Project Assessment Essentials of Corporate Finance Chapters 4, 8, 9, 12 Materials Created by Glenn Snyder – San Francisco State University

February 26, 2007 Materials Created by Glenn Snyder – San Francisco State University 2 Topics Internal Financial Analysts  The Importance of Internal Analysts Investment Pool Funding  Criteria and Project Types  Projections  Cost of Capital  IRR vs. NPV  Scenario Analysis  Business Impact  Decision Making Career Advice for an Internal Financial Analyst

February 26, 2007 Materials Created by Glenn Snyder – San Francisco State University 3 Internal Financial Analysts An Internal Financial Analyst is a member of the Finance organization that works to analyze, consult, project, and generate ideas to make the company more financially sound. Internal Financial Analysts usually work in groups called:  Financial Planning & Analysis  Corporate Planning & Development  Finance Business Partners

February 26, 2007 Materials Created by Glenn Snyder – San Francisco State University 4 The Importance of Internal Financial Analysts Internal Financial Analysts do:  Budgeting and Variance Analysis  Strategic Planning for internal business units  Internal Financial Reporting  Profitability Analysis  Growth and Trend Analysis  Liaising between Finance and other business units  Strategic Project Analysis

February 26, 2007 Materials Created by Glenn Snyder – San Francisco State University 5 Investment Pool Funding Investment Pools are funds the company sets aside at the beginning of the fiscal year for strategic projects Senior Finance and business leaders make up the Investment Pool Committee and decide which projects the company is willing to take on, and which ones will be put on hold. Internal Financial Analysts typically  Organize and summarize all of the requests  Provide insight to the Investment Pool Committee  Assist business units in constructing their proposals  Track and report on expenses and revenues after the projects are approved

February 26, 2007 Materials Created by Glenn Snyder – San Francisco State University 6 Investment Pool Funding When a project is submitted to the Investment Pool, it would include:  Description of the project  Description of the need  Cost projections for the project  Additional non-direct project costs / resources  Benefits to the organization  IRR / NPV Analysis  Scenario Analysis  Time schedule of milestones and estimated completion

February 26, 2007 Materials Created by Glenn Snyder – San Francisco State University 7 Criteria and Project Types To apply for Investment Pool Funding, the project has to cost more than the minimum threshold, e.g. $500,000. Strategic Projects include:  System Upgrades and Purchases  Small Acquisitions  Strategic Initiatives Companies can easily have over 300 Investment Pool projects going at one time  Many more projects can be submitted and not approved

February 26, 2007 Materials Created by Glenn Snyder – San Francisco State University 8 Projections Cost and Benefit Projections  Cost Projections would include: Direct Costs – Actual costs to do the project Indirect Costs – Support costs from other areas of the company (e.g. HR, Finance, IT, etc.)  Benefit Projections would include: Impact to net revenue Impact to sales Impact to market share and/or competitors Efficiency gains and how they equate to the bottom line Impact to the organization beyond the project’s life

February 26, 2007 Materials Created by Glenn Snyder – San Francisco State University 9 Cost of Capital Most companies don’t calculate (or even know) their cost of capital  Typically, the company uses a standard or average rate, such as 12% for the cost of capital Why don’t companies use their actual cost of capital? The rate could change every month It would require resources to constantly update the cost of capital It would add confusion to the business units that submit multiple projects using similar templates/forms.

February 26, 2007 Materials Created by Glenn Snyder – San Francisco State University 10 IRR vs. NPV Most companies prefer to see some kind of ROI (return on investment) calculation  Since ROI is stated as a rate (Return on investment), IRR is the calculation used the most  Many companies use both IRR and NPV, as NPV is much easier to understand

February 26, 2007 Materials Created by Glenn Snyder – San Francisco State University 11 IRR vs. NPV Problems with IRR and NPV  Many times, a business unit is not aware of all of the costs (indirect in particular) that go into a project Thus, the IRR is badly overstated (e.g. 600% returns)  Corporations try to simplify the process to get information that is directionally correct 80 / 20 rule – 80% of the answer for 20% of the effort  When the business unit that wants the project approved submits the projections and analysis, the data is often much to favorable for the project

February 26, 2007 Materials Created by Glenn Snyder – San Francisco State University 12 Scenario Analysis Each project should be presented in three scenarios:  Best Case – What would happen if everything went perfectly  Worst Case – What would happen if little went right  Most Likely Case – The case that the business truly thinks will happen  Sometimes, the best case scenario, may be the worst for cash flow. Projects that drastically increase sales, may constrain cash flow and require financing, which is an additional cost.

February 26, 2007 Materials Created by Glenn Snyder – San Francisco State University 13 Business Impact Many projects get approved not on their financial contribution, but their impact to the business.  Upgrade from Windows 2000 to Windows XP This upgrade could cost a company millions, but will not enhance revenue or sales  Enhancements to a customer service call center These enhancements may be in new systems or personnel They may not generate revenue, but keep existing clients from leaving

February 26, 2007 Materials Created by Glenn Snyder – San Francisco State University 14 Decision Making The Investment Pool Committee must decide which projects will have the greatest impact on the organization.  Financial Impact Increase Revenue Reduction of Expenses  Efficiency Impact Greater production from existing resources  Market Impact Positive public awareness

February 26, 2007 Materials Created by Glenn Snyder – San Francisco State University 15 Decision Making The senior management team that makes up the Investment Pool Committee is often rated based on the impact of the projects they approve  Incentive to pick the best projects for the organization Strong projects can add to a senior manager’s bonus and rating at year-end  Senior managers must be careful not to play favorites with projects submitted from their divisions Many cases there are conflicts of interest, which is why the decisions are made by a committee and not an individual

February 26, 2007 Materials Created by Glenn Snyder – San Francisco State University 16 Career Advice for an Internal Financial Analyst Skills required to be a successful internal financial analyst  Adaptability – Be willing and able to adapt to an ever-changing environment  Intelligence – The faster you can learn, the more value you can add to the company  Creativity – The ability to be able to develop new ideas and solutions Career Path for an Internal Financial Analyst  Just about anything Internal Financial Analysts are exposed to many areas of the company and build skills that apply just about everywhere Many companies offer management training programs