1. What is Target’s capital budgeting process? Is this process consistent with the company’s business and financial objectives? (40 marks)
Capital budgeting is the process through which firms and organizations decide which projects to take and which long-term investments to make. Capital budgeting involves the assessment of potential long-term investments, which generate cash flows over many years. The decision whether to accept or reject a project depends on various factors which are different for different companies, but the most common factors include the Cash flows generated by the project over its life, its Net Present Value (NPV), and its Internal Rate of Return (IRR).
In the case of Target, the capital budgeting process is operated by the Capital Expenditure Committee (CEC). The CEC is comprised of a team of top executives of Target who meet monthly to review all the Capital Project Requests (CPRs), which exceed $100,000.The CEC can approve any CPR up to $50 million; however, CPRs in excess of $50 million are approved by the board of directors.
There are different types of CPRs that include remodeling, rebuilding, relocating and the closure of an existing store in order to build a new one. The CEC normally rejects those CPRs that have questionable economics, at ainitial evaluation stage.If a CPR has a negative NPV, then the CEC would consider its strategic importance to the overall organization and to other business units, before accepting or rejecting it.
Targets main financial objective can be described as maximizing its profitability as we can see that the level of competition is extremely severe between target and some of its main competitors including Wal-Mart and Costco. Profit margins are extremely thin and in order to maximize the profit, crucial investment decisions must be taken after a thorough assessment of the investment. The CEC recognized that the capital investment could have a significant impact on the short and long-term profitability of the company therefore, before making the decision of whether to accept or reject a CPR; the review process evaluated the investments rigorously.
Furthermore, before making a decision precedents were considered, for example a CPR for remodeling would be rejected, if the initial investment is too high compared to other remodeling CPRs. Even if the NPV is positive this CPR would be rejected, due to the fact that this will create a troublesome precedent for the subsequent CPRs. Normally a consensus is reached for each investment decision, however when there are too many disagreements within the CEC, the CEO usually makes the final decision.Projects and investments usually require 12-24 months of development before being forwarded to the CEC for evaluation.
In the case of new store CPRs, which form the majority of the CPRs, a real-estate manager is assigned to that geographic region, who would be responsible for the project since its inception, till its completion. Before submitting the CPR to the CEC, the manager would work on it, and design its feasibility. A substantial amount of time and effort is required by the managers to find the most viable opportunities and to present it in front of the CEC in such a way that it maximizes the chances of it being accepted.
In order to evaluate an investment opportunity, the CEC considers several factors before making the final decision. In addition, to meet the objective of ‘100 new stores per year’of the company, a steady stream of proposals must be presented to the CEC. Projects needed to meet a number of financial objectives that included financial return measured by discounted cash flow techniques, such as the NPV and IRR. Other financial considerations included projected profit, and earnings per share impacts, total investment size, impact on sales of other nearby Target stores, and the sensitivity of NPV and IRR to sales variations.
Cash flowsare based on projected sales, which are determined on the basis of economic trends, and demographic shifts. It also considers the effect on sales due to the entrance of new competitors and from online shopping stores.
Target Corporation Case Solution
Lastly, CEC attempts to keep the project approvals within the designated budget for the year. If excess numbers of projects are approved then Target would have to borrow the funds in order to cover the shortfall...........................................
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Situational Analysis: Target Corporation has become a strong performing company in the retail industry in part because of its successful investment decisions and continued growth. That is why when Dan Scovanner, CFO of Target, and the four other executives in the CEC (Capital Expenditure Committee) meet it is of high importance. The approval or denial of CPR’s (Capital Project Requests) has the potential to set precedents that would affect possible decisions in the future. Every month the CEC meets to go over new CPR’s that could have a lasting impact on the short-term and long-term profitability of Target. For the month of November in 2006, there were five particular projects Scovanner knew were going to be the most highly discussed and evaluated. These projects involved four new store openings and one remodeling of an existing store. The new openings were Gopher Place, Whalen Court, The Barn, and Goldie’s Square. The remodeling of an existing store format into a SuperTarget was Stadium Remodel. To come to a conclusion on whether to approve or deny projects the CEC uses a “dashboard” that has many factors. These factors include total investment size, NPV, IRR, population, population growth, and so on. The problem was whether capital was better spent on one project or another to create the most value and the most growth for the company and its shareholders.