CASE 19

Target Corporation

ritten By: Stephanie Milas, Amber Wells, Justice Young, Kodi Kuhnash, Herbert
Lohrberg, and Chelsea Synder
March 28, 2019
Financial Analysis and Decision Making, MBA 7300-01
Case Introduction

During 1962 in Roseville, Minnesota the Dayton Company opened the first Target store for the
purpose of providing customers with discounted prices. The main objective for this was to create
an atmosphere that was different from the Dayton Company’s more upscale stores. By using this
concept, the Target store flourished ultimately leading to more stores opening across the United
States. By 2000, the official name of all the Target stores become known as the Target
Corporation

In the Target Corporation case study, it compares Target’s business model and marketing
strategies to other discounted retailers including Wal-Mart and Costco. While at the same time, it
analyzes Target’s capital budgeting process. Additionally, some of the other information given
consist of Doug Scovanner being the CFO and having to analyze 5 different capital project
requests (CPRs) to accept or reject in order to create the most value and growth for the Target
Corporation and its shareholders. Some factors to consider with accepting each CPR are by
evaluating the financial calculations, as well as customer demographics and brand awareness.
With looking at these factors, it can be determined what the positives and negatives of each of
these CPRs are. The names of the CPRs are Gopher Place, Whalen Court, The Barn, Goldie
Square, and Stadium Remodel.

Business Model Comparisons

Targets two main competitors in the retail industry are Walmart and Costco. Target and Walmart
are competitors because they have similar store formats, meaning they have food sections,
clothing, electronics, home décor, and pharmacy. Where Target and Costco are competitors
because they have similar target markets, customers who are looking for great value at a fair
price. The similarities start to stray though from there, Costco requires a membership card to
allow access to the store where at Target you do not have to be a member to shop there. Costco
also operates on the strategy of buying in bulk to save money on the purchase. Target and
Walmart don’t operate on bulk sales, they operate on the strategy of low prices but great value
for your dollar.

Walmart is the dominant player in the retail industry due to its size and extensive globalization
strategy. To gain a foot hold in the industry Target had to put more emphasis on the profile of its
target customer. Target homed in on the target customer being an educated family woman who
was more affluential than the typical Walmart customer. So, to appeal to this target market Target
decided to focus on the ambience and style of the interior of the store, to make the shopping
experience feel classier and user driven. Target realized its main specialty was in apparel and
home décor, but it still priced competitively on other goods that were common in other
competitor stores.

Target generally selects areas to build a new location that are experiencing high population
growth and change towards becoming affluential communities. Sometimes new stores are
selected though to block out other retail competitors, despite the stores ability to generate returns
for the overall company. Target announced plans to continue to open approximately 100 stores
per year for the foreseeable future to continue growing domestically.
Target’s Capital Budgeting Process

Every company has some sort of a capital budgeting process. Capital budgeting is the process
through which companies decide which projects to accept or reject and which long-term
investments to make. Capital budgeting includes the valuation of potential long-term projects,
which create cash flows for several years. The decision whether to accept or reject a project
depends on many factors. These factors are different for all companies and/or industries. The
most common factors include the project’s Net Present Value (NPV), its Internal Rate of Return
(IRR), and the cash flows that are created by the project over its life time.

Target’s capital budgeting process is comprised of the Capital Expenditure Committee (CEC).
The top executives of Target make up the CEC. They meet monthly to evaluate all the Capital
Project Requests (CPRs) that are greater than $100,000. The CEC can accept any CPR up to $50
million. However, the Board of Directors decides to accept or reject the CPRs in excess of $50
million. By taking this out of the hands of the day to day operations the personal agendas and
agency problems are largely taken out of the highest impact projects which will ideally be
decided on the merit of maximizing stockholder’s wealth.

CPRs that fall into the CEC category are decided by this designated committee as described
above consisting of key top executive officers. Exhibit 1 offers a breakdown of all the executive
officers and the Capital Expenditure committee members. The CEC members include:

 VP of property development
 VP of stores
 VP/CFO
 President
 CEO

The key value driver for Target’s management team is the amount of sales per store. With more
sales means more profitability thus creating the most value and growth for the Target
Corporation and its shareholders. The CEC uses the sensitivity analysis to evaluate how the
predicted sales differs from the expected sales. It also shows management how volatile the NPV
is to the changes in sales. This is a major decision metric for the CEC when determining whether
to approve or deny a CPR.

There are several different types of CPRs that the CEC evaluates. These include rebuilding,
remodeling, relocating and the closure of an existing store in order to build a new one. The CPRs
that are usually rejected are the ones that have questionable costs, especially during the initial
appraisal period. If a CPR happens to have a negative NPV, it does not determine that CEC
automatically rejects the project. Before accepting or rejecting the CPR, the CEC reviews its
strategic importance to the overall company.

Target management’s highest priority and main financial objective is to maximize its
profitability. It is evident that the level of competition is very serious between Target and some of
its main competitors. As stated above, these competitors include Wal-Mart and Costco. For
Target to maximize profits, it is extremely important to make the best investment decisions after
carefully evaluating each of the CPRs. The review process of the CPRs are very meticulous
because the CEC recognizes that the capital investment could have a significant impact on the
short and long-term profitability of the company. Therefore, making the decision of whether to
accept or reject a CPR is not taken lightly.

Precedents are usually considered before deciding whether to accept or reject a CPR. For
example, a CPR for remodeling would be excluded, if the initial investment is too high compared
to other remodeling CPRs. Even though the NPV is positive for a particular CPR, it would still
be rejected. This is mainly because it will develop a troublesome precedent for the preceding
CPRs. Usually an agreement is reached for each CPR decision. On the contrary, the CEO
typically makes the final decision when there are too many disagreements within the CEC.
Generally, CPRs take between 12-24 months of development before being forwarded to the CEC
for review. This time includes gathering and compiling all the data, demographics, and analysis
compiled in the dashboards presented as in Exhibit 8.

The largest portion of the CPRs are new store developments. For the new store CPRs, a real-
estate manager is assigned to a specific geographic region. They are responsible from the start to
finish of the project. They perform the research of the area in which the they think the new store
should be established. Before the real-estate manager presents the CPR to the CEC, they collect
data about the new store location including real-estate and tax incentives. Since there needs to be
a significant amount of time and effort spent on the projects this may lead to bias. It is necessary
for the real-estate managers to find the most reasonable opportunities and to present it to the
CEC in such a way that it increases the chances of the CPR being accepted. This bias may be
intentional to gain an advantage or unintentional in that they make the project look better than it
really is. A rejection after such effort affords significant disappointment which can affect the
quality of future work and proposals. While this lengthy process ensures that all aspects of a
project can be captured to make an informed decision, the proposal is then subject to agency
problems and care should be taken to ensure the quality of the work put in is awarded rather than
the outcome of the proposal.

The CEC make up keeps the groups small enough to be effective and large enough to provide
diversification of ideas. Exhibit 1 also indicates there is a healthy degree of experience within the
CEC leading to what should be a greater degree of qualified decisions. The down fall to having
all internal experience is that the group is completely cohesive and does not experience new
members, therefore resulting in reduced amounts of ideas, innovation, and viewpoints. The
make of the group is consistent with the key players needed to idealize the project. The VP of
property development analyzes the presented information against that experience to determine if
things such as the location, the costs, and the demographics add up to what is presented by the
real estate agents.

Even though Target’s main goal is to open 100 new stores per year, there are also many CPRs
that must be presented to the CEC for approval. The CEC deliberates several factors before
making the final decision for every investment decision. CPRs need to meet several financial
objectives such as the NPV and IRR. Some of the other factors that the CEC analyzes include the
total investment size, projected sales, earnings per share influences, economic tendencies in the
geographic area, and demographics. The CEC also evaluates the sensitivity of NPV and IRR to
sales variations, as well as, the impact on sales of other nearby Target stores.

The main objective of Target’s CPRs are to generate cash flows for several years. These cash
flows are created by projecting the future sales of the new stores. The projected sales are
determined by the demographic changes in the geographic location and the economic trends
presented. Another aspect that is considered are the entrance of new competitors and the
availability of the online shopping experience.

Every year Target has a specific budget and the CEC tries to keep the accepted CPRs within the
designated budget. However, there may be a chance where there are many CPRs that are
accepted, therefore leading to more funds needed to cover the cost of projects. If this occurs
Target would either have borrow the funds or issue more stocks to cover the extra costs.

Target’s capital budget system is set up to provide a reasonable means to make capital decisions
and is overall seen as effective. There are always going to be potential negative aspects to any
system and a review of how that system internally functions are a necessary indicator of whether
the potential negatives are present or if the system is operating as intended.

The Dashboards Usage

As described in the case information, NPV and IRR are the two main quantitative decision
makers for accepting or rejecting a project but having low NPV or IRR statistics for a certain
project proposal does not immediately disqualify the project. Projects that reach the CEC with
low NPV and IRR profiles are looked at for their strategic importance to the company overall in
determining the possibility of acceptance.

Many quantitative values other than NPV and IRR can represent the core direction Target looks
for in project proposals. Predicted values like projected profit, earnings per share impacts, total
investment size, impact on sales of other nearby target stores, and sensitivity of NPV and IRR to
sales variations are taken into consideration quantitatively.

Key qualitative values that instill the core of Target’s plan to add 100 new stores per year are
included as well that shift the quantitative landscape in the dashboard. For example, included tax
and real estate incentives by local communities and demographic landscapes like average median
income of the community, to the statistical analysis of four-year degree graduates living around
the area must be considered as well. Whether properties were purchased or leased, population
growth, and attractiveness of the ‘ideal’ target customer are also taken into consideration.

Target explained in the case information what the typical quest exemplifies; A college educated
woman with children at home who is more affluent than the typical Wal-Mart customer.
Statistically this quest has an above average median income, living in a prosperous or rapidly
growing area. The Dashboard request was created to highlight in depth all the quantitative and
qualitative attributes of a proposed store in order to reach out to the typical Target guest.
The Dashboard sheets summarize the NPV and IRR calculations, but also give an elaborate
discounted cashflow model for the next 60 years including remodels that happen every ten years
to satisfy the targeted customer. When looking at a Dashboard proposal, Target executives must
consider the core values of enriching the company beyond just analyzing quantitative aspects,
but also highlighting what the public opinion of the ‘typical guest’ might be when walking into a
Target storefront.

Which CPRs to Accept

While all five are quantitatively acceptable, we would advise CFO Scovanner to accept only the
first four. The fifth ranked project (Goldie’s Square) does not meet all quantitative and qualitative
CEC (Capital Expenditure Committee) decision standards, and the money earmarked could be
better invested elsewhere. The CPR rankings and rationale follow:

1. The Barn (accept): CFO should accept “The Barn” project. This is the best investment
because it has the second highest NPV and a low initial investment. In addition, The Barn has the
highest IRR at 16.4% meaning that this project should be more desirable to take on. This project
would be entering a new small market. Although, The Barn does not experience heavy foot
traffic in their rural location, this is also a huge opportunity to expand the brand’s name into a
new market since there are no other Target stores within 80-90 miles. The Barn appear to show
low sensitivity to changes in sales, gross profit, construction costs, and market specific
assumptions while maintaining solid profitability.

2. Gopher Place (accept): CFO should accept “Gopher Place” because of its solid NPV and
IRR. In addition, the initial investment is quite low. The Gopher Place demographic also ranks
second in terms of highest median income and matches closely with Target’s prioritized
marketing strategy. Gopher Place will cannibalize 19% of their own store sales, which makes this
its biggest negative attribute. However, if Gopher Place’s sensitivity to changes in sales is any
indication for other stores in the area, the addition of this store should not have an overly
significant impact on the other nearby stores’ NPV.

3. Stadium Remodel (accept): CFO Scovanner should accept “Stadium Remodel” because they
have been a stable company in the area since 1972. Even though sales have recently slightly
declined, the remodel should help attract new inflows of customers to this location again and
make the store look more presentable. The NPV and IRR are not the best when compared to the
other projects, but they are still a safe investment since the store has been at the stadium for an
extended length of time and very successful throughout this period. In addition, the area around
the stadium remodel has the highest median income and second highest population with people
with 4+ years of college in that state.

4. Whalen Court (accept): Scovanner should accept “Whalen Court” because it yields the
largest NPV, however one must consider that the initial investment is the largest too. Another
positive with Whalen Court is that it located in a dense urban area with a large population that is
growing by 3%/yr., which is a lot for a population of that size. What makes Whalen Court
number 4 in the rankings is that Target is entering the unknown because they are straying from
normal Target store strategies. They are setting up a new store layout/design and they are also
leasing the property instead of owning it like they normally do which creates uncertainty relative
to cost structure. Whalen Court has a massive lease payment due to the highly competitive
location that it is entering. However, it makes up for it with massive sales relative to the
prototype, which keeps its NPV much better than the prototype.

5. Goldie’s Square (reject): Even though this project has a positive NPV, Scovanner should
reject “Goldie’s Square” because it also has a high initial investment and low IRR. Another
major concern for this project is the high levels of retail competition existing in the area.
Currently, Wal-Mart and Wal-Mart Supercenters are dominant in this local market, while other
stores such as JC Penney, Borders, Bed Bath and Beyond, and Ross will pose additional barriers
to Target gaining retail market share in such a location. Its NPV becomes negative with a slight
decrease in sales, a 1% decrease in gross margin, or a 10% increase in construction costs.
Although its NPV and profitability index drastically increase when applying market specific
assumptions, this does not make it worth taking on due to not having much room for error in the
other factors. There are some positives relative to the Goldie’s Square location like high median
income and large population growth, but we expect the $23.9 million investment required for this
CPR could yield better returns elsewhere.

How Each of the Considerations Influenced Our Decision?

a. NPV and IRR

When looking at the NPV across all projects (Exhibit 1), the values all appear to be similar in
profitability except for Goldie Square. At a value of $300, it is very close to being unprofitable at
these expected assumptions. When looking at the IRR of this project, it also appears to be
slightly less than the projected WACC (Exhibit 2), which is not the case for any of the other
projects (Exhibit 6). In fact, when applying 10% sales decrease to test sensitivity (Exhibit 3), all
projects still retain a positive NPV except for Goldie Square. It is important to note that this is
not due to a high sensitivity to a sales decrease. Overall, Goldie Square experiences similar
sensitivities to a change in sales, but its magnitude of NPV is a problem in all sales related
scenarios (Exhibit 4).

b. Size of the project

When looking at the size of the projects, all appear to be in a similar range except for Whalen
Court. Compared to all other projects, which have an initial investment within $10,000 of each
other, Whalen Court has an initial investment that is $96,300 greater than the next highest. Even
though this large initial investment significantly affects its profitability index (Exhibit 7), it
achieves the largest NPV at expected conditions amongst all potential projects. Secondly,
although Whalen Court appears to be much more sensitive to a change in sales, the magnitude of
its NPV still stays relatively high even when sales are expected to be 10% less than what is
expected. Therefore, overall, its high NPV makes up for its large initial investment.

c. Cannibalization of other stores’ sales

Cannibalization of other stores’ sales was also important to consider. The main two that this will
impact are The Barn and Gopher Place. The Barn strongly benefits from this due to entering a
brand-new area that is already populated with Target’s Competitors. Also, they should not
experience any cannibalization of Target’s own sales because there is not another Target store
within 80-90 miles. Therefore, it is likely that the only sales they will be stealing is from their
competitors. Meanwhile, although Gopher Place was accepted, this was a negative for them.
Gopher Place will cannibalize 19% of their own store sales, which makes this its biggest
negative attribute. However, if Gopher Place’s sensitivity to changes in sales is any indication for
other stores in the area, the addition of this store should not have an overly significant impact on
the other nearby stores’ NPV.

d. Store sensitivities
Although there are expected values for sales, profit margin, and other important variables, it is
important to factor in changes to these rates since projections are rarely 100% accurate. Overall,
Gopher Place and The Barn appear to show low sensitivity to changes in sales, gross profit,
construction costs, and market specific assumptions while maintaining solid profitability (Exhibit
8). When looking at Whalen Court, it is important to note that it shows much greater sensitivity
to a change in sales, gross profit margin, and market specific assumptions than the average
project listed. However, it makes up for it with a high NPV across the board for all variables,
which makes this high sensitivity reasonably okay. The Stadium Remodel appears to show
average sensitivity to most changes in these factors, but it does show large changes when
applying market specific assumptions. In fact, it becomes the lowest NPV but remains positive.
Lastly, when looking at Goldie’s Square, it shows low sensitivity to most factors, but its NPV
becomes negative with a slight decrease in sales, a 1% decrease in gross margin, or a 10%
increase in construction costs. Although its NPV and profitability index drastically increase when
applying market specific assumptions, this does not make it worth taking on due to not having
much room for error in the other factors.

e. Variance to prototype
The variance to prototype was also something that was considered. The only CPRs that appear to
be a problem in this category are Whalen Court and Goldie’s Square. Whalen Court has a
massive lease payment due to the highly competitive location that it is entering (Exhibit 10).
However, it makes up for it with massive sales relative to the prototype, which keeps its NPV
much better than the prototype. Meanwhile, Goldie’s Square continues to lack in this department
by showing a large, negative NPV relative to prototype driven by much lower expected sales
(Exhibit 9).

f. Customer demographics
Customer Demographics was also something that was taken into consideration. Looking at the
extremities in these values, Whalen Court and The Barn show extremely low population growth
(Exhibit 11). However, Whalen Court makes up for it by already having a large total population
with an above average percentage of people falling within the target demographic (Exhibit 12).
For The Barn, growth, population, and target demographic living within the area all appear to be
near the bottom for all CPRs being considered. This should definitely be taken into consideration
when making the final decision on this CPR. Lastly, Gopher’s Place shows large growth potential
in the area, which already supports its already solid NPV, IRR, and sensitivities.
g. Brand-awareness impact
Lastly, Brand-awareness is something that was strongly considered. In three of the five CPRs
being considered, Target’s brand had already been established in the area. However, Whalen
Court and The Barn give Target a brand-new market to expand their brand. Due to the heavy
pedestrian traffic in Whalen Court, this CPR gains the benefit of being a huge advertising
campaign to people living and visiting this urban area. Although, The Barn does not experience
heavy foot traffic in their rural location, this is also a huge opportunity to expand the brand’s
name into a new market since there are no other Target stores within 80-90 miles.

Target Corporation Hurdle Rates for Stores and Credit Cards

Credit card sales have always been key revenue boosters for many “big-box” retailers like
Target. In fact, to keep or improve its position as the #2 US retailer behind Wal-Mart, Target
likes to differentiate its product lines with the slogan “Expect more, pay less” to indicate that
their product offerings are better quality and more fashionable than the lower quality and cheaper
items offered by Wal-Mart under its motto “Always low prices.” Since 1995, Target has used
credit card sales to boost their sales revenues to achieve their own IRRs and maintain their
competitive posture with the other big retailers (especially Wal-Mart and Costco). But Target
also makes a conscious decision to appeal to a more affluent demographic (average household
income >$64K/year, and with college completion rates at twice the national average). For the
latter retail market niche Target believes having credit card programs is an important factor to
maintaining sales levels in their 1800+ stores around the country.

Currently, Target Corp. offers two main types of credit card programs to their customers. The
first and biggest is their store credit card program called “Target REDcard” which has an APR of
24.4% (vs. the Wal-Mart rate of 22.3%), but which also has a 5% discount rate on purchases and
extra time for returns to entice their more affluent clientele to carry a credit card balance at the
24.4% APR. Of course, this REDcard can only be used at Target stores and for buys of Target
items online under the slogan “Exclusive Savings, Exclusive Extras.” The second credit card
program is a standard Target Mastercard program offered through its captive Target National
Bank (formerly Retailers National Bank). The chief advantages of the Target Mastercard are the
APR interest rates are about half those of the Target store card (REDcard) and that it can be used
“wherever Mastercard is accepted.” Of course, both these cards are supplemented by debit and
check card programs. Also, it should be noted that Target credit cards suffered through major
data breach and hacking scandals in 2013. Overall, Target maintains that credit card programs
have been tremendously successful for them, encouraging customer loyalty and raising sales
revenues in a non-price fashion (almost like a marketing function) from 6% to 24% at many
Target store locations.

The case reports the internal hurdle rates for acceptance/retention of Target capital expenditure
projects is required to be 9% for activities traceable to “brick and mortar” stores and 4% for
projects involving the various credit/debit card programs. Check of Exhibit 4 Target Corporation
Balance Sheets show increases in Account Receivable and Other Asset accounts may be
attributable to credit cards sales and interest charges on credit card balances. Fixed asset
investment on physical store functions are listed in the financial summary of each CPR and feed
into each IRR and NPV value summary in the dashboard documents. The difference in hurdle
rates for stores versus credit cards is traceable to the different costs of capital in each Target store
for funding store operations in a” brick and mortar” facility, and in the case of credit cards
represents the lower cost of servicing a typical credit card transaction. Standard IRR and NPV
calculations are used to check the reasonableness and acceptance of current and proposed store
or credit card programs at Target Corporation. Based on the latter criteria and on the assumption
that all projects proposed are independent and not mutually exclusive in nature, all Target store
and credit card projects, except for “Goldie’s Square,” meet the Target hurdle rate criteria and
could be accepted from a financial return perspective.

As a member of the CEC, would you continue to approve CPRs if it meant that Target
would need to fund the requests with external funds, either debt or equity?

If approving the CPRs means that it will further the company’s goal of opening 100 stores a year
as well as expanding the brand awareness of the company, then yes, we would approve them
even if it meant acquiring external funds. We would most likely use equity finance as the
company’s current debt ratio is on the higher side. The current debt makes up about 60%
(20,790/34,995). If you also compare the Targets beta (1.05) with Walmart (0.8) or Costco (0.85)
you can tell that Target has a higher financial risk as they are in the same industry and have the
same business risk. So, this increase in financial risk would most likely be explained by having a
higher debt to equity ratio.