Case New Heritage Doll Company

Wk 4 is the second of two weeks on CAPITAL BUDGETING. Study the Wk 3 Solutions Template before proceeding into Wk 4.

Learning Objectives You will learn the three steps in capital budgeting: basics accomplished in Wk3

1 Identify relevant incremental cash flows2 Calculate cost of capital (k-wacc) to use as the discount rate3 Calculate the metrics of capital budgeting: Net Present Value, Profitability Index,

Internal Rate of Return, and Payback Period. Then, you will apply the metrics and information in the case study to make a recommendation about which of the two projects to accept.focus of Wk4The essence of the capital budgeting process is to make sure, before an investment is made,that its prospective rate of return is high enough to justify the investment.

Reading Cohen finance book chapter 4 is a review of Time Value of Money, which you covered in a previous course.Review it as necessary, but defer the review until you look at the TVM applications in chapter 5 beginning on p 79, and in the case exhibits.You need to know TVM to understand the capital budgeting metrics of NPV, PI, and IRR. Make sure youhave that context in mind before reviewing the TVM chapter 4 (only if you need to).

Read the Heritage Doll Company case again, focussing first on the two case exhibits, shown in the Q1 and Q2 tabs.Perform the numerical analysis as requested in Q1 and Q2.Then, with the decision metrics in hand, prepare to make the recommendation as requested in the Q3 tab, by consideringthe facts and opinions in the case IN ADDITION to the decision metrics.

Read Cohen finance book chapter 5 selectively. Focus on:

See the FLOW DIAGRAM in GREEN depicting the CAPITAL BUDGETING template.See the IS/BS Model in GREEN depicting the connection between PPE (BS) and operating expense (IS).Review the Wk 3 focussed reading as necessary.

Read pps 69-75 on weighted average cost of capital to answer Q1.

Read bottom p 67 to 69 on Net Working Capital to answer Q2.

Read pps 78-82 on NPV, PI, IRR, PP to answer Q3.

Study the Generic Capital Budgeting Template, p 65-69, and the worked out example on p 82. Realize that both the Generic Capital Budgeting Template and the Heritage case exhibits are very similar -

they are both constructed to calculate FREE CASH FLOW=EBIT-TAX+DEPREC+/-CHANGE NWC+/-CAPEX.

Questions See tabs for Q1, Q2, Q3

THESE QUESTIONS MUST BE ANSWERED USING EXCEL.

MAKING CALCULATIONS OUTSIDE THE SPREADSHEET AND ENTERING THE RESULTS IS NOT USING EXCEL.

Calculate the metrics of capital budgeting: Net Present Value, Profitability Index,

Then, you will apply the metrics and information in the case study to make a recommendation

The essence of the capital budgeting process is to make sure, before an investment is made,

Cohen finance book chapter 4 is a review of Time Value of Money, which you covered in a previous course.Review it as necessary, but defer the review until you look at the TVM applications in chapter 5 beginning on p 79, and in the case exhibits.You need to know TVM to understand the capital budgeting metrics of NPV, PI, and IRR. Make sure you

Read the Heritage Doll Company case again, focussing first on the two case exhibits, shown in the Q1 and Q2 tabs.

Then, with the decision metrics in hand, prepare to make the recommendation as requested in the Q3 tab, by considering

See the FLOW DIAGRAM in GREEN depicting the CAPITAL BUDGETING template.See the IS/BS Model in GREEN depicting the connection between PPE (BS) and operating expense (IS).

Read pps 69-75 on weighted average cost of capital to answer Q1.

Read bottom p 67 to 69 on Net Working Capital to answer Q2.

Study the Generic Capital Budgeting Template, p 65-69, and the worked out example on p 82. Realize that both the Generic Capital Budgeting Template and the Heritage case exhibits are very similar -

they are both constructed to calculate FREE CASH FLOW=EBIT-TAX+DEPREC+/-CHANGE NWC+/-CAPEX.

MAKING CALCULATIONS OUTSIDE THE SPREADSHEET AND ENTERING THE RESULTS IS NOT USING EXCEL.

New Heritage Doll Company: Capital BudgetingExhibit 1

2010 2011 2012 2013 2014 2015

Revenue 4,500 6,860 8,409 9,082 9,808

Revenue Growth 52.4% 22.6% 8.0% 8.0%

Production Costs

Fixed Production Expense (excl depreciation) 575 575 587 598 610

Variable Production Costs 2,035 3,404 4,291 4,669 5,078

Depreciation 152 152 152 152 164

Total Production Costs 0 2,762 4,131 5,029 5,419 5,853

Selling, General & Administrative 1,250 1,155 1,735 2,102 2,270 2,452

Total Operating Expenses 1,250 3,917 5,866 7,132 7,690 8,305

Operating Profit (1,250) 583 994 1,277 1,392 1,503

Working Capital Assumptions:

Minimum Cash Balance as % of Sales 3.0% 3.0% 3.0% 3.0% 3.0%

Days Sales Outstanding 59.2x 59.2x 59.2x 59.2x 59.2x

Inventory Turnover (prod. cost/ending inv.) 7.7x 8.3x 12.7x 12.7x 12.7x

Days Payable Outstanding (based on tot. op. exp.) 30.8x 30.9x 31.0x 31.0x 31.0x

Capital Expenditures 1,470 952 152 152 334 361

NET WORKING CAPITAL:

RECEIVABLES

INVENTORY

PAYABLES

TOTAL NET WORKING CAPITAL

CHANGE IN NET WORKING CAPITAL

FREE CASH FLOW:

EBIT

TAX

DEPRECIATION

CHANGE IN NWC

CAPITAL EXPENDITURE

FREE CASH FLOW

CUMULATIVE FREE CASH FLOW

DISCOUNT RATE (K-WACC)

NET PRESENT VALUE

PROFITABILITY INDEX

INTERNAL RATE OF RETURN

Selected Operating Projections for Match My Doll Clothing Line Expansion

PAYBACK PERIOD

Q1

The input data are provided in rows 4-23 above.

Your challenge is to complete the spreadsheet by entering new rows to calculate:

1 Net working capital. HINT: Follow the approach used in Q2 of the Wk3 assignment.

Row labels are entered above as a guide. You must enter the data and/or formulas to make the calculations.

YEAR 2010 IS THE BASE YEAR, YEAR 0; YEAR 2011 IS THE FIRST YEAR OF OPERATIONS.ENTER ANY SALVAGE VALUE AT THE END OF THE PROJECT IN THE CAPEX ROW (37)

2 Free Cash Flow.

Hint: FREE CASH FLOW=EBIT-TAX+DEPREC+/-CHANGE NWC+/-CAPEX.

Row labels are entered above as a guide. You must enter the data and/or formulas to make the calculations.

3 NPV

4 PI

5 IRR

6 PP

SEE Q1 AT ROW 50 BELOW

2016 2017 2018 2019 2020

10,593 11,440 12,355 13,344 14,411

8.0% 8.0% 8.0% 8.0% 8.0%

622 635 648 660 674

5,521 6,000 6,519 7,079 7,685

178 192 207 224 242

6,321 6,827 7,373 7,963 8,600

2,648 2,860 3,089 3,336 3,603

8,969 9,687 10,462 11,299 12,203

1,623 1,753 1,893 2,045 2,209

3.0% 3.0% 3.0% 3.0% 3.0%

59.2x 59.2x 59.2x 59.2x 59.2x

12.7x 12.7x 12.7x 12.7x 12.7x

31.0x 31.0x 31.0x 31.0x 31.0x

389 421 454 491 530

Row labels are entered above as a guide. You must enter the data and/or formulas to make the calculations.

Row labels are entered above as a guide. You must enter the data and/or formulas to make the calculations.

New Heritage Doll Company: Capital Budgeting SEE Q2 AT ROW 50 BELOWExhibit 2

2010 2011 2012 2013 2014 2015

Revenue 0 6,000 14,360 20,222 21,435

Revenue Growth 139.3% 40.8% 6.0%

Production Costs

Fixed Production Expense (excl depreciation) 0 1,650 1,683 1,717 1,751

Variable Production Costs 0 2,250 7,651 11,427 12,182

Depreciation 0 310 310 310 436

Total Production Costs 0 4,210 9,644 13,454 14,369

Selling, General & Administrative 1,201 0 1,240 2,922 4,044 4,287

Total Operating Expenses 1,201 0 5,450 12,566 17,498 18,656

Operating Profit (1,201) 0 550 1,794 2,724 2,779

Working Capital Assumptions:

Minimum Cash Balance as % of Sales 3.0% 3.0% 3.0% 3.0%

Days Sales Outstanding 59.2x 59.2x 59.2x 59.2x

Inventory Turnover (prod. cost/ending inv.) 12.2x 12.3x 12.6x 12.7x

Days Payable Outstanding (based on tot. op. exp.) 33.7x 33.8x 33.9x 33.9x

Capital Expenditures 4,610 0 310 310 2,192 826

NET WORKING CAPITAL:

RECEIVABLES

INVENTORY

PAYABLES

TOTAL NET WORKING CAPITAL

CHANGE IN NET WORKING CAPITAL

FREE CASH FLOW:

EBIT

TAX

DEPRECIATION

CHANGE IN NWC

CAPITAL EXPENDITURE

FREE CASH FLOW

CUMULATIVE FREE CASH FLOW

DISCOUNT RATE (K-WACC)

NET PRESENT VALUE

PROFITABILITY INDEX

INTERNAL RATE OF RETURN

Selected Operating Projections for Design Your Own Doll

PAYBACK PERIOD

Q2

The input data are provided in rows 4-23 above.

Your challenge is to complete the spreadsheet by entering new rows to calculaAFTER YOU COMPLETE Q1, COPY ROWS 25-45 TO Q2.

1 Net working capital. HINT: Follow the approach used in Q2 of the Wk3 assignment.

Row labels are entered above as a guide. You must enter the data and/or formulas to make the calculations.

YEAR 2010 IS THE BASE YEAR, YEAR 0; YEAR 2012 IS THE FIRST YEAR OF OPERATIONS.ENTER ANY SALVAGE VALUE AT THE END OF THE PROJECT IN THE CAPEX ROW (37)

2 Free Cash Flow.

Hint: FREE CASH FLOW=EBIT-TAX+DEPREC+/-CHANGE NWC+/-CAPEX.

Row labels are entered above as a guide. You must enter the data and/or formulas to make the calculations.

3 NPV

4 PI

5 IRR

6 PP

SEE Q2 AT ROW 50 BELOW

2016 2017 2018 2019 2020

22,721 24,084 25,529 27,061 28,685

6.0% 6.0% 6.0% 6.0% 6.0%

1,786 1,822 1,858 1,895 1,933

12,983 13,833 14,736 15,694 16,712

462 490 520 551 584

15,231 16,145 17,113 18,140 19,229

4,544 4,817 5,106 5,412 5,737

19,775 20,962 22,219 23,553 24,966

2,946 3,123 3,310 3,509 3,719

3.0% 3.0% 3.0% 3.0% 3.0%

59.2x 59.2x 59.2x 59.2x 59.2x

12.7x 12.7x 12.7x 12.7x 12.7x

33.9x 33.9x 33.9x 33.9x 33.9x

875 928 983 1,043 1,105

AFTER YOU COMPLETE Q1, COPY ROWS 25-45 TO Q2.

Row labels are entered above as a guide. You must enter the data and/or formulas to make the calculations.

Row labels are entered above as a guide. You must enter the data and/or formulas to make the calculations.

Q3aBriefly present the business cases for each project. Which one is the most compelling and why?

Q3bHow do the capital budgeting metrics you calculated in Q1 and Q2 influence Emily's deliberations?Which project creates more value for Heritage Doll Company?

Q3cDoes Emily need additional information to complete her analysis, and if so, what questions should she put to the sponsors of each prioject.

Q3dAs Emily, using the information you have and your professional judgment, make the recommendation and justify it.

How do the capital budgeting metrics you calculated in Q1 and Q2 influence Emily's deliberations?

As Emily, using the information you have and your professional judgment, make the recommendation and justify it.