THE CONNECTICUT VALLEY SCHOOL

The Connecticut Valley School (CVS) is a private boarding school in Massachusetts. Headmaster John Loring has just submitted his annual recommendations for capital spending to the board of trustees. Capital spending will be funded from two sources, new debt and the accumulated interest on the school's endowment. Since the school is approaching its debt capacity and the trustees are determined not to draw on the principal of the endowment, the school can afford to spend only $900,000 to $1,000,000 on capital improvements over the next year. The seven major projects under consideration are described briefly below.

1. Swimming Pool

Cost: $640,000 Expected life: 15 years

Currently the school rents a local facility for $60,000 per year. In addition, the school pays $10,000 per year to bus students to the facility. If the school owned its own pool, it could rent out pool time to local organizations for $30,000 per year. The headmaster feels that more students would use the pool if it were located on campus.

2. Buses

Cost: $270,000 (3 buses) Expected life: 6 years

Salvage value: 000

CVS owns two campuses several miles apart. A private bus company transports students between campuses at a cost of $180,000 per year. If the school owns and operates its own buses, it will incur $80,000 in operating expenses each year.

3. New Roof for Hockey Rink

Cost: $60,000

A new roof is essential to prevent further damage to the rink and to the arena's infrastructure. The project could be delayed one year; but due to the additional damage that would result, total repair costs would jump to $120,000.

4. Wood Chip Heating System

Cost: $800,000 Expected life: 15 years

Cold New England winters and the high cost of fuel oil have been draining the school's operating funds. This new heating system could save the school between $140,000 and $160,000 per year over the next 15 years (assuming that the school defrayed fuel costs by harvesting $30,000 of wood each year from its own land rather than purchasing this fuel on the market).

5. Renovation of Fine Arts Building

Cost: $300,000

The faculty and trustees agree that an improved fine arts program is critical to the school's "liberal arts mission". The renovated fine arts building would include a photography lab, a pottery shop, and art studios, as well as a small gallery. The building would not generate any incremental revenues or cost savings. However, a wealthy benefactor (after whom the building would be named) has offered to contribute $150,000 to subsidize the project. In addition, the facility would provide some "marketing benefits", as a strong arts program attracts quality students.

6. Renovations to Women's Locker Room

Cost: $40,000

The women's locker room has not been renovated since it was built 33 years ago for visiting men's teams. Many of the women have complained that the facility is dirty, depressing, and overcrowded. Some women refuse to use the facility. The headmaster insists that these complaints are "unfounded". The renovations would generate no incremental revenues or cost savings.

7. Upgrading the Computer Lab

Cost: $120,000

Over the past eight years computer equipment has been purchased on a piecemeal basis with surplus operating funds. To support curricular goals the school needs state of the art computers and more work stations. The director of computing has proposed that the equipment be upgraded over three years. The first stage of this plan would require spending $120,000 on computers in the coming year. An additional $160,000 would be spent over the following two years.

The school uses a 12 percent annual discount rate to evaluate all cost saving investment projects.

Since not all of these projects can be undertaken, they must be prioritized. In his report to the trustees, Headmaster Loring ranked the six projects as follows:

1. Swimming pool $640,000

2. Hockey rink roof 60,000

3. Buses 270,000

4. Heating system 800,000

5. Fine arts building 150,000

6. Women's locker room 40,000

7. Computer Lab 120,000

He recommended that this year's capital funds be spent on the construction of a swimming pool, repairs to the roof of the hockey rink, and the purchase of three buses. These projects would require a total expenditure of $970,000. Loring's rankings were based on his subjective evaluation of cost/benefit trade-offs.

While the trustees must make the final decision, they have solicited advice from the faculty. The faculty is in touch with the day-to-day operations of the school and with the needs of the students. In addition, many faculty members feel that they were closed out of the decision process last year and that the ultimate allocation of funds was inconsistent with the school's objectives. In an attempt to improve the decision process, the trustees appointed a faculty budget committee to advise them on capital spending priorities. The faculty has pointed out that some of the proposed projects provide important intangible benefits, which cannot be easily quantified. They believe that projects which promote the mission of the school and serve the interests of students should be highly valued.

The faculty was very unhappy with last year's allocation of funds. They feel that spending decisions were driven more by the headmaster's political agenda than by the pressing needs of the faculty and students. The headmaster is a strong booster of athletic programs, and his capital spending priorities reflect this commitment. For example, last year's projects included: 1) improving drainage on the soccer field, 2) building new stands for the football field, 3) constructing four new tennis courts, and 4) purchasing two new vans to transport men's interscholastic teams. While all of these projects were worthwhile, the faculty feels the capital budget overemphasized athletics.

A meeting of the trustees, the faculty budget committee and the headmaster has been scheduled. The purpose of this meeting is to prioritize capital spending projects. It is expected to be a lively and productive session.

YOUR CHALLENGE. You are a trustee. In advance of the meeting, you must decide which projects the school should fund. Provide a clear rationale for your recommendation. Fully defend the two projects that you support most enthusiastically.

CONFIDENTIAL INFORMATION

The Board of Trustees

The trustees feel that an optimal allocation of scarce capital funds can be achieved by applying the following decision rule:

1. Calculate a "profitability index" (or "benefit-cost ratio") for each project:

(PRESENT VALUE of net cash

inflows and cost savings)

___________________

initial investment

2. Reject any project with an index less than 1.

3. Select those projects with the highest profitability indexes - until all available capital funds have been applied.

According to one member of the Board of Trustees, this rule is particularly appropriate when funds are being rationed, since it promises the biggest "bang for the buck" -- that is, the highest ratio of present value to initial investment. (The school uses a 12 percent annual discount rate to evaluate all "cost saving" investment projects.) While they will consider using other decision rules, the trustees feel that this rule is "prudent." They view themselves as guardians of fiscal restraint. It is their job to hold spending within the budget and to veto questionable projects.

The trustees feel that it is important to include the faculty in the decision process. Some faculty members were vocal in their criticism of last year's spending priorities. They were upset that over half the budget was allocated to building or improving athletic facilities*** at the expense of other pressing needs. Accordingly, the trustees are determined to give the faculty a fair hearing.

The trustees plan to develop their own tentative ranking of projects before meeting with the headmaster and the faculty. Their objective is to forge agreement on a capital budget which will promote the long-run interests of the school.

*** Last year's projects included: 1) improving drainage on the soccer field, 2) building new stands for the football field, 3) constructing four new tennis courts, and 4) purchasing two new vans to transport men's interscholastic teams.

The Connecticut Valley School

To: John Loring, Headmaster

Board of Trustees

Faculty Budget Committee

From: Nancy Clarke, Dean of Students

Re: Need for improved lighting on campus walkways

Last month a female student was assaulted while walking from the library to her dormitory late at night. The assailant has not been apprehended, but was probably from off campus.

We are fortunate that our campus is relatively safe. Only one other incident of this type has been reported in the past 9 months. However, we are determined to be proactive in maintaining campus safety.

Since the assault, I have talked extensively with both faculty and students about safety on campus. As a result of these discussions, the campus security office has been instructed to be more vigilant and students have been asked not to walk alone after dark.

Some faculty and students feel that the danger of assault is aggravated by a lack of lighting on walkways between the dorms, the library, and the student center. I agree. These paths are illuminated only by the light from nearby buildings, and it is usually necessary to carry a flashlight to see your way.

I have thoroughly researched possible remedies. The cost of installing lamp posts every 50 feet on these paths (along with the necessary landscaping) is $80,000. This lighting system would solve the problem without compromising the aesthetics of the campus. While lower cost options are possible, I feel that we should do this right.