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Genesis Energy Capital Plan Report

Module 5 Assignment 2

Argosy University Online

Katrina Caver

The decision on capital outlays is among the most significant a firm has to make. A decision to build a new plant or expand into a foreign market may influence the performance of the firm over the next ten years. The capital budgeting decision includes the planning of expenditures for a project with a life of at least one year and usually considerably longer. Capital budgeting assists with the decision making of how a firm should invest its capital.

Different capital budgeting alternatives that are used includes the payback period, which calculates the amount of time it will take before the cumulative net cash flows are equal to the initial cost of the investment (Argosy Online University, 2012); accounting rate of return (return on investment, An indicator of profitability that is measured by dividing the accounting net income by the amount invested (AccountingCoach, 2004-2015)); discounted payback period(examines the time that is required to cover the investment of the project considering the present value of all the cash inflows); net present value(measures the present value of all the cash inflow from the project and compare the same with the initial investment); profitability index(measures the present value of cash inflows at the required rate of cash inflows at the rate of return that is required to for the initial cash outflow for the investment. However, if the present value of cash inflows is positive, then the project is accepted; if the project is negative, then the project is not accepted.

Upon evaluating the capital budget, the outcomes include cost of debt at eight percent, cost of equity at ten percent, short-term interest rate at eight percent, long-term interest rate at nine percent, and long-term equity interest rate at ten percent. Operating projections for a project is utilized to establish a forecast for cash flows that would underpin calculations of net present value, internal rates of return, payback period, and other investment metrics. The purpose of forecasting cash flows is to capture the incremental effect of a proposed project. Each project’s cash flow forecasts does not include depreciation expenses and cost that would be incurred regardless of whether a given project was undertaken or not. High, medium, and low risks categories for each division were associated with a corresponding discount rate set by the capital budgeting committee in consultation with the corporate treasurer.

The weighted average cost of capital is another method to evaluate proposed projects and capital budgeting. By computing a weighted average, the company can decide the interest for every dollar that is invested. Cost of capital assist with the determination of the minimum rate of return a company is expected to make from the project. Weighted average cost of capital is the weighted average of different components. Proper changes needed to be made based on the risk of the project. If a project is riskier than normal projects, increase the WACC can be increased; but if it is less risky, decrease the WACC. There is an allowance for multiple risk factors in the WACC (Brigham, 2004). The WACC would be different if it is computed in the form of retained profits as compared to the form of equity. The dividend policy also impacts WACC.

Weighted average cost of capital can be thought of as the rate of return that is required by the suppliers of capital to attract their funds to the firm. If the risk is held constant, projects with a rate of return above the cost of capital will increase the value of the firm. Richard (2003) states, “ Weighted average cost of capital calculated on the cost of different long-term financing of the company to the proportion of the respective finance held by the company.” There are a few components that is involved with determining the weighted average cost of capital are cost of debt (the cost that creditors of the firm demand on their borrowings); cost of preferred stock (determined by the dividend paid/the present value of the stock); and cost of equity (computed by the dividend growth model as well as through CAPM). Previously, we discussed the two models that include the CAPM model and the dividend growth approach. The cost of retained profits don’t include any flotation cost, which is included in the cost of capital of common stock when the new shares are issued. Based upon all computations of all components, the cost of capital for the company is 9.43%.

With all projects, we can state that Project C is determined to be the best choice, which results in the highest net present value of $2083.18, internal rate of return seventeen percent, and the payback period of 6.25 years. For the proposed project, it has three equipments. The company has three different categories, which includes automatic, semi-automatic, and manual. Upon examining the cash flows of the projects, equipment 1 obtains the highest net present value of $1665.69, internal rate of return thirty-three percent, and a payback period of 5 years. Equipment 1 would be considered an acceptable solution. Unlike equipment 1, the company has two option (standard or top of line) should not choose equipment 2, which has net present value $2998.42 and internal rate of return twenty-nine percent. For equipment 3, the company has three options. Even though the three equipments give negative returns, the three-man machine has the lowest negative return, and therefore, it should be an acceptable option. As a word of advice, the company should consider monitoring all financial and non-financial performances, which can be accomplished by using a scorecard. “The balanced scorecard supplemented traditional financial measures with criteria that measured performance from three additional perspectives—those of customers, internal business processes, and learning and growth”, (Kaplan & Norton, 2007). This can assist with improvement of reaching a net present value of $1452.17 as compared to a net present value of $635.89 from the contract overview. Utilizing a balanced scorecard, which includes perspectives, which is listed in the chart below, can complete the measuring of performances. Once again, the company will be eligible to review performances of all components and see which areas needs adjustments. After this thorough examination, the company should consider following the strategic operating plan.

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