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**Homework #5 – Capital Budgeting **** **

Instructions: This assignment asks you to apply concepts related to Capital Budgeting to answer the following questions. Make sure to pay attention to the capital budgeting method specified in each part of each question to properly apply formulas/equations and rationale for each capital budgeting decision. **As a reminder, I do not require that you submit your calculations, however your calculations should be built into your written responses. **

Q1. You are the finance director for an expansion team in the United Soccer League (USL). Your organization is trying to determine if it should invest in new LED display boards that wrap around the perimeter of the playing field. There is a pretty big initial cost to this project: $500,000. However, there is also the potential to earn new revenues from expanded sponsorship agreements. You estimate these new LED boards will have an expected useful life of 5 years and produce the following amounts of incremental cash flow per year:

Year 1 = $150,000

Year 2 = $150,000

Year 3 = $125,000

Year 4 = $100,000

Year 5 = $100,000

- Calculate the cumulative cash flow of this project for each year

- Assume an annual cost of capital of 5% and calculate the discounted cumulative cash flow of this project for each year

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- Assume organizational standards dictate an acceptable payback period of 3 years for any capital project. Would you accept this capital project using the payback period method? Would you accept this capital project using the discounted payback period method? Why or why not?

- Using the NPV and IRR methods, would you accept this capital project? Why or why not?

Q2. You are the finance manager for a DII college. You are debating whether to invest in a new track & field facility. Initial cost projections for the project are $1,500,000. Due to the ability to host track & field events at this facility, you estimate the following incremental cash flows for this project:

Year 1: $250,000

Year 2: $500,000

Year 3: $750,000

Year 4: $200,000

Year 5: $200,000

- a) If the organization set an acceptable payback period of 4 years on a capital project, would you recommend investing in this project using the payback period method? If you assumed an annual 6.5% cost of capital, would you recommend investing in this capital project using the discounted payback period method following the same institutional guidelines for an acceptable payback period? Why or why not?

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- Let’s assume this track & field facility has an expected useful life of 5 years before major renovations would be required. Using the NPV and IRR capital budgeting methods, would you recommend accepting this capital project? Why or why not?

- Due to the rising cost of materials, the initial project cost is now estimated at $2,000,000. If estimated incremental cash flows, cost of capital, and expected useful life of the facility remain the same, would you recommend accepting this capital project given this new project cost using the NPV and IRR capital budgeting methods? Why or why not?

Q3. You have decided to embark on a new business venture by developing a name, image, and likeness (NIL) consulting firm to educate college athletes, athletic departments, and NIL collectives on new state, federal, and athletic association NIL policies. Based on market conditions, you estimate a constant 7% annual cost of capital. You expect a useful project life of 5 years before you may need to rethink your business model. You project the following cash flows from business operations for years 1-5 of your business:

Year 1 = $50,000

Year 2 = $65,000

Year 3 = $100,000

Year 4 = $150,000

Year 5 = $150,000

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- If you estimate this new business venture will require $400,000 in start-up costs, would you recommend investing in this capital project using the NPV/IRR capital budgeting methods? Why or why not?

- If you estimate this new business venture will require $350,000 in start-up costs, would you recommend investing in this capital project using the NPV/IRR capital budgeting methods? Why or why not?

- If you estimate this new business venture will require $450,000 in start-up costs, would you recommend investing in this capital project using the NPV/IRR capital budgeting methods? Why or why not?

Q4. The Cleveland University Bobcats, a Power-5 college athletics program, is planning to renovate its basketball arena. The university expects this renovation to cost $75 million. Due to enhanced premium seating and luxury box options for men’s and women’s basketball games at the arena, as well as net increases in merchandise and sponsorship sales, the university projects this renovation will lead to incremental cash flows of $11 million during Year 1 of the renovated arena. After Year 1, incremental revenues are projected to increase 2% year-over-year due to price increases related to inflation. The university expects a 6% annual cost of capital for this project.

- Given this information, and assuming an expected useful life of 8 years for these arena renovations, would you recommend investing in this capital project using the NPV/IRR capital budgeting methods? Why or why not?

- Based on new economic data, you now expect incremental revenues to increase 3% year-over-year after Year 1 of project competition. Assuming all other information remains the same (project cost, annual cost of capital, Year 1 incremental revenue), would you recommend investing in this capital project using the NPV/IRR capital budgeting methods? Why or why not?

Q5. This capital budgeting analysis is based on article from Maxcy and Larson (2015) where they investigated whether a new football stadium for Colorado State University would result in an acceptable capital project for the university. We will be analyzing the base projection scenario with investment cost less donations and no attendance adjustments.

Here is the relevant data to consider for this analysis:

Initial stadium project cost = $146,050,000

Projected annual incremental revenues = $11,316,000

Expected useful life of the project = 30 years

Calculate the NPV and IRR for this project under the following scenarios:

- Annual Cost of Capital = 2.5%
- Annual Cost of Capital = 5%
- Annual Cost of Capital = 7.5%
- Annual Cost of Capital = 10%

Based on your analysis, under which cost of capital scenarios would you accept this capital project? Under which cost of capital scenarios would you reject this capital project? Explain your reasoning.

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__Discussion Questions__

- For the first assignment question (LED display boards for a USL team) what was your capital budgeting decision for this project using the following capital budgeting methods: a) payback period method (assuming an acceptable payback period of 3 years); b) discounted payback period method (assuming an acceptable payback period of 3 years); c) NPV/IRR method (assuming an expected useful life of 5 years).
.__Explain your reasoning for each answer__

- For the second assignment question (new track & field facility for a DII college) how did a change in the project cost estimate impact your recommendation on whether to accept the capital project? What was your capital budgeting recommendation (using the NPV/IRR method and assuming an expected useful life of 5 years) when the initial project cost was estimated at $1.5 million? What was your capital budgeting recommendation (using the NPV/IRR method and assuming an expected useful life of 5 years) when the initial project cost was estimated at $2.0 million?
__Explain your reasoning for each answer.__

- For the third assignment question (NIL education consulting firm), discuss how changes in initial project cost estimates impacted your decision on whether to recommend the capital project using the NPV/IRR capital budgeting method. How does this tie back to the concept of performing a sensitivity analysis within a budgeting process?

- For the fourth assignment question (new basketball arena for Cleveland University) how did a change in incremental revenue projections impact your recommendation on whether to accept the capital project? What was your capital budgeting recommendation (using the NPV/IRR method and assuming an expected useful life of 8 years) when incremental revenue was projected to increase 2% year-over-year? What was your capital budgeting recommendation (using the NPV/IRR method and assuming an expected useful life of 8 years) when incremental revenue was projected to increase 3% year-over-year?
__Explain your reasoning for each answer.__

- For the fifth assignment question (new football stadium for Colorado State) how did changes in estimated annual cost of capital impact your recommendation on whether to accept the capital project using the NPV/IRR capital budgeting method? How did changes in estimated annual cost of capital impact the projected IRR for the capital project? Why?

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