Capital Budgeting Case

Fall 2015

Viking Freight Forwarding

Viking Freight Forwarding, LLC is a family run operation. It is owned by the Ostrem family, with the 2 Ostrem brothers and 1 sister making up the upper level management team. Tom Bertram, son-in-law of the youngest Ostrem brother, has been hired as the assistant financial vice president of the firm. His primary duties are to evaluate capital budgeting projects and other related long term projects of the operation.

Bertram is currently undertaking an analysis of five major capital budgeting projects for the coming year. All of the projects except for the Ankeny Satellite Terminal project would have the same level of risk as the other long term assets of the firm. Descriptions of the five projects are below and estimate of expected cash flows for each project is outlined in Table 1.

Project Exp2015-A: Expansion of existing facilities at Des Moines Terminal.

Viking Freight Forwarding operates primarily as a bonded freight forwarder, and thus must provide rapid delivery, on short notice, of freight temporarily stored in its bonded warehouse located on Guthrie Avenue on Des Moines eastside. The terminal has six existing loading docks and this number is often insufficient for the amount of freight that must be forwarded for prompt delivery.

Because of growth in business, Viking has been unable to meet the needs of its customers on a number of occasions because of backlogs at the loading docks. Firms have begun using other freight forwarders in the area and is starting to have an effect on the revenues of the firm.

Project Exp2015-A calls for the building of an annex to the existing warehouse; the annex would provide 3 new loading docks and 5,000 square feet of additional storage space. This would take some time to construct and the amount of lost revenues would continue to mount so that the recouping the lost revenues would be spread out over a longer time period. However, the additional storage space would allow for more growth in the future.

Project Exp2015-B: Alternative expansion of existing facilities at Des Moines Terminal.

Project Exp2015-Bis to simply add 3 additional loading docks to the existing building. This would significantly reduce the construction time relative to project a so that lost revenues could be recouped faster. However, no additional storage space would be added. Project Exp2015-Bwould disrupt the current operation more and the warehouse layout would have to be reconfigured, so that the total cost of the project would be the same as Project Exp2015-A. While the cash inflows would be more rapid, the projects life would be much shorter. This solves the immediate problem but does not address the growth issue.

Project Exp2015-SAT: Build a new satellite terminal in Ankeny

Rather than expanding at the current Guthrie Avenue location, Bertram is considering building a satellite terminal in the industrial park in Ankeny which is located 6 miles from the current location. The current site in Des Moines does not have the potential for extensive expansion so he is considering this expansion in an off-site location. This is a much more expensive project and more risky in that excess capacity will be built and coordinating shipments will be more difficult

Project TT2015-A: Purchase of Three New Tractor-Trailers.

An increase in business has not only caused backlogs at the loading docks but also has forced Viking to lease tractor-trailers since they have insufficient quantity of their own. This increases the cost of transportation as well as making it difficult to do regularly scheduled maintenance on their tractor-trailers since they are being fully utilized with little down time. Project TT2015-A would alleviate this problem.

Project BH2015-A: Special equipment for handling bulk commodities.

A profitable capital investment made in 1990 to handle bulk commodities and forward them by rail would be upgraded under Project BH2015-A. This would involve the installation of a movable conveyor belt to increase rail car loading efficiency by reducing current labor costs.

Table 1	Mutually					Exclusive		Independent	Independent
	Project		Project			Project		Project	Project
	Exp2015-A		Exp2015-B			Exp2015-C		TT2015-A	BH2015-A
CFo	$(750,000.00)		$(840,000.00)			$(2,600,000.00)		$(1,250,000.00)	$(720,000.00)
1	$ 195,000.00		$ 275,000.00			$ 625,000.00		$ 258,900.00	$ 261,900.00
2	$ 225,000.00		$ 295,000.00			$ 650,000.00		$ 258,900.00	$ 261,900.00
3	$ 214,500.00		$ 315,900.00			$ 750,000.00		$ 258,900.00	$ 261,900.00
4	$ 216,500.00		$ 200,000.00			$ 750,000.00		$ 258,900.00	$ 261,900.00
5	$ 229,400.00		$ 110,000.00			$ 775,000.00		$ 258,900.00	$ 261,900.00
6	$ 219,400.00		$ 90,000.00			$ 800,000.00		$ 258,900.00
7	$ 210,400.00		$ 90,000.00			$ 675,000.00		$ 258,900.00
8	$ 205,400.00		$ 80,000.00			$ 650,000.00		$ 258,900.00
9	$ 195,400.00		$ 80,000.00			$ 625,000.00		$ 258,900.00
10	$ 185,400.00		$ 70,000.00			$ 500,000.00		$ 258,900.00

Note all cash-flows are on an after tax basis.

The existing capital structure uses very little debt and relies mostly on retention of earnings and additional equity provided by the Ostrem family. While Bertram believes that the cost of capital could be reduced by changing the capital structure to include more debt, the current capital budget must be analyzed using the existing capital structure and the relevant component costs. See Table 2 for the cost of capital and the current capital structure.

	Table 2	Cost of capital and capital structure		Component
			weight	cost
Present		Debt	40%	7%
		Common Equity	60%	14%
		Tax rate =30%

Requirements:

Compute the weighted average cost of capital for the firm.

Simply, without consideration for the life of the projects, calculate Payback, NPV, IRR, Profitability Index and MIRR for each project using the current cost of capital. Assume the reinvestment rate for MIRR is the weighted average cost of capital for the firm.

Based on your computations in requirement number one, which projects should be accepted? Note: Projects Exp2015-A, Exp2015-B and Exp2015-C are mutually exclusive.