lOMoARcPSD|9770463 Fin 321 answers Advanced Corporate Finance (University of Illinois at Urbana-Champaign) StuDocu is not sponsored or endorsed by any college or university Downloaded by ghh ioo (approachu@outlook.com) lOMoARcPSD|9770463 1. Describe and critique Target’s capital-budgeting system. Give specific consideration to the role of the real-estate managers and the makeup of the CEC. From the very beginning, Target Corportation has strived to set out a positive brand image and tried to offer something unique to their customers or “guests” as referred by the company. All of its decisions are well thought through to be able to provide reasonable answers to their shareholders if necessary. Target focuses on stylish yet affordable merchandise. They try to open new stores where they believe their core guests reside, who are above the Wal-Mart budget. To be able to offer competitive prices, Target, as a retailer, also considered off-shore sources for products and lower purchase price from its suppliers. Furthermore, the company gives special attention to the ambience of all Target stores, the location and their brand awareness and invest accordingly. In 2005, Target spent $1 billion or 26.6% of their operating profits on advertising and saw fruitful rewards when Target’s bullseye logo became the most recognized corporate symbol, ahead of Nike. To ensure good decision-making processes within the company, Target has a Capital Expenditure Committee (CEC) established. CEC, made of 5 top executive members, meets once every month to discuss around ten Capital Project Requests (CECs), which have an investment of more than $100,000. Projects with investment requirement of more than $50 million are passed up to the Board of Directors. This tiered project approval system proves again how much importance Target places on good decisions and valuable investments. Retail companies’ growth can happen in two ways: creation of new stores and self-sustained growth of existing stores. For organic growth of existing stores, Target provides credit cards that contributed 14.9% of Target’s operating earnings. On the other hand, Target’s CFO Doug Scovanner is trying to push 5 CPRs out of which 4 pertain to new stores with positive NPVs. Each CPR goes through a 12 to 24-month long development process before reaching the CEC. Opening a new store requires a lot of behind the scenes research and work. A real-estate manager is hired to oversee the new store proposal, starting from examination of the geographic region to the completion of the proposal. Target also considers tax and real-estate incentives provided by the local communities and the regional demographics to target the right audience. Based on such factors, there are two types of set store formats: P04 and SuperTarget. To measure the potential success of a new store, the company compares the project’s NPV and IRR to predetermined prototype for the specific kind of store format. Even the calculations that go behind NPV and IRR are carefully structured by the Research and Planning team and presented in the “dashboard”. The R&P group uses a variety of data such as demographics and sitespecific forecasts to estimate sales. Each project also incurs some pre-CPR expenditures which are non-recoverable if the project gets rejected at CEC. This highlights Scovanner’s dilemma even more –picking the best investments out of the 5 difficult decision CPRs. Downloaded by ghh ioo (approachu@outlook.com) lOMoARcPSD|9770463 2. Which of the five CPRs should Doug Scovanner accept? Explain how each of the following considerations influenced your decision: a. NPV and IRR b. Size of the project c. Cannibalization of other stores’ sales d. Store sensitivities e. Variance to prototype f. Customer demographics g. Brand-awareness impact 1. Gopher Place: NPV = $16,755,000 (3rd best), IRR = 12.3% (2nd best), Median Income is decent and there is a great population growth projection (for future sales increase): however, such promises are bringing 2 Walmart supercenters to the area where there are 5 Target stores already. The initial investment of $23 million is not that outrageous (it still $5.5 million more than prototype) for P04 store format; however, is this investment worth 19% of cannibalism? 2. Whalen Court: NPV = $25,875,000 (the highest of all), IRR = 9.8% (4th place), median income is not that high but that is partly because the population is ridiculously high compared to other locations. This also means that there are more of Target Corporation’s core guests residing in Whalen Court area. The initial investment is very high for a moderate increase in the NPV and the window of opportunity is limited. Moreover, the land would have to be leased and that is more responsibility than just purchasing the land. The recommendation here is to avoid investing in Whalen Court because there are already 45 stores in the same market and the benefits do not outweigh the cons. 3. The Barn: NPV = $20,527,000 (2nd place), IRR = 16.4% (first place), median income is not that high and there aren’t a lot of college educated people there, low promise for population growth but the population is already a decent size. The initial investment is not that high either. The Barn offers a new market to Target as the nearest store are about 100 miles away so less scare of cannibalism. Doing much better than the prototype in terms of NPV and the competition stays relatively the same. 4. Goldie’s Square: NPV = 300,000 (the worst), IRR= 8.1% (worst again), the population is decent sized and the median income is high too, 24% of the adults are college educated and the population is projected to grow at 16%. The investment is 23,900,000 for opening the SuperTarget store format. The numbers don’t look promising in terms of financial return; however, the affluent community will contribute to Target’s brand awareness and eventually see a growth. Target already has 12 stores there, but to compete with big retailers, they are thinking of doubling the number of their stores. Downloaded by ghh ioo (approachu@outlook.com) lOMoARcPSD|9770463 5. Stadium Remodel: NPV = 15,700,000 (4th), IRR = 10.8% (3rd), median income and % of college educated adults is very high. Also the store has been in effect since 1972 and has been remodeled twice. There is no prototype for remodeling, however the fact that Target has flourished for so long there should be a great evidence for its sustainence. 3. Why does Target use different hurdle rates for the store and the credit cards (9% and 4%, respectively)? What process would you use to estimate these discount rates to see if they are reasonable? Since there are two different ways of growing a retail store company, namely creation of new stores and organic growth of existing store, it only makes sense to use different discount rate to suit each case. The different discount rates were chosen to represent the different cost of capital for funding store operation as opposed to funding credit-card receivables. Store operations and credit-card related expenses cannot be combined together under one discount rate when calculating the NPV because store operations are operating expenses while credit card is related to debt or accounts receivable. 4. As a member of the CEC, would you continue to approve CPRs if it meant that Target would need to fund the requests with external funds, either debt or equity? Helpful links: https://prezi.com/ru8bx_ucsbuq/capital-budgeting-and-resource-allocation-target-corporation/ https://prezi.com/h-7m5qtek_nq/target-corporation-presentation/ https://www.scribd.com/doc/217353875/Case-Study-20-Target-Corporation Downloaded by ghh ioo (approachu@outlook.com)
