Discussion

Anonymous
timer Asked: Apr 2nd, 2017

Question Description

Preparation:

1-Research risk management approaches for managers. (You must find the research)

2-View Videos: (See the link)

a-Price Your Flight Algorithm

b-Set D: Management Functions and Risk Management

https://www.dropbox.com/sh/as8us7yc9188ywv/AACTL4YaQIeWy-78q4wKR7Jfa?dl=0

Discussion:

Discuss how a similar “set your price” approach could be used for Heritage Doll with -

A- Match my Doll product line.

B- Design your own Doll product line.

+ In separate file

You should write two general comments about the topic.

+ Note:

1- Write more than 1 page and less than 4 pages

2-Avoid plagiarism.

3-The following format guidelines are suggested:

-standard 1" margins
-single-spacing (text)
-double-spacing between paragraphs
-no paragraph indentation (left justified)
-size 12 font, Times New Roman, black text
-italicized or bold font for section headings

4- See attachment which is factsheet of Heritage Doll that I have wrote. Also, I will provide the article of Heritage Doll that you may use it.

Tags: c f
Name: Date: 03/10/2017 1 Heritage Doll Case Background In the US gaming and toys industry, New Heritage Doll Company has been operating successfully over the years. Their primary product for this industry is quite well know Doll category which is manufactured by the company at various ranges in accordance with the targeted age bracket of the customer. There have been some significant variations in this industry affecting the revenue figures and operating profits since 2010 and now the company is looking to avail some new opportunities to ease their constraints. Investment Options The CEO of the company is of the view that they should expand their production and operating capacity by more investment inflow. There are two investment option which are being considered. One option is to expand the currently running mechanism which is “Match my Doll clothing” (Option 1) and the other option which is a new one, is “Design your own Doll” (Option 2). The company needs to make a decision to opt for any of the two alternate options after a detailed evaluation with calculative analysis is being completed. The management along with analysts will evaluate these two proposals based on some assumption and then decide which one is to be adopted after reviewing their profitability. Case Assumptions: For the purpose of the evaluation and calculation the following assumptions have been made: • Revenue Growth Rate of 8% and 6% is assumed for option 1 and option 2 respectively. For option 1, the discount rate is presumed to be 8.4% as this project bears the medium risk. For option 2, the discount rate is presumed to be 9% as this option is liable to very high risk being an inventive design, thus a higher discount rate is presumed. Income tax rate is assumed to be 40%. It is also being assumed that uniform cash flow projections are derived for to develop capital budget and cash flow forecast. Name: Date: 03/10/2017 2 NPV As a general rule for the Net Present Value (NPV), the project will be accepted when NPV is more than the amount of investment. As per this calculative analysis, the investment decision of option 1 which is “Matching my doll clothing Line” is more favorable as having a higher NPV than that of option 2. Although the difference is not much high to straight away accept the option one but still the higher NPV option should be accepted so as per this decision rule “Match my doll clothing line” should prevail over “Design your own doll”. IRR (Internal Rate of Return) As a general rule the option, having a higher IRR will be accepted. As per our calculative analysis, option 1 has an IRR being calculated at 24% and IRR calculated for option 2 is 18%. Hence, following the general rule this calculation supports the investment decision regarding “Matching my doll clothing line” and the same option should be selected. Pay Back Period As per the general rule for Payback period, the project with shorter payback period should be selected instead of accepting a project that has a longer payback period, which might lead the business into unsafe scenarios. As per our calculative analysis, the payback period decision rule backs the investment decision related to option 1 as having a shorter payback period than that of option 2. PI (Profitability Index) As per the general rule, the PI decision rule matches the NPV rule, more the PI of an investment, more it is acceptable for the business. As per our calculation, this evaluation also backs the investment decision related to option 1 as it has higher PI of 3.37 than that of option 2 having a lower PI. Name: Date: 03/10/2017 3 Recommendations As we have made four evaluation technique with calculation and based on all calculations and evaluations of the two projects, option 1 which is. As per the financial evaluations, this project requires shorter period to recoup its initial investment and less capital cost and also having a higher return than the second option. What if: - Heritage doll decides to go with Match my doll clothing line extension: Coordinate my apparel line comprised of two or three attire and extras for the late spring. It was gigantically prevalent as a result of the big name kids who were seen wearing them. Marcy McAdams, the brand trough of the line would have liked to take advantage of its prosperity by growing the dress line to incorporate garments and adornments of all seasons. Advantages: • • • The strategy was at that point tried and tremendously prevalent. The new line would acquire in any event a similar net revenue if not more. There was a nature with the working of the venture and the organization had involvement with the usage of a piece of the venture. Would help lessen the regularity of the New Heritage's income. Disadvantages: • • Due to the flighty way of youthful child's mold sense, the new line must be propelled rapidly and there was no opportunity to squander. It was additionally a bet, as nobody knew to what extent this specific venture would bring picks up for New Heritage. - Heritage doll decides to go with Design your own doll: This activity required in customizing the dolls as per the client's tastes and redoing them to the individual information of future proprietors. This would draw in a considerable measure of present and new proprietors to purchase and make another doll like them. Advantages • • • Would help make more deals as this was a novel idea and the deals should be possible to new and existing clients. It had a direct settled cost proportion. It served well for the organization's saying of making a novel affair for the clients. Disadvantages • It was an unsafe recommendation. The organization would be obscure region for the organization and a considerable measure of speculation would be required. Name: Date: 03/10/2017 • It would require flawlessness in executing the venture else it would wind up in harming New Heritage's notoriety and its association with a portion of the best clients. The argument Ms. Harris: Two projects would be represented by Ms. Harris to Ms. Beckwith and to capital budgeting. Ms. Harris has reached that matching the clothes for dolls is feasible. Thus, she should focus on benefits for New Heritage doll. Moreover, Ms. Harris should convince the capital budgeting committee that her case will make an increase in the sales and revenues, profitability, and payback period. 4
4212 SEPTEMBER 15, 2010 TIMOTHY LUEHRMAN HEIDE ABELLI New Heritage Doll Company: Capital Budgeting In mid-September of 2010, Emily Harris, vice president of New Heritage Doll Company’s production division, was weighing project proposals for the company’s upcoming capital budgeting meetings in October. Two proposals stood out based on their potential to strengthen the division’s innovative product lines and drive future growth. However, due to constraints on financial and managerial resources, Harris knew it was possible that the firm’s capital budgeting committee would decline to approve both projects. She also knew that New Heritage’s licensing and retail divisions would promote compelling projects of their own. Consequently, Harris had to be prepared to recommend one of her projects over the other. The Doll Industry Revenues in the U.S. toy and game industry totaled $42 billion in 2008 and were projected to increase by 4.6% per year to $52.5 billion by 2013. The market was divided into two broad segments: video games (48%) and traditional toys and games (52%). The second segment was further divided into infant/preschool toys (14.5%), dolls (14.1%), outdoor & sports toys (12.3%), and other toys & games (59.1%) including arts and crafts, plush toys, action figures, vehicles, and youth electronics. The U.S. market for toys and games was dominated by large global enterprises that enjoyed economies of scale in design, production, and distribution. Revenues were highly seasonal; the largest selling season in the United States coincided with the winter holiday period. Within the toy and game segment, U.S. retail sales of dolls totaled $3.1 billion in 2008 and were projected to grow by 3% per year to $3.6 billion by 2013. The doll category included large, soft, and mini dolls, as well as doll clothing and other accessories. The phenomenon of “age compression”— the tendency of younger children to acquire dolls that had traditionally been designed for older girls—reduced growth in the “baby-doll” sub-segment. Competition among doll producers was vigorous, as a small number of large producers targeted similar demographics and marketed their dolls through the same media. Lasting franchise value for a branded line of dolls was rare; the enormous success of Barbie® dolls was an obvious exception. More recently and on a much smaller scale, New Heritage also had created a durable franchise for its line of heirloom dolls. But the popularity of most doll lines waned after a few years. ________________________________________________________________________________________________________________ HBS Professor Timothy Luehrman and HBS MBA Heide Abelli prepared this case solely as a basis for class discussion and not as an endorsement, a source of primary data, or an illustration of effective or ineffective management. This case, though based on real events, is fictionalized, and any resemblance to actual persons or entities is coincidental. There are occasional references to actual companies in the narration. Copyright © 2010 President and Fellows of Harvard College. To order copies or request permission to reproduce materials, call 1-800-545-7685, write Harvard Business Publishing, Boston, MA 02163, or go to http://www.hbsp.harvard.edu. This publication may not be digitized, photocopied, or otherwise reproduced, posted, or transmitted, without the permission of Harvard Business School. This document is authorized for use only in FIN 620 by Pamela Queen at Morgan State University from January 2013 to July 2013. 4212 | New Heritage Doll Company: Capital Budgeting New Heritage Dolls The New Heritage Doll Company was founded in 1985 by Ingrid Beckwith, a retired psychologist specializing in child development and the grandmother of two young girls. Dr. Beckwith believed the dolls produced by the major toy companies did little to develop girls’ imagination or foster a positive self-image, so she created a line of dolls with unique storylines and wholesome themes. Dr. Beckwith’s dolls struck a chord among mothers and grandmothers who also rejected the dated, clichéd images portrayed by the popular dolls of the day. By 2009, New Heritage had grown to 450 employees and generated approximately $245 million of revenue1 and $27 million of operating profit from three divisions: production, retailing, and licensing. The production division, discussed further below, designed and produced dolls and doll accessories. The retailing division offered a unique “intergenerational experience” for grandmothers, mothers, and daughters, centered upon the character histories and storylines of the company’s dolls and delivered through an online website (42%), a mail-order paper catalog (33%), and a network of retail stores (25%). In fiscal 2009, the retailing division generated roughly $190 million of revenue and $4.8 million of operating profit. The licensing division was started in 1998, and represented the company’s newest and most profitable division. It sought to extend the New Heritage brand and capitalize on high levels of customer loyalty by selectively licensing the company’s doll characters and themes to a variety of media that reached the firm’s target demographic of toddler to pre-teen girls. In fiscal year 2009 the licensing division generated $24.5 million of revenue and $14.5 million in operating profit. New Heritage’s Production Division Production was New Heritage’s largest division as measured by total assets, and easily its most asset-intensive. Approximately 75% of the division’s sales were made to the company’s retailing division, with the remaining 25% comprising private label goods manufactured for other firms. Table 1 summarizes the division’s various sources of revenue and operating income. Table 1 Production Division Data: Revenue ($ millions) Operating Income ($ millions) New Heritage Dolls Accessories 80 14 4.4 0.5 Private Label Dolls Accessories 26 5 2.3 0.3 Total $125 $ 7.5 New Heritage’s dolls and accessories were offered under distinct brands with different price points, targeting girls between the ages of 3 and 12 years. The company’s baby dolls were generally priced from $15–$30, and were offered to younger girls in earlier stages of development. These dolls typically came with a “birth certificate” and a short personal history. Dolls in the higher-end of this category incorporated technology that produced a limited amount of speech and motion. For the $75–$150 price range, New Heritage produced a line of heirloom-quality dolls and accessories. These were designed to appeal to older girls and to convey a sense of cultural and family tradition among grandmothers, mothers, and daughters. The heirloom dolls had more elaborate accessories and personal histories. Finally, the company offered a line of high-end dolls based on fictional “celebrities,” each associated with a charitable cause and embracing more contemporary fashion 1 The division revenue figures include approximately $95 million of internal sales within divisions which are eliminated when considering consolidated revenue for the company. 2 BRIEFCASES | HARVARD BUSINESS SCHOOL This document is authorized for use only in FIN 620 by Pamela Queen at Morgan State University from January 2013 to July 2013. New Heritage Doll Company: Capital Budgeting | 4212 trends. These dolls targeted girls in the so-called “tween” age range of 8–12 years, and also were priced from $75–$150. Like the heirloom dolls, celebrity dolls also came with more elaborate stories and accessories. New Heritage outsourced much of its production to a select number of contract manufacturers in Asia. To ensure product quality and safety, the company maintained a fulltime staff to oversee material sourcing, production, and quality control on site at each of its manufacturing partners. Manufacturing activities that required precise tolerances or proprietary processes, along with all the creative elements (design and product prototyping, for example), were handled in-house at the company’s headquarters facilities in Sacramento, California. Capital Budgeting at New Heritage New Heritage’s capital budgeting process retained some of the informality that characterized the company’s early years as an innovative startup. As the company grew, deliberate steps were taken to decentralize some of the project approval process and increase spending authority at the division level. However, large and/or strategic spending proposals were reviewed at the corporate level by a capital budgeting committee consisting of the CEO, CFO, COO, the controller, and the division presidents. The committee examined projects for consistency with New Heritage’s business strategy and sought to balance the needs and priorities of each division against practical financial and organizational constraints. The committee also sought to understand project interdependencies and the potential for a given investment to strengthen the whole company, not solely the division proposing it. New Heritage’s capital budget was set by the board of directors in consultation with top officers, who in turn sought input from each of the divisions. The capital and operating budgets were linked; historically, the capital budget comprised approximately 15% of the company’s EBITDA. The committee had limited discretion to expand or contract the budget, according to its view of the quality of the investment opportunities, competitive dynamics, and general industry conditions. Before being considered by the committee, projects were described, analyzed, and summarized in self-contained proposal documents prepared by each division. These contained business descriptions, at least five years of operating and cash flow forecasts, spending requirements by asset category, personnel requirements, calculations of standard investment metrics, and identification of key project risks and milestones. Financial Analyses Financial analysis began with operating forecasts developed with oversight from New Heritage operating managers. Revenue projections were derived from forecasts of future prices and volumes. Fixed and variable costs were estimated separately, by expense category. Forecasts of working capital requirements were likewise vetted by line managers, who paid particular attention to a project’s requirements for various types of inventory. Forecasts for fixed assets and related depreciation charges were developed in cooperation with analysts reporting to the controller. Operating projections for a given project were used to develop cash flow forecasts that would underpin calculations of net present value (NPV), internal rates of return (IRR), payback period, and other investment metrics. Cash flow forecasts were intended to capture the incremental effect of a proposed project on the firm’s cash flow for each year within the forecast period. That is, each project’s cash flow forecasts excluded non-cash items, such as depreciation charges, and nonincremental items such as sunk costs (i.e., costs that would be incurred regardless of whether a given project was undertaken or not). The cash flow forecasts were computed on an after-corporate-tax HARVARD BUSINESS SCHOOL | BRIEFCASES This document is authorized for use only in FIN 620 by Pamela Queen at Morgan State University from January 2013 to July 2013. 3 4212 | New Heritage Doll Company: Capital Budgeting basis, but excluded all financing charges. Some elements of the cash flow forecasts were prepared with assistance from treasury analysts, but most of the necessary adjustments were well understood by division staff. New Heritage assigned discount rates to projects according to a subjective assessment of each project’s risk. High-, medium-, and low-risk categories for each division were associated with a corresponding discount rate set by the capital budgeting committee in consultation with the corporate treasurer. Assessments of each project’s risk were made at the division level, but subject to review by the capital committee. Factors considered in the assessment of a project’s risk included, for example, whether it required new consumer acceptance or new technology, high levels of fixed costs and hence high breakeven production volumes, the sensitivity of price or volume to macroeconomic recession, the anticipated degree of price competition, and so forth. In 2010, “medium”-risk projects in the production division received a discount rate of 8.4%. High- and low-risk projects were assessed at 9.0% and 7.7%, respectively. Projects that created value indefinitely, given continuing investment, were treated as going concerns with a perpetual life. That is, NPV calculations included a terminal value computed as the value of a perpetuity growing at a constant rate. However, to preserve an element of conservatism, the capital committee generally insisted on relatively low perpetual growth rates – lower than New Heritage’s historical growth and lower than near-term growth forecasts for a given division. Investment Opportunities in the Production Division Emily Harris was focused on two of the production division’s most attractive current proposals. The first involved expanding the successful Match My Doll Clothing Line to include matching allseason clothing for tween girls and their favorite dolls. The second involved a new initiative, the Design Your Own Doll line, which employed web-based doll-design software to let users “customize” a doll’s features to the customer’s specifications. Match My Doll Clothing Line Expansion The Match My Doll Clothing line originally consisted of a few sets of matching doll and child clothing and accessories for warm weather. It quickly became successful after the daughters of a few celebrities were spotted and photographed wearing items from the line, and girls’ magazines included some of the line in “what’s hot to wear” sections. Given recent publicity, Marcy McAdams, the brand manager responsible for the line, believed the timing was perfect to expand. Specifically, McAdams proposed to create an “All Seasons Collection” of apparel and gear covering all four seasons of the year. She expected the new offerings to be at least as profitable as the existing line, since its current popularity would make it possible to maintain premium prices. She also hoped to take advantage of off-peak discounts offered by some suppliers and contract manufacturers as they tried to smooth their capacity utilization. In the same fashion, McAdams argued the expansion would help reduce, or at least not exacerbate, the seasonality in New Heritage’s sales and earnings. To exploit the current popularity of the original Match My Doll Clothing line, especially given the fickle nature of children’s fashion trends, McAdams believed the opportunity had to be exploited without delay. Her investment proposal contained relatively large outlays for R&D, market research, and marketing to maximize the probability of quick acceptance and longer-term success for the follow-on line. Upfront investment expenditures are summarized in Table 2. 4 BRIEFCASES | HARVARD BUSINESS SCHOOL This document is authorized for use only in FIN 620 by Pamela Queen at Morgan State University from January 2013 to July 2013. New Heritage Doll Company: Capital Budgeting | 4212 Table 2 Match My Doll Clothing Extension Outlays Initial Expenditures ($ thousands) Upfront R&D Upfront Marketing Investment in Working Capital Property, Plant & Equipment Total 2010 $ 625 625 800 1,470 $ 3,520 The R&D and marketing expenditures would be deductible for tax purposes at New Heritage’s 40% corporate tax rate. The property, plant and equipment was expected to have a useful life of 10 years; the associated depreciation charges, shown in Exhibit 1, were based on the modified accelerated cost recovery system (“MACRS”) allowed by the IRS. Working capital requirements, shown in Table 2 for 2010 and in Exhibit 1 for subsequent years were based largely on recent historical experience with the original Match My Doll Clothing line. Finally, given the proven success of Match My Doll Clothing, Harris believed the project entailed moderate risk—that is, about the same degree of risk as the production division’s existing business as a whole. Design Your Own Doll This initiative targeted existing New Heritage customers, many of whom owned several of the company’s heirloom dolls. The company’s research showed that, when asked what features (e.g., appearance, ethnicity, “life story,” etc.) New Heritage should give to future dolls, loyal customers’ responses had a high correlation with their own personal data. That is, girls wanted dolls like themselves. Further research suggested that many loyal customers would purchase yet another doll if they could customize the doll’s features to create a “one-of-a-kind” addition to a girl’s or family’s existing collection of dolls. It also promised to increase the girl’s pride in and identification with the doll, both because of their shared features and because of the girl’s participation in creating the doll. This in turn further cemented customer loyalty. The customization process would begin with a new section of New Heritage’s website, where proprietary design software enabled the customer to select physical attributes of the doll such as hair color, hair length & style, skin color, eye shape, eye color, and other facial features. The software could combine selected features and produce a photo-realistic image showing the finished doll with user-selected accessories. The customer could zoom in or out on the image and rotate it to see different aspects. The software made it easy to try out different combinations of features and accessories before making a purchase. Elizabeth Holtz, brand manager for heirloom dolls, was very excited about the project. She observed, “A girl’s relationship with her favorite doll is often partly mommy and partly big sister. Either way, having your doll look more like you is really powerful. And there’s excitement in the experience: exploring the website, naming the doll-to-be, selecting her first outfit…even the anticipation of waiting for the new doll to arrive. I really think this is big.” Holtz also believed that the dolls could command a premium price. “Customers will naturally expect to pay more [for a custom doll],” she said. Market research with focus groups revealed significant enthusiasm for the product concept and supported the notion of premium prices. However, even a limited degree of customization increased manufacturing complexity and expense. Further, because of the low production runs and volume, fixed costs on a per unit basis were expected to be relatively high. Consequently, the breakeven volume for the project was also expected to be high. HARVARD BUSINESS SCHOOL | BRIEFCASES This document is authorized for use only in FIN 620 by Pamela Queen at Morgan State University from January 2013 to July 2013. 5 4212 | New Heritage Doll Company: Capital Budgeting The web-based software tools and order entry system required New Heritage to make significant modifications to its existing technology infrastructure, expand its webhosting capacity, and modify the terms of its third-party service agreements to ensure a higher level of service quality. The majority of the R&D expenditures shown below were related to software development, hardware upgrades, and web design. The development time involved, including product testing, was expected to be approximately 12 months. Initial outlays, some of which occurred in 2010 and some in 2011, are summarized in Table 3. Table 3 Design Your Own Doll Outlays Initial Expenditures ($ thousands) 2010 2011 Upfront R&D Upfront Marketing Investment in Working Capital $ 841 $ 360 Property, Plant & Equipment Total $ 4,610 $ 5,811 $ 1,000 $ 1,000 As with Match My Doll Clothing, the required R&D and marketing costs would be tax deductible. Manufacturing equipment had to be ordered by the end of 2010 to be ready for production at the beginning of 2012. While New Heritage had the option to pay for custom equipment in quarterly installments, the firm could get a substantial discount by paying for the equipment up front, in 2010. Figures in Table 3 and Exhibit 2 reflect the discounted cost of the equipment. To support the forecasted level of sales, substantial investment in working capital (primarily work in process inventory of partially manufactured dolls) would be required beginning in 2011. And still more equipment would have to be purchased and installed no later than 2014. In years 2015 and following, investments in working capital and equipment would revert to patterns familiar from the production division’s traditional lines of dolls. To complete development work, Holtz planned to use some of the company’s existing IT staff. The majority of the work would take place during calendar 2011. The number of people and their fully loaded costs are shown Table 4. These costs were not included by Holtz in the initial outlays shown in Table 3 or in the forecasts presented in Exhibit 2. The development personnel Holtz needed were considered “corporate” resources and were almost certainly available to work on the project. Table 4 Design Your Own Doll Development Personnel, ($ 000s) Application Development Personnel Costs: Web Application Developers Database Manager Systems Integration Specialist Total Cost Number Salary Total 1 1 1 $ 150 160 $ 125 $ 150 160 125 $ 435 Finally, Holtz needed to give Harris her assessment of the project’s riskiness. On the one hand, Design Your Own Doll had a relatively long payback period, introduced some untested elements into the manufacturing process, and depended on near-flawless operation of new customer-facing software and user interfaces. If the project stumbled for some reason, New Heritage risked damaging relationships with its best customers. On the other hand, the project had a relatively modest fixed cost ratio, and it played to the company’s key strength—creating a unique experience for its consumers. 6 BRIEFCASES | HARVARD BUSINESS SCHOOL This document is authorized for use only in FIN 620 by Pamela Queen at Morgan State University from January 2013 to July 2013. New Heritage Doll Company: Capital Budgeting | 4212 Harris’s Decision Emily Harris still needed to complete her review and financial analysis of the two proposals. McAdams and Holtz were in frequent touch with Harris and both had offered to respond to any questions she might have about the proposals: the business case, the financial projections, the operating details, or anything else. Harris expected that she would indeed have some follow-up questions as she worked through her financial analyses. She also knew that her final recommendation might disappoint some executives within the division, who would scrutinize it closely. It had to be well-supported. HARVARD BUSINESS SCHOOL | BRIEFCASES This document is authorized for use only in FIN 620 by Pamela Queen at Morgan State University from January 2013 to July 2013. 7 This document is authorized for use only in FIN 620 by Pamela Queen at Morgan State University from January 2013 to July 2013. $ $ 952 3.0% 59.2x 7.7x 30.8x 583 $ $ 152 3.0% 59.2x 8.3x 30.9x 994 575 3,404 152 4,131 1,735 $ 5,866 575 2,035 152 2,762 1,155 $ 3,917 2012 $ 6,860 52.4% 2011 $ 4,500 2013 $ 152 3.0% 59.2x 12.7x 31.0x $ 1,277 587 4,291 152 5,029 2,102 $ 7,132 $ 8,409 22.6% Capital Expenditures 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.) $ 4,610 $ (1,201) Operating Profit 1,201 1,201 $ 2010 $ 0 $ 0 $ 0 $ $ 310 3.0% 59.2x 12.2x 33.7x 550 1,650 2,250 310 4,210 1,240 $ 5,450 0 0 0 0 0 2012 $ 6,000 0 2011 $ $ 310 3.0% 59.2x 12.3x 33.8x 1,794 1,683 7,651 310 9,644 2,922 $ 12,566 $ 14,360 139.3% 2013 Selected Operating Projections for Design Your Own Doll ($ in thousands) 1,470 Revenue Revenue Growth Production Costs Fixed Production Expense (excl depreciation) Variable Production Costs Depreciation Total Production Costs Selling, General & Administrative Total Operating Expenses Exhibit 2 Capital Expenditures $ $ (1,250) 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.) $ 0 1,250 1,250 2010 3.0% 59.2x 12.6x 33.9x 2,724 $ 2,192 $ 1,717 11,427 310 13,454 4,044 $ 17,498 $ 20,222 40.8% 2014 $ 334 3.0% 59.2x 12.7x 31.0x $ 1,392 598 4,669 152 5,419 2,270 $ 7,690 $ 9,082 8.0% 2014 2015 361 $ $ 826 3.0% 59.2x 12.7x 33.9x 2,779 1,751 12,182 436 14,369 4,287 $ 18,656 $ 21,435 6.0% 2015 $ 3.0% 59.2x 12.7x 31.0x $ 1,503 610 5,078 164 5,853 2,452 $ 8,305 $ 9,808 8.0% Selected Operating Projections for Match My Doll Clothing Line Expansion ($ in thousands) Revenue Revenue Growth Production Costs Fixed Production Expense (excl depreciation) Variable Production Costs Depreciation Total Production Costs Selling, General & Administrative Total Operating Expenses Exhibit 1 2016 $ $ 875 3.0% 59.2x 12.7x 33.9x 2,946 1,786 12,983 462 15,231 4,544 $ 19,775 $ 22,721 6.0% 2016 $ 389 3.0% 59.2x 12.7x 31.0x $ 1,623 622 5,521 178 6,321 2,648 $ 8,969 $ 10,593 8.0% 2017 $ $ 928 3.0% 59.2x 12.7x 33.9x 3,123 1,822 13,833 490 16,145 4,817 $ 20,962 $ 24,084 6.0% 2017 $ 421 3.0% 59.2x 12.7x 31.0x $ 1,753 635 6,000 192 6,827 2,860 $ 9,687 $ 11,440 8.0% 2018 $ $ $ 983 3.0% 59.2x 12.7x 33.9x 3,310 1,858 14,736 520 17,113 5,106 $ 22,219 454 3.0% 59.2x 12.7x 31.0x 1,893 $ 25,529 6.0% 2018 $ 648 6,519 207 7,373 3,089 $ 10,462 $ 12,355 8.0% $ 2019 $ $ 1,043 3.0% 59.2x 12.7x 33.9x 3,509 1,895 15,694 551 18,140 5,412 $ 23,553 491 3.0% 59.2x 12.7x 31.0x 2,045 660 7,079 224 7,963 3,336 $ 11,299 $ 27,061 6.0% $ 2019 $ 13,344 8.0% 2020 -8- $ 1,105 3.0% 59.2x 12.7x 33.9x 3,719 1,933 16,712 584 19,229 5,737 $ 24,966 $ 2,209 530 3.0% 59.2x 12.7x 31.0x $ 28,685 6.0% 2020 $ $ 674 7,685 242 8,600 3,603 $ 12,203 $ 14,411 8.0% 4212
New Heritage Doll Case – Additional Information to compute cash flows – Helpful Hints I. Compute the initial outlay For Exhibit #1, use table 2:   Upfront R&D = $625 plus Upfront marketing = $625 => $1,250 Capital Expenditure => $1,470 Using the Free Cash flow equation; where operating profit is “revenues – costs – depreciation” Operating profit (1-T) + Depreciation -  net working capital - Capital expenditures _______________ = FCF So for 2010, the initial outlay is: - $1250 (1-T)+ 0 - $800 - $1,470 = ($3,020) NOTE: it is not uncommon for a project to have negative cash flows in out years (beyond year zero) II. Compute net working capital Recall: net working capital equals current assets minus current liabilities Use the working capital assumptions to compute net working capital for each year. For year 2011:  Cash =>3% of sales or revenue = $135  Account receivables: o Days sales in receivable = 365 / receivable turnover =>59.2 = 365/receivable turnover o Account receivable = Sales/ receivable turnover => $4,500/6.17 o So, Account receivable = $729  Inventory: 1  o Inventory = COGS (use total production cost)/inventory =>7.7 = $2,762/ inventory o So, Inventory = $359 Accounts payable (note: this is a liability which will be subtracted): o DPO = 365/payable turnover =>30.8 = 365/payable turnover o Payable turnover = Cost of Sales (use total operating costs minus depreciation)/ accounts payable => 11.85 = (3,917 – 152)/accounts payable o Accounts payable = $318 Net working capital = $135 + $ 729 + $359 - $318 = $905 III. Compute Change in net working capital – NOTE: the FCF equation uses “change in net working capital” o o For 2011,  net working capital => look at difference between years; so, for year 2011, the difference is between Year 2010 and Year 2011; So,  net working capital in 2011 is $905-$800 = $105 IV. Compute Terminal Cash Flows Use the following formula to compute terminal cash flows in 2020: where 2020 is the end of project TV2020 = FCF2020 (1+ g)/ (r – g) If we using the following : g = 3%; computed FCF2020= $857; and if project risk of medium is used, then r = 8.4%, then: TV2020 = $857 (1.03)/ (.084- .03) = $16.35 mil NOTE: both the TV2020 cash flow plus the FCF2020must be included in the NPV, IRR, PI, and payback period computations. Therefore, for year 2020, the total cash flow (FCF, plus TV) would be $16.35 mil + $857 or $17,202. Of course, if you use different growth rates (g) and different required returns ( r), the value will be different. 2

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Brown University





1271 Tutors

California Institute of Technology




2131 Tutors

Carnegie Mellon University




982 Tutors

Columbia University





1256 Tutors

Dartmouth University





2113 Tutors

Emory University





2279 Tutors

Harvard University





599 Tutors

Massachusetts Institute of Technology



2319 Tutors

New York University





1645 Tutors

Notre Dam University





1911 Tutors

Oklahoma University





2122 Tutors

Pennsylvania State University





932 Tutors

Princeton University





1211 Tutors

Stanford University





983 Tutors

University of California





1282 Tutors

Oxford University





123 Tutors

Yale University





2325 Tutors