Companies make capital budgeting decisions


Companies make capital budgeting decisions based on the expected profitability of a project.  Companies must also make financing decisions. The investing and financing decisions, although related, are independent of one another.  For purposes of this phase of the Comprehensive Project, assume the capital project analyzed last week has been undertaken. Remember, the cost of the project is 2% (rounded to nearest $00 million) of the company’s total assets.

You are considering five possible financing options:

Retained Earnings:  Paying for the project with existing resources; the cost of this option is the opportunity cost of the next best option…in this case, the foregone interest of 4% determined last week.

Five-Year, 5% Note Payable:  The face-value of the note will be equal to the cost of the project; the note will bear interest at 5%; repayment of the note principal is due at the end of 5 years with the last interest payment

Ten Year; 8% Bond Issue:  The bonds will be issued at par with a face value equal to the cost of the project.  One tenth of the bond principal will be retired each year along with the annual interest payment.

6% Preferred Stock: Preferred Stock with a total par value equal to the cost of the project will be issued; the stock pays an annual dividend of 6%.

Issue of Common Stock:  Common stock will be issued at par for a total value equal to the cost of the project.

Quantify the cost of each alternative on the Week 6 tab of the CP file.

Submit a 3-4 page (double spaced) summary (MAX) of the pros and cons of the different methods for financing the project. Include both qualitative and quantitative considerations. Consider the impact of your analysis on relevant ratios of your selected company. Which of the financing options would you recommend?

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