WMBA 6070 Week 7 Capital Budget Allocation Example

Spending a $5 Million Capital Budget on Four Proposals: Fund Telematics, the 250-Ton Crane and Yard Paving, Hold the Wind Venture, and Watch the Order Survive a Higher Rate and Flat Prices

Student Name

Walden University

WMBA 6070: Managerial Finance

Instructor Name

Month Day, Year

Spending a $5 Million Capital Budget on Four Proposals: Fund Telematics, the 250-Ton Crane and Yard Paving, Hold the Wind Venture, and Watch the Order Survive a Higher Rate and Flat Prices

The Budget and the Proposals

Brightwater's owners, in this invented crane rental case, have set a capital budget of $5 million for the coming year, the most they are willing to commit given the acquisition financing approved in Week 6. Four proposals compete for it. This report ranks them, funds as many as the ceiling allows and tests whether the ranking holds when the discount rate and the growth assumption are pushed the unfavorable way.

Table 1

The Four Proposals at Their Base Cases

The crane figures come from the Week 5 memo and the rates from Week 4; the other figures are the proposers' estimates, reviewed by finance. Composite figures.

Each proposal is worth doing on its own: every net present value is positive at its own discount rate. Together they would cost $6.66 million, so at least one must wait.

Ranking Under a Budget Limit

When capital is limited, the aim is to choose the set of projects with the greatest total net present value that fits within the budget. The profitability index, present value per dollar invested, is a useful guide because it shows which projects produce the most value for each scarce dollar, though it can mislead when projects are lumpy and leave money unspent (Brealey et al., 2023). The report therefore checks every combination that fits.

Table 2

Combinations That Fit the $5 Million Budget

Composite figures.

Telematics, the crane and paving together produce the most value, about $713,000, and leave about $1.54 million unspent. The wind venture alone cannot be added without dropping the crane, and the combination with the wind venture produces less value even though it uses more of the budget. The unspent $1.54 million should not be forced into a weaker project; it can reduce the bank line or wait for next year.

The Stress Test

The ranking rests on two assumptions that could move against the firm: the cost of capital and the growth in rental rates. The stress test raises every discount rate by two percentage points and assumes rental rates stay flat for five years instead of rising about 2 percent a year.

Table 3

Net Present Value Under the Unfavorable Case

Stress values are estimates from each proposal's cash flow model; composite figures.

The funded projects remain positive under stress, though the crane's margin shrinks sharply because its value depends heavily on rental income. The wind venture turns negative, because it is the most sensitive to both assumptions: its customers are few, its equipment is specialized and its revenue grows only if turbine construction does. The stress test therefore strengthens the decision to hold it.

Order of Spending

Telematics should come first, because it pays back fastest and its data on engine hours and idle time will improve the scheduling of every crane, including the new one. The crane comes second, timed for spring delivery. Paving comes third, in late summer when the yard is least busy.

The Wind Venture

Holding the wind venture is not rejecting it. Its base-case value is real, and the market may grow. The report recommends revisiting it next year with two pieces of evidence: a signed service agreement with at least one turbine operator, which would reduce customer risk, and a used specialized crane at a lower price, which would reduce the investment. Graham and Harvey (2001) found that many firms adjust for project risk informally rather than through separate rates; Brightwater's use of a higher rate for this venture made its weakness visible before money was committed.

What Happens to the Unspent $1.54 Million

The unspent budget should not sit idle, and it should not be pushed into a weaker project to use it up. The best use is to reduce the bank line of credit, which costs 7 percent. Paying down $1.54 million saves about $108,000 a year in interest and restores borrowing room for the next season, when the wind venture may return with better terms. If a project with a clearly positive value appears during the year, the line can be drawn again. In effect, the unspent money earns a safe 7 percent while the firm waits for a better use, a return that compares well with the riskier projects on the list.

How the Proposals Were Reviewed

Each proposal came from the manager who would run it, and finance reviewed each for three things: whether the cash flows followed the firm's standard assumptions on taxes and depreciation, whether the discount rate matched the project's risk and whether the sensitivity analysis tested the assumption most likely to be wrong. The wind venture's proposal used the firm's ordinary 10.5 percent rate; finance applied 13 percent, which reduced its value from about $560,000 to about $350,000 and changed its rank.

None of the four proposals was rejected for lack of value; the budget limit, not the analysis, forced the choice.

What the Owners Are Approving

The owners are asked to approve $3.46 million for telematics, the crane and paving, to keep $1.54 million uncommitted and to schedule a review of the wind venture next autumn. Ross et al. (2022) note that capital rationing imposed by owners is often a way of controlling growth and risk, and in this case the budget limit has done its job by forcing the riskiest project to prove itself first.

References

Brealey, R. A., Myers, S. C., & Allen, F. (2023). Principles of corporate finance (14th ed.). McGraw Hill.

Graham, J. R., & Harvey, C. R. (2001). The theory and practice of corporate finance: Evidence from the field. Journal of Financial Economics, 60(2-3), 187-243. https://doi.org/10.1016/S0304-405X(01)00044-7

Ross, S. A., Westerfield, R. W., Jaffe, J., & Jordan, B. D. (2022). Corporate finance (13th ed.). McGraw Hill.