Capital budgeting & structure, FFS & project differentiation methods

JWI 530 Financial Management I, week 9 summary, 3/10/13

Fundamentals of capital budgeting process and ways to achieve target capital structure with right Debt/Equity mix made this a very interesting week. FFS method for financial bounding of best/nominal/worst case scenarios equips me with a powerful framework to forecast and lead a firm. Identification of parameters with which projects can be distinguished adds to my tool set.

excellent week...insightful discussions...takeaways below
Dr DP

I. Financial planning methodology.
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- move away from setting targets arbitrarily based primarily on past data and colored by inward-looking views of some executives.
Instead, the firm's growth and incentive compensation targets should be based on a rigorous analysis of external marketplace dynamics,
anticipated moves of competitors and an accurate forecast of the future.

- adopt the Forecasted Financial Statements (FFS) methodology
to project a complete set of financial statements and bound the financial metrics by envisioning future scenarios:
a bedrock case (conservative), a nominal case (attainable), an optimistic case (rosy) and a pessimistic case (worst case).
The FFS method will be critical to optimize operations with which the firm's intrinsic value and the stock price can be steadily improved.

- have a never-ending focus on the linkages between corporate strategy, business planning and financial forecasting
to continually elevate the game and drive the firm to higher and higher performance.

- improve the firm's productivity and employee morale with these changes

B. There are several factors that need to be taken into account in making a choice between two projects
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(1) Potential for financial returns - this is just one of the important factors but in my opinion it should not be the first consideration.
(2) Strategic fit & Industry situation- First and foremost, the manager should ask if it makes strategic sense for the firm to engage in either of the projects (Welch, 2005). The more strategic a project the more attractive it is for the firm's future. For example, IBM realized that its PC business which was getting commoditized in the marketplace was no longer strategically important and decided to sell the PC business unit though it was at times profitable (http://news.cnet.com/ibm-sells-pc-group-to-lenovo/2100-1042_3-5482284.html).
(3) Debt/Equity financing mix - the more leveraged a project is, the more risk it could pose for the firm. Understanding the D/E financing mix for the projects would help to weed out the weaker project (http://educ.jmu.edu/~drakepp/principles/module6/capbudtech.pdf)
(4) Uncertainty of cash flows - all financial models such as NPV are based on assumptions about cash flows. The impact of uncertainty in cash flows needs to be assessed carefully for the projects. If one project carries higher uncertainty, it would become possibly less attractive (http://educ.jmu.edu/~drakepp/principles/module6/capbudtech.pdf)
(5) Payback period (Ehrhardt & Brigham, 2009) ie liquidity of investment - the time it takes to get back the investment is an important metric to consider. If one project takes much longer to payback, uncertainty associated with it will increase and thereby make it less attractive.
(6) Ethical considerations - if one project makes money by not following environmental standards (eg. one dairy farm could use rGBH growth harmone to increase milk production while another would not) then it should be de-prioritized.
(7) Competitive advantage
(8) IP

C. Manage the capital structure
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Achieve target structure for Debt and Equity taking tax benefits into account

D. Capital budgeting process
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Use capital judiciously to replace, expand, invest, comply