I need a discussion done for week 6 for my Financial Managnment 11

 Week 6 Discussion

COLLAPSE

Aligning Strategy and Budget

In Chapter 9 of The CFO Guidebook, we are introduced to the tools of capital budgeting. Making specific reference to what you read in that chapter, respond to the following questions:

• Which metrics and methodologies are the most useful when evaluating a capital investment? Why?
• How can finance leaders be more effective partners to managers and business leaders in developing capital budgets that align with the risk tolerance and mission of the organization?
• What can be done to make sure everyone understands the connection between the strategy and the capital budget?

Post your initial response by Wednesday, midnight of your time zone, and reply to at least 2 of your classmates’ initial posts by Sunday, midnight of your time zone.​

©Strayer University. All Rights Reserved. This document contains Strayer University Confidential and Proprietary information and may not

be copied, further distributed, or otherwise disclosed in whole or in part, without the expressed written permission of Strayer University.

JWI 531 (1202) Page 1 of 9

JWI 531: Financial Management II

Week Six Lecture Notes

© Strayer University. All Rights Reserved. This document contains Strayer University Confidential and Proprietary information and may not
be copied, further distributed, or otherwise disclosed in whole or in part, without the expressed written permission of Strayer University.

JWI 531 (1202) Page 2 of 9

STRATEGY AND CAPITAL BUDGETING

What It Means

Capital budgeting is a process focused on fixed-asset investment opportunities to drive growth and create
shareholder value. Analytical techniques like Payback, Net Present Value and Internal Rate of Return are
tools to support the broader strategic capital investment decision-making process. Capital budgets are how
organizations plan to put their strategy into action.

Why It Matters

• Management is responsible for the owners’ wealth and all of the capital invested in the
organization. A well-run organization with an effective strategy will create shareholder value.

• The capital budgeting process is much more than just the quantitative tools to evaluate forecasts

of future cash flows. It is also a learning process to develop and refine the organization’s strategy.

• Budget data in the right format allows you to compare your results against your plans, and take
appropriate actions in a more insightful manner than just looking at the original budget.

“Your organization has picked the strategy, the
strategy has been bought into, and it’s going to

require certain amounts of capital. For every
capital project the question is going to be:
does this capital and the strategy match?”

Jack Welch

© Strayer University. All Rights Reserved. This document contains Strayer University Confidential and Proprietary information and may not
be copied, further distributed, or otherwise disclosed in whole or in part, without the expressed written permission of Strayer University.

JWI 531 (1202) Page 3 of 9

THE CHALLENGE AND OPPORTUNITY FOR MANAGERS

Capital budgeting is strategy!

What else would you call decisions about large-scale, long-term investments of capital?

Yet, this important process is often undermined when it becomes, as Jack says, “a game of minimalization.”
As we discussed last week, the budgeting process is too often viewed as a painful and time-consuming
exercise. Reform requires a change in organizational culture and a change in the way the budget information
is used to direct managerial actions. This is also true for large-scale capital investments. You can play a role
in changing that.

Capital budgeting is based entirely on forecasts. But unlike operating budgets that typically look just a year
into the future, capital budgets look many years into the future. This means there is even more uncertainty
in any forecast you make about future cash flows. There’s no way to avoid this uncertainty, but there are
ways to accommodate it.

As with everything else we have discussed in this course, your ability to contribute to strategy in your
organization is determined by your ability to tell a story or paint a picture. If the story you tell or the picture
you paint lacks proper financial analysis, then it’s incomplete. As we learned last week, the work that goes
into forecasting future cash flows and modeling a range of possibilities for those cash flows allows your
organization to scrutinize whether pursuing an opportunity makes sense. While the numbers don’t make
the decision for you, the work to develop those numbers makes your choice a more informed one, even
when you must acknowledge that certain data are incomplete.

Keep in mind that being incomplete doesn’t mean it’s wrong. In fact, your ideas may be brilliant. Your
experience, your intelligence, and your gut may be pointing you in exactly the right direction. But no matter
how exciting your vision is, no matter how appealing the destination is, if you can’t explain how you’re
going to get there, what it will cost, and how long it will take, it is going to be very difficult to get others to
follow. And if the people you want to follow you are the same ones who get to say yes or no to capital
budget allocations, then the journey you are proposing may be over before it has even begun.

But don’t despair. You don’t need to know everything about every detail in the plan. You just need to know
enough to speak intelligently about the most important factors that can influence the outcome.

If you want to be a passionate champion for a capital project, then talking about positive NPV, IRR, and
Payback is not the most compelling way to demonstrate that passion. Numbers are necessary to back up
the claims you make and your view of the future. But numbers cannot stir the soul in the way a fiery
speech about achieving the organization’s mission can. If you want to rally the troops, you’ve got to frame
your pitch for capital investments in the organization’s mission and strategy. Just make sure you can back
up those statements with sound financial analysis.

© Strayer University. All Rights Reserved. This document contains Strayer University Confidential and Proprietary information and may not
be copied, further distributed, or otherwise disclosed in whole or in part, without the expressed written permission of Strayer University.

JWI 531 (1202) Page 4 of 9

YOUR STARTING POINT

1. How involved are you in capital investment decisions in your organization? How would being
more involved help you become a more strategic leader?

2. Do you know the discount rates that the financial managers in your organization require when
analyzing different types of capital investments? If not, track those down. The same goes for the
hurdle rates for IRR and the time periods for Payback. If you’re not aware of these benchmarks,
then speak to the financial managers and get this information.

3. How comfortable are you today with interpreting and applying the capital budgeting tools of
Payback, NPV, and IRR? Are you aware of the different Payback benchmarks your
organization uses to analyze different kinds of capital investment projects? If not, how could
you familiarize yourselves with these?

4. Are you aware of your organization’s weighted average cost of capital (WACC)? If not, how
might you go about getting this information?

5. Does your organization have formal processes to collect, analyze, and share any learning or
insights that come from past capital investment processes to help it make better capital
investment decisions in the future?

6. How clearly articulated are the following in your organization: mission, strategy, analysis and

implementation? There should be a clear line of sight as you move from each step to the next
so that everyone involved with the implementation of a capital project understands how it
supports the mission, is based upon strategy, and has been considered and selected.

© Strayer University. All Rights Reserved. This document contains Strayer University Confidential and Proprietary information and may not
be copied, further distributed, or otherwise disclosed in whole or in part, without the expressed written permission of Strayer University.

JWI 531 (1202) Page 5 of 9

STRATEGY AND CAPITAL BUDGETING

Aligning Finance Strategy to the Mission

Making good capital budgeting decisions allows organizations to grow while protecting cash flows. As
Bragg notes, this is an essential function of finance strategy.

“In a capital-intensive business, one of the most important responsibilities of the CFO is to
review proposals to acquire fixed assets. The amount of funding involved may comprise a
large part of company cash flows, so an incorrect purchase decision could seriously harm
the liquidity of the business. In these situations, the CFO may find that capital budgeting is
the most critical task of all.”

The CFO Guidebook, p. 183

Before budgeting tools can be applied to evaluate a proposed capital investment, any request for funding
must clearly articulate how the asset will help the business meet its strategic goals. The finance leader
must then work with business leaders to: (a) consider options for attaining the desired capability, and (b)
analyze the financial impact of the project for each of the options. There are several ways to do this, but
most proposals will consider three ways to attain the asset/capability:

• Buy it. Purchasing the asset means the organization is responsible for ownership costs, including
taxes, interest, and maintenance, but can usually take depreciation on expenses over time.

• Lease it. Renting the asset may have advantages. The lessor may offer more favorable terms
than using cash or a loan, and may cover maintenance and operating expenses in the lease.

• Outsource it. Assigning responsibility for a process to a vendor is often more efficient than
building capacity in-house. It may cost more over the long term, but it allows the organization to
focus on its core areas of expertise while avoiding a large outlay of capital.

Sometimes, businesses will make buy, lease, or outsource decisions for reasons that go beyond pure
financials. These might include strengthening a strategic partnership, avoiding legal or compliance
requirements, or minimizing risks to the supply chain.

Evaluating the Financial Impact

Capital budgeting analysis provides visibility into whether a capital investment opportunity may or may not
meet your organization’s financial requirements. This is determined through reviewing several different
metrics. The three most common are:

• Payback – measured in years – tells you how long it will take to recoup the initial capital
investment made to start a capital project. A capital investment project appears financially
attractive when the payback period is shorter than the benchmark established for this particular
category of project.

© Strayer University. All Rights Reserved. This document contains Strayer University Confidential and Proprietary information and may not
be copied, further distributed, or otherwise disclosed in whole or in part, without the expressed written permission of Strayer University.

JWI 531 (1202) Page 6 of 9

• Net Present Value (NPV) – measured in dollars – tells you how much greater than the initial
project investment the benefits will be that will flow into the organization over the project’s life. A
capital investment project appears financially attractive if the net present value of all forecasted
future cash flows is positive when discounted at the appropriate rate for this particular category of
project.

• Internal Rate of Return (IRR) – measured as a percentage – tells you the annual rate of return an
investment in a capital project will earn. A capital investment project appears financially attractive
when its internal rate of return is higher than the hurdle rate set for this particular category of
projects.

Choosing the Right Analysis Tool

Each calculation has advantages and disadvantages which will impact its use and applicability in different
organizations. Bragg summarizes some of these limitations as follows:

“The trouble with NPV is that it does not account for how an investment might impact the
profit generated by the entire system of production; instead, it tends to favor the
optimization of specific work centers, which may have no particular impact on overall
profitability. Also, the results of NPV are based on the future projections of cash flows,
which may be wildly inaccurate. Managers may even tweak their cash flow estimates
upward in order to gain project approval, when they know that actual cash flows are likely
to be lower. Given these issues, we favor constraint analysis over NPV…”

The CFO Guidebook, p. 186

In terms of payback as a financial analysis methodology for capital investments, while you or your
colleagues are likely to use this as a “back of the envelope” calculation, to use the author’s words, it has
some significant limitations. After illustrating this with an example, Bragg summarizes:

“The payback method is not overly accurate, does not provide any estimate of how
profitable a project may be, and does not take account of the time value of money.
Nonetheless, its extreme simplicity makes it a perennial favorite in many companies.”

The CFO Guidebook, p. 190

His preferred method is constraint analysis. As you review this part of the chapter, pay particular attention
to his argument for why a capital investment project that focuses on increasing throughput should be given
priority over one that only decreases costs. Ask yourself whether you agree with this.

“Constraint analysis focuses on how to maximize use of the bottleneck operation. The
bottleneck operation is the most constricted operation in a company; to improve the
overall profitability of the company, concentrate all attention on management of that
bottleneck.”

The CFO Guidebook, p. 186

© Strayer University. All Rights Reserved. This document contains Strayer University Confidential and Proprietary information and may not
be copied, further distributed, or otherwise disclosed in whole or in part, without the expressed written permission of Strayer University.

JWI 531 (1202) Page 7 of 9

To be clear, we are not advocating for or against any of these analytical tools. We are raising issues that
you should ask of your business leaders/managers who are requesting approval of a capital project if you
are in a financial leadership position, and you should be prepared to answer these questions if you are a
manager seeking funding for your project.

Capital Budgeting and Leadership

The capital investment process touches upon every aspect of your organization, from your company’s
mission to its decision-making processes. It isn’t a one-time or occasional activity. The capital budgeting
process provides a means to bring a strategic focus to everything you do.

Planning and execution are parts of the capital investment system, but so are the activities of control and
learning. When a capital investment project reaches a full operational level, then a formal post-
investment review should be conducted that specifically asks managers to identify: (a) what was learned
through the experience, and (b) how those lessons will be applied to make better decisions in the future.

The operation of capital projects should be reviewed against the planning that led to their selection. Every
experience in implementing and operating a capital investment is a learning opportunity to formally share
and use within the organization.

Thinking about the role that capital budgeting tools play inside the overall system is the starting point for
refining every step in that system. However, you need to be comfortable in shifting the discussion of the
analysis of a capital project to the underlying mission of the organization and why it has raised capital in
the first place.

Making the Case for Your Project

Going into any discussion about capital projects, you are immediately more credible if you have done your
financial homework and can bring your sensitivity analysis into the conversation. But presenting calculations
for just the positive points in your estimates while failing to acknowledge what is unknown shows that you
don’t fully appreciate the uncertainty associated with every capital project. The more prepared you are, and
the more clearly you can demonstrate you’ve thought through all of the contingencies, the more convincing
you’ll be.

If you want to be an effective champion for a great capital investment idea, then numbers alone won’t do
the talking for you. Make your pitch with all of the fire in your eyes that Jack and every other leader want to
see before making the strategic bets associated with a capital investment.

© Strayer University. All Rights Reserved. This document contains Strayer University Confidential and Proprietary information and may not
be copied, further distributed, or otherwise disclosed in whole or in part, without the expressed written permission of Strayer University.

JWI 531 (1202) Page 8 of 9

SUCCEEDING BEYOND THE COURSE

As you read the materials and participate in class activities, stay focused on the key learning outcomes for
the week and how they can be applied to your job.

• Apply capital budget tools to support the organization’s strategy

Before you look at the numbers and apply the tools of capital budgeting for calculating Payback,
NPV, and IRR to any capital investment opportunity, you have to be convinced that it will
contribute to your organization’s mission. Use the language of the mission statement in a brief
description of a capital investment opportunity that you’re considering. If you needed to go back to
your suppliers of capital for additional funds to pursue a specific capital investment opportunity,
how obvious would it be that the project supports your mission? These are the quick tests to
ensure that you’re on the right track.

• Manage budgets through process analysis and updates

Managing capital investments in the real world begins with understanding the fixed and variable
costs. Find out if your organization has any formal control processes in capital budgeting that are
designed to advance organizational learning, not just double-check how much cash was actually
spent. If not, think about a process where information about capital projects can be shared and
used. Share those ideas with the managers in your organization along with the insights and
hypotheses you’ve developed by looking at past capital investments and results.

• Examine the role of financial leadership and culture in aligning budgets to strategy

Be honest about capital budgeting. Enlist the help of financial managers to refine your process.
Show your analysis to the people in your organization who have the data. Get their reaction and
input on refining your model, and ask for help regarding any missing information or information that
needs to be disaggregated. With their help, you’ll refine your capital investment strategy into a tool
that will direct your attention, investigations, and actions as variances begin to appear between
your plans and the actual results.

© Strayer University. All Rights Reserved. This document contains Strayer University Confidential and Proprietary information and may not
be copied, further distributed, or otherwise disclosed in whole or in part, without the expressed written permission of Strayer University.

JWI 531 (1202) Page 9 of 9

ACTION PLAN

To apply what I have learned this week in my course to my job, I will…

Action Item(s)

Resources and Tools Needed (from this course and in my workplace)

Timeline and Milestones

Success Metrics