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Target Corporation Capital Budgeting Process and Project Selection Type Your Name 5/1/2016
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This is case study analyzed five different projects Target Corporation had to decide on capital spent for which project created the most value and the most growth for the company and its shareholders. By analyzing the financial statements and exhibits of each project, the solution determines the positives and negatives of each of these alternatives. The alternatives were Gopher Place, Whalen Court, The Barn, Goldie’s Square, or Stadium Remodel. It shows how only NPV and IRR are not the only drivers for project selection decision. It answers four specific questions as required by this case study.
This case solution answers the following questions as required by this Harvard Published Case Study
1.
How does Target’s business model compare with Wal-Mart’s and Costco’s? .....................................................3
2.
What is Target’s capital-budgeting process? Is it consistent with the company’s business and financial objectives? ............................................................................................................................................................3
3.
Explain what the dashboards tell you as a manager. Isn’t the NPV enough information for you to make a go/no-go decision? ................................................................................................................................................3
4.
Which of the five CPRs did you accept? Which project attributes did you consider as part of your decision? ....4
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1. How does Target’s business model compare with Wal-Mart’s and Costco’s? Target is a mass volume retailer that offered discount of branded products. There is no membership fee for buying at Target. On the other hand, Costco is a membership model and the fee account for 2% of total revenue and 72.8% of operating revenue. Similar model is also run by Sam’s Club, a subsidiary of Wal-Mart. Sam’s Club contributes 13% to Wal-Mart’s total revenue. Rest business of Wal-Mart is similar to Target. However, the stores of Target are more attractive than Wal-Mart and offer better shopping experience to its customers.
2. What is Target’s capital-budgeting process? Is it consistent with the company’s business and financial objectives? Target has set a goal of opening at least 100 new stores every year. In order to achieve this, the company needs to identify suitable location and steady flow of cash flows. The company has a team of real estate managers who are on a constant search mode to find the most suitable and viable opportunities which once captured are presented for approval to CEC. These decisions are very crucial for the organization as it has impact on future growth and cash flows. Hence real-estate managers’ incentives are also linked to success of approved project which can easily be tracked by reviewing actual vs. forecast (at the time of case presentation. Given the importance of this decision, the approval committee comprises of CFO, the President and CEO. All of Target’s capital investment decisions above $100,000 receive scrutiny of senior management. With the objective and goal in mind, the committee meets every month to have sufficient time for evaluating all proposals submitted by the real-estate managers. Evaluations are made based on NPV and IRR of individual investment and investment allocation is made based on capital rationing decisions. Besides such, the very large ticket size projects of worth $50 million and above are also reviewed by CEC but it finally required approvals of Board of Directors. This ensures that CEO and CFO are on top of the proposals submitted and are closely in track of performance of newly opened stores in order to achieve the objective of opening 100 new stores every year.
3. Explain what the dashboards tell you as a manager. Isn’t the NPV enough information for you to make a go/no-go decision? Senior Management has limited time for reviewing multiple things that are running simultaneously in the organization on an ongoing basis. Hence, dashboards are critical MIS which helps Senior Management in decision making without getting into details or day-to-day operations. The CPR dashboard gives many insights to CEC. For instance, the key element of the dashboard includes, differential discount rates being used for store cash flows (9%) and credit card cash flows (4%); break-up of sales into total sales, incremental sales and prototype sales; profit and loss summary with EBIT level information; detail on investments made into the stores with full break-up into land, sitework, building and others; demographics; competition details; NPV and IRR details at store level, credit card 3
level, prototype level; stores’ sensitivities with respect to critical parameters to NPV and IRR. Above information in dashboard, reveal that why NPV is not the only thing to consider while giving a decision. In addition to NPV, what becomes more important is also to consider the quality of assumptions behind the NPV and IRR and how a change in critical assumptions would affect the NPV and IRR. Besides financial value, each project also has strategic and qualitative value in terms of brand, social responsibility etc, hence dashboard becomes a critical element while submitting a CPR for evaluation.
4. Which of the five CPRs did you accept? Which project attributes did you consider as part of your decision? Of the five CPRs, the following three in my opinion should be accepted:
Gopher Place Whalen Court The Barn Goldie’s Square Stadium Remodel
Investment ($000) 23,000 119,300 13,000 23,900 17,000
NPV ($000) 16,800 25,900 20,500 300 15,700
Profitability Index 0.73 0.22 1.58 0.01 0.92
Decision Accepted Accepted Accepted Rejected Rejected
When projects are to be chosen out of multiple choices profitability index is the best attribute as it shows the NPV per dollar amount needed for investment. Of the given five CPRs, profitability index is highest in case of The Barn, third highest in case of Gopher Place and fourth highest in case of Whalen Court. In case of rejected CPRs the profitability index is second highest in case of Stadium Remodel and lowest in case of Goldie’s Square. As discussed earlier, NPV and IRR are not the only attribute for coming to decisions. Gopher represented a typical Target store with strong economics and hence should be accepted. Whalen Court although expensive, but is relatively less risky to achieve financial results. Barn has the highest profitability index and perceived to have high risk if a recession occurs due to unsatisfactory demographics which is not a likelihood case. Also with the land available to Target, the value-added was too high to ignore and reject the case. Goldie’s Square has negative NPV for the store (core operation) and a positive NPV for credit cards which make the overall NPV marginal positive and hence also increases the risk of customer bad-debts. Also the NPV would improve only if an established store in the vicinity is closed which is not a suitable proposition to consider. Stadium Remodel is rejected as it would be a difficult precedent to approve such an expensive remodeling case. Hence, it is not only financial which become relevant and important to accept or reject the project.
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