The Island Development Corporation: Capital Budgeting Project

In September 2022, the chief executive officer (CEO) and founder of Maximum Quality Equipment (Maximum), was trying to decide whether to invest in a joint venture company to operate a quarry that would extract and sell rock armour. The joint venture company, Island Development Corporation (IDC), had secured a 25-year mineral production sharing agreement with the Philippine government. IDC would purchase equipment and extract rock armour in Chiquita Island and then sell the rock armour to San Miguel Corporation (SMC), a major Philippine corporation. The contract was currently under negotiation, with SMC offering a two-year contract and IDC asking for a five-year contract. The CEO asked his chief financial officer to run a discounted cash flow, estimate the cost of capital for the project, and determine the net present value (NPV), internal rate of return (IRR), and project payback. He needed to decide whether he would invest in the project.

This case is designed for use in an MBA-level course as an introduction to capital budgeting and estimating the cost of capital. The authors have used this in a core financial management course covering financial analysis, capital budgeting, and the cost of capital. It has also been used as an exam covering capital budgeting and cost of capital in the MBA program of the Asian Institute of Management. After working through the case and assignment questions, students will be able to do the following:<ul><li>Describe the benefits and risks of a capital budgeting project.</li><li>Determine and estimate relevant cash flows, including operating cash flows, capital expenditures, working capital requirements, and sunk costs.</li><li>Assess the importance of client contracts in determining a project’s viability.</li><li>Explain and estimate the various components of the capital asset pricing model (CAPM)–based weighted average cost of capital (WACC)—namely, cost of debt, cost of equity, weigh of debt, and weight of equity—for a Philippine corporation.</li><li>Calculate NPV, IRR, and payback, and assess the viability of a new project based on these metrics and the ability to address project risks.</li><li>Recommend whether a company should undertake a capital budgeting project, and justify this recommendation.</li></ul>

• capital budgeting
• NPV
• IRR
• weighted average cost of capital
• free cash flows