New Heritage Doll Company is a firm that has ventured into doll production which has sought to extend its brand in order to broaden its market framework and more importantly capitalize on high levels of customer loyalty. The vice president of the Company, Emily Harris, is to forward her project proposal to the Budgeting Committee for evaluation. The Vice-president’s objective for proposing the project was based on potential to strengthen the Company’s division of production and drive future growth. Emily Harris has to produce a compelling project to avoid the committee from declining the proposal.
Basis of Assessment
There are two projects between which the company can choose from or drop the proposals in their entirety. The methods of project evaluation would be based on discounting cash flows analysis and thereafter determining the Net Present Value (NPV) of each of the proposed project with Internal Rate of Return (IRR), Profitability Index and Payback Period. If the project has a positive NPV, it would suggests the project is generating more cash than is required to service the debt and provide the appropriate returns; thus, the higher NPV, the better it is for the company. The project proposal with the positive and highest NPV, IRR and profitability index along with the shortest payback period would be acceptable for investment. New Heritage Doll Company managed to produce a capital budgeting structure in order to evaluate the revenue generated in the Doll industry. It is clearly evident that a segment of the Doll industry generates income progressively with an increasing rate of 4.6%. Cash flows forecast is used to capture the incremental effect of a proposed project in order to acknowledge the breakeven point and profit or loss time frame.
If the company continues with its investment in the toy and game segment, it is going to experience the economies of scale and have high operating profits. However, for a company to embrace another project proposal, it has to evaluate its financial capacity to fund the project. Thus, any project which does not generate significant revenue, the company must cultivate the capital rationing. Similarly, the company must consider some factors in the assessment of project’s risk, such as whether the project product’s required new traders or consumers who are willing to accept the goods or services rendered by the company; where the project proposal requires high level of the fixed costs, the project to be appraised is at very high risk considering such costs do not generate high returns; sensitivity of the selling price of the finished goods, and high level of breakeven production volumes. The prudent way to evaluate the company’s feasibility whether or not to invest on a new venture is by analyzing the returns or the operating profits. If the firm’s expects to experience some losses, it should reject the proposal. However, if the firm is operating at a breakeven point, the company may have the option to forecast whether it is an on-going concern.
The Heritage Doll Company is appraising two proposed projects, Match My Doll Clothing and Design Your Own Doll. Emily Harris, vice president of the company’s production division must have compelling reasons to influence the budgeting department to accept the project for implementation. The theoretical reasons behind Match My Doll Clothing to be implemented by the company budgeting committee is that the products produced fully match all seasonal clothing for the young girls and their preferred doll; the popularity of the company’s product; and it is the best time for expansion due to its popularity. The reasons for choosing Design Your Own Doll is that the company’s products would have high correlation with the consumers; the company’s doll can be customized based on the tastes and preferences of the consumers; permanent customer loyalty; dolls demand a strong selling probability; and the company’s potential to strengthen its future growth.
However, the company is also limited to take this project due to several constrains including: low production runs and volumes, limited gradation of customization increased manufacturing complication; increase in production and development costs for the technology modification and infrastructure. One of the key distinctions between the two projects is that Design Your Own Doll and Match My Doll Clothing are two mutually exclusive projects. Their cash flows are related and have the same function and they compete with each other meaning that the acceptance of one project eliminates consideration of the other project.
DCF and Sensitivity Analysis
The Company should maximize on cash management by capital rationing on the project accepted. NPV of the project should be implemented as it reflects the time value of money invested in the accepted project. Similarly this can be further elaborated by computation of IRR of both project proposal. The analysis was performed by comparing the two projects using the same fixed terminal growth rate of 3% because both projects include a terminal growth rate element. For both projects, it would also be beneficial to know how the terminal growth rate value is generated. Because the “medium”- risk projects in the production division received a discount rate of 8.4% in 2010, this rate was used for the Match My Doll Clothing line’s DCF analysis. Design Your Own Doll project is long-term project and it is considered to have a higher risk; thus, the rate of 9.00% was used in the analysis. The results of the analysis are presented below.
Design Your Own Doll Match My Doll Clothing
NPV = $7,310.21
The NPV is positive – the project is feasible.
NPV = $7,139.18
The NPV is positive – the project is feasible.
Profitability Index = 1.26
Profitability Index = 2.03
Payback Period = 9.3 years
Payback Period = 9.2 year
From the Working Capital requirements assumptions, Design Your Own Doll requires a higher amount of working capital than Match My Doll Clothing; however, the results of the analysis of the Operating Profit show that Design Your Own Doll line would generate a higher operating profit than that of the Match My Doll Clothing line. Also, Design Your Own Doll generates higher cash flows compared to the Match My Doll Clothing and this is another argument for choosing Design Your Own Doll for its investment. From the NPV method standpoint, the NPV rule chooses a project in terms of net dollars or net financial impact on the company; thus, it can be easier to use when allocating capital. Also, NPV method requires an assumed discount rate and also assumes that this percentage rate will be stable over the life of the project. In the real world, this assumption does not always work because the interest rates are fluctuating.
From the analysis, both of the projects are feasible but Design Your Own Doll has the higher NPV than the Match My Doll Clothing line. IRR method doesn’t assume a discount rate and the worthiness of the investment is purely a function of the internal inflows and outflows of that particular investment. However, IRR does not assess the financial impact on a firm; it only requires meeting a minimum return rate. The internal rate of return is the most critical method to determine the decision option for accepting the project proposal. Also, the highest operating rate of returns with the shortest payback period of the cost of capital is opted to be accepted.
From the analysis, Match My Doll Clothing line has the higher IRR than the Design Your Own Doll line. In conclusion, even though both projects are feasible and Design Your Own Doll has the higher NPV, Match My Doll Clothing line project has a higher IRR, profitability index and a shorter payback period. Thus, the budgeting committee should accept Match My Doll Clothing line instead of Design Your Own Doll since Match My Doll Clothing line has the higher IRR, profitability and the shortest payback period. The NPV of both proposals are not significantly different.