Target Corporation Capital Expenditure Committee
In modern corporations, various projects compete for the same source of capital allocated for new investments. In preparing an analysis for a Capital Expenditure Committee, the two most important predictive financial metrics used are Net Present Value (NPV) and Internal Rate of Return (IRR). NPV is the present value of the project's cash inflows minus the present value of the project's cash outflows. It indicates the expected impact of the project on the value of the firm. A positive NPV increases the value of the firm. When comparing among mutually exclusive projects, the highest NPV is key in decision making. The IRR is that discount or interest rate which will cause the present value of all future cash flows to equal the incremental investment. In other words, it's the discount rate at which the NPV of a project eventually equals zero. All projects with an IRR greater than the cost of capital should be accepted. When comparing projects, the highest IRR is most attractive. It is critical for any CEC to understand how to utilize these metrics. NPV is typically better when comparing mutually exclusive project alternatives. It implicitly assumes that the project's cash flows can be reinvested at the firm's cost of capital. This is probably a more realistic assumption. The IRR metric implicitly assumes that the cash flows can be reinvested at the project's IRR. In short, any corporation must make critical decisions regarding how to invest its resources. Through a proper understanding of predictive business metrics, various potential investment decisions can be thoroughly analyzed and the best predicted outcome can be realized for the interests of the corporation.
Gopher Place:
Brief Statement: This location is a $23 million investment in a growing, highly favorable market of 70,000 people which has grown 27% in the last five years. Target is currently highly present in the trade area with a 5 store density. Furthermore, Wal-Mart is planning on moving into the market with plans to build two supercenters in the next few years. Based on predications, the predicted value of this investment is worth the cost, despite other factors such as negative impact on other Target stores and encroachment of competitors.
Key Facts: Investment - $23 million; Base NPV -- 16.8 million; IRR -- 12.3%; 19% of sales are forecasted to come from existing Target stores; NPV achievable w / sales 5.3% below R&
Identification of Possible Alternatives and Analysis -- It is critical that other alternatives be explored in considering the predictive performance of Gopher Place and its effect on our surrounding stores: 1) As the IRR of the store is encouraging at 12.3%, steps should be taken to mitigate the effect the store would have on other Target stores possibly through consolidation or investment in a Target Supercenter; 2) To mitigate competitor encroachment steps should be taken to strengthen market presence before Wall-Mart establishes its presence a year or two after us; 3) The most exposed area of the project according to the predications is potential overrun of construction costs. Efforts should be mitigated this risk to ensure project profitability.
Recommendation of Best Alternative -- I would recommend that as Target has a high market density in Gopher Place, 19% of sales will come from existing stores and that we will be competing with larger Wall-Mart super centers in the near future, that consolidation of existing Target resources into the Gopher Place project should be considered to establish a supercenter. This decision will create new market presence that will sell items not offered by existing stores and shield Target by establishing market presence before Wall-Mart super center competition arrives in one or two years.
Reflection on Broader Implication -- This analysis has larger implications as it forces management to examine their investment in light of changing market conditions. Gopher Place is a locale in transition with significant population expansion and change and new stores coming into the city over the next few years. By analyzing both the predicted value of the project as well as it its impact on existing stores, management can look at the health of Target in a larger sense rather than thinking of only one store. Also, by taking into account the impact of Wall-Mart's presence will have on the project, management can consider how best to alter their strategy. The idea of creating a Target Supercenter is key as it will decrease strain on existing stores as it will offer unique product lines, thereby ensuring novel customers rather than drawing from other stores, as well as establish a Target brand in the market before...
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