The Business of D & D laundry Products Company - Case Study Example

CASE STUDY- DANFORTH & DONNALLEY LAUNDRY PRODUCTS COMPANY Answer Rainey, who was the vice-president in charge of new products in D & D laundry Products Company, presented the cost and cash flow analysis for the new product, Blast in front of the board for acceptance. He presented two copies of cash flow statements namely, Exhibit 1 and Exhibit 2 to make things clear for the members present in the meeting. It was proposed in the project that the initial outlay of the project will include $500,000 for a marketing test and $2,000,000 for new equipments and packaging facilities which are essential for the new product. The estimated life was 15 years, without any salvage value for the above mentioned facilities. There are already two existing detergent products available in the market from D & D Company namely, Lift-off and Wave. With the new product launch, the sales of the existing products are bound to get diverted which is shown in the two exhibits 1 & 2. Since the estimated life of the facilities was 15 years, the projected cash flows are also given for 15 years. The opportunity cost of funds is given as 10% for the proposed project by Rainey. To answer whether it is feasible to include the cost of market testing into the initial outflow of the proposed project for its acceptance, we need to analyse the project in terms of present value. We analyse the future prospects of the proposed projects at present in terms of time value of money and the investment appraisal conditions. The present values of the projected cash flows are calculated and shown in the following table. (Young, 2007, pp.49-50) Cash Flow Present Cash Flow Present Years (Exhibit 1) Value (Exhibit 1) Value ($ 000) ($ 000) ($ 000) ($ 000) 1 280 254.54 250 227.27 2 280 231.41 250 206.61 3 280 210.37 250 187.83 4 280 191.24 250 170.75 5 280 173.86 250 155.23 6 350 197.57 315 177.81 7 350 179.61 315 161.64 8 350 163.28 315 146.95 9 350 148.43 315 133.59 10 350 134.94 315 121.45 11 250 87.62 225 78.86 12 250 79.66 25 71.69 13 250 72.42 225 65.18 14 250 65.83 225 59.25 15 250 59.85 225 53.86 2250.63 2017.97 From the above table we can see that the total sums of the present values of future cash flows are $ 2,250,630 and $ 2,017,970 for Exhibit 1 and Exhibit 2 respectively with respect to the given opportunity cost of funds. For the project appraisal we use the discounted method and calculate the net present values (NPV) from both the Exhibits. The discounted methods take into account the time value of money and all the cash flows occurring during the entire life of the project. It means cash flows are discounted by using cost of capital as minimum discounting rate and all the benefits and costs occurring during the entire life of the project are considered. The NPV of a project is equal to the sum of the present value of all the cash flows associated with it. It means, NPV is equal to the difference between the present value of future cash inflows and the present cash outflow. If the NPV of the proposed project is positive it is accepted, else it is rejected. So, the calculated NPV for both Exhibits is negative if the cost of marketing test is included in the present cash outflow but if cost of market testing is omitted from the outflow then the NPV becomes positive. Since, the condition of acceptance of a project requires it’s NPV to be positive, we suggest the exclusion of the marketing cost from the initial cash outflow. (Helfert, 2001, pp.237-245); (Atrill and McLaney. 2006); (Dayananda, 2002, p.80). Answer 2 The question is whether the product is charged for the use of excess production facilities and buildings, for that we have to analyse the data given by the Vice-President in charge of new products, Rainey in terms of capacity utilization of the plant. The success of a project depends on the effective resource allocation and full utilization of plant capacity. The concept of capacity utilization refers to the installed capacity of production that can be used to the maximum extent by an enterprise. It shows the relationship between the actual output which is produced and the potential output which could have been produced if the plant capacity is fully utilized. The effective capacity utilization of a plant comprises of the proper utilization of the factors of production. As stated in the case study, according to Rainey, the existing product Lift-off utilizes only 55% of the plant capacity and hence, they have another 45% of plant capacity left to be utilized. According to the Vice-President in charge of new products, Rainey, the new product line will require only 10% of plant capacity for its full production other than the new specialized equipments and packaging facilities. Although there is an increase in working capital of $ 200,000 for the production of the new product, Blast but the money will be with the firm for ever in liquid form and hence, it is not included in the calculations and not treated as cash outflow. From the argument of Donnalley it is known that if the unutilized space of the plant is rented to other firms for their production then that would have fetched lease rent of $ 2,000,000, which can be treated as an inflow to the firm but there is no information about the cost of doing the production of new product line outside the plant. He also acknowledged the fact that D&D follows a strict policy of not renting their production facilities to outsiders. (Tinnirello, 2002, p.466); (Capacity Utilization, Tenrox, n.d) So, from the analysis point of view, it can be said that the capacity of plant is under utilized for the existing product lines and it has enough scope of utilization for the new product line, Blast. Hence, there should be any charge on the new product for the use of excess production facilities and buildings. As the production of new product, Blast will require only mere 10% capacity utilization; there is no need to charge it for any excess use of plant capacity. There is no need to treat the new project as an outsider if the existing products are not utilizing the full capacity of the plant and there is enough scope of full production of the new product, Blast in the same plant. Hence, it is suggested that the production of the new product, Blast should be done inside the same plant where the production of existing product Lift-off is going on. (Turner, 2009, pp. 47-49); (Cerrato, 2001, pp. 49-50) Answer 3 The question is to suggest whether the cash flows resulting from erosions of sales from current laundry detergent should be included as the cash inflow or not. In the given data in the case study, Exhibit 1 is showing the projected cash inflows for the estimated life of 15 years if the cash flows from sales diversion of the existing product lines are included but in Exhibit 2 we see the projected cash inflows if the same is excluded. From the above table, it is clearly seen that the sum of present values of the projected future cash flows is high in Exhibit 1 among the two Exhibits. The present values of the future projected cash flows are calculated on the basis of the given opportunity cost of funds. This indicates that the NPV is higher, if the cash flows from sales diversion of the existing product lines are included as the cash inflows. Higher NPV indicates better future for the proposed project. Thus, it is suggested that the cash flows resulting from erosions of sales from the existing detergent products should be included as a cash inflow. (Ross, Westerfield, Jaffe, 2004, p.179) If there is chance of competition of introduction of a new substitute product in the market in that case Blast should be definitely introduced. This is because, if a new similar product is introduced in the market by some other company then that product will absorb the cash flows from diversion of sales from current existing products of D&D Company. Hence, D&D will face the loss of cash inflows. To overcome this phenomenon, D&D should introduce the new product, Blast to grab the market of the laundry detergent. This is due to the rivalry and competition in the industry and to cope up with that every firm had to introduce new advanced products to grab the market share. However, this fact does not effect the above proposition which says that the cash flows resulting from erosions of sales from the existing detergent products should be included as a cash inflow. This is because; the suggestion is given on the support of introduction of the new detergent product, Blast in the market. Hence, no substitute products introduction can hamper the cash inflows as projected in Exhibit 1. (Cleland and Ireland, 2006, pp.104-105) From an overall point of view it can be said that introduction of the new proposed project will be beneficiary for Danforth and Donnalley Laundry Product Company, and hence the project should be accepted for the future prospect of the firm. References 1. Tinnirello.P.C, (2002), Capacity Utilization, New directions in project management, Florida: CRC Press 2. Turner.J.R, (2009), Project success and strategy, The handbook of project-based management, New York: McGraw Hill Professional 3. Cerrato.C, (2001), Competition Analysis, Model for the evaluation of project funding in emerging markets, New York: Universal Publishers 4. Young. T.L, (2007), The result of effective selection, The handbook of Project Management: a practical guide to effective policies, London: Kogan Page Publishers 5. ‘Capacity Utilization’, (n.d), Tenrox Project Management Software & Workforce Management solutions. Available at: http://glossary.tenrox.com/Capacity-Utilization.htm (accessed on December 24, 2009) 6. Helfert, E.A, (2001), Financial Analysis: tools and techniques: a guide for managers, New York: McGraw Hill Professional 7. Atrill P. and McLaney E. (2006), Analysing and interpreting financial statements, Accounting and Finance for Non-Specialists, fifth edition, London: Prentice Hall 8. Ross.A.S, Westerfield .R, Jaffe.J, (2004), Opportunity cost, Corporate Finance, New York: Tata McGraw Hill 9. Dayananda. D, (2002), Present value of a series of cash flows, Capital Budgeting: financial appraisal of investment projects, Cambridge: Cambridge University Press 10. Cleland.D.I, Ireland.L.R, (2006), Implication of technology, Project management: strategic design and implementation, New York: McGraw-Hill Professional Read More