New Heritage Doll
1. Compute the Free Cash Flows for the years 2010 to 2020 for both projects See excel File attached.
* We assumed the required working capital in table 2 and 3 is the amount required in 2010, for further years we computed the WCR based on the ratio’s of minimum cash balance, number of days sales outstanding, inventory turnover and days payable outstanding (deducting the depreciation as instructed) * We assumed the SG&A and fixed production costs were project specific and therefore included them in the FCF analysis 2. Compute the NPV of both projects. Which would you recommend? What if they are not mutually exclusive? NPVMMDC = 7,150
NPVDYOD = 7,298
Based solely on the NPV analysis we would suggest to implement the DYOD project as it has a higher NPV. If both projects weren’t mutually exclusive, we would suggest implementing both as both have a positive NPV. 3. Compute IRR and payback period for both projects. Based on each criterion, which project would you recommend? If this differs from NPV analysis, explain the deviation? For MMDC:
IRR = 23,99%*
Payback period = 8 years (assuming the cash flows occur at year end, as instructed) For DYOD:
IRR = 18,33%*
Payback period = 11 years (assuming the cash flows in 2021 is indeed CF2020*1,03) *For the IRR analysis we drafted a NPV sensitivity graph in order to make sure that there are not 2 possible values for IRR. These graphs are to be found in the excel file attached. Based on these criteria we would recommend investing in the MMDC project as IRR is higher and payback period is shorter. These analyses differ from the NPV analysis as these methods penalize projects with high initial investments and positive cash flows that occur later in time. 4. Describe possible risks and advantages that one might need to take into account but are not considered by NPV analysis? Risks:
* The allocation of a limited amount of capital available within the company, there may be an opportunity cost for the capital allocated to these projects rather than to projects of other departments that have even higher returns * According to the case info, lasting brands in the doll business are rare, therefore the positive outlook during the first 10 years and a terminal value based on an assumption of a 3% perpetual growth rate could possibly be unrealistic * NPV solely looks at the company’s internal financial side of the project. We might also want to take competitor actions into account and how these may affect our decision making (e.g. perhaps first mover advantages in the design your own doll project might be very positive, but if a competitor introduces a similar value proposition between the investment decision and market introduction (2 years later), this may have a negative impact on the projects profitability) * We have not taken cannibalization into account for the DYOD project. It may actually move customers away from the standard doll. Advantages
* We are not looking at which projects may have a positive impact on the company’s other business units. Perhaps one project stimulates the retail of licensing business more than the other. * The MMDC project could allow you to start using fashion outlets as an additional sales channel for the clothes and even increase sales of all dolls in the process * The MMDC project will be moving in another product category (fashion) and may create a brand name in that category. People that hadn’t heard from Heritage as a doll manufacturer may therefore get to know the company and purchase dolls in the future 5. List two assumptions that you think are prone to error and explain your choice For this question we tried to identify the assumptions that have the highest possible impact on the NPV analysis. a. Terminal value of the project.
The project makes the assumption that cash flows in 2021 and onwards will continue into eternity growing at a rate of 3%. Although this number is the expected growth rate of the industry,...
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