CAPITAL BUDGETING
Specific Concerns for the Sports Business

Product Line
o
Traditional vs Digital Products
o
Fans Engagement
o
Sustainability

Market Competition
o
Global Competition
o
Technology Disruption
o
Changin Consumer Preferences
Capital Budgeting

process of identifying, analyzing, and selecting investment projects
whose returns (cash flows) are expected to extend beyond one year

process of deciding whether or not to commit resources to projects
whose costs and benefits are spread over several time periods. It
involves:
o
The preparation of annual budget for capital investment
o
The assessment of funding capacities
o
The allocation of resources to renewal and expansion projects
which most clearly conform with the companies’ priorities

Is an investment concept
Key Considerations
1. Return on Investment (ROI) - he potential return on their capital
investments. This involves analyzing factors like ticket sales,
merchandise revenue, sponsorship deals, and media rights.
2. Risk Assessment - A thorough risk assessment is essential to
understand the potential downsides and mitigate risks.
3. Financial Resources - Sports businesses need to consider their
available financial resources and the potential need for external
funding through loans or equity investments.
4. Project Feasibility and Sustainability - Capital projects must be
feasible in terms of construction, operation, and long-term
sustainability.
5. Fan Experience - Sports investments should focus on enhancing the
fan experience, whether through improved facilities, technology, or
entertainment options.
Common Capital Budgeting Projects in Sports
1. Stadium and Arena Construction/ Renovation
2. Training Facilities
3. Technology Upgrades
4. Player Acquisitions
5. Marketing Promotion
Challenges in Sports Capital Budgeting
1. Unpredictability of Sports Results
2. Competition and Market Dynamics
3. Long-Term Planning
Capital Budgeting Process – is a system of interrelated steps for making
a long-term investment decision.
Capital Budgeting Process
1. Generating Project Proposal
a. Replacement and Acquisition of Long-Term Assets
b. Improvement of Products
c. Expansion of Facilities
d. Trading or Exchanging Assets
e. Safety and/or Environmental Projects
f.
Mergers
g. Other projects
Categories of Capital Investment Decisions

Independent Capital Investment Projects or Screening Decision
– these are projects which are evaluated individually and reviewed
against predetermined corporate standards of acceptability in an
“accept” or “reject” decision.
o
The screening process for independent projects involves
evaluating each project against pre-defined criteria to
determine if it meets the company's minimum requirements.
These criteria typically include:

Minimum Rate of Return (Hurdle Rate): The project's
expected return on investment must exceed the company's
required rate of return.

Risk Tolerance: The project's level of risk must be within the
company's acceptable risk appetite.

Strategic Alignment: The project must align with the
company's overall strategic goals and objectives.
o
Investment in long-term assets such as property, plant and
equipment
o
New product development
o
Undertaking a large-scale advertising campaign
o
Introduction of a computer
o
Corporate acquisitions (such as purchase of shares in
subsidiaries affiliates).

Mutually Exclusive Capital Investment or Preference Decision these relate to several acceptable alternatives. The project to be
acceptable must pass the criteria of acceptability set by the company
and better than the other investment alternatives.
o
Replacement against renovation of equipment or facilities
o
o
o
Rent or lease against ownership of facilities
Manual bookkeeping system against computerized system
Preventive maintenance against periodic overhaul of
machineries
2. Collecting Relevant Information about Opportunities
3. Estimating Cash Flows

Net Cash Flow is the difference between inflows and outflows of
cash that result from a firm undertaking a project.

Cash Flows of a project fall into three categories:
o
The net amount of investment
o
The operating cashflows or returns from the investment
o
The minimum acceptable rate of return on the investment.

Net Initial Investment or Project Cost

Net investment represents the initial cash outlay that is required
to obtain future returns or the net cash outflows to support a
capital investment project.

The cash returns are the inflows of cash expected from the
project reduced by the cash cost that can be directly attributed to
the project.

The minimum or lowest acceptable rate of return or
opportunity cost may equal the average rate of return that the
company will earn from alternative investment opportunities or
the cost of capital which is the average rate of return that the firm
must pay to attract investment fund. The cost of capital according
to source may be computed as follows:
o
Cost of Debt
o
Cost of Preference Shares
o
Cost of Ordinary Shares

Stock price-based

Book-value based
o
Cost of Retained Earnings - same as cost of ordinary equity.
This is used when dividend growth rate is not known.
4. Evaluating Project Proposals
5. Selecting Projects
Three major factors in final selection of projects

Project type

Availity of funds

Decision criteria
6. Implementing and Reviewing Projects

Acceptable projects must then be implemented in a timely and
efficient manner. The implementation stage involves developing
formal procedures for authorizing the expenditures of funds for
capital projects.

The review stage involves analyzing projects that have been
adopted in order to determine if they should be continued, modified
or terminated.
A final aspect of the capital budgeting process is the post –audit, which
involves:

Comparing actual results with those predicted by the project’s
sponsor

Explaining why any differences occurred
Forecasting risk or estimation risk is the possibility that a bad decision
will be made because of errors in the projected cash flows. Our goal in
performing risk analysis is to assess the degree of forecasting risk and to
identify the most critical components of the success or failure of an
investment.
Capital Budgeting Risk refers to the uncertainty surrounding the financial
outcomes of long-term investment decisions. It encompasses the possibility
that a project may not generate the expected returns, leading to financial
losses for the company.
Factors that can influence cash flows:

Economic conditions: Changes in interest rates, inflation, and
overall economic growth can impact a project's profitability.

Market demand: Fluctuations in consumer demand for a product
or service can affect sales and revenue.

Technological advancements: Rapid technological changes can
lead to obsolescence of equipment or products, impacting a
project's lifespan and profitability.

Competition: New competitors entering the market can erode
market share and reduce profitability.

Regulatory changes: Government regulations, such as
environmental regulations or tax laws, can impact a project's costs
and profitability.

Operational risks: unexpected events, such as natural disasters,
accidents, or labor strikes, can disrupt operations and affect
project outcomes.
Methods of Estimating and Measuring the Risk
1. Scenario Analysis – The basic form of “what-if” analysis
2. Sensitivity Analysis – is the process of changing one or more
variables to determine how sensitive a projects’ returns are to
these changes.
3. Simulation Analysis – is a combination of scenario and
sensitivity analysis. Let all the items vary at the same time.
Beta Estimation – This approach to risk measurement involves
the concepts of Capital Asset Pricing Model (CAPM). It is a
measure of systematic risk of a project. Systematic risk principle
state that the reward of bearing risk depends only of that asset’s
systematic risk.
Capital Budgeting Techniques

Non-discounted Cash Flow (Unadjusted Approach)
1. Payback Period (PBP) - also known as payoff and pay out period,
measures the length of time required to recover the amount of
initial investment. It is the time interval between time of the initial
outlay and the full recovery of the investment.

Decision Rule: The desirability of the project is determined
by comparing the project’s payback period against the
maximum acceptable payback period as predetermined by
management. The project with shorter payback period than
the maximum will be accepted.

If: PB ≤ Maximum Allowed PB period; Accept

If: PB > Maximum Allowed PB period: Reject

Advantages

It is easy to compute and understand

It is used to measure the degree of risk associated with
a project

Generally, the longer the payback period, the higher
the risk.

It is used to select projects which provide a quick
return of invested funds.

Disadvantages

It does not recognize the time value of money.

It ignores the impact of cash inflows after the payback
period.

It does not distinguish between alternatives having
different economic lives.

The conventional payback computation fails to
consider the salvage value, if any.

It does not measure profitability – only the relative
liquidity of the investment

There is no necessary relationship between a given
payback and investor wealth maximization so an
investor would not know what an acceptable payback
is.
2. Payback Reciprocal (PBR) is the rate of recovery of investment
during the payback period. When the project is at least twice the
payback period and the annual cash flows are approximately
equal. The payback reciprocal may be used to estimate the
discounted rate of return. A project with an infinite life would have
a discounted rate of return exactly equal to its payback reciprocal.
3. Accounting Rate of Return (ARR) - also known as book value
rate of return, measures profitability from the conventional
accounting standpoint by relating the required investment to the
future annual net income.

Decision Rule: Under the ARR method, choose the project
with the highest rate of return. Accept the project if the ARR
is greater than the cost of capital. Thus:

IF: ARR ≥ Required rate of return; ACCEPT

IF: ARR < Required rate of return; REJECT

Advantages

It is easily understood by investor acquainted with
financial statements.

Emphasizes on profitability rather than liquidity.

ARR considers income over the entire life of the asset.

Disadvantages

It ignores the time value of money by failing to discount
the future cash inflows and outflows

It does not consider the timing component of cash
inflows

Different averaging techniques may yield inaccurate
answer. Ignore the effect Inflation.

It utilizes the concepts of capital and income primarily
designed for the purposes of financial statements
preparation and which may not be relevant to the
evaluation of investment proposal.

Discounted Cash Flow (Time-Adjusted) Approach
1. Discounted Payback Period (DPBP) is a capital budgeting
method that determines the length of time required for an
investment cash flows, discounted at the investments cost of
capital, to cover its cost. It is a method that recognizes the time
value of money in a payback context.

Decision Rule:

Accept Project if Calculated DPB < Maximum Allowable
Discounted Payback

Reject Project if Calculated DPB > Maximum Allowable
Discounted Payback
4.
2.
Net Present Value (NPV) - is the excess of the present values of
the project’s cash inflows (net operating cash flows plus net
terminal cash) over the amount of the initial investment.

Decision Rule: Accept the project if it’s NPV is equal or
greater than zero; otherwise, the project is rejected.
3. Internal Rate of Return (IRR) - also known as discounted rate of
return and time adjusted rate of return is the rate which equates
the present value of the future cash inflows with the cost of the
investment which produces them. The IRR Technique is, by far,
the most popular rate-based capital budgeting technique.
4. Profitability Index (PI) - is the ratio of the total present value of
future cash inflows divided by its net investment. The index
expresses the present value of cash benefits as to an amount per
peso of investment in a project and is used as a means of ranking
in a descending order of desirability.

Decision Rule: The higher the PV Index the more desirable
the project
Why is Capital Budgeting Important?

This process helps the management invest in the assets that can
maximize the firm’s value.

It brings to light a potentially bad investment option, which, if
avoided, helps to maximize the firm value.