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Performance Boating Products

Essay by   •  May 11, 2011  •  Case Study  •  1,292 Words (6 Pages)  •  2,255 Views

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Performance Boating Products, Inc.

Overview:

Performance Boating Products (PBP) is a manufacturing company that produces attachments, including boat hulls and motors, for new and retrofitted boats. PBR is currently considering three independent projects, that would increase their production and sales. The first, Melville, would involve the construction of a new warehouse. The second, Broadside, is a new facility that would increase the availability of products. The last project, Turbine, would be a new part produced at one of PBP's existing facilities. PBP has brought in Sam Cutlowe to evaluate the three projects and provide recommendations on which would be beneficial for the company to proceed with.

Project Comparison:

All three of PBP's options fall into the "expansion of existing projects or markets" category of capital budgeting. They are all expenditures to increase output of existing products or to expand distribution facilities in markets now being served. Since expansion decisions are more complex, a detailed analysis is required before a decision can be made. We have used the following criteria to examine the projects:

* Net Present Value (NPV): How much a project contributes to shareholder wealth.

- Independent Projects: Accept if NPV exceeds zero.

* Internal Rate of Return (IRR): The rate that forces NPV to equal zero.

- Independent Projects: Accept if IRR exceeds the WACC.

* Modified Internal Rate of Return (MIRR):Similar to IRR, but based on the assumption that cash flows are reinvested at the WACC.

- Independent Projects: Accept if MIRR exceeds the WACC.

* Regular Payback: The number of years required to recover the funds invested in a project from its operating cash flows.

- Independent Projects: Payback simply tells us when we recover our investment; It is not used to accept or reject a project unless the company has a specific payback requirement.

* Discounted Payback: Cash flows are discounted and then used to find the number of years required to recover the funds invested in a project.

- Independent Projects: Like regular payback, discounted payback is only used to find out how many years it will take to recuperate our investment.

Based on the criteria above, we have calculated the following numbers for PBP's capital budgeting projects :

PBP Project Comparison

Melville Broadside Turbine

NPV $11.20 $10.58 $17.56

IRR 16.7% 17.4% 15.6%

MIRR 11.6% 11.8% 11.5%

Payback 5.78 5.56 6.14

Discounted Payback 9.19 8.69 10.16

We know that for independent projects the NPV, IRR and MRR always reach the same accept or decline decision. Therefore, based on the calculations alone, we would be able to accept the Melville and Broadside projects. Both of these projects have IRRs that exceed the WACC, which means that the return on the project will be greater than the cost. This will increase the money for the firm's stockholders and therefore, increase the stock price.

However, the Turbine project should not be accepted. Because the projects are independent, they would be done starting with the one that has the highest rate of return and then in descending order of IRRs from there. In other words, we would do the Broadside project first, then the Melville, and then finally the Turbine project. However, by the time funding would need to be raised for the Turbine project, it would not be worth it. Halfway through the project the cost of additional capital would be greater than the rate of return we would expect from the project. Therefore, the turbine project should be rejected.

Cost of Capital:

PBR's cost of equity was estimated in three ways, the first being the Discounted Cash Flow (DCF) method. In this method, the future cash flow projections are discounted to arrive at a present value, which is used to evaluate the potential for the investment. When firms are expected to grow forever, this method

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