Question
Synopsis The Murphy Stores case study involves a major retailer deciding whether to allocate $7 million of its limited capital budget to either an investment
Synopsis
The Murphy Stores case study involves a major retailer deciding whether to allocate $7 million of its limited capital budget to either an investment in RFID technology to reduce merchandise theft from stores, or to invest in new energy-efficient store lighting to reduce operating costs and be better for the environment, or some combination of the two.
The two-investment options focus on making financial improvements in two different aspects of Murphy Stores operations: decreasing shrink due to theft and saving on electricity costs. This case also offers the opportunity to discuss trade-offs between selecting lower-risk capital projects and higher risk projects with higher expected returns but more variability in potential outcomes.
Discussion/Assignment Questions:
- Describe the two investment opportunities and why each of them has an appeal for Murphy Stores.
- Calculate the WACC for Murphy Stores and compare it with the 12% assumption the company has made for project submissions.
- Evaluate the two EAS projects and the lightning proposal. Prepare and interpret a project analysis that includes NPV, IRR, and Profitability Index calculations. As a starting point, you should assume:
- that the investments must be made upfront (at t=0)
- you can evaluate the cash flows at the end of each year (with a 10-year horizon)
- that only six months of benefits occur in year 1, because your investment at t=0
- is installed in the first 6 months of year 1.
- What are the key value drivers for each project? (That is, which variables have the most impact?) How do you know this? What are the major risks or uncertainties that you are concerned about for these projects?
- What do you recommend that Murphy do? Think carefully about how to get the most value for Murphys limited capital dollars.
| IM Exhibit 1 | |||||||
| Summary of Project Base Case Results | |||||||
| EAS Full Line Stores | |||||||
| Base case assumptions: | Reduction in shrink 30%, shrink rate without EAS grows 0.1% per year, base rate sales forecast | ||||||
| EAS Hardware Stores | |||||||
| Base case assumptions: | Reduction in shrink 30%, shrink rate without EAS grows 0.1% per year, base rate sales growth | ||||||
| Lighting | |||||||
| Base case assumptions: | Energy cost savings at average of estimated range (35%); energy costs rise with inflation | ||||||
| Project | EAS Full Line Stores | EAS Full Line Stores | EAS Full Line Stores | EAS Hardware Stores | EAS Hardware Stores | EAS Hardware Stores | Lighting |
| Measure of Benefit | Differential Sales | Differential Costs | Differential Gross Margin $ | Differential Sales | Differential Costs | Differential Gross Margin $ | Cost Savings |
| NPV | $14,712,340 | $3,811,088 | $1,226,004 | $17,799,104 | $9,743,226 | $6,110,183 | $1,151,539 |
| IRR | 58% | 27% | 17% | 97% | 66% | 50% | 16% |
| Profitability Index | 4.69 | 1.96 | 1.31 | 9.00 | 5.38 | 3.75 | 1.16 |
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