KPG Groceries Capital Budgeting Case Analysis

Capital budgeting enables planners to forecast future financial impacts of decisions on a company. The capital budgeting approach has assumptions that enable the criteria to give reliable results, which can help the company to achieve its short-term and long-term goals. Expansion of business is a complex process and requires careful analysis. For instance, the expansion comes with financial and operational risks that must be considered before making the decision to open the subsidiaries. The initial outlay of money towards the expansion is also high. It requires careful analysis of how long the company will take to recoup the expenses should the decision to open a new distribution center be approved.

The First Option

Companies with sustainability strategies deemed functional by the shared experience have increased sales, leading to high profits (Rafi, 2021). As outlined by Jones, the first option available to the company is to avoid taking steps regarding opening a new distribution center until the beginning of the year, when the new distribution center in a central place will be ready for use (Lovata & Murray, 2017). The vice president determined that if a central distribution center is successfully identified at the beginning of the new year, the deal will save the company 700,000 trucking miles annually. The 700,000 trucking miles imply a reduced cost of fuel, reduced salaries, and reduced emissions to the environment. The central distribution center will enable the company to gain a competitive advantage over other companies, and the move will improve the company's reputation as a good corporate citizen.

The disadvantage of the first option is that the company has to save time waiting for the new central place to be ready. The waiting time has cost implications for the company. For instance, the company has to use excess gasoline to track products to the distribution center in Phoenix and finally to consumers. The option will also see the company continue to pollute the environment as it waits for the new year as other companies continue to build their reputation on going green. As such, the first option of waiting until January does not solve the worry of the board of management, which is to take temporary measures to ensure that the company implements sustainable measures to be at par with competitors.

The Second Option

Jones' second option is to build a new distribution center outside St. Louis on an acre of land, costing the company $1 million to purchase (Lovata & Murray, 2017). The main advantage of the second option is that when it is completed, it will decrease the truck miles per year, reducing the cost of operation and pollution. The main disadvantage is that purchasing land and building a new distribution center will cost the company a fortune. The initial capital required for the project to be completed may greatly impact the company's finances. Like the first option, the company will not shift operations immediately after it purchases the piece of land. The project will take a long time for it to be completed. Like the first option, the second option of purchasing land and building a new distribution center will take a long time. By the time the building of the distribution center ends, the company will have spent more on mileage and gas too, which will have yet to solve the pollution problem as soon as possible.

The Third Option

The third option of Jones is to lease space outside the St. Louis area and set up a distribution center there. According to Menlo Group (2022), leasing space in Wood River is estimated at $5 per square meter. In total, the company may need at least 100,000 square feet of space for it to set up a standard distribution center. Suppose the company leases the underground space for $6.5 per square meter. In that case, the company will save electricity costs which may average $50000 (Menlo Group, 2022)—the main advantage of leasing the space at Springfield, Mo. The company will not incur extra costs on maintaining and repairing the store because it already has the equipment it requires to kick-start operations. Also, the company will start operations immediately, hence saving time and the cost of extra mileage of transporting goods to the distribution center in Phoenix. The main disadvantage is that the company will lose the money it will have spent on any improvements in the store at the end of the lease.

Proposed Solution

In capital budgeting, the decision is made after computing the net present value, the internal rate of return, and the discounted payback period using the hurdle rate or weighted cost of capital. The company should also conduct a sensitivity analysis to determine the extent to which changes in market demands will affect the cost of operating the new distribution center and the company's total revenues. Considering the options identified by Jones, the company needs to lease the underground space at Springfield, Mo, due to its low starting capital and low cost of operating the company's business.

Recommendations

Now that the two distribution centers are closed, the company should avoid using its new tracks, which use gasoline. Instead, the company should consider using energy-saving hybrid cars to distribute its groceries to its customers. The migration from trucks to hybrid cars will enable the company to spend less on gasoline and become green.

In the long run, the company should consider purchasing underground space for its distribution services. The purchase will save the company much money that it pays as rent and the money it would spend on buying land and building a new distribution center. Also, if the company succeeds in purchasing the underground space, it will retain the money expended on improving the space by installing new equipment such as CCTV.

Conclusion

KPG intends to become a green company and has hired a sustainability officer, Marshall, to implement the idea. The officer has had talks with the vice president of the company, Jones, who has identified three options, including waiting until January to move to a new distribution center, buying land and building a new distribution center, and leasing a space at St. Louis or an underground space at Springfield Mo. This analysis recommends underground space due to its cost-efficiency and benefits.