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 flows 2 Calculate cost of capital (k-wacc) to use as the discount rate 3 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 Wk4 The 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 cou Review it as necessary, but defer the review until you look at the TVM applications in chapter 5 beginnin You need to know TVM to understand the capital budgeting metrics of NPV, PI, and IRR. Make sure you have 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 an 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 t
the 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
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

Realize that both the Generic Capital Budgeting Template and the Heritage case exhibits a they are both constructed to calculate FREE CASH FLOW=EBIT-TAX+DEPR 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 U

ue, Profitability Index,

e a recommendation

nvestment is made,

you covered in a previous course. plications in chapter 5 beginning on p 79, and in the case exhibits. PV, PI, and IRR. Make sure you

se exhibits, shown in the Q1 and Q2 tabs.

dation as requested in the Q3 tab, by considering

UDGETING template. tween PPE (BS) and operating expense (IS).

capital to answer Q1. tal to answer Q2.

d the worked out example on p 82.

nd the Heritage case exhibits are very similar CASH FLOW=EBIT-TAX+DEPREC+/-CHANGE NWC+/-CAPEX.

ING THE RESULTS IS NOT USING EXCEL.

New Heritage Doll Company: Capital Budgeting Selected Operating Projections for Match My Doll Clothing Line Expansion Exhibit 1
2010 Revenue Revenue Growth Production Costs Fixed Production Expense (excl depreciation) Variable Production Costs Depreciation Total Production Costs Selling, General & Administrative Total Operating Expenses Operating Profit Working Capital Assumptions: Minimum Cash Balance as % of Sales Days Sales Outstanding Inventory Turnover (prod. cost/ending inv.) Days Payable Outstanding (based on tot. op. exp.) Capital Expenditures 1,470 3.0% 59.2x 7.7x 30.8x 952 3.0% 59.2x 8.3x 30.9x 152 3.0% 59.2x 12.7x 31.0x 152 3.0% 59.2x 12.7x 31.0x 334 3.0% 59.2x 12.7x 31.0x 361 0 1,250 1,250 (1,250) 575 2,035 152 2,762 1,155 3,917 583 575 3,404 152 4,131 1,735 5,866 994 587 4,291 152 5,029 2,102 7,132 1,277 598 4,669 152 5,419 2,270 7,690 1,392 610 5,078 164 5,853 2,452 8,305 1,503 2011 4,500 2012 6,860 52.4% 2013 8,409 22.6% 2014 9,082 8.0% 2015 9,808 8.0%

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 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.
2 ENTER ANY SALVAGE VALUE AT THE END OF THE PROJECT IN THE CAPEX ROW (37) 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. NPV PI IRR PP

3 4 5 6

SEE Q1 AT ROW 50 BELOW

2016 10,593 8.0% 622 5,521 178 6,321 2,648 8,969 1,623

2017 11,440 8.0% 635 6,000 192 6,827 2,860 9,687 1,753

2018 12,355 8.0% 648 6,519 207 7,373 3,089 10,462 1,893

2019 13,344 8.0% 660 7,079 224 7,963 3,336 11,299 2,045

2020 14,411 8.0% 674 7,685 242 8,600 3,603 12,203 2,209

3.0% 59.2x 12.7x 31.0x 389

3.0% 59.2x 12.7x 31.0x 421

3.0% 59.2x 12.7x 31.0x 454

3.0% 59.2x 12.7x 31.0x 491

3.0% 59.2x 12.7x 31.0x 530

o make the calculations.

o make the calculations.

New Heritage Doll Company: Capital Budgeting Selected Operating Projections for Design Your Own Doll Exhibit 2
2010 Revenue Revenue Growth Production Costs Fixed Production Expense (excl depreciation) Variable Production Costs Depreciation Total Production Costs Selling, General & Administrative Total Operating Expenses Operating Profit Working Capital Assumptions: Minimum Cash Balance as % of Sales Days Sales Outstanding Inventory Turnover (prod. cost/ending inv.) Days Payable Outstanding (based on tot. op. exp.) Capital Expenditures 4,610 0 3.0% 59.2x 12.2x 33.7x 310 3.0% 59.2x 12.3x 33.8x 310 1,201 1,201 (1,201) 0 0 0 0 0 0 0 1,650 2,250 310 4,210 1,240 5,450 550 1,683 7,651 310 9,644 2,922 12,566 1,794 2011 0 2012 6,000 2013 14,360 139.3%

SEE Q2 AT ROW 50 BELOW

2014 20,222 40.8% 1,717 11,427 310 13,454 4,044 17,498 2,724

2015 21,435 6.0% 1,751 12,182 436 14,369 4,287 18,656 2,779

3.0% 59.2x 12.6x 33.9x 2,192

3.0% 59.2x 12.7x 33.9x 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 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 calculate: AFTER YOU COMPLETE Q1, COPY ROWS 2 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

ROW 50 BELOW

2016 22,721 6.0% 1,786 12,983 462 15,231 4,544 19,775 2,946

2017 24,084 6.0% 1,822 13,833 490 16,145 4,817 20,962 3,123

2018 25,529 6.0% 1,858 14,736 520 17,113 5,106 22,219 3,310

2019 27,061 6.0% 1,895 15,694 551 18,140 5,412 23,553 3,509

2020 28,685 6.0% 1,933 16,712 584 19,229 5,737 24,966 3,719

3.0% 59.2x 12.7x 33.9x 875

3.0% 59.2x 12.7x 33.9x 928

3.0% 59.2x 12.7x 33.9x 983

3.0% 59.2x 12.7x 33.9x 1,043

3.0% 59.2x 12.7x 33.9x 1,105

ETE Q1, COPY ROWS 25-45 TO Q2. make the calculations.

make the calculations.

Q3a Briefly present the business cases for each project. Which one is the most compelling and why?

Q3b How do the capital budgeting metrics you calculated in Q1 and Q2 influence Emily's deliberations? Which project creates more value for Heritage Doll Company?

Q3c Does Emily need additional information to complete her analysis, and if so, what questions should she put to the sponsors of each prioject.

Q3d As Emily, using the information you have and your professional judgment, make the recommendation and justify it.

eliberations?

ecommendation and justify it.