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Financial paper
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Running head: LEARNING TEAM DELIVERABLE 1
Pontrelli Recycling
Sara Doyle, Kevin Jackson, and Ali Lakhani
FIN/575
Michael Plesko
January 20, 2014
LEARNING TEAM DELIVERABLE 2
Pontrelli Recycling
Pontrelli Recycling, Inc. has a mission to “increase the efficiency of recycling
usable materials in order to create a better environment for all,” and to “create value and
a fair return on investment for shareholders” (Callahan, Stetz, and Brooks, 2007). A
project must always be aligned with the company’s strategy and financial goals. When
devising any new project, a company can refer to many available resources for the
information needed for the plan by reviewing financial sheets and documents. In the
upcoming project for Pontrelli Recycling the high level cost estimate for the project is
$8.8 million. In the following project plan overview, the details of the project will be
reviewed.
Debt and equity financing are two methods that may be employed by a company
to obtain necessary capital for projects. Equity financing uses investors to obtain
necessary funds. Equity financing does not have to be paid back like a loan and leaves
more cash on hand for a company. While this method sounds appealing for those reasons,
equity financing can lead to less control and ownership of a company, higher returns to
be paid out to investors in the long run, and a longer financing process. Debt financing
uses loans from banks or other financial institutions to acquire funds. By using debt
financing, a company is able to maintain control and ownership of their company, use
interest on the loan as a tax deductible, and plan for known repayment figures. Pontrelli
Recycling can take advantage of the benefits of both of these methods for financing, and
reduce their disadvantages by using both methods to fund their upcoming project. They
can turn to investors for a portion of their financing and use banks for the other portion of
financing.
LEARNING TEAM DELIVERABLE 3
One major part of creating a project proposal is being able to measure the value of
the company. Pontrelli Recycling will need to determine the value of their company to
assist in determining credit worthiness, tax purposes, and to be able to present their
current status to potential lenders or investors. To measure value, a company can use
either the economic value added (EVA) or the market value added (MVA)approach.
“Economic value added can be calculated as the difference between the company’s net
operating profit after tax and a portion of the amount of capital invested in the business”
while “the market value added can be calculated as the difference between the company’s
market value and the amount of capital invested in the business” (Hanks, n. d.). The
MVA measures the “operational capabilities of a company’s management” and the EVA
measures the “opportunity cost of alternative investments,” and the company’s efficiency
of management (Hanks, n. d.).
Weighted Average Cost of Capital.
Weighed average cost of capital (WACC) is a composite of the individual costs of
financing incurred by each capital source. The firm WACC is a function of (1) the
individual cost of capital, (2) the capital structure mix, and (3) the level of financing
necessary to make the investment (Titman, Keown, & Martin, 2011). WACC is
calculated by multiplying the after cost of debt to the proportion of capital raised by debt.
Multiply the cost of preferred stock to the proportion of capital raised by preferred stock,
and then multiply the cost of common stock to the proportion of capital raised by
common stock. The formula for WACC is:
WACC= (after tax cost of debt X proportion of capital raised by debt)+(Cost of preferred
stock X proportion of capital raised by preferred stock)+(Cost of common stock X
LEARNING TEAM DELIVERABLE 4
proportion of capital raised by common stock).
The advantage of using the WACC method is it is familiar to mot business executives.
The WACC minimizes estimation cost, as there is only one cost of capital calculation for
the firm. In addition, using WACC reduces the problem of influence cost issues (Titman,
Keown, & Martin, 2011). However the weaknesses of a firm using the WACC method is
(Titman, Keown, & Martin, 2011):
WACC does not adjust discount rates for differences in project risk
WACC does not provide for flexibility in adjusting for differences in project debt
in the capital structure.
WACC is used to value the entire firm, it used as a starting point to determine the
discount rate for project investments. In addition, the WACC is the appropriate rate to
use when evaluating the firm performance to determine if the firm has created value for
its shareholders.
Project Viability
To calculate the cash flows for the project a cash flow statement has to be created
for Pontrelli Recycling Inc. The cash flow statement shows the projected cash flows for
Pontrelli Recycling Inc. project (Callahan, Stetz, & Brooks, 2007):
Cash Flow Statement
2007 2008 2009 2010Net Income 2,205,535 3,413,387 5,296,138 8,532,792Depreciation and Amortization
(7,500,000) 0 0 0
Acct. Receivable
(86,406) (90,726) (95,263) (100,026)
Inventory 60,759 63,580 66,767 70,105Prepaid Expenses
0 0 0 0
LEARNING TEAM DELIVERABLE 5
Acct. Payable 27,265 29,991 49,485 56,908Taxes Payable 31,402 66,332 103,404 177,682Customer Deposit
0 0 0 0
Net Cash Flow Provided by Operating Activities
(5,261,798) 3,455,564 5420531 8737461
Net Property, Plant, and Equipment
0 0 0 0
Other Assets (19,791) (21,769) (35,920) (41,308)Net Cash Flow Provided by Investing Activities
(19,791) (21,769) (35,920) (41,308)
Borrowings 7,522,016 (839,806) (752,358) (673,482)
Common Stock/Equity
0 0 0 0
Net Cash Flow Used by Financing Activities
7,522,016 (839,806) (752,358) (673,482)
Change in Cash 2,258,247 2,593,989 4,632,253 8,022,671Beginning Cash 5,402,551 7,608,086 11,021,473 16,317,611
Ending Cash 7,660,798 10,202,075 15,653,726 24,340,282
The projected cash flows for Pontrelli Recycling Inc., project is as followed:
2007 Cash Flow- 7,660,798
2008 Cash Flow- 10,202,075
2009 Cash Flow- 15,653,726
2010 Cash Flow- 24,340,282
Using these projected cash flows the financial manager can calculate the net present
value (NPV) of the project to obtain the present value of future cash flows. The initial
cash outflow is 8.8 million dollars, and the discount rate is 18% (8% loan financing +
10% equipment amortization). NPV is calculation is:
LEARNING TEAM DELIVERABLE 6
-Cash outflow+ Cash inflow1/(1+discount rate)+Cash inflow2/ (1+discount rate)2+Cash
inflow3(1+discount rate)3+Cash inflow4(1+discount rate)4.
To calculate the profitability index Pontrelli Recycling Inc. will take the present value
of future cash flow from calculating NPV and divide by the cash outflow of 8.8 million
dollars:
2007 present value-6,492,202
2008 present value-7,326,971
2009 present value-9,527,341
2010 present value-12,554,447
The total present value of future cash flow is 35,900,961 divide this amount by the
cash outflow of 8.8 million, and the profitability index is 4.08. According to Titman,
Keown, and Martin (2011), “When the profitability index is greater than one, the NPV
will be positive, so the project should be accepted. When the profitability index is less
than one, which indicates a bad investment, NPV will be negative, and the project should
be rejected. Because the profitability index for Pontrelli Recycling Inc. is 4.08 the
project should be accepted.
Alternate Capital Structure
Pontrelli Recycling Inc. can use economic value added as an alternate capital
structure instead of the traditional WACC. The economic value added is the difference
of net operating profit after taxes (NOPATO) minus the capital charge (CC). However,
to obtain the capital charge, Pontrelli Recycling Inc. would use the product of WACC and
multiply the beginning balance of the firm’s capital or equity (Callahan, Stetz, & Brooks,
2007). According to Callahan, Stetz, and Brooks (2007) economic value added shows
LEARNING TEAM DELIVERABLE 7
the amount of value that is created or destroyed by Pontrelli Recycling Inc. for the period
of operations. Pontrelli Recycling Inc. can use the EVA to see if the project would
increase or decrease value to the firm for years the project is initiated.
Alternate Project Budget
The budget made by Pontrelli and the actual projections of what the project
is going to be over by almost six percent. In creating an alternative budget it is
important to first see where the pervious budget was and where the actual
projection costs of the project are. Then a new budget can be made that takes that
into account so that the projections and budget are not too far off from one another.
The current budget takes into account: Project Initiation and Planning, Plant
Equipment, New Trucks, Construction, Installation, Process Review and Change,
Project Management, Training, New Equipment, Construction and Renovation, and
Training and Change Management. All together, there is roughly 7.5 million dollars
budgeted for this specific project. However, the project is estimated actually cost 8.8
million dollars. When creating an alternate budget it is important to take this into
account.
Currently, there is $100,000 budgeted for Project Initiation and Planning.
The new budget will allocate $150,000 for Project Initiation and Planning. Next,
Plant Equipment is budgeted at $ 5 million, so now it will be taken up a bit to 5.5
million dollars. New Trucks have a budget of $750,000 so to take into account the
high costs, the new budget will be $850,000. Construction is currently budgeted at
$800,000 and now the new budget will be 1 million dollars.
LEARNING TEAM DELIVERABLE 8
Next for Installation, the budget is $450,000, but now since the project
estimate is going to be higher, the company needs to allocate $525,000 as a new
budget for Installation. Process Review and Change is currently budgeted at
$162,000, but now the company needs to increase that budget to $200,000. Project
Management can be increased to $200,000 as well to account for the new project
estimates. Training is budgeted for $125,000, and now it will be changed to
$200,000 to include the new high cost project estimates. So now, the budget for the
project has actually increased to $8,625,000 and the Project Estimate remains at
$8.8 million. Now there is only one percent to two percent difference between the
Project Estimate and the Budget Estimate. There are still constraints to this.
The constraints to this budget are that the project estimate is still way over
the actual budget that Pontrelli has sent. When it comes to any one of these
categories, if corners are cut the entire project could suffer. Planning and Project
Initiation is one place where costs can be cut. However when it comes to
construction, installation, and training the full resources of money are going to be
needed or the staff will not be trained and equipment will not be installed properly.
In the long run, this could have affects on the customer experience, which could lead
to a loss in sales for the company.
Project Budget Plan
“An alternative plan to manage the project budget can include using
budgeting as a control tool instead of overestimating or underestimating the
project” (Eichenbeger, 1998, p. 269). When using the budget as a control method, it
allows the project manager to be able to manage the costs of the project more
LEARNING TEAM DELIVERABLE 9
closely and not allowing the actual cost of the project to be that much higher than
the projected budget. This can keep the project from becoming a risk factor the
company.
LEARNING TEAM DELIVERABLE 10
References
Callahan, K.R., Stetz, G.S., & Brooks, L.M. (2007). Project Management
Accounting:Budgeting, Tracking, and Reporting Cost and Profitability . Hoboken,
N.J.: John Wiley & Sons, Inc.
Eichenberger, J. (1998). Project management, part III budgets for projects. AAOHN
Journal, 46(5), 268-70. Retrieved from
http://search.proquest.com/docview/1013462577?accountid=35812
Hanks, G. (n.d.). Market Value Added Vs. Economic Value Added Chron.com.
Retrieved January 18, 2014, from http://smallbusiness.chron.com/market-value-
added-vs-economic-value-added-72854.html
Titman, S., Keown, A.J., & Martin, J.D. (2011). Financial Management:Principles and Applications (11th ed.). Boston, M.A.: Prentice Hall