Running head: LEARNING TEAM DELIVERABLE 1

Pontrelli Recycling

Sara Doyle, Kevin Jackson, and Ali Lakhani

FIN/575

Michael Plesko

January 20, 2014

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Pontrelli Recycling

Pontrelli Recycling, Inc. has a mission to “increase the efficiency of recycling

usable materials in order to create a better environment for all,” and to “create value and

a fair return on investment for shareholders” (Callahan, Stetz, and Brooks, 2007). A

project must always be aligned with the company’s strategy and financial goals. When

devising any new project, a company can refer to many available resources for the

information needed for the plan by reviewing financial sheets and documents. In the

upcoming project for Pontrelli Recycling the high level cost estimate for the project is

$8.8 million. In the following project plan overview, the details of the project will be

reviewed.

Debt and equity financing are two methods that may be employed by a company

to obtain necessary capital for projects. Equity financing uses investors to obtain

necessary funds. Equity financing does not have to be paid back like a loan and leaves

more cash on hand for a company. While this method sounds appealing for those reasons,

equity financing can lead to less control and ownership of a company, higher returns to

be paid out to investors in the long run, and a longer financing process. Debt financing

uses loans from banks or other financial institutions to acquire funds. By using debt

financing, a company is able to maintain control and ownership of their company, use

interest on the loan as a tax deductible, and plan for known repayment figures. Pontrelli

Recycling can take advantage of the benefits of both of these methods for financing, and

reduce their disadvantages by using both methods to fund their upcoming project. They

can turn to investors for a portion of their financing and use banks for the other portion of

financing.

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One major part of creating a project proposal is being able to measure the value of

the company. Pontrelli Recycling will need to determine the value of their company to

assist in determining credit worthiness, tax purposes, and to be able to present their

current status to potential lenders or investors. To measure value, a company can use

either the economic value added (EVA) or the market value added (MVA)approach.

“Economic value added can be calculated as the difference between the company’s net

operating profit after tax and a portion of the amount of capital invested in the business”

while “the market value added can be calculated as the difference between the company’s

market value and the amount of capital invested in the business” (Hanks, n. d.). The

MVA measures the “operational capabilities of a company’s management” and the EVA

measures the “opportunity cost of alternative investments,” and the company’s efficiency

of management (Hanks, n. d.).

Weighted Average Cost of Capital.

Weighed average cost of capital (WACC) is a composite of the individual costs of

financing incurred by each capital source. The firm WACC is a function of (1) the

individual cost of capital, (2) the capital structure mix, and (3) the level of financing

necessary to make the investment (Titman, Keown, & Martin, 2011). WACC is

calculated by multiplying the after cost of debt to the proportion of capital raised by debt.

Multiply the cost of preferred stock to the proportion of capital raised by preferred stock,

and then multiply the cost of common stock to the proportion of capital raised by

common stock. The formula for WACC is:

WACC= (after tax cost of debt X proportion of capital raised by debt)+(Cost of preferred

stock X proportion of capital raised by preferred stock)+(Cost of common stock X

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proportion of capital raised by common stock).

The advantage of using the WACC method is it is familiar to mot business executives.

The WACC minimizes estimation cost, as there is only one cost of capital calculation for

the firm. In addition, using WACC reduces the problem of influence cost issues (Titman,

Keown, & Martin, 2011). However the weaknesses of a firm using the WACC method is

(Titman, Keown, & Martin, 2011):

WACC does not adjust discount rates for differences in project risk

WACC does not provide for flexibility in adjusting for differences in project debt

in the capital structure.

WACC is used to value the entire firm, it used as a starting point to determine the

discount rate for project investments. In addition, the WACC is the appropriate rate to

use when evaluating the firm performance to determine if the firm has created value for

its shareholders.

Project Viability

To calculate the cash flows for the project a cash flow statement has to be created

for Pontrelli Recycling Inc. The cash flow statement shows the projected cash flows for

Pontrelli Recycling Inc. project (Callahan, Stetz, & Brooks, 2007):

Cash Flow Statement

2007 2008 2009 2010Net Income 2,205,535 3,413,387 5,296,138 8,532,792Depreciation and Amortization

(7,500,000) 0 0 0

Acct. Receivable

(86,406) (90,726) (95,263) (100,026)

Inventory 60,759 63,580 66,767 70,105Prepaid Expenses

0 0 0 0

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Acct. Payable 27,265 29,991 49,485 56,908Taxes Payable 31,402 66,332 103,404 177,682Customer Deposit

0 0 0 0

Net Cash Flow Provided by Operating Activities

(5,261,798) 3,455,564 5420531 8737461

Net Property, Plant, and Equipment

0 0 0 0

Other Assets (19,791) (21,769) (35,920) (41,308)Net Cash Flow Provided by Investing Activities

(19,791) (21,769) (35,920) (41,308)

Borrowings 7,522,016 (839,806) (752,358) (673,482)

Common Stock/Equity

0 0 0 0

Net Cash Flow Used by Financing Activities

7,522,016 (839,806) (752,358) (673,482)

Change in Cash 2,258,247 2,593,989 4,632,253 8,022,671Beginning Cash 5,402,551 7,608,086 11,021,473 16,317,611

Ending Cash 7,660,798 10,202,075 15,653,726 24,340,282

The projected cash flows for Pontrelli Recycling Inc., project is as followed:

2007 Cash Flow- 7,660,798

2008 Cash Flow- 10,202,075

2009 Cash Flow- 15,653,726

2010 Cash Flow- 24,340,282

Using these projected cash flows the financial manager can calculate the net present

value (NPV) of the project to obtain the present value of future cash flows. The initial

cash outflow is 8.8 million dollars, and the discount rate is 18% (8% loan financing +

10% equipment amortization). NPV is calculation is:

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-Cash outflow+ Cash inflow1/(1+discount rate)+Cash inflow2/ (1+discount rate)2+Cash

inflow3(1+discount rate)3+Cash inflow4(1+discount rate)4.

To calculate the profitability index Pontrelli Recycling Inc. will take the present value

of future cash flow from calculating NPV and divide by the cash outflow of 8.8 million

dollars:

2007 present value-6,492,202

2008 present value-7,326,971

2009 present value-9,527,341

2010 present value-12,554,447

The total present value of future cash flow is 35,900,961 divide this amount by the

cash outflow of 8.8 million, and the profitability index is 4.08. According to Titman,

Keown, and Martin (2011), “When the profitability index is greater than one, the NPV

will be positive, so the project should be accepted. When the profitability index is less

than one, which indicates a bad investment, NPV will be negative, and the project should

be rejected. Because the profitability index for Pontrelli Recycling Inc. is 4.08 the

project should be accepted.

Alternate Capital Structure

Pontrelli Recycling Inc. can use economic value added as an alternate capital

structure instead of the traditional WACC. The economic value added is the difference

of net operating profit after taxes (NOPATO) minus the capital charge (CC). However,

to obtain the capital charge, Pontrelli Recycling Inc. would use the product of WACC and

multiply the beginning balance of the firm’s capital or equity (Callahan, Stetz, & Brooks,

2007). According to Callahan, Stetz, and Brooks (2007) economic value added shows

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the amount of value that is created or destroyed by Pontrelli Recycling Inc. for the period

of operations. Pontrelli Recycling Inc. can use the EVA to see if the project would

increase or decrease value to the firm for years the project is initiated.

Alternate Project Budget

The budget made by Pontrelli and the actual projections of what the project

is going to be over by almost six percent. In creating an alternative budget it is

important to first see where the pervious budget was and where the actual

projection costs of the project are. Then a new budget can be made that takes that

into account so that the projections and budget are not too far off from one another.

The current budget takes into account: Project Initiation and Planning, Plant

Equipment, New Trucks, Construction, Installation, Process Review and Change,

Project Management, Training, New Equipment, Construction and Renovation, and

Training and Change Management. All together, there is roughly 7.5 million dollars

budgeted for this specific project. However, the project is estimated actually cost 8.8

million dollars. When creating an alternate budget it is important to take this into

account.

Currently, there is $100,000 budgeted for Project Initiation and Planning.

The new budget will allocate $150,000 for Project Initiation and Planning. Next,

Plant Equipment is budgeted at $ 5 million, so now it will be taken up a bit to 5.5

million dollars. New Trucks have a budget of $750,000 so to take into account the

high costs, the new budget will be $850,000. Construction is currently budgeted at

$800,000 and now the new budget will be 1 million dollars.

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Next for Installation, the budget is $450,000, but now since the project

estimate is going to be higher, the company needs to allocate $525,000 as a new

budget for Installation. Process Review and Change is currently budgeted at

$162,000, but now the company needs to increase that budget to $200,000. Project

Management can be increased to $200,000 as well to account for the new project

estimates. Training is budgeted for $125,000, and now it will be changed to

$200,000 to include the new high cost project estimates. So now, the budget for the

project has actually increased to $8,625,000 and the Project Estimate remains at

$8.8 million. Now there is only one percent to two percent difference between the

Project Estimate and the Budget Estimate. There are still constraints to this.

The constraints to this budget are that the project estimate is still way over

the actual budget that Pontrelli has sent. When it comes to any one of these

categories, if corners are cut the entire project could suffer. Planning and Project

Initiation is one place where costs can be cut. However when it comes to

construction, installation, and training the full resources of money are going to be

needed or the staff will not be trained and equipment will not be installed properly.

In the long run, this could have affects on the customer experience, which could lead

to a loss in sales for the company.

Project Budget Plan

“An alternative plan to manage the project budget can include using

budgeting as a control tool instead of overestimating or underestimating the

project” (Eichenbeger, 1998, p. 269). When using the budget as a control method, it

allows the project manager to be able to manage the costs of the project more

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closely and not allowing the actual cost of the project to be that much higher than

the projected budget. This can keep the project from becoming a risk factor the

company.

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References

Callahan, K.R., Stetz, G.S., & Brooks, L.M. (2007). Project Management

Accounting:Budgeting, Tracking, and Reporting Cost and Profitability . Hoboken,

N.J.: John Wiley & Sons, Inc.

Eichenberger, J. (1998). Project management, part III budgets for projects. AAOHN

Journal, 46(5), 268-70. Retrieved from

http://search.proquest.com/docview/1013462577?accountid=35812

Hanks, G. (n.d.). Market Value Added Vs. Economic Value Added Chron.com.

Retrieved January 18, 2014, from http://smallbusiness.chron.com/market-value-

added-vs-economic-value-added-72854.html

Titman, S., Keown, A.J., & Martin, J.D. (2011). Financial Management:Principles and Applications (11th ed.). Boston, M.A.: Prentice Hall