Target Corporation has a distinctive capital-budgeting system. It uses Capital Project Requests (CPRs) to propose projects and obtain authorization for funds allocation. The required level of approval depends on the requested amount. Projects seeking less than $100K can be approved by lower management. However, if the requested amount exceeds $100K, it is forwarded to the Capital Expenditure Committee (CEC), which comprises 5 executive officers. For projects that surpass $50 million, approval from the Board of Directors is obligatory.
The Capital Expenditure Committee convenes monthly to sanction projects while adhering to the capital budget, advocating for the opening of 100 stores annually, and approving projects that propel the company’s growth trajectory. During these meetings, the sponsoring real estate manager presents the projects alongside a dashboard that provides a concise overview of the key metrics. These monthly meetings typically endure for multiple hours. However, executive officers perceive this meeting as inefficient use of time.
To improve time management, we propose increasing the approval threshold for projects from $100K to approximately $1 million. This adjustment can reduce the number of projects discussed and, consequently, make the meetings shorter, allowing for more thorough discussions on the proposed projects. The real estate managers are responsible for owning and presenting the project proposals (CPRs). Prior to presentation, significant pre-work is undertaken, involving a duration of 12-24 months. During this period, various data points are collected, including NPV, IRR, demographics, brand awareness, and sensitivity analysis.
The Research and Planning group provides sales projections and summarizes project metrics into a standardized template called a dashboard. This dashboard will be referred to by the committee. We believe that the real estate managers spend too much time on pre-work, resulting in a significant cost, both financially and emotionally, from gathering information. We propose adding an extra approval layer during the initial months of the project pre-work for projects exceeding $1 million.
A project update should be presented 3 months into the pre-work and approval would be necessary to continue pursuing the project. This would help keep resources away from bad projects that would have been rejected and might also be used for allocating additional resources to expedite highly attractive projects. #2: Project analysis: Our team reviewed all five of the projects based on a series of metrics and developed the below rankings. We decided to approve The Barn, Gopher Place, and the Stadium Remodel. We will recommend the Whalen Court project for approval but the Board of Directors will ultimately make the decision.
We are rejecting the Goldie’s Square project. We have explained our decisions for each project in detail and have also ranked all the projects. During the ranking process, we considered the following categories and assigned weights to them according to their importance. NPV was given the highest weight as we believe it is the most accurate metric for evaluating projects. IRR and Size of project were given the next highest weights as they help in comparing the projects with each other.
We considered Store Sensitivities as a crucial factor for assessing risk, while the remaining metrics were deemed somewhat less significant. Regarding the Gopher Place project, it necessitates an investment amounting to $23 million and presents an anticipated NPV of $16.8 million and an IRR of 12.3%. This project appears quite secure, as it can achieve the prototype NPV even with a sales projection shortfall of 5.3%. Even if sales have a variance of 10%, the anticipated NPV would still amount to $12 million. Moreover, the recent rise in population within the region makes this project even more appealing.
The investment of Gopher Place is expected to lead to a 19% decrease in sales from five existing Target stores in the area, but this will not have a significant impact on the overall situation. The financials for Gopher Place indicate low risk and growth in the region, so I have decided to approve Whalen Court. This project requires an investment of $119.3 million and is projected to have a net present value (NPV) of $25.9 million and an internal rate of return (IRR) of 9.8%. However, despite having the highest NPV, Whalen Court’s unusually high investment cost exceeding $119 million results in a less favorable return on investment compared to other projects.
Whalen Court is expected to have higher costs of approximately $90 million due to leasing a building, but it also anticipates a sales increase of nearly $100 million compared to the prototype store. Despite being in an area with 45 Target stores, Whalen Court offers excellent brand visibility opportunities and is located in a densely populated center. As a result, it is estimated that only 10% of current Target sales will be affected in the future. However, there are concerns about the high risk variance associated with Whalen Court. Current projections indicate that this project needs a 1% improvement in sales performance to achieve an Internal Rate of Return (IRR) comparable to that of the prototype store. On the other hand, if sales decline by 10%, there would be a significant decrease in Net Present Value (NPV) by 64%, causing the IRR to drop below 9%. From a market strategy perspective, Whalen Court is considered the best project because its demographics align with Target’s traditional customer base. Additionally, being positioned as a single-level store in an urban area would provide substantial brand visibility and essentially free advertising for Target.
Target has the opportunity to expand into a large city and meet the needs of a growing population. The potential for increased brand awareness and free marketing can help offset some of the sales risks. However, considering the size of the investment, the company may have other preferences for allocating capital. Ultimately, it is up to the board to make the final decision, but our recommendation is to approve this project.
The Barn project requires a $13 million investment and is projected to have a net present value (NPV) of $20.5 million with a 16% internal rate of return (IRR). This was an easy decision among all the projects because not only do the NPV and IRR perform well, but there are also other positive factors such as entering a new market for growth without any competition within an 80-mile radius. Despite projected sales being 18.1% below target, this project still has potential to achieve prototype NPV while presenting minimal risk of decline.
Despite the lack of branding opportunity due to the store’s location, this project is not a major concern given its strong financial performance. In conclusion, Goldie’s Square is approved with an investment of $23.9 million, an expected NPV of $0.3 million, and an IRR of 8.1%. This project ranked the lowest in almost every category. Goldie’s Square is situated near 12 existing Target stores, with 24 more planned for the region in the near future. It is expected that 38% of its sales will be cannibalized from other Target stores in the area.
This store needs to achieve sales that are 45.1% better than expected in order to match the prototype. However, if there is a 10% decline in sales, the project will have an expected negative NPV value. In terms of market strategy, Goldie’s Square could be a valuable demographic for Target. It is the second largest population among the proposed project locations and it has the second largest population growth. Despite these positive factors, Goldie’s Square has too much risk for a low return. Therefore, the final decision is to reject it.
The Stadium Remodel project requires an investment of $17 million, with an expected NPV of $15.7 million and an IRR of 10.8%. The store’s sales figure is relatively high, leading to variability if sales exceed or fall below projections. As a remodel, there is no comparison to a prototype. Given the declining sales in recent years, we focused on a scenario with a 10% sales decline. Running the project under this scenario yields an IRR of 9%, which is low for such projects, but expects an NPV of $8 million. Stadium Remodel has historically performed well, catering to the population’s needs since 1972. Despite recent lagging sales, the deteriorating facilities at the location may be partially responsible. The area’s demographics rank second-best among all projects and represent Target’s desired consumer profile. The branding opportunity for this store lies in repairing the brand through remodeling and regaining or retaining loyal customers.
The financials are not the best, but still result in a favorable NPV based on the size of the project. Final decision: Approve #3: Target uses different hurdle rates for the store and credit cards (9% and 4%, respectively) because of the different nature of risk, strategy, and financing. Target assigns a lower hurdle rate for credit card sales versus stores because they favor them more. Additionally, credit card sales flows generate a slightly higher operating income since the company does not have to pay outside credit agencies a cut of the sales price.
Target specifically targets customers who have made credit card purchases because they align with the company’s strategy of concentrating on in-store visitors. By monitoring these customers’ credit card activities, Target can promote products to them with the aim of generating additional sales. Moreover, Target can leverage the gathered data to improve marketing strategies for other customer segments. Due to these motives, Target prioritizes credit card transactions and integrates them into their financial calculations by employing a lower hurdle rate. This lower rate subsequently leads to increased net present value for future cash flows.
