New Heritage Doll

1375 Words Oct 9th, 2014 6 Pages
New Heritage Doll
1. Compute the Free Cash Flows for the years 2010 to 2020 for both projects
See excel File attached.
Assumptions:
* 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
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The terminal value makes up a significant a part of the NPV (without it, the NPV of both projects would actually be negative).
Although we do not think the terminal value should be ignored, we should however be aware that it is prone to error.
It could also change our decision to go for one or the other project, especially if the NPV values are close to one another.
b. Discount factor
The discount factor has a big impact on the NPV analysis, especially for projects with a long time frame. This means that small estimation errors in the discount factor could possibly have big effects on the NPV. Since the NPV for the two potential projects are quite close, a small estimation error in discount factor might lead to wrong business decision.
6. Assume the two projects also compete with projects from other divisions for a limited amount of capital. Which investment criterion would you use to communicate the projects to the capital budgeting committee? Explain why. Which project (MMDC or DYOD) is preferable based on this criterion.
We would use the profitability index to communicate the projects to the committee.
This index allows us to compare our projects with those of other divisions based on how efficiently they use the limited amount of capital available.
We calculated the PI index for both projects using the formula PI = NPV (incl. initial investment) / initial investment. For initial investment, we used the initial cash outflow (including

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