Target Corporation Capital Expenditure Committee in Modern

Target Corporation Capital Expenditure Committee

In modern corporations, various projects compete for the same source of capital allocated for new investments. In preparing an analysis for a Capital Expenditure Committee, the two most important predictive financial metrics used are Net Present Value (NPV) and Internal Rate of Return (IRR). NPV is the present value of the project's cash inflows minus the present value of the project's cash outflows. It indicates the expected impact of the project on the value of the firm. A positive NPV increases the value of the firm. When comparing among mutually exclusive projects, the highest NPV is key in decision making. The IRR is that discount or interest rate which will cause the present value of all future cash flows to equal the incremental investment. In other words, it's the discount rate at which the NPV of a project eventually equals zero. All projects with an IRR greater than the cost of capital should be accepted. When comparing projects, the highest IRR is most attractive. It is critical for any CEC to understand how to utilize these metrics. NPV is typically better when comparing mutually exclusive project alternatives. It implicitly assumes that the project's cash flows can be reinvested at the firm's cost of capital. This is probably a more realistic assumption. The IRR metric implicitly assumes that the cash flows can be reinvested at the project's IRR. In short, any corporation must make critical decisions regarding how to invest its resources. Through a proper understanding of predictive business metrics, various potential investment decisions can be thoroughly analyzed and the best predicted outcome can be realized for the interests of the corporation.

Gopher Place:

Brief Statement: This location is a $23 million investment in a growing, highly favorable market of 70,000 people which has grown 27% in the last five years. Target is currently highly present in the trade area with a 5 store density. Furthermore, Wal-Mart is planning on moving into the market with plans to build two supercenters in the next few years. Based on predications, the predicted value of this investment is worth the cost, despite other factors such as negative impact on other Target stores and encroachment of competitors.

Key Facts: Investment - $23 million; Base NPV -- 16.8 million; IRR -- 12.3%; 19% of sales are forecasted to come from existing Target stores; NPV achievable w / sales 5.3% below R&

Identification of Possible Alternatives and Analysis -- It is critical that other alternatives be explored in considering the predictive performance of Gopher Place and its effect on our surrounding stores: 1) As the IRR of the store is encouraging at 12.3%, steps should be taken to mitigate the effect the store would have on other Target stores possibly through consolidation or investment in a Target Supercenter; 2) To mitigate competitor encroachment steps should be taken to strengthen market presence before Wall-Mart establishes its presence a year or two after us; 3) The most exposed area of the project according to the predications is potential overrun of construction costs. Efforts should be mitigated this risk to ensure project profitability.

Recommendation of Best Alternative -- I would recommend that as Target has a high market density in Gopher Place, 19% of sales will come from existing stores and that we will be competing with larger Wall-Mart super centers in the near future, that consolidation of existing Target resources into the Gopher Place project should be considered to establish a supercenter. This decision will create new market presence that will sell items not offered by existing stores and shield Target by establishing market presence before Wall-Mart super center competition arrives in one or two years.

Reflection on Broader Implication -- This analysis has larger implications as it forces management to examine their investment in light of changing market conditions. Gopher Place is a locale in transition with significant population expansion and change and new stores coming into the city over the next few years. By analyzing both the predicted value of the project as well as it its impact on existing stores, management can look at the health of Target in a larger sense rather than thinking of only one store. Also, by taking into account the impact of Wall-Mart's presence will have on the project, management can consider how best to alter their strategy. The idea of creating a Target Supercenter is key as it will decrease strain on existing stores as it will offer unique product lines, thereby ensuring novel customers rather than drawing from other stores, as well as establish a Target brand in the market before Wall-Mart, thereby making the town less conducive to our competitor's presence when they arrive. Analyses of this sort are critical to ensuring the long-term health of an investment.

Whalen Court:

Brief Statement: This location is a $119 million investment to build a unique single level store in an metropolitan setting of 600,000 people which has grown 3% in the last five years. Target is currently highly present in the trade area with a 45 store density. Furthermore, the project would be leased rather than owned as per typical procedure. The motivation for entering this project is based on brand visibility and achievable sales NPV despite high market density. If we do not go forward with the project at this time competitors will surely move to seize the opportunity.

Key Facts: Investment - $119 million; Base NPV -- 25.9 million; IRR -- 9.8%; 45 stores currently exist in the market; NPV can be achieved with sales 1.9% over R&P; high visibility.

Identification of Possible Alternatives and Analysis -- The critical decision here must be made in regards to the value of the advertising exposure that this significant investment will provide. At over $100 million ($87 lease/$29 renovations) this store is a significant departure from our usual resource allocation in the name of intangible gains based on advertising potential, brand recognition and blocking our competitors from taking over the sight in the following months. Three alternatives exist: 1) Going through with acquiring and investing in the location due to its achievable 1.9% sales over projected NPV, taking advantage of its free advertising potential and ensuring that competitors do not reap these positives in the next few months in a highly sought after location; 2) Passing on the location due to its steep investment price tag of over $100 million, our high market presence of 45 stores, minimal maturity yield and unquantifiable advertising exposure benefit; or 3) Acquiring the lease without investing in the renovations/construction costs. This tactic will establish our brand presence while minimizing our exposure; however it is unclear how this will influence profits or customer estimation of the store's brand value.

Recommendation of Best Alternative: The best course of action is to go through with detailed in alternative #1. Though there are areas of concern with this project the potential upside is tremendous in free advertising and brand name recognition along with a realistic sales over NPV.

Reflection on Broader Implication: The larger value of this project is reflected in its intangibles, such as advertising exposure and name brand recognition. By establishing a flagship store in a highly visible area we will be ensuring that consumers will not only utilize the Whalen Court store but will also consider Target stores when in other locations. This will have a positive impact on our entire line of stores and encourage customer-brand identification through the concept of "first-mover advantage." Also, to look on the other side, our presence will stop our competitors from taking over a high visibility location with an achievable NPV vs. projections.

The Barn:

Brief Statement: This location is a $13 million investment in a growing, highly favorable market of 151,000 people which has grown 3% in the last five years. Target is currently not represented at all in the regional market with two stores 80 and 90 miles away respectively. The project has been delayed due to difficulties with the developer, however as NPV can be achieved with sales 18% below R&P this is an extremely attractive opportunity to get a secure return on investment with even significantly lower sales figures than projected.

Key Facts: Investment: $13 million; Base NPV -- 20.5 million; IRR -- 16.4%; NPV achievable w / sales 18% below R&P. No Target stores in regional market. Significant competitor presence.

Identification of Possible Alternatives and Analysis: Three main alternatives exist for this project: 1) This project can be developed as planned in light of secure return on investment, minimal investment cost when compared to other markets and the opportunity posed for Target to move into a new market; 2) In light of small overall profit, high competitor presence and existing difficulties with the developer, this project can be passed on to focus on higher earning projects in other markets; or 3) As this is generally a small investment project, Target can consider investing more into this market to distinguish itself from the existing competition. This market is large at 150,000 people with no existing Target presence the company could considering placing a Target Super Center or even investing more in a P04 store to attract business away from the existing Wal-Mart, Sam's Club and planned K-Mart stores.

Recommendation of Best Alternative: Target should strongly consider this project. It is a secure return on investment with the opportunity to expand our brand presence. Significant thought be put into option 3 as with minimally more investment Target can get maximize its returns in a new market while ensuring that it distinguishes itself from the existing competition.

Reflection on Broader Implication: This project reflects some of the larger challenges that any organization faces when moving into a new market. It is always difficult to move into a market where existing product competition exists, however, a new product (such as a Target Super Center) or tweaks to an existing product (expanded investment in a regular P04 store) can help with this, but that's only a part of the equation. There's still the challenge of making things happen so that the existing brand image translates well into the new market.

Tapping into a new market means that there's new data that needs to be mined. Management must narrow down what specific part of the market the business is going to tap into to distinguish itself. No dramatic changes to market or product line need to be made but through an analysis of the competition, we can design a smooth transition into this market area. In an ideal situation, any changes made to the product or marketing would be something that is welcomed by both old and new markets. That's an exceedingly rare thing, though, so most people settle for striking some kind of balance between existing Targets and this new store.

Remember that, much like in the old market, the process will likely start off slowly.. Once the general public gets their hands on it, the company can only hope to steer things this way or that. This means that before releasing things, there should be a clear idea on where public opinion should be steered towards. Target through offering a unique product line and distinguishing itself can best expand and thrive in a new market such as this project.

Goldie's Square:

Brief Statement: This location is a $23.9 million investment to build a Target Super Center in a growing, high-income market of 222,000 people which has grown 16% in the last five years. Target currently has 12 stores and is planning to open 24 stores in the growing market. Despite poor NPV performance numerous other non-competitive retailers are building in order to access the market in the years ahead as the high-earning market continues to grow.

Key Facts: Investment: $23.9 million; Base NPV -- $300,000; IRR -- 8.1%; NPV achievable w / sales 45% above R&P. 12 Target stores with plans for 24 total in regional market.

Identification of Possible Alternatives and Analysis: Numerous options exist for this project: 1) Target could go forward on this project, investing in a project that has high hopes for future developments despite a $23 million investment with exceedingly poor odds of having a return on investment in the near future (45% sales above projections); 2) Target could cancel this project which is exceedingly optimistic and concentrate on other projects with greater opportunity for a return on investment in the foreseeable future; 3) Other stores in the market, particularly T-683, can close in order to redirect business towards the new store. Three plans exist: T-683 closes immediately on store opening and waiting one or two years. Closing immediately is predicted to modify the existing estimate to an NPV of 6.3 million and increase the IRR to 9.6%. This decision will improve somewhat the return for investment on this project.

Recommendation of Best Alternative: The best alternative to this project is to cancel the project. This scheme is based on unquantifiable future development that is prey to downturns in the economy and other unknowns. The fact is that this project requires unreasonable sales over projections to realize any return on this investment in the near future. Competitor store WSMC has recently closed in this market demonstrated its unprofitability.

Reflection on Broader Implication: The larger implications of this project are that Target must expand conservatively with solid financial figures underlying its decisions. To predicate a $23 million dollar investment on the unclear market potential despite exceedingly poor current market projections is not an efficient way to run a company. Despite the investments of other non-competitive retailers to expand into this market, this project is risky in light of current economic conditions as it predicates its entire value on future growth. As with other forms of risk, the potential loss amount due to market risk may be measured in a number of ways or conventions. Traditionally, one convention is to use Value at Risk. The conventions of using Value at risk is well established and accepted in the short-term risk management practice. However, it contains a number of limiting assumptions that constrain its accuracy. The first assumption is that the composition of the portfolio measured remains unchanged over the specified period. Over short time horizons, this limiting assumption is often regarded as reasonable. However, over longer time horizons, many of the positions in the portfolio may have been changed. The Value at Risk of the unchanged portfolio is no longer relevant. In addition, care has to be taken regarding the intervening cash flow, embedded options, changes in floating rate interest rates of the financial positions in the portfolio. They cannot be ignored if their impact can be large on larger Target corporation's financial health.