Target Corporation uses an interesting capital-budgeting system. Projects are proposed using Capital Project Requests (CPRs) and must be approved before money can be spent. The level of approval needed depends on the amount being requested. For projects requiring less than $100K, lower management can approve, but anything above this amount goes to the Capital Expenditure Committee (CEC) which is comprised of 5 executive officers. For projects requiring greater than $50 million, the Board of Directors must approve.
The Capital Expenditure Committee meets once a month to approve projects. The committee tries to stay within the capital budget, push for opening 100 stores yearly, and approve projects that keep the company on a growth trajectory. In the monthly meeting, projects are presented by their sponsoring real estate manager, along with data in the form of a dashboard that summaries key metrics of each project. The monthly meeting usually last several hours. We feel that this meeting is not the best use of time for executive officers.
To help allow for better use of time we suggest that the approval cut-off for projects be raised from $100K to something closer to $1million. This should help lower the number of projects discussed and in turn shorten the meeting while the proposed projects can be discussed more in depth. The project proposals (CPRs) are owned and presented by the real estate managers. There is a lot of pre-work that goes into the project before it’s presented. Typically 12-24 months of work is done to collect various data such as NPV, IRR, demographics, brand awareness, and sensitivity analysis.
The sales projections are provided by the Research and Planning group and all project metrics are summarized into a standardized template, called a dashboard that the committee will reference. We feel that too much time is spent during pre-work by the real estate managers and at the end there is a great deal of sunk cost both financially and emotionally from the time spent gathering information. We suggest that an additional layer of approval be added in the early months of the project pre-work for projects above the $1million threshold.
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 eths decision.
We reject the project Goldie’s Square. We have provided a detailed explanation of each decision. We have also provided an overall ranking of the projects. To do this we ranked each project based on the below categories. We then weighted each category to the level of importance we deemed. We assigned the highest weight to NPV because we feel this is the best metric for determining projects. The next highest weights were IRR and Size of project because we feel this metrics help compare the projects to each other.
We felt Store Sensitivities was important to gauge risk. The rest of the metrics we felt should be considered, but not with as much importance. Gopher Place: This project requires an investment of $23 million and has an expected NPV of $16. 8 million and 12. 3% IRR. This project seemed fairly safe since it is able to meet the prototype NPV even with 5. 3% below projected sales. Even a variance of 10% sales would result in expected NPV of $12 million. The recent population increase in the region also makes this project attractive.
The investment of Gopher Place will cause 19% of its sales to be cannibalized from five pre-existing Target stores in the area but this is not enough to impact the scenario. The financials are consistent, risk seems low, and the region is growing. Final decision: Approve Whalen Court: This project requires an investment of $119. 3 million and has an expected NPV of $25. 9 million and 9. 8% IRR. Even though this project has the highest NPV, it carries an unusually high investment cost of over 119 million so the return on investment is not as favorable as the other projects.
In comparison to the prototype store, Whalen Court expects nearly $100 million more in sales, but since the building must be leased the operating costs are also much higher than the prototype at nearly $90 million more. The Whalen Court project will be in an area with 45 Target stores saturating the market, but with a great opportunity for brand visibility and in a large population center, it will only cannibalize 10% of current Target sales in the future. Whalen Court brings concerns regarding its high risk variance. Based on current estimates, this project requires a 1. % better than expected sales to have an IRR in line with the prototype store. A 10% sales decline is expected to result in an NPV loss of 64% from its base, dropping the IRR below 9%. In terms of market strategy, Whalen Court is the best project because the demographics allowing for Target to cater to their traditional customer base. In addition to the population base being most aligned with their target market, the location of this single-level store in a metropolitan area would afford Target major brand visibility and essentially free advertising.
Target could enter in to a large metropolitan area and cater to the needs of a growing population. The opportunity for brand awareness and free marketing help offset some of the sales risks but since this is a large investment the company may have other way it would like to spend its capital. The board will make the final decision, but we recommend approval. Final decision: Send to Board recommending approval The Barn: This project requires an investment of $13 million and has an expected NPV of $20. 5 million and 16. % IRR. This was the easiest decision of all the projects. The NPV and IRR alone are great metrics, but this project also has other positives. The Barn is a new market for growth with no Target stores within 80 miles, carrying 0% cannibalization. This project was the most favorable among all due to its potential to achieve the prototype NPV with even with 18. 1% below the projected sales. The Barn project does not appear to present a huge opportunity for growth, but the risk of decline is also minimal.
This project also does not offer much in terms of branding due to the store location but this is of little concern with such high financials. Final decision: Approve Goldie’s Square: This project requires an investment of $23. 9 million and has an expected NPV of $0. 3 million and 8. 1% IRR. In nearly every category this project ranked lowest. The project at Goldie’s Square is already in the vicinity of 12 Target stores with an expected total of 24 supporting the region in the near future, it is expected that 38% of its sales will be taken from other Target stores in the area.
This store requires better than expected sales of 45. 1% to match prototype and with 10% sales decline the project would result in an expected negative NPV value. In terms of market strategy, Goldie’s Square has the potential to be a key demographic population for Target. The population is the second largest in the proposed project locations and the growth in population is second largest. Despite the positives for location, Goldie’s Square appears to carry too high of a risk for a minimal return. Final decision: Reject
Stadium Remodel: This project requires an investment of $17 million and has an expected NPV of $15. 7 million and 10. 8% IRR. The store shows a relatively high sales figure which leads to high variance if sales are higher or lower than projections. This project is a remodel, so there is no prototype to compare to. Since the store has seen declining sales the last few years, we felt the important part to look at was a 10% decline scenario. The expected IRR when running the project at a 10% decline in sales results in IRR of 9% which is low for these projects but expect NPV still at $8 illion. Stadium Remodel has, traditionally, has been a good performer; the store has catered to the needs of the population since 1972. Though the sales for Stadium Remodel have been recently lagging, the deteriorating facilities as the location could be partly to blame. The demographics of the area are the second best of all the projects and represent the type of consumers Target desires. The branding opportunity for this store is to repair the brand by remodeling the store and maintain or bring back 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: Why does Target use different hurdle rates for the store and credit cards (9% and 4%, respectively)? Target uses these different rates because 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. For starters, credit card sales flows generate a slightly higher operating income due to the fact that the company does not have to pay outside credit agencies a cut of the sales price.
Secondly, Target values credit card sales customers because they fit into the overall company strategy of focusing only on customers who have visited Target stores. By tracking these customers, using their credit cards, the company can market towards them in hopes of obtaining incremental sales. Target can also use the data collected to make better marketing decisions for other customers as well. Because of these reasons, Target favors credit card sales and thus incorporates this in their financial calculations by using a lower hurdle rate. The lower hurdle rate results in higher net present value for future cash flows.