# Kellogs

Pages: 5 (1335 words) Published: April 24, 2011
According to the text, the initial costs for this project is \$15 868 000 and in order to generate the Return on Investment, Jeff Wiemann decided to consider the useful life of the project to be 5 years (n=5).

1. What is the appropriate discount rate for a government agency such as the San Diego City Schools? WACC calculation (estimation)
WACC = cost of debt + cost of equity (weighted by the % of debt/equity in the capital stack) Though we do not know the precise numbers specific to SDCS at that time, we can make some generalizations. Cost of debt = interest rate of a school bond

Typically these types of bonds are voted for (approved) and paid back by the local community (known as voted indebtedness); payments are collected with property taxes Typically these bonds bear very low nominal interest rates (usually just a CPI adjustment) since the voters are the ones who bear the interest (does not make sense for them to issue themselves a high-interest rate loan) If the bonds are sold in the open market, they are considered low-risk, thus bondholders do not require a high interest rate Approx. risk-free rate at time of the case (2002) (US 10-year T-Bill ) = 5% Approx. school bond rate at time of the case (2002) (link ) = 5% Cost of equity = expected return of equity investments

Equity in this case is provided via tax revenue (probably a mixture of local, state and federal sources) The median income of San Diego City at the 2000 Census was measured at about \$46,000 The estimated tax rate for this income bracket is estimated at 9.3% Cost of equity is 9.3%

Weighted average: debt to equity ration approximately 60:40 (based on the balance sheet on page 21 of this report ) Weighted average = 8.7%
Why not use a relative scale?
Must not arbitrarily adjust for risks otherwise the decision analysis is dubious 2. Calculate the ROI for San Diego's ERP system. How can you quantify the soft benefits of the system and include them in the analysis? Assumptions: Implementation of the HR module only will take 8,000 man-hours, or approx 10 months with 5 resources 80% allocated at a 40-hour workweek

•The project, once implemented, will have a useful life of 5 years; current year is 2002 •Initial costs are \$15,868,000
•The project will be implemented by EOY 2003.

Review the original in Excel (on Groove)
Assuming this calculation is correct (I'm pretty sure it is), the project is not one that should be funded. The IRR must exceed the discount rate in order to be chosen (on these benefits alone). Notice, too, that the NPV is negative. Same idea. Negative NPV is no good. Unless the soft benefits (that are so difficult to quantify) tip the scale. This does not account for tax and depreciation and cost of capital The calculation includes a quantified amount for productivity improvements This does not include soft benefit or option value

Ideas for Quantifying the Soft Costs
Improved morale/productivity
Improved morale results in less turnover; this article explains that the cost of finding a new teacher can be upwards of \$10,000... Quantify higher accountability?
Clue: 82% of district budget goes to salaries
Improved recruiting
Principals lost potentially high quality candidates due to poor systems and processes. The head of HR equated prior recruitment improvements to “getting an extra hiring team” -- \$320,000 Improved management access to data

The internal audit team currently costs \$400,000/year.
Assuming that can be reduced by half as a result of the HR module implementation will bring the cost down to \$200,000

Review the original in Excel (on Groove)

Already (w/o morale and productivity improvements) the project makes sense, assuming the discount rate of 15 is correct.

What about option value? Option value is the value of the opportunity to implement additional projects in the future (not possible without this project).

3. With the information you have access to, what should Wiemann present and recommend at...

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