA Budgeting Analysis, located on the internet


www.exinfm.com/training. Prepared by: Mat
Evans, CPA, CMA, CFM
Purpose of Spreadsheet

Illustrate concepts related to capital budgeting analysis of projects. Certain aspects of a capital
project may have not been included in order to help highlight basic concepts, such as
Net Present Value. The spreadsheet is setup to evaluate six different projects and summarize
all projects based on both economic analysis and risk factors assigned.
Note: The Solver feature of Excel is used in an example at the end. Please make sure that you
have installed Solver: Solver add-on feature (Tools => Add-Ins => Solver).

Economic Analysis

Three economic criteria are applied to projects: Net Present Value, Modified Internal Rate of
Return and Discounted Payback Period. If your project(s) have non-periodic payments
(payments are not equal over the life of the project), then you should use these Excel Functions:
=XNPV for Net Present Value by entering specific dates of cash flows
=XIRR for Internal Rate of Return by entering specific dates of cash flows

Cell Indicators

Certain cells are highlighted as follows:

Selected input cells (not all input cells are highlighted since each project is unique)
Cell includes a comment - move mouse and point over cell for comment
Indication of an error in calculation or a red flag that a criteria has not been met

Organization of Spreadsheet

Lead Worksheet
Project A Analysis - Example with Annual Cash Flow Calculations
Project B Analysis - Example with Sunk Costs & Projected Financials
Project C Analysis - Example of Upgrade Investment
Project D Analysis - Example of Project Financing
Project E Analysis - Example of Foreign Investment
Project F Analysis - Example of Monthly Inflows / Outflows
Summary and Example of Using Excel Solver
Answer Report 1 - Output from Using Excel Solver in Summary Example

General Input
The following general inputs have been used on different worksheets:

A Diesel Generation System <= Enter project name


B New Clinic in Kansas City <= Enter project name
C Upgrade to DuBois Center <= Enter project name
D Southeastern Upgrades <= Enter project name
E Canadian Partnership <= Enter project name
F Regulatory Compliance NE <= Enter project name
27.50% <= Marginal Tax Rate *
9.50% <= Weighted Average Cost of Capital
$10,000 <= Threshold investment amount where formal project analysis
is not required - general expenditure item.

* If you expect changes in future tax rates, you may want to consider these changes
in your analysis.

Project Codes (Used to help categorize various capital projects)

Project Classification Codes:


1 Land
2 Buildings
3 Leasehold Improvement
4 Equipment
5 Furniture and Fixtures
6 Vehicles
7 Acquisitions
8 Investments
9 Other

Primary Justification for Project:


A Cost Reduction
B Replacement
C Expansion / Addition
D Service Improvement
E Safety & Compliance
F Operating Necessity
G Other

Priority Code:
1 Carry over project, already in progress, requires additional funding
2 Essential for continued operations, regulatory compliance, etc.
3 Economically desired for revenue growth, cost reductions, etc.
4 General improvement for building or expanding the business
ial for Short Course 3: Capital
, located on the internet at
aining. Prepared by: Matt H.
CFM
Lead Wks
Project A
Project B
Project C
Project D
Project E
Project F
Summary
mal project analysis
Capital Budgeting Analysis for
Medical Services USA
A Diesel Generation System
Project Information

Project Description > New diesel backup system for high volume medical plant
Project Benefits > Eliminate downtime, improve efficiency, better service
Project Location > Mobile, AL
Responsible Division > Southern
Responsible Department > Plant Engineering
Contact Person Name > John Pearson, Southern Div Manager
Estimated Project Start Date > 01/01/92
Classification > 4
Justification > F
Priority > 2

Preliminary Review

Assign points from 0 to 5 for each of the following project attributes. 0 indicates that the
attribute does not apply to the project. 5 is the highest rating, indicating that the project
strongly meets this project attribute.

Financial Attributes:
F1 Project improves overall profitability of the company 2
F2 Project lowers cost structure 3
F3 Project will generate a rate of return 3
F4 Project improves asset utilization 1
F5 Other Financial Attribute __________________________________ 0
F6 Other Financial Attribute __________________________________ 0

Operating Attributes:
O1 Improves operating efficiencies 4
O2 Increases the customer base 0
O3 Improves overall customer service 0
O4 Improves competitive position of company 0
O5 Other Operating Attribute _________________________________ 0
O6 Other Operating Attribute _________________________________ 0

Contingency Attributes:
C1 Project has options that allow for change during life 2
C2 Project will positively impact company even if value is negative 4
C3 Project can be abandoned easily with some positive value 1
C4 Project permits several options to maximize value 2
C5 Other Cont Attribute _____________________________________ 0

Miscellaneous Attributes:
M1 Expands Human Resource Capital 0
M2 Enhances workforce productivity 0
M3 Project meets a critical regulatory, security or specific need 0
M4 Project fits with company strategy and goals 1
M5 Probability of project success is very high / low risk 4
M6 Other Misc Attribute _____________________________________ 0
M7 Other Misc Attribute _____________________________________ 0
M8 Other Misc Attribute _____________________________________ 0

Total Preliminary Points 27

Projects with point totals less than 15 may represent poor investments and require additional
approval before further analysis and processing. Projects with point totals between 15 and 20
require caution and careful analysis. Projects with point totals greater than 20 may proceed
with analysis and submission.

Financial Analysis

Proposed Project Expenditure:


* Equipment & Facilities (purchase price) 165,000
* Installation Cost 650
* Labor 4,500
* Materials 250
* Shipping 1,280
* Taxes 11,550
Other Costs (expensed) 350
Intial Cash Outlay for Project 183,580
Tax Breaks for Investment (1,500)
Sale of Existing Assets 0
Tax Benefit on Loss - Sale of Assets 0
Total Project Investment 182,080
Project Analysis Required? Yes

* capitalized costs subject to depreciation using double declining method over 8 years with $ 8,000 salvag
NOTE: Depreciation for tax purposes is considered the same for accounting purposes. If tax depreciatio
different than accounting depreciation, deduct tax depreciation in calculating taxes.

Cash Flows associated with Project:


Year 1:
Reductions in annual operating costs 28,900
New revenues from higher output volumes 6,200
Eliminate third party vendor service 35,000
Annual service and maintenance (4,600)
Annual fuel costs (1,500)
Depreciation:
Cost 183,230
Salvage Value 8,000
Useful Life 8
Depreciation in Yr 1 (45,808)
Operating Cash Flow in Year 1 18,193
Less Taxes (5,003)
Net Income - Year 1 13,190
Add Back Non Cash Depreciation 45,808
Change to Net Working Capital (3,500)
Net Cash Flow - Year 1 55,497

Year 2:
Reductions in annual operating costs 32,100
New revenues from higher output volumes 6,900
Eliminate third party vendor service 35,000
Annual service and maintenance (5,000)
Annual fuel costs (1,800)
Depreciation:
Cost 183,230
Salvage Value 8,000
Useful Life 8
Depreciation in Yr 2 (34,356)
Operating Cash Flow in Year 2 32,844
Less Taxes (9,032)
Net Income - Year 2 23,812
Add Back Non Cash Depreciation 34,356
Change to Net Working Capital (650)
Net Cash Flow - Year 2 57,518

Year 3:
Reductions in annual operating costs 34,800
New revenues from higher output volumes 7,100
Eliminate third party vendor service 35,000
Annual service and maintenance (5,000)
Annual fuel costs (2,000)
Depreciation:
Cost 183,230
Salvage Value 8,000
Useful Life 8
Depreciation in Yr 3 (25,767)
Operating Cash Flow in Year 3 44,133
Less Taxes (12,137)
Net Income - Year 3 31,997
Add Back Non Cash Depreciation 25,767
Change to Net Working Capital (550)
Net Cash Flow - Year 3 57,213

Year 4:
Reductions in annual operating costs 37,200
New revenues from higher output volumes 7,900
Eliminate third party vendor service 0
Annual service and maintenance (5,200)
Annual fuel costs (2,100)
Depreciation:
Cost 183,230
Salvage Value 8,000
Useful Life 8
Depreciation in Yr 4 (19,325)
Operating Cash Flow in Year 4 18,475
Less Taxes (5,081)
Net Income - Year 4 13,394
Add Back Non Cash Depreciation 19,325
Change to Net Working Capital (250)
Net Cash Flow - Year 4 32,469

Year 5:
Reductions in annual operating costs 40,900
New revenues from higher output volumes 8,900
Eliminate third party vendor service 0
Annual service and maintenance (5,300)
Annual fuel costs (2,200)
Depreciation:
Cost 183,230
Salvage Value 8,000
Useful Life 8
Depreciation in Yr 5 (14,494)
Operating Cash Flow in Year 5 27,806
Less Taxes (7,647)
Net Income - Year 5 20,160
Add Back Non Cash Depreciation 14,494
Change to Net Working Capital (350)
Net Cash Flow - Year 5 34,303

Year 6:
Reductions in annual operating costs 44,200
New revenues from higher output volumes 9,700
Eliminate third party vendor service 0
Annual service and maintenance (5,400)
Annual fuel costs (2,300)
Depreciation:
Cost 183,230
Salvage Value 8,000
Useful Life 8
Depreciation in Yr 6 (10,870)
Operating Cash Flow in Year 6 35,330
Less Taxes (9,716)
Net Income - Year 6 25,614
Add Back Non Cash Depreciation 10,870
Change to Net Working Capital (150)
Net Cash Flow - Year 6 36,334

Year 7:
Reductions in annual operating costs 50,100
New revenues from higher output volumes 10,200
Eliminate third party vendor service 0
Annual service and maintenance (5,500)
Annual fuel costs (2,400)
Depreciation:
Cost 183,230
Salvage Value 8,000
Useful Life 8
Depreciation in Yr 7 (8,153)
Operating Cash Flow in Year 7 44,247
Less Taxes (12,168)
Net Income - Year 7 32,079
Add Back Non Cash Depreciation 8,153
Change to Net Working Capital (150)
Net Cash Flow - Year 7 40,082

Year 8:
Reductions in annual operating costs 55,500
New revenues from higher output volumes 11,000
Rebuild / Repair Unit Option (25,000)
Annual service and maintenance (4,600)
Annual fuel costs (2,600)
Depreciation:
Cost 183,230
Salvage Value 8,000
Useful Life 8
Depreciation in Yr 8 (6,115)
Operating Cash Flow in Year 8 28,185
Less Taxes (7,751)
Net Income - Year 8 20,434
Add Back Non Cash Depreciation 6,115
Change to Net Working Capital (50)
Net Cash Flow - Year 8 26,499

Terminal Year 9
Salvage Value of Asset 5,000
Working Capital Reversed 2,500
Terminal Value 7,500

At the end of Year 8, a decision will be made to either rebuild the asset or outsource to third party.

Economic Analysis

Summarize Cash Outflows and Inflows for Project:


Cash Present Recovery
Year Flows Value Payback
0 (182,080) (182,080)
1 55,497 49,997 (132,083)
2 57,518 46,683 (85,400)
3 57,213 41,834 (43,566)
4 32,469 21,389 (22,177)
5 34,303 20,357 (1,820)
6 36,334 19,426 17,606 <= payback
7 40,082 19,306 36,912
8 26,499 11,499 48,410
9 7,500 2,932 51,342
Net Present Value 51,342
Required Rate of Return for Project => 11.00%
Reinvestment Rate for Project => 6.00%

Net Present Value $51,342


Modified IRR 11.03%
Discounted Payback (years) 6.1

Economic Assessment

Project has positive Net Present Value? Yes


Project has IRR in excess of cost? Yes
Project has a positive payback? Yes

Project must meet at least two of the three Economic Criteria, otherwise special
approval is required.

Risk Analysis

Risk Premium Applied to Project 1.50%

Compare Risk Factor with Government Treasury Bond (lowest risk) to Project Risk Factor:
Risk Ranking = 1 for lowest possible risk up to 10 for highest possible risk
Probability of Accurate and Reliable Information - Gov't T Bond 1.00 (a)
Risk Ranking assigned to Gov't Treasury Bond ( 1 to 10) 1 (b)
Exponential power to apply to Risk Ranking is 2 - (a) 1 (c)
Risk Factor = (b) raised to the power (c) 1

Probability of Accurate and Reliable Information for Project 0.6


Risk Ranking assigned to project (1 to 10) 5
Exponential power to apply to Project 1.4
Risk Factor for Project 10

Assign probabilities to three possible outcomes for project:


P Pesimistic outlook, declining growth, slower volumes, etc. 25.00%
N Normal expected outlook as applied in analysis 60.00%
O Optomistic outlook, better than expected growth 15.00%
Total should equal 100.00% 100.00%

Enter Expected Cash Flows for different outcomes:

Standard Coeff of
Net Cash Flows Expected Deviation Variation
Year Pesimist Normal Optomist Value (Abs Risk) (Rel Risk)
1 41,800 55,497 64,900 53,483 17,758 0.332
2 39,750 57,518 67,300 54,543 21,584 0.396
3 37,400 57,213 66,100 53,593 22,854 0.426
4 26,200 32,469 41,050 32,189 10,699 0.332
5 21,050 34,303 40,900 31,979 15,679 0.490
6 13,200 36,334 39,800 31,071 22,531 0.725
7 11,800 40,082 40,800 33,119 25,430 0.768
8 8,100 26,499 35,700 23,279 21,793 0.936
Terminal 1,000 7,500 8,500 6,025 6,346 1.053
Totals 200,300 347,416 405,050 319,282 164,674 0.516

Absolute Risk of Project (Std Deviation) 164,674


Relative Risk of Project (Coeff of Variation) 0.516

Revised Economic Analysis using Expected Values

Expected Present Recovery


Year Value Value Payback
0 (182,080) (182,080)
1 53,483 48,183 (133,897)
2 54,543 44,268 (89,628)
3 53,593 39,187 (50,442)
4 32,189 21,204 (29,238)
5 31,979 18,978 (10,259)
6 31,071 16,612 6,352 payback
7 33,119 15,952 22,304
8 23,279 10,102 32,406
9 6,025 2,355 34,761
Totals 34,761

Net Present Value $34,761


Modified IRR 10.07%
Discounted Payback (years) 6.6
d over 8 years with $ 8,000 salvage value
unting purposes. If tax depreciation is
ulating taxes.
t or outsource to third party.
Capital Budgeting Analysis for
Medical Services USA
B New Clinic in Kansas City
Project Information

Project Description > New Walk In Clinic - Kansas City


Project Benefits > Toehold market position, profit center, business expansion
Project Location > Kansas City
Responsible Division > Mid West
Responsible Department > Business Development
Contact Person Name > Bill Watson, Operations Director
Estimated Project Start Date > 04/01/92
Classification > 2
Justification > C
Priority > 3

Preliminary Review

Assign points from 0 to 5 for each of the following project attributes. 0 indicates that the
attribute does not apply to the project. 5 is the highest rating, indicating that the project
strongly meets this project attribute.

Financial Attributes:
F1 Project improves overall profitability of the company 3
F2 Project lowers cost structure 2
F3 Project will generate a rate of return 4
F4 Project improves asset utilization 2
F5 Other Financial Attribute __________________________________ 0
F6 Other Financial Attribute __________________________________ 0

Operating Attributes:
O1 Improves operating efficiencies 2
O2 Increases the customer base 3
O3 Improves overall customer service 3
O4 Improves competitive position of company 2
O5 Other Operating Attribute _________________________________ 0
O6 Other Operating Attribute _________________________________ 0

Contingency Attributes:
C1 Project has options that allow for change during life 0
C2 Project will positively impact company even if value is negative 0
C3 Project can be abandoned easily with some positive value 0
C4 Project permits several options to maximize value 0
C5 Other Cont Attribute _____________________________________ 0

Miscellaneous Attributes:
M1 Expands Human Resource Capital 0
M2 Enhances workforce productivity 0
M3 Project meets a critical regulatory, security or specific need 0
M4 Project fits with company strategy and goals 3
M5 Probability of project success is very high / low risk 0
M6 Other Misc Attribute _____________________________________ 0
M7 Other Misc Attribute _____________________________________ 0
M8 Other Misc Attribute _____________________________________ 0

Total Preliminary Points 24

Projects with point totals less than 15 may represent poor investments and require additional
approval before further analysis and processing. Projects with point totals between 15 and 20
require caution and careful analysis. Projects with point totals greater than 20 may proceed
with analysis and submission.

Financial Analysis

Proposed Project Expenditure:


Rework / Upgrade Existing Building 85,000 (1)
Equipment and Fabrication 45,000 (2)
Marketing and Promotion of Clinic 7,500
Contingency Costs 3,500
Market Study / Research 2,500 <= exclude since sunk cost, not relevan
Total Project Investment 141,000
Project Analysis Required? Yes

(1): Depreciated over 30 years using the straight line method with no salvage value.
(2): Depreciated over 12 years using the declining balance method with no salvage value.
Tax depreciation and accounting depreciation are considered the same.

Working Capital Requirements:


Historical analysis of other similar clinics indicates that clinics require:

Cash 3,500
Accounts Receivable 7,500
Inventories 5,000
Total Current Assets 16,000
Accounts Payable 6,000
Other accruals 4,000
Total Current Liab 10,000
Net Working Capital 6,000
Sales Revenues 60,000
Ratio (NWC / Sales) 10.00%

The above Ratio will be applied to estimate working capital requirements

Opportunity Cost Analysis:

As a result of this project investment, the company expects some negative impact to its
Topeka, Kansas facility as follows:
Year 1 Year 2 Year 3
Reduction to Sales Revenues (4,000) (5,000) (3,000)
Reductions in overall cost 1,500 2,000 1,200
Net Reduction to Income (2,500) (3,000) (1,800)

Five Year Financial Forecast:


Year Year Year
1 2 3
Sales Revenues 65,000 75,000 100,000
Cost of Services:
Personnel / Labor (15,000) (18,000) (22,000)
Supplies, Vendors, etc. (8,000) (10,000) (15,000)
Adm Overhead Increases (22,000) (28,000) (30,000)
Opportunity Cost (per above) (2,500) (3,000) (1,800)
Profit before Tax 17,500 16,000 31,200
Taxes (4,813) (4,400) (8,580)
Investment Credits 50 0 0
Net Profit 12,738 11,600 22,620
Depreciation:
Upgrade to Building
Useful Life => 30 2,833 2,833 2,833
Equipment
12 6,923 6,346 5,769
Operating Cash Flow 22,494 20,779 31,223
Net Working Capital (6,500) (7,500) (10,000)
Planned Critical Cash Outlays (1,500) (2,500) (3,500)
Total Cash Flow 14,494 10,779 17,723

Economic Analysis

Summarize Cash Outflows and Inflows for Project:


Cash Present
Year Flows Value Payback
0 (141,000) (141,000)
1 14,494 12,883 (128,117)
2 10,779 8,517 (119,599)
3 17,723 12,447 (107,152)
4 30,696 19,163 (87,989)
5 30,634 17,000 (70,990)
6 34,197 16,868 (54,121)
7 33,845 14,840 (39,282)
8 35,043 13,658 (25,624)
9 36,604 12,681 (12,943)
10 36,914 11,368 (1,575)
11 31,450 8,609 7,033 payback
12 31,450 7,652 14,686
13 31,450 6,802 21,488
14 31,450 6,046 27,534
15 31,450 5,374 32,908
16 31,450 4,777 37,686
17 31,450 4,246 41,932
18 31,450 3,775 45,707
19 31,450 3,355 49,062
20 31,450 2,982 52,044
Net Present Value 52,044

Required Rate of Return for Project => 12.50%


Reinvestment Rate for Project => 7.50%

Net Present Value $52,044


Modified IRR 11.36%
Discounted Payback (years) 11.18

Economic Assessment

Project has positive Net Present Value? Yes


Project has IRR in excess of cost? No
Project has a positive payback? Yes

Project must meet at least two of the three Economic Criteria, otherwise special
approval is required.

Risk Analysis

Risk Premium Applied to Project 3.00%

Compare Risk Factor with Government Treasury Bond (lowest risk) to Project Risk Factor:
Risk Ranking = 1 for lowest possible risk up to 10 for highest possible risk
Probability of Accurate and Reliable Information - Gov't T Bond 1.00
Risk Ranking assigned to Gov't Treasury Bond ( 1 to 10) 1
Exponential power to apply to Risk Ranking is 2 - (a) 1
Risk Factor = (b) raised to the power (c) 1

Probability of Accurate and Reliable Information for Project 0.5


Risk Ranking assigned to project (1 to 10) 7
Exponential power to apply to Project 1.5
Risk Factor for Project 19

Assign probabilities to three possible outcomes for project:


P Pesimistic outlook, declining growth, slower volumes, etc. 35.00%
N Normal expected outlook as applied in analysis 60.00%
O Optomistic outlook, better than expected growth 5.00%
Total should equal 100.00% 100.00%

Enter Expected Cash Flows for different outcomes:

Standard Coeff of
Net Cash Flows Expected Deviation Variation
Year Pesimist Normal Optomist Value (Abs Risk) (Rel Risk)
1 8,650 14,494 26,800 13,064 13,845 1.060
2 6,800 10,779 27,500 10,223 15,031 1.470
3 7,900 17,723 33,200 15,059 19,774 1.313
4 8,600 30,696 37,800 23,317 25,865 1.109
5 8,100 30,634 43,900 23,410 30,422 1.300
6 7,500 34,197 42,100 25,248 30,794 1.220
7 7,100 33,845 41,850 24,884 30,908 1.242
8 6,200 35,043 40,950 25,243 31,501 1.248
9 6,000 36,604 40,200 26,072 31,630 1.213
10 5,500 36,914 39,900 26,068 31,993 1.227
11 5,100 31,450 37,750 22,543 29,386 1.304
12 4,900 31,450 35,950 22,383 28,367 1.267
13 4,250 31,450 34,150 22,065 27,779 1.259
14 3,705 31,450 32,990 21,816 27,520 1.261
15 3,250 31,450 31,650 21,590 27,054 1.253
16 2,680 31,450 31,280 21,372 27,349 1.280
17 2,005 31,450 31,000 21,122 27,806 1.316
18 1,490 31,450 30,850 20,934 28,197 1.347
19 1,105 31,450 29,990 20,756 27,986 1.348
20 790 31,450 28,750 20,584 27,454 1.334
Totals 101,625 595,428 698,560 427,753 540,660 1.264

Absolute Risk of Project (Std Deviation) 540,660


Relative Risk of Project (Coeff of Variation) 1.264

Revised Economic Analysis using Expected Values

Expected Present Recovery


Year Values Value Payback
0 (141,000) (141,000)
1 13,064 11,612 (129,388)
2 10,223 8,077 (121,311)
3 15,059 10,576 (110,734)
4 23,317 14,557 (96,177)
5 23,410 12,991 (83,186)
6 25,248 12,454 (70,732)
7 24,884 10,911 (59,821)
8 25,243 9,838 (49,983)
9 26,072 9,032 (40,951)
10 26,068 8,028 (32,923)
11 22,543 6,171 (26,752)
12 22,383 5,446 (21,306)
13 22,065 4,772 (16,534)
14 21,816 4,194 (12,340)
15 21,590 3,689 (8,651)
16 21,372 3,246 (5,404)
17 21,122 2,852 (2,552)
18 20,934 2,513 (40)
19 20,756 2,214 2,175 payback
20 20,584 1,952 4,127
Net Present Value 4,127
Net Present Value $4,127
Modified IRR 9.68%
Discounted Payback (years) 19.02
since sunk cost, not relevant

alvage value.

Year 4 Year 5
(1,500) (500)
700 100
(800) (400)

Terminal
Year Year Year Year Year Year Year Flow
4 5 6 7 8 9 10 11 to 20
125,000 135,000 140,000 145,000 149,000 153,000 155,000 160,000

(25,000) (30,000) (32,000) (35,000) (36,000) (36,500) (37,000) (40,000)


(18,000) (19,000) (15,000) (15,000) (15,000) (15,000) (15,000) (18,000)
(32,000) (35,000) (36,000) (37,000) (37,000) (37,000) (37,000) (40,000)
(800) (400) 0 0 0 0 0 0
49,200 50,600 57,000 58,000 61,000 64,500 66,000 62,000
(13,530) (13,915) (15,675) (15,950) (16,775) (17,738) (18,150) (17,050)
0 0 0 0 0 0 0 0
35,670 36,685 41,325 42,050 44,225 46,763 47,850 44,950

2,833 2,833 2,833 2,833 2,833 2,833 2,833 2,500

5,192 4,615 4,038 3,462 2,885 2,308 1,731 0


43,696 44,134 48,197 48,345 49,943 51,904 52,414 47,450
(12,500) (13,500) (14,000) (14,500) (14,900) (15,300) (15,500) (16,000)
(500) 0 0 0 0 0 0 0
30,696 30,634 34,197 33,845 35,043 36,604 36,914 31,450
t Risk Factor:

(a)
(b)
(c)
Capital Budgeting Analysis for
Medical Services USA
C Upgrade to DuBois Center
Project Information

Project Description > Upgrade DuBois for unused capacity


Project Benefits > Better use of facility, more income
Project Location > Iowa
Responsible Division > Mid West
Responsible Department > Finance
Contact Person Name > Cheryl Strickland, Controller
Estimated Project Start Date > 03/15/92
Classification > 4
Justification > C
Priority > 3

Preliminary Review

Assign points from 0 to 5 for each of the following project attributes. 0 indicates that the
attribute does not apply to the project. 5 is the highest rating, indicating that the project
strongly meets this project attribute.

Financial Attributes:
F1 Project improves overall profitability of the company
F2 Project lowers cost structure
F3 Project will generate a rate of return
F4 Project improves asset utilization
F5 Other Financial Attribute __________________________________
F6 Other Financial Attribute __________________________________

Operating Attributes:
O1 Improves operating efficiencies
O2 Increases the customer base
O3 Improves overall customer service
O4 Improves competitive position of company
O5 Other Operating Attribute _________________________________
O6 Other Operating Attribute _________________________________

Contingency Attributes:
C1 Project has options that allow for change during life
C2 Project will positively impact company even if value is negative
C3 Project can be abandoned easily with some positive value
C4 Project permits several options to maximize value
C5 Other Cont Attribute _____________________________________

Miscellaneous Attributes:
M1 Expands Human Resource Capital
M2 Enhances workforce productivity
M3 Project meets a critical regulatory, security or specific need
M4 Project fits with company strategy and goals
M5 Probability of project success is very high / low risk
M6 Other Misc Attribute _____________________________________
M7 Other Misc Attribute _____________________________________
M8 Other Misc Attribute _____________________________________

Total Preliminary Points

Projects with point totals less than 15 may represent poor investments and require additional
approval before further analysis and processing. Projects with point totals between 15 and 20
require caution and careful analysis. Projects with point totals greater than 20 may proceed
with analysis and submission.

Cost Volume Profile of DuBois Facility

Personnel & Labor 37.50


Supplies and Inventory 2.65
Variable Adm Overhead 3.60
Fixed Overhead Costs 10.50
Total Unit Costs per Billable Hour 54.25

Current Operating Capacity => 60%


Maximum Capacity per month 15,000 billable hours
Sales growth rates over the next ten years are estimated at 4% per year with increases to costs
estimated at 1.5% per year for each variable component.

Estimated Changes from Upgrade Investment

Upgrade Investment will result in additional 5,000 billable hours per month
New Services from Upgrade Investment are billable to customers at $ 50.00 per hour
Capacity after upgrade => 14,000
Does upgrade project exceed max? No

Financial Analysis

Proposed Project Expenditure:


Upgrade Systems & Facilities 1,150,000
Executive Management Time 405,000
Training and Promotion 135,000
Contingency Costs 90,000
Total Investment 1,780,000
Project Analysis Required? Yes

Annual < - - relevant annual costs to project - - >


Incremental Personnel Supplies Var Adm Profits
Year Revenues & Labor & Inventory Overhead before Tax
1 3,000,000 (2,250,000) (159,000) (216,000) 375,000
2 3,090,000 (2,283,750) (161,385) (219,240) 425,625
3 3,182,700 (2,318,006) (163,806) (222,529) 478,359
4 3,278,181 (2,352,776) (166,263) (225,867) 533,275
5 3,376,526 (2,388,068) (168,757) (229,255) 590,447
6 3,477,822 (2,423,889) (171,288) (232,693) 649,952
7 3,582,157 (2,460,247) (173,857) (236,184) 711,868
8 3,689,622 (2,497,151) (176,465) (239,727) 776,279
9 3,800,310 (2,534,608) (179,112) (243,322) 843,267
10 3,914,320 (2,572,627) (181,799) (246,972) 912,921

Due to the rapid changes in services provided by this upgrade investment project, no term
calculated for the periods beyond year 10.

Economic Analysis

Summarize Cash Outflows and Inflows for Project:


Cash Present
Year Flows Value Payback
0 (1,780,000) (1,780,000)
1 256,875 233,523 (1,546,477)
2 295,578 244,279 (1,302,198)
3 334,811 251,548 (1,050,650)
4 374,625 255,874 (794,776)
5 416,074 258,349 (536,427)
6 459,215 259,215 (277,212)
7 504,105 258,685 (18,527)
8 550,802 256,953 238,427 payback
9 599,369 254,191 492,618
10 649,868 250,552 743,170
Net Present Value 743,170

Required Rate of Return for Project => 10.00%


Reinvestment Rate for Project => 4.00%

Net Present Value $743,170


Modified IRR 11.24%
Discounted Payback (years) 8.07

Economic Assessment

Project has positive Net Present Value? Yes


Project has IRR in excess of cost? Yes
Project has a positive payback? Yes

Project must meet at least two of the three Economic Criteria, otherwise special
approval is required.

Risk Analysis

Risk Premium Applied to Project 0.50%

Compare Risk Factor with Government Treasury Bond (lowest risk) to Project Risk Factor:
Risk Ranking = 1 for lowest possible risk up to 10 for highest possible risk
Probability of Accurate and Reliable Information - Gov't T Bond
Risk Ranking assigned to Gov't Treasury Bond ( 1 to 10)
Exponential power to apply to Risk Ranking is 2 - (a)
Risk Factor = (b) raised to the power (c)

Probability of Accurate and Reliable Information for Project


Risk Ranking assigned to project (1 to 10)
Exponential power to apply to Project
Risk Factor for Project

Assign probabilities to three possible outcomes for project:


P Pesimistic outlook, declining growth, slower volumes, etc.
N Normal expected outlook as applied in analysis
O Optomistic outlook, better than expected growth
Total should equal 100.00%

Enter Expected Cash Flows for different outcomes:

Standard
Net Cash Flows Expected Deviation
Year Pesimist Normal Optomist Value (Abs Risk)
1 212,500 256,875 285,700 252,324 54,978
2 242,500 295,578 324,300 289,271 62,301
3 301,200 334,811 362,050 332,174 44,892
4 326,700 374,625 401,200 369,026 56,638
5 370,900 416,074 441,300 410,823 53,493
6 411,800 459,215 483,700 453,405 54,949
7 461,900 504,105 533,100 500,013 53,239
8 510,200 550,802 582,200 547,391 53,323
9 561,300 599,369 631,100 596,515 51,374
10 615,100 649,868 677,700 647,089 46,230
4,014,100 4,441,320 4,722,350 4,398,031 531,419

Absolute Risk of Project (Std Deviation) 531,419


Relative Risk of Project (Coeff of Variation) 0.121

Revised Economic Analysis using Expected Values

Expected Present Recovery


Year Values Value Payback
0 (1,780,000) (1,780,000)
1 252,324 229,385 (1,550,615)
2 289,271 239,067 (1,311,548)
3 332,174 249,568 (1,061,981)
4 369,026 252,050 (809,931)
5 410,823 255,089 (554,842)
6 453,405 255,935 (298,907)
7 500,013 256,586 (42,321)
8 547,391 255,362 213,041 payback
9 596,515 252,980 466,021
10 647,089 249,481 715,502
Net Present Value 715,502

Net Present Value $715,502


Modified IRR 11.12%
Discounted Payback (years) 8.17
3
3
4
4
0
0

4
3
3
2
0
0

0
0
0
0
0

0
0
0
2
3
0
0
0

31

1.03
1.02

Less Project Adj to Cash


Taxes Income Income Flow
(103,125) 271,875 (15,000) 256,875
(117,047) 308,578 (13,000) 295,578
(131,549) 346,811 (12,000) 334,811
(146,651) 386,625 (12,000) 374,625
(162,373) 428,074 (12,000) 416,074
(178,737) 471,215 (12,000) 459,215
(195,764) 516,105 (12,000) 504,105
(213,477) 562,802 (12,000) 550,802
(231,898) 611,369 (12,000) 599,369
(251,053) 661,868 (12,000) 649,868

de investment project, no terminal value was

roject Risk Factor:


1.00 (a)
1 (b)
1 (c)
1

0.7
4
1.3
6

20.00%
65.00%
15.00%
100.00%

Coeff of
Variation
(Rel Risk)
0.218
0.215
0.135
0.153
0.130
0.121
0.106
0.097
0.086
0.071
0.121
Capital Budgeting Analysis for
Medical Services USA
D Southeastern Upgrades
Project Information

Project Description > Upgrade to various Southeastern facilities


Project Benefits > Better use of facility, more income
Project Location > Atlanta
Responsible Division > Southeast
Responsible Department > Engineering
Contact Person Name > Bob Ferrell
Estimated Project Start Date > 02/05/92
Classification > 4
Justification > C
Priority > 3

Preliminary Review

Assign points from 0 to 5 for each of the following project attributes. 0 indicates that the
attribute does not apply to the project. 5 is the highest rating, indicating that the project
strongly meets this project attribute.

Financial Attributes:
F1 Project improves overall profitability of the company
F2 Project lowers cost structure
F3 Project will generate a rate of return
F4 Project improves asset utilization
F5 Other Financial Attribute __________________________________
F6 Other Financial Attribute __________________________________

Operating Attributes:
O1 Improves operating efficiencies
O2 Increases the customer base
O3 Improves overall customer service
O4 Improves competitive position of company
O5 Other Operating Attribute _________________________________
O6 Other Operating Attribute _________________________________

Contingency Attributes:
C1 Project has options that allow for change during life
C2 Project will positively impact company even if value is negative
C3 Project can be abandoned easily with some positive value
C4 Project permits several options to maximize value
C5 Other Cont Attribute _____________________________________

Miscellaneous Attributes:
M1 Expands Human Resource Capital
M2 Enhances workforce productivity
M3 Project meets a critical regulatory, security or specific need
M4 Project fits with company strategy and goals
M5 Probability of project success is very high / low risk
M6 Other Misc Attribute _____________________________________
M7 Other Misc Attribute _____________________________________
M8 Other Misc Attribute _____________________________________

Total Preliminary Points

Projects with point totals less than 15 may represent poor investments and require additional
approval before further analysis and processing. Projects with point totals between 15 and 20
require caution and careful analysis. Projects with point totals greater than 20 may proceed
with analysis and submission.

Project Summary

Several facilities in the Southeast area need to upgrade existing scanner equipment to better serve customers
and produce higher quality analysis / treatments. The Atlanta Bank has agreed to finance $ 500,000 towards
the investment at 9% over a five year period. The loan repayment schedule is as follows:

Interest Number of Loan Interest Principal Total


Rate Installments Year Balance Payment Payment Payment
0.09 5 1 500,000 (45,000) (83,546) (128,546)
2 416,454 (37,481) (91,065) (128,546)
3 325,388 (29,285) (99,261) (128,546)
4 226,127 (20,351) (108,195) (128,546)
5 117,932 (10,614) (117,932) (128,546)

Financial Analysis

Proposed Project Expenditure:

Total Upgrade Acquisition Price 1,650,000 (1)


Installation / Training / Other Costs 65,000
Total Investment 1,715,000
Financed through Bank (500,000)
Net Cash Outlay 1,215,000
Project Analysis Required? Yes

(1): $ 650,000 of this price is subject to capitalization. Depreciation deducted on the tax return
differs from depreciation for accounting purposes: Tax Return Accounting
Year Depreciation Depreciation
1 325,000 65,000
2 162,500 65,000
3 81,250 65,000
4 40,625 65,000
5 40,625 65,000
6 65,000
7 65,000
8 65,000
9 65,000
10 65,000
Total 650,000 650,000

Cash Flow Analysis #1 - Only Project Cash Flows


Service Other Depreciation Taxable
Year Revenues Costs Costs Deduction Income
1 535,800 (112,000) (38,000) (325,000) 60,800
2 585,900 (155,100) (46,500) (162,500) 221,800
3 612,600 (188,600) (54,100) (81,250) 288,650
4 636,050 (202,900) (63,200) (40,625) 329,325
5 644,112 (224,200) (68,900) (40,625) 310,387
6 653,500 (241,600) (72,110) 339,790
7 668,200 (258,800) (77,800) 331,600
8 677,400 (272,100) (83,100) 322,200
9 689,800 (287,800) (88,900) 313,100
10 705,300 (298,400) (94,200) 312,700
11 712,900 (309,100) (97,800) 306,000
12 719,600 (319,400) (101,050) 299,150
13 722,800 (325,400) (104,900) 292,500
14 729,100 (329,900) (107,800) 291,400
15 734,300 (334,100) (110,100) 290,100

Economic Analysis #1
Present
Year Cash Flow Value Payback
0 (1,215,000) (1,215,000)
1 339,580 303,875 (911,125)
2 290,205 232,386 (678,739)
3 254,921 182,668 (496,071)
4 241,486 154,846 (341,225)
5 227,256 130,400 (210,825)
6 207,148 106,364 (104,461)
7 200,010 91,901 (12,560)
8 192,395 79,107 66,547 payback
9 185,098 68,104 134,651
10 184,408 60,716 195,367
11 179,050 52,754 248,120
12 173,284 45,686 293,807
13 167,963 39,627 333,434
14 166,665 35,187 368,621
15 165,223 31,214 399,835
Net Present Value 399,835

Required Rate of Return for Project => 11.75%


Reinvestment Rate for Project => 4.50%

Net Present Value $399,835


Modified IRR 9.25%
Discounted Payback (years) 8.16
Cash Flow Analysis #2 - Include Financing Flows / Discount Rate = Cost of Borrowing:
Service Other Taxable Less
Year Revenues Costs Costs Income Taxes
1 535,800 (112,000) (38,000) 385,800 (106,095)
2 585,900 (155,100) (46,500) 384,300 (105,683)
3 612,600 (188,600) (54,100) 369,900 (101,723)
4 636,050 (202,900) (63,200) 369,950 (101,736)
5 644,112 (224,200) (68,900) 351,012 (96,528)
6 653,500 (241,600) (72,110) 339,790 (93,442)
7 668,200 (258,800) (77,800) 331,600 (91,190)
8 677,400 (272,100) (83,100) 322,200 (88,605)
9 689,800 (287,800) (88,900) 313,100 (86,103)
10 705,300 (298,400) (94,200) 312,700 (85,993)
11 712,900 (309,100) (97,800) 306,000 (84,150)
12 719,600 (319,400) (101,050) 299,150 (82,266)
13 722,800 (325,400) (104,900) 292,500 (80,438)
14 729,100 (329,900) (107,800) 291,400 (80,135)
15 734,300 (334,100) (110,100) 290,100 (79,778)

Economic Analysis #2
Present
Year Cash Flow Value Payback
0 (1,215,000) (1,215,000)
1 223,409 209,724 (1,005,276)
2 171,966 151,544 (853,731)
3 134,428 111,208 (742,523)
4 118,536 92,054 (650,469)
5 101,628 74,089 (576,380)
6 207,148 141,766 (434,614)
7 200,010 128,496 (306,118)
8 192,395 116,033 (190,085)
9 185,098 104,794 (85,291)
10 184,408 98,008 12,718 payback
11 179,050 89,332 102,050
12 173,284 81,159 183,209
13 167,963 73,849 257,058
14 166,665 68,790 325,848
15 165,223 64,017 389,865
Net Present Value 389,865

After Tax Cost of Borrowing => 6.53%


Reinvestment Rate for Project => 2.50%

Net Present Value $389,865


Modified IRR 6.38%
Discounted Payback (years) 10.87

Economic Assessment (based on Analysis #1)

Project has positive Net Present Value? Yes


Project has IRR in excess of cost? No
Project has a positive payback? Yes

Project must meet at least two of the three Economic Criteria, otherwise special
approval is required.

Risk Analysis (based on analysis #1)

Risk Premium Applied to Project 2.25%

Compare Risk Factor with Government Treasury Bond (lowest risk) to Project Risk Factor:
Risk Ranking = 1 for lowest possible risk up to 10 for highest possible risk
Probability of Accurate and Reliable Information - Gov't T Bond 1.00
Risk Ranking assigned to Gov't Treasury Bond ( 1 to 10) 1
Exponential power to apply to Risk Ranking is 2 - (a) 1
Risk Factor = (b) raised to the power (c) 1

Probability of Accurate and Reliable Information for Project 0.65


Risk Ranking assigned to project (1 to 10) 6
Exponential power to apply to Project 1.35
Risk Factor for Project 11

Assign probabilities to three possible outcomes for project:


P Pesimistic outlook, declining growth, slower volumes, etc. 10.00%
N Normal expected outlook as applied in analysis 70.00%
O Optomistic outlook, better than expected growth 20.00%
Total should equal 100.00% 100.00%

Enter Expected Cash Flows for different outcomes:

Standard Coeff of
Net Cash Flows Expected Deviation Variation
Year Pesimist Normal Optomist Value (Abs Risk) (Rel Risk)
1 321,100 339,580 361,200 342,056 30,106 0.088
2 271,600 290,205 311,950 292,694 30,291 0.103
3 237,200 254,921 276,705 257,506 29,762 0.116
4 224,850 241,486 261,890 243,903 27,901 0.114
5 211,800 227,256 248,605 229,980 27,951 0.122
6 190,450 207,148 227,690 209,586 28,057 0.134
7 184,100 200,010 220,280 202,473 27,325 0.135
8 176,350 192,395 211,650 194,642 26,549 0.136
9 169,150 185,098 204,880 187,459 26,935 0.144
10 168,340 184,408 203,090 186,537 26,078 0.140
11 163,100 179,050 197,450 181,135 25,763 0.142
12 158,350 173,284 192,770 175,688 26,038 0.148
13 153,300 167,963 185,200 169,944 23,958 0.141
14 152,820 166,665 183,990 168,746 23,512 0.139
15 152,650 165,223 183,690 167,659 23,671 0.141
Totals 2,935,160 3,174,689 3,471,040 3,210,006 403,897 0.126
Absolute Risk of Project (Std Deviation) 403,897
Relative Risk of Project (Coeff of Variation) 0.126

Revised Economic Analysis using Expected Values

Expected Present Recovery


Year Values Value Payback
0 (1,215,000) (1,215,000)
1 342,056 306,090 (908,910)
2 292,694 234,379 (674,531)
3 257,506 184,520 (490,011)
4 243,903 156,396 (333,614)
5 229,980 131,963 (201,651)
6 209,586 107,616 (94,035)
7 202,473 93,032 (1,002)
8 194,642 80,030 79,028 payback
9 187,459 68,973 148,001
10 186,537 61,417 209,418
11 181,135 53,368 262,786
12 175,688 46,320 309,106
13 169,944 40,095 349,201
14 168,746 35,626 384,827
15 167,659 31,675 416,502
Net Present Value 416,502

Net Present Value $416,502


Modified IRR 9.33%
Discounted Payback (years) 8.01
2
2
4
5
0
0

5
1
2
3
0
0

0
1
1
0
0

0
2
0
2
2
0
0
0

32

better serve customers


ce $ 500,000 towards

Tax Benefit
of Interest
12,375
10,307
8,053
5,597
2,919

d on the tax return


Tax Benefit
Depreciation
89,375
44,688
22,344
11,172
11,172
Less Net Add Back Working Cash
Taxes Income Depreciation Capital Flow
(16,720) 44,080 325,000 (29,500) 339,580
(60,995) 160,805 162,500 (33,100) 290,205
(79,379) 209,271 81,250 (35,600) 254,921
(90,564) 238,761 40,625 (37,900) 241,486
(85,356) 225,031 40,625 (38,400) 227,256
(93,442) 246,348 (39,200) 207,148
(91,190) 240,410 (40,400) 200,010
(88,605) 233,595 (41,200) 192,395
(86,103) 226,998 (41,900) 185,098
(85,993) 226,708 (42,300) 184,408
(84,150) 221,850 (42,800) 179,050
(82,266) 216,884 (43,600) 173,284
(80,438) 212,063 (44,100) 167,963
(80,135) 211,265 (44,600) 166,665
(79,778) 210,323 (45,100) 165,223
Net Tax Benefit Tax Benefit Loan Working Cash
Income Depreciation Interest Payment Capital Flow
279,705 89,375 12,375 (128,546) (29,500) 223,409
278,618 44,688 10,307 (128,546) (33,100) 171,966
268,178 22,344 8,053 (128,546) (35,600) 134,428
268,214 11,172 5,597 (128,546) (37,900) 118,536
254,484 11,172 2,919 (128,546) (38,400) 101,628
246,348 (39,200) 207,148
240,410 (40,400) 200,010
233,595 (41,200) 192,395
226,998 (41,900) 185,098
226,708 (42,300) 184,408
221,850 (42,800) 179,050
216,884 (43,600) 173,284
212,063 (44,100) 167,963
211,265 (44,600) 166,665
210,323 (45,100) 165,223
(a)
(b)
(c)
Capital Budgeting Analysis for
Medical Services USA
E Canadian Partnership
Project Information

Project Description > Expand Toronto Urban Centers


Project Benefits > Market expansion, new source of revenues, leverage of assets
Project Location > Toronto
Responsible Division > Canadian Division
Responsible Department > Marketing
Contact Person Name > Allen J. Herbert
Estimated Project Start Date > 04/01/92
Classification > 8
Justification > C
Priority > 3

Preliminary Review

Assign points from 0 to 5 for each of the following project attributes. 0 indicates that the
attribute does not apply to the project. 5 is the highest rating, indicating that the project
strongly meets this project attribute.

Financial Attributes:
F1 Project improves overall profitability of the company
F2 Project lowers cost structure
F3 Project will generate a rate of return
F4 Project improves asset utilization
F5 Other Financial Attribute __________________________________
F6 Other Financial Attribute __________________________________

Operating Attributes:
O1 Improves operating efficiencies
O2 Increases the customer base
O3 Improves overall customer service
O4 Improves competitive position of company
O5 Other Operating Attribute _________________________________
O6 Other Operating Attribute _________________________________

Contingency Attributes:
C1 Project has options that allow for change during life
C2 Project will positively impact company even if value is negative
C3 Project can be abandoned easily with some positive value
C4 Project permits several options to maximize value
C5 Other Cont Attribute _____________________________________

Miscellaneous Attributes:
M1 Expands Human Resource Capital
M2 Enhances workforce productivity
M3 Project meets a critical regulatory, security or specific need
M4 Project fits with company strategy and goals
M5 Probability of project success is very high / low risk
M6 Other Misc Attribute _____________________________________
M7 Other Misc Attribute _____________________________________
M8 Other Misc Attribute _____________________________________

Total Preliminary Points

Projects with point totals less than 15 may represent poor investments and require additional
approval before further analysis and processing. Projects with point totals between 15 and 20
require caution and careful analysis. Projects with point totals greater than 20 may proceed
with analysis and submission.

Project Summary

In order to establish a toehold position in the Toronto area, a joint venture investment will be
made since the current major provider in Toronto needs improved child care services for the
urban areas of Toronto. Medical Services USA will provide personnel and overall management
for urban child care. In return, Medical Services USA will share in the profits 50% / 50%. The Joint
Venture Agreement has a ten year term period.

Financial Analysis (all amounts are expressed in Canadian Dollars)


Convert
to U.S.$ *
Initial Relocation / Setup Costs $750,000 1.12 $840,000

Ten Year Projected Income Statement


Adj to
Year Sales Cost of Income Less Net Cash
(100%) Service before Tax Taxes Income Flow
1 ** 637,500 270,000 367,500 79,500 288,000 42,000
2 895,000 366,000 529,000 119,000 410,000 82,000
3 912,000 377,000 535,000 101,000 434,000 55,000
4 942,000 378,000 564,000 104,000 460,000 68,000
5 977,000 370,000 607,000 112,000 495,000 88,000
6 1,015,000 368,000 647,000 129,000 518,000 90,000
7 1,045,000 362,000 683,000 140,000 543,000 110,000
8 1,088,000 355,000 733,000 138,000 595,000 115,000
9 1,135,000 350,000 785,000 151,000 634,000 122,000
10 1,180,000 348,000 832,000 157,000 675,000 135,000

* convert from Canadian Dollars to U.S. Dollars


** partial year in 1992

Economic Analysis (U.S. Dollars)

Summarize Cash Outflows and Inflows for Project:


Cash Present
Year Flows Value Payback
0 (840,000) (840,000)
1 189,750 167,181 (672,819)
2 290,280 225,333 (447,486)
3 295,845 202,338 (245,148)
4 316,800 190,898 (54,250)
5 341,055 181,069 126,819
6 355,680 166,374 293,193
7 382,005 157,434 450,626
8 415,350 150,816 601,442
9 442,260 141,486 742,929
10 473,850 133,562 876,491
Net Present Value 876,491

Required Rate of Return for Project => 13.50%


Reinvestment Rate for Project => 3.50%

Net Present Value $876,491


Modified IRR 16.95%
Discounted Payback (years) 5.30

Economic Assessment

Project has positive Net Present Value? Yes


Project has IRR in excess of cost? Yes
Project has a positive payback? Yes

Project must meet at least two of the three Economic Criteria, otherwise special
approval is required.

Risk Analysis

Risk Premium Applied to Project 4.00%

Compare Risk Factor with Government Treasury Bond (lowest risk) to Project Risk Factor:
Risk Ranking = 1 for lowest possible risk up to 10 for highest possible risk
Probability of Accurate and Reliable Information - Gov't T Bond
Risk Ranking assigned to Gov't Treasury Bond ( 1 to 10)
Exponential power to apply to Risk Ranking is 2 - (a)
Risk Factor = (b) raised to the power (c)

Probability of Accurate and Reliable Information for Project


Risk Ranking assigned to project (1 to 10)
Exponential power to apply to Project
Risk Factor for Project

Assign probabilities to three possible outcomes for project:


P Pesimistic outlook, declining growth, slower volumes, etc.
N Normal expected outlook as applied in analysis
O Optomistic outlook, better than expected growth
Total should equal 100.00%
Enter Expected Cash Flows for different outcomes:

Standard
Net Cash Flows Expected Deviation
Year Pesimist Normal Optomist Value (Abs Risk)
1 132,000 189,750 198,500 177,500 55,685
2 227,300 290,280 311,100 279,740 66,708
3 239,100 295,845 315,200 286,498 60,421
4 244,050 316,800 340,500 304,538 76,871
5 267,800 341,055 368,500 329,603 79,304
6 285,200 355,680 387,500 346,015 79,171
7 307,900 382,005 416,900 372,203 84,006
8 329,100 415,350 460,900 405,175 100,391
9 363,300 442,260 484,800 433,155 92,352
10 380,050 473,850 517,100 461,213 105,845
2,775,800 3,502,875 3,801,000 3,395,638 800,754

Absolute Risk of Project (Std Deviation) 800,754


Relative Risk of Project (Coeff of Variation) 0.236

Revised Economic Analysis using Expected Values

Expected Present Recovery


Year Values Value Payback
0 (840,000) (840,000)
1 177,500 156,388 (683,612)
2 279,740 217,152 (466,461)
3 286,498 195,945 (270,516)
4 304,538 183,509 (87,007)
5 329,603 174,989 87,982
6 346,015 161,853 249,835
7 372,203 153,394 403,228
8 405,175 147,121 550,350
9 433,155 138,574 688,923
10 461,213 130,000 818,923
Net Present Value 818,923

Net Present Value $818,923


Modified IRR 16.58%
Discounted Payback (years) 5.50
3
2
4
4
0
0

1
4
4
3
0
0

0
2
0
0
0

0
0
0
3
2
0
0
0

32

management
/ 50%. The Joint

Estimated
Cash 50% Convert
Flow Share to U.S.$ *
330,000 165,000 1.15 189,750
492,000 246,000 1.18 290,280
489,000 244,500 1.21 295,845
528,000 264,000 1.20 316,800
583,000 291,500 1.17 341,055
608,000 304,000 1.17 355,680
653,000 326,500 1.17 382,005
710,000 355,000 1.17 415,350
756,000 378,000 1.17 442,260
810,000 405,000 1.17 473,850
Project Risk Factor:

1.00 (a)
1 (b)
1 (c)
1

0.6
6
1.4
12

25.00%
50.00%
25.00%
100.00%
Coeff of
Variation
(Rel Risk)
0.314
0.238
0.211
0.252
0.241
0.229
0.226
0.248
0.213
0.229
0.236
Capital Budgeting Analysis for
Medical Services USA
F Regulatory Compliance NE
Project Information

Project Description > Regulatory Compliance in NE


Project Benefits > Compliance
Project Location > Northeast Regional Office - Boston, MA
Responsible Division > Finance
Responsible Department > Finance
Contact Person Name > Carl Jackson, V.P. Finance
Estimated Project Start Date > 01/01/92
Classification > 9
Justification > E
Priority > 2

Preliminary Review

Assign points from 0 to 5 for each of the following project attributes. 0 indicates that the
attribute does not apply to the project. 5 is the highest rating, indicating that the project
strongly meets this project attribute.

Financial Attributes:
F1 Project improves overall profitability of the company
F2 Project lowers cost structure
F3 Project will generate a rate of return
F4 Project improves asset utilization
F5 Other Financial Attribute __________________________________
F6 Other Financial Attribute __________________________________

Operating Attributes:
O1 Improves operating efficiencies
O2 Increases the customer base
O3 Improves overall customer service
O4 Improves competitive position of company
O5 Other Operating Attribute _________________________________
O6 Other Operating Attribute _________________________________

Contingency Attributes:
C1 Project has options that allow for change during life
C2 Project will positively impact company even if value is negative
C3 Project can be abandoned easily with some positive value
C4 Project permits several options to maximize value
C5 Other Cont Attribute _____________________________________

Miscellaneous Attributes:
M1 Expands Human Resource Capital
M2 Enhances workforce productivity
M3 Project meets a critical regulatory, security or specific need
M4 Project fits with company strategy and goals
M5 Probability of project success is very high / low risk
M6 Other Misc Attribute _____________________________________
M7 Other Misc Attribute _____________________________________
M8 Other Misc Attribute _____________________________________

Total Preliminary Points

Projects with point totals less than 15 may represent poor investments and require additional
approval before further analysis and processing. Projects with point totals between 15 and 20
require caution and careful analysis. Projects with point totals greater than 20 may proceed
with analysis and submission.

Project Summary

A major regulatory change is expected to change certain services in the Northeastern United States.
In order to meet this new mandate, an investment is required in field personnel, training, and
equipment. Revenues from the new services are also forecasted based on demand in California
which adopted this regulatory change two years ago. The regulatory change is subject to future
modification and therefore, the project is only projected over two years on a month to month basis.
There is no initial investment required for this project.

Economic Analysis (Cash Flows by Month)

Monthly
Period Setup Service Misc / Total Net Cash
Date Revenues Costs Costs Taxes Outflows Flow

1 31-Jan-92 35,200 -16,000 -3,500 -2,500 -22,000 13,200


2 28-Feb-92 39,400 -5,000 -3,500 -2,000 -10,500 28,900
3 31-Mar-92 41,000 -3,500 -3,500 -2,000 -9,000 32,000
4 30-Apr-92 42,550 -1,500 -4,000 -1,750 -7,250 35,300
5 31-May-92 43,990 -1,500 -4,000 -1,750 -7,250 36,740
6 30-Jun-92 44,550 -2,000 -4,000 -1,750 -7,750 36,800
7 31-Jul-92 45,100 -4,500 -1,650 -6,150 38,950
8 31-Aug-92 46,990 -4,500 -1,650 -6,150 40,840
9 30-Sep-92 47,800 -4,500 -1,650 -6,150 41,650
10 31-Oct-92 48,650 -5,100 -1,500 -6,600 42,050
11 30-Nov-92 49,280 -5,100 -1,500 -6,600 42,680
12 31-Dec-92 48,300 -5,100 -1,500 -6,600 41,700
1992 Total 532,810 -102,000
13 31-Jan-93 47,100 -10,000 -5,800 -1,350 -17,150 29,950
14 28-Feb-93 45,500 -2,000 -5,800 -1,350 -9,150 36,350
15 31-Mar-93 44,100 -5,800 -1,350 -7,150 36,950
16 30-Apr-93 42,400 -6,200 -1,275 -7,475 34,925
17 31-May-93 41,000 -6,200 -1,275 -7,475 33,525
18 30-Jun-93 39,100 -6,200 -1,275 -7,475 31,625
19 31-Jul-93 38,500 -6,750 -1,205 -7,955 30,545
20 31-Aug-93 37,900 -6,750 -1,205 -7,955 29,945
21 30-Sep-93 37,100 -6,750 -1,205 -7,955 29,145
22 31-Oct-93 36,800 -7,000 -1,170 -8,170 28,630
23 30-Nov-93 36,400 -7,000 -1,170 -8,170 28,230
24 31-Dec-93 36,000 -5,000 -7,000 -1,170 -13,170 22,830
1993 Total 481,900 -109,250
Total 1,014,710 -211,250

Annual
Required Rate of Return for Project => 6.50%

Net Present Value


Rate of Return (IRR Annual Basis)
Discounted Payback Immediate

Economic Assessment

Project has positive Net Present Value? Yes


Project has IRR in excess of cost? Yes
Project has a positive payback? Yes

Project must meet at least two of the three Economic Criteria, otherwise special
approval is required.

Risk Analysis

Risk Premium Applied to Project 0.00% (Required for Compliance)

Compare Risk Factor with Government Treasury Bond (lowest risk) to Project Risk Factor:
Risk Ranking = 1 for lowest possible risk up to 10 for highest possible risk
Probability of Accurate and Reliable Information - Gov't T Bond
Risk Ranking assigned to Gov't Treasury Bond ( 1 to 10)
Exponential power to apply to Risk Ranking is 2 - (a)
Risk Factor = (b) raised to the power (c)

Probability of Accurate and Reliable Information for Project


Risk Ranking assigned to project (1 to 10)
Exponential power to apply to Project
Risk Factor for Project

Assign probabilities to three possible outcomes for project:


P Pesimistic outlook, declining growth, slower volumes, etc.
N Normal expected outlook as applied in analysis
O Optomistic outlook, better than expected growth
Total should equal 100.00%

Enter Expected Cash Flows for different outcomes:

Standard
Net Cash Flows Expected Deviation
Month Pesimist Normal Optomist Value (Abs Risk)
1 12,050 13,129 13,700 13,081 1,200
2 26,200 28,589 29,900 28,493 2,684
3 28,830 31,486 32,920 31,374 2,971
4 31,390 34,545 36,050 34,373 3,417
5 32,710 35,761 37,430 35,637 3,425
6 32,600 35,626 37,250 35,497 3,379
7 34,170 37,505 39,250 37,354 3,699
8 35,870 39,113 40,900 38,984 3,648
9 36,275 39,673 41,470 39,523 3,780
10 36,510 39,839 41,680 39,708 3,748
11 36,810 40,218 42,050 40,073 3,808
12 35,860 39,083 40,920 38,967 3,660
Annual Sub Total 413,063
13 25,620 27,919 29,200 27,830 2,594
14 30,850 33,702 35,240 33,582 3,189
15 31,170 34,074 35,630 33,950 3,242
16 29,350 32,033 33,510 31,926 3,017
17 27,960 30,583 31,920 30,457 2,889
18 26,300 28,695 30,010 28,599 2,691
19 25,120 27,565 28,850 27,456 2,715
20 24,470 26,878 28,140 26,769 2,672
21 23,690 26,019 27,300 25,926 2,619
22 23,150 25,422 26,700 25,337 2,570
23 22,660 24,932 26,200 24,845 2,565
24 18,230 20,054 21,100 19,990 2,075
Annual Sub Total 336,665
687,845 752,443 787,320 749,729 72,259

Absolute Risk of Project (Std Deviation) 72,259


Relative Risk of Project (Coeff of Variation) 0.096

Revised Economic Analysis using Expected Values

Expected Present
Dates Values Value
1 13,129 13,058
2 28,589 28,282
3 31,486 30,979
4 34,545 33,807
5 35,761 34,808
6 35,626 34,490
7 37,505 36,113
8 39,113 37,458
9 39,673 37,791
10 39,839 37,744
11 40,218 37,898
12 39,083 36,629
13 27,919 26,025
14 33,702 31,247
15 34,074 31,422
16 32,033 29,381
17 30,583 27,900
18 28,695 26,036
19 27,565 24,876
20 26,878 24,126
21 26,019 23,229
22 25,422 22,573
23 24,932 22,019
24 20,054 17,615
Net Present Value 705,507

Net Present Value $705,507


Rate of Return (IRR Annual Basis) 92.45%
Discounted Payback Immediate 0
2
3
4
3
0
0

2
3
3
2
0
0

3
1
0
0
0

0
0
5
2
1
0
0
0

34

rn United States.

in California

to month basis.

Present Present
Value Value
(simple calc) (functional)
13,129 13,129
28,589 28,590
31,486 31,488
34,545 34,551
35,761 35,771
35,626 35,642
37,505 37,527
39,113 39,144
39,673 39,714
39,839 39,889
40,218 40,280
39,083 39,155

27,919 27,980
33,702 33,788
34,074 34,173
32,033 32,140
30,583 30,698
28,695 28,815
27,565 27,695
26,878 27,018
26,019 26,168
25,422 25,582
24,932 25,103
20,054 20,204

752,443 754,244

Monthly
0.54% Calculate IRR (annual basis):

752,443 Annual Annual


123% Outflow Inflow
0
-102,000 532,810
-109,250 481,900

erwise special

Compliance)

k) to Project Risk Factor:

1.00 (a)
1 (b)
1 (c)
1

0.75
4
1.25
6

15.00%
65.00%
20.00%
100.00%

Coeff of Adjusted Adjusted


Variation Inflows Outflows
(Rel Risk)
0.092
0.094
0.095
0.099
0.096
0.095
0.099
0.094
0.096
0.094
0.095
0.094

0.093
0.095
0.095
0.095
0.095
0.094
0.099
0.100
0.101
0.101
0.103
0.104

0.096
Calculate IRR (annual basis):

Annual Annual
Outflow Inflow

-102,000 413,063
-109,250 336,665
Capital Budgeting Analysis for
Medical Services USA
Summarize Economic and Risk Analysis for All Projects

Project Required Preliminary Justification Priority


Ref Project Name Investment Points Code Code

A Diesel Generation System $182,080 27 F 2


B New Clinic in Kansas City $141,000 24 C 3
C Upgrade to DuBois Center $1,780,000 31 C 3
D Southeastern Upgrades $1,215,000 32 C 3
E Expand Toronto Urban Centers $840,000 32 C 3
F Regulatory Compliance in NE $0 34 E 2

* Provide additional narrative information on "strategic" reasons for making this investment since the return is less t

Using Solver for Program Constraints

Financial Modeling Textbooks provide useful examples of how Excel Solver can be used to solve for capital budget
set of constraints. The following example will illustrate how we could apply Solver for finding the right set of projects

Example:
Objective: Maximize Net Present Value of Projects
Contraints: Year 1: Only $ 200,000 can be spent on all capital projects
Year 2: Only $ 150,000 can be spent on all capital projects
Year 3: Only $ 120,000 can be spent on all capital projects
Year 4: Only $ 100,000 can be spent on all capital projects
Year 5: Only $ 75,000 can be spent on all capital projects

Five Projects require investments over five years and have the following Net Present Values:

Select?
Project 0 = No < - - - - - Five Year Capital Budgets for Each Project - -
Ref 1 = Yes Project Name NPV Year 1 Year 2 Year 3

A 1 Annual Marketing Program 650,000 45,000 40,000 38,000


B 0 IT Infrastructure Development 820,000 55,000 60,000 60,000
C 1 Executive Leadership 540,000 25,000 20,000 20,000
D 1 HR Capital Improvement 701,000 35,000 30,000 30,000
E 0 Product Research 490,000 50,000 45,000 42,000
Total (SumProduct) 1,806,385 99,051 85,282 83,672
Maximum Allowed Budget 200,000 150,000 120,000

We will enter the following constraints into Solver:

$ 45,000 A + $ 55,000 B + $ 25,000 C + $ 35,000 D + $ 50,000 E .LE. $ 200,000


$ 40,000 A + $ 60,000 B + $ 20,000 C + $ 30,000 D + $ 45,000 E .LE. $ 150,000
$ 38,000 A + $ 60,000 B + $ 20,000 C + $ 30,000 D + $ 42,000 E .LE. $ 120,000
$ 35,000 A + $ 58,000 B + $ 18,000 C + $ 28,000 D + $ 40,000 E .LE. $ 100,000
$ 35,000 A + $ 55,000 B + $ 17,000 C + $ 27,000 D + $ 40,000 E .LE. $ 75,000

Each of the above constraints recognizes that we can spend no more than what is budgeted each year. We also
have the equation we are trying to solve for:

Maximize NPV = $ 650,000 A + $ 820,000 B + $ 540,000 C + $ 701,000 D + $ 490,000 E

We will also use as our variables "0" for No and "1" for Yes as to which projects we should select given the above
constraints and equation. The "maximum" NPV will show up in our "set" cell which is cell D43.

Now go to the main toolbar, select Tools -> Solver and enter the following:

1. Target Cell is D43


2. Equal to: Select the Max button since we are solving for maximum values.
3. By Changing Cells: Select the range B38:B42 as our variables.
4. Subject to Constraints: Add two contraints as follows:
B38:B42 .EQ. Binary EQ or = (equal)
E43:I43 .LE. E44:I44 LE or <= (less than or equal to)
5. Click on Solve. The Find Solution dialog box may pop up. Click on Answer. Solver will change the variables
(which we first entered all as zero's in cells B38:B42) and produce a report (Answer Report 1)

Using Excel Solver, we would select Projects A, C, and D!


9.50% <= weighted average cost of capital
rate of return is less than weighted average cost of capital *
(years)
Project Rate of Payback Risk Relative Absolute
Value Return Period Factor Risk Risk

$34,761 10.07% 6.6 9.5 0.52 $164,674


$4,127 9.68% 19.0 18.5 1.26 $540,660
$715,502 11.12% 8.2 6.1 0.12 $531,419
$416,502 9.33% 8.0 11.2 0.13 $403,897
$818,923 16.58% 5.5 12.3 0.24 $800,754
$705,507 92.45% 0.0 5.7 0.10 $72,259

ent since the return is less than the cost of investments (cost of capital).

d to solve for capital budgeting program decisions given a


ding the right set of projects given a set of contraints:

Budgets for Each Project - - - - - >


Year 4 Year 5

35,000 35,000
58,000 55,000
18,000 17,000
28,000 27,000
40,000 40,000
77,154 75,000
100,000 75,000

LE: Less than or Equal to


geted each year. We also

uld select given the above

ll change the variables


Microsoft Excel 9.0 Answer Report
Worksheet: [CBAnalysis.xls]Summary
Report Created: 2/26/2003 9:58:29 AM

Target Cell (Max)


Cell Name Original Value Final Value
$D$43 Total (SumProduct) NPV 0 1,806,385

Adjustable Cells
Cell Name Original Value Final Value
$B$38 A 1 = Yes 0 1
$B$39 B 1 = Yes 0 0
$B$40 C 1 = Yes 0 1
$B$41 D 1 = Yes 0 1
$B$42 E 1 = Yes 0 0

Constraints
Cell Name Cell Value Formula Status Slack
$E$43 Total (SumProduct) Year 1 99,051 $E$43<=$E$44 Not Binding 100948.7
$F$43 Total (SumProduct) Year 2 85,282 $F$43<=$F$44 Not Binding 64717.94
$G$43 Total (SumProduct) Year 3 83,672 $G$43<=$G$44 Not Binding 36328.21
$H$43 Total (SumProduct) Year 4 77,154 $H$43<=$H$44 Not Binding 22846.16
$I$43 Total (SumProduct) Year 5 75,000 $I$43<=$I$44 Binding 0
$B$38 A 1 = Yes 1 $B$38=binary Binding 0
$B$39 B 1 = Yes 0 $B$39=binary Binding 0
$B$40 C 1 = Yes 1 $B$40=binary Binding 0
$B$41 D 1 = Yes 1 $B$41=binary Binding 0
$B$42 E 1 = Yes 0 $B$42=binary Binding 0