New Heritage Doll Company: Capital Budgeting

Teaching Note
TN Exhibit 1 NPV Analysis for Match My Doll Clothing Line Extension

2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020
Revenue 4,500 6,860 8,409 9,082 9,808 10,593 11,440 12,355 13,344 14,411
Revenue Growth NA 52.4% 22.6% 8.0% 8.0% 8.0% 8.0% 8.0% 8.0% 8.0%
Production Costs
Fixed Production Expense (excl depreciation) 575 575 587 598 610 622 635 648 660 674
Variable Production Costs 2,035 3,404 4,291 4,669 5,078 5,521 6,000 6,519 7,079 7,685
Depreciation 152 152 152 152 164 178 192 207 224 242
Total Production Costs 0 2,762 4,131 5,029 5,419 5,853 6,321 6,827 7,373 7,963 8,600
Selling, General & Administrative 1,250 1,155 1,735 2,102 2,270 2,452 2,648 2,860 3,089 3,336 3,603
Total Operating Expenses 1,250 3,917 5,866 7,132 7,690 8,305 8,969 9,687 10,462 11,299 12,203

Operating Profit (1,250) 583 994 1,277 1,392 1,503 1,623 1,753 1,893 2,045 2,209
Operating Profit/Sales 0.130 0.145 0.152 0.153 0.153 0.153 0.153 0.153 0.153 0.153
SG&A/Sales 0.257 0.253 0.250 0.250 0.250 0.250 0.250 0.250 0.250 0.250

Working Capital Assumptions:

Minimum Cash Balance as % of Sales NA 3.0% 3.0% 3.0% 3.0% 3.0% 3.0% 3.0% 3.0% 3.0% 3.0%
Days Sales Outstanding NA 59.2x 59.2x 59.2x 59.2x 59.2x 59.2x 59.2x 59.2x 59.2x 59.2x
Inventory Turnover (prod. cost/ending inv.) NA 7.7x 8.3x 12.7x 12.7x 12.7x 12.7x 12.7x 12.7x 12.7x 12.7x
Days Payable Outstanding (based on tot. op. exp.) 0.0x 30.8x 30.9x 31.0x 31.0x 31.0x 31.0x 31.0x 31.0x 31.0x 31.0x

Capital Expenditures 1,470 952 152 152 334 361 389 421 454 491 530
Growth in capex -35.2% -84.0% 0.0% 119.3% 8.0% 8.0% 8.0% 8.0% 8.0% 8.0%

Net Working Capital Accounts 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020
Cash 135 206 252 272 294 318 343 371 400 432
Accounts Receivable 729 1112 1363 1472 1590 1717 1855 2003 2163 2336
Inventory 360 500 396 427 461 498 538 581 627 677
Accounts Payable 317 484 593 640 692 747 807 871 941 1016
Net Working Capital 800 907 1334 1418 1531 1653 1786 1929 2083 2250 2429
DNWC 107 427 84 113 122 132 143 154 167 180
NWC/Sales 0.202 0.195 0.169 0.169 0.169 0.169 0.169 0.169 0.169 0.169

NPV Analysis

Free Cash Flows 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020
EBIT(1-t) (750) 350 596 766 835 902 974 1,052 1,136 1,227 1,325
plus depreciation 0 152 152 152 152 164 178 192 207 224 242
less DNWC (107) (427) (84) (113) (122) (132) (143) (154) (167) (180)
less capital expenditures (952) (152) (152) (334) (361) (389) (421) (454) (491) (530)
Free Cash Flow (750) (557) 169 682 541 583 630 680 735 793 857
Terminal value 3.00% 16,345

Initial Outlays
Net working capital (800)
Net property, plant & equipment (1470)

Discount factor 8.40% 1.0000 0.9225 0.8510 0.7851 0.7242 0.6681 0.6163 0.5686 0.5245 0.4839 0.4464
Present value (3,020) (514) 144 536 392 390 388 387 385 384 7679
Net Present Value $ 7,150
NPV without Terminal Value $ (146)

IRR Analysis
2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020
Cash Flows (3,020) (557) 169 682 541 583 630 680 735 793 17,202
IRR 24.0%

Payback Analysis
2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020
Cash flows (3,020) (557) 169 682 541 583 630 680 735 793 17,202
Cumulative cash flow (3,020) (3,577) (3,408) (2,726) (2,185) (1,602) (972) (291) 443
Payback period 7.40 years

5-year Cumulative EBITDA $ 6,522

Profitability Index
NPV/Initial Investment 2.37

Sensitivity Analysis
1% 1.5% 2% 2.5% 3% 3.5% 4% 4.5% 5%
Free Cash Flows (3,020) (557) 169 682 541 583 630 680 735 793 857 11,696 12,606 13,657 14,888 16,345 18,101 20,255 22,962 26,464

Change in discount factor

Discount Factor 7% 7.50% 8% 8.40% 9% 9.50% 10% 10.50% 11%

8,439.72 7,958.93 7,500.91 7,150.07 6,648.43 6,251.79 5,873.51 5,512.67 5,168.36

Terminal Value Growth Rat 1% 1.5% 2% 2.5% 3% 3.5% 4% 4.5% 5%

5,074.72 5,480.77 5,950.26 6,499.33 7,150.07 7,933.62 8,895.25 ### ###
New Heritage Doll Company: Capital Budgeting
Teaching Note
TN Exhibit 2 NPV Analyss for Design Your Own Doll

2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020
Revenue 0 6,000 14,360 20,222 21,435 22,721 24,084 25,529 27,061 28,685
Revenue Growth NA 139.3% 40.8% 6.0% 6.0% 6.0% 6.0% 6.0% 6.0%
Production Costs
Fixed Production Expense (excl depreciation) 0 1,650 1,683 1,717 1,751 1,786 1,822 1,858 1,895 1,933
Additional development costs (IT personnel) 435
Variable Production Costs 0 2,250 7,651 11,427 12,182 12,983 13,833 14,736 15,694 16,712
Depreciation 0 310 310 310 436 462 490 520 551 584
Total Production Costs 0 435 4,210 9,644 13,454 14,369 15,231 16,145 17,113 18,140 19,229
Selling, General & Administrative 1,201 0 1,240 2,922 4,044 4,287 4,544 4,817 5,106 5,412 5,737
Total Operating Expenses 1,201 435 5,450 12,566 17,498 18,656 19,775 20,962 22,219 23,553 24,966

Operating Profit (1,201) (435) 550 1,794 2,724 2,779 2,946 3,123 3,310 3,508 3,719
Operating Profit/Sales 0.092 0.125 0.135 0.130 0.130 0.130 0.130 0.130 0.130
SG&A/Sales 0.207 0.203 0.200 0.200 0.200 0.200 0.200 0.200 0.200

Working Capital Assumptions:

Minimum Cash Balance as % of Sales NA NA 3.0% 3.0% 3.0% 3.0% 3.0% 3.0% 3.0% 3.0% 3.0%
Days Sales Outstanding NA NA 59.2x 59.2x 59.2x 59.2x 59.2x 59.2x 59.2x 59.2x 59.2x
Inventory Turnover (prod. cost/ending inv.) NA NA 12.2x 12.3x 12.6x 12.7x 12.7x 12.7x 12.7x 12.7x 12.7x
Days Payable Outstanding (based on tot. op. exp.) NA NA 33.7x 33.8x 33.9x 33.9x 33.9x 33.9x 33.9x 33.9x 33.9x

Capital Expenditures 4,610 0 310 310 2,192 826 875 928 983 1,043 1,105
Growth in capex 0% 608% -62% 6% 6% 6% 6% 6%

Net Working Capital Accounts 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020
Cash 0 180 431 607 643 682 723 766 812 861
Accounts Receivable 973 2328 3278 3475 3683 3904 4139 4387 4650
Inventory 346 786 1065 1130 1197 1269 1345 1426 1512
Accounts Payable 474 1135 1598 1694 1796 1904 2018 2139 2267
Net Working Capital 1,000 1,024 2,410 3,352 3,553 3,766 3,992 4,232 4,486 4,755
DNWC 1,000 24 1,386 942 202 213 226 240 254 269
NWC/Sales 0.171 0.168 0.166 0.166 0.166 0.166 0.166 0.166 0.166

NPV Analysis
2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020
Free Cash Flows
EBIT(1-t) (721) (261) 330 1,077 1,634 1,667 1,767 1,874 1,986 2,105 2,231
plus depreciation 0 310 310 310 436 462 490 520 551 584
less DNWC (1,000) (24) (1,386) (942) (202) (213) (226) (240) (254) (269)
less capital expenditures (4,610) 0 (310) (310) (2,192) (826) (875) (928) (983) (1,043) (1,105)
Free Cash Flow (5,331) (1,261) 306 (309) (1,190) 1,076 1,141 1,210 1,283 1,359 1,441
Terminal value 3.00% 24,737

Discount factor 9.00% 1.000 0.9174 0.8417 0.7722 0.7084 0.6499 0.5963 0.5470 0.5019 0.4604 0.4224
Present value (5,331) (1,157) 258 (239) (843) 700 681 662 644 626 11,058
Net Present Value $ 7,058
NPV without Terminal Value $ (3,391)

IRR Analysis
2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020
Cash Flows (5,331) (1,261) 306 (309) (1,190) 1,076 1,141 1,210 1,283 1,359 26,178
IRR 17.9%

Payback Analysis
2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020
Cash flows (5,331) (1,261) 306 (309) (1,190) 1,076 1,141 1,210 1,283 1,359 26,178
Cumulative cash flow (5,331) (6,592) (6,286) (6,595) (7,784) (6,708) (5,566) (4,357) (3,074) (1,715) 24,464
Payback period >10 years

5-year Cumulative EBITDA $ 8,778

Profitability Index
NPV/Initial Investment 1.32

Sensitivity Analysis

Free Cash Flows (5,331) (1,261) 306 (309) (1,190) 1,076 1,141 1,210 1,283 1,359 1,441.00 1% 18,193
1.50% 19,502
Change in discount factor 2% 20,997
2.50% 22,724
Discount Factor 7% 7.50% 8% 8.50% 9% 9.50% 10% 10.50% 11% 3% 24,737
9,672.30 8,968.85 8,299.72 7,663.08 7,057.21 6,480.49 5,931.41 5,408.51 4,910.44 3.50% 27,117
4% 29,973
Terminal Value Growth Rat 1% 1.5% 2% 2.5% 3% 3.5% 4% 4.5% 5% 4.50% 33,463
₹ 4,292.72 ### ### ### ### ₹ 8,062.48 ₹ 9,268.80 ### ### 5% 37,826
The Match My Doll Clothing Line project involves expanding the existing successful clothing line, which consists of a few se
there is a consideration to expand it to include an all-season clothing line. Since it is an expansion to the existing produc
based on historical information. It was found that this project was already tested and is widely popular, bringing in the s
working of the project and the company has the experience with this part of a project. Lastly, MMDC would help redu
However, due to the fickle nature of young children’s fashion sense, the new line had to be launched quickly. MMDC was a
for New Heritage.

The Design Your Own Doll project involves creation of new customized dolls to the customer’s specification. This project w
company will have to consider manufacturing this made-to-order product line in-house or outsource it to contract manuf
product cost is expected to be high. Market research indicated that there was a lot of enthusiasm for this project among a
was a novel concept and the sales could be from potential and existing customers. Not to mention, it serves well for the c
information technology aspect is a risky proposition as the company would be in unknown territory and it would require a
as otherwise it would end up damaging New Heritage’s reputation and relationships with its best customers.

Without taking the financial analysis into consideration, we believe the Design Your Own Doll project to be more compellin
stay in line to their values, industry trends, and the ever-changing technology aspect. This company’s founder saw that the
self-image, so she created a line of dolls with unique storyline and wholesome themes. DYOD continues to follow their core
surrounding realistic body images or types. We find that the Match My Doll Clothing Line fails to follow this same route as D
fashion, rather than just being themselves.
We recommend that Harris chooses the Design Your Own Doll Project. This is due to the project being more sustainable in the
company's core customers.