Capital Budgeting Decisions for New Heritage Doll Company (Math Problem Sample)

CAPITAL BUDGETING DECISIONS FOR NEW HERITAGE DOLL COMPANY
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Introduction
Firms are always operating with economic resources and thus they always have to maximize their operations considering a budget constraint that characterises these resources. Consequently, they are forced to make decisions on projects they should finance (Lerner, 1968). This is the case that faces New Heritage Doll Company, where it has to make a decision to invest. Thus, they would invest on projects that will give them maximum returns.
NPV of the projects and their value
Following the Net present value (NPV) method, a project that is said to create more value to a firm, is one with a positive NPV (Messner, 2013). The method makes use of discounted cash flows, since it recognises that a shilling today is not the same as a shilling in the Nth year. As such, inflows and outflows are compared at their present value. One with high positive NPV are invested on as they have high capital gains to the firm. Projects with negative NPV are not considered since they do not create value but instead leads to losses. Therefore, between the two options, matching my doll line expansion is expected to create more value to the firm as recorded by the positive inflows which are higher than the outflows leading to a high positive NPV.
Project evaluation assumptions
The NPV method is founded on a number of assumptions. There are two major assumptions to this method. First, it assumes that money generated from the project is immediately re-invested and generates a return equal to the firm rate of return. Second, it assumes that apart from the initial investment, other inflows and outflows occur at the end of each period (Messner, 2013). Among the two assumptions, the first assumption is open to critical challenge. This is because some of the inflows and outflows used in determination of NPV are non-cash in nature. In addition, due to economic uncertainties, macro-economic factors may affect business and thus making it hard to realise a return equal to the discount rate projected. If this happens, the actual results could be lower which could result to a negative NPV. Consequently, negative returns for the company in the long-run.
Fund sourcing and project recommendation
Firms have options to make use of internally generated funds as well as externally generated funds. For the case of Heritage Doll Company, external funding has not been preferred and thus their investments have to be prioritised based on high returns to the firm. Employing the NPV method, projects with a positive NPV should be selected (NPV ≥0). Thus ventures are ranked from those with the highest NPV to those with lowest. This is because those with the highest NPV have high capital gains to the firm. Thus from the analysis, the first project for matching my Doll cloth line expansion is recommended as it has a high positive NPV compared to design your own doll project.
Factors to consider in investment decisions
The firm has considered a number of factors including the marketing strategies, target market, competition, market positioning, research, finances available, discounts available, seasonality, market risk, and product design and development. There are also other factors that the firm should consider to ensure they are able to move their product. First, they should consider legal and political factors like consumer’s rights, tax policies, trade regulations, political stability at the time of development to ensure their project is sustainable, and government policies. In addition, they should consider technological innovations that have been advanced in the doll industry to keep up with the developments. Finally, they should consider different environmental policies to ensure their product is made from environmentally friendly materials.
Year No.

0

1

2

3

4

5

6

7

8

9

10

Year

2010

2011

2012

2013

2014

2015

2016

2017

2018

2019

2020

Pre-tax inflows (EBT)

(1250)

583

994

1277

1392

1503

1623

1753

1893

2045

2209

Tax at 40%

500

233.2

397.6

510.8

556.8

601.2

549.2

701.2

757.2

818

883.6

Net income

-750

349.8

596.4

766.2

835.2

901.8

1073.8

1051.8

1135.8

1227

1325.4













Cash flow from operations:












Revenue

0

4500

6860

8409

9082

9808

10593

11440

12355

13344

14411

Less operating cost

-1250

3917

5866

7132

7690

8305

8969

9687

40462

11299

12203

Add depreciation

0

152

152

152

152

164

178

192

207

224

242

Less tax

500

233.2

397.6

510.8

556.8

601.2

549.2

701.2

757.2

818

883.6

Total operating cash flow

-750

501.8

748.4

918.2

987.2

1065.8

1251.8

1243.8

1342.8

1451

1567.4













Working capital (3% of sales)
Receivables
Inventory
Payables
NWC

0
800

135
729.86
358.70
330.53
893.03

205.8
1112.63
497.71
496.60
1319.55

252.27
1363.87
395.98
605.73
1406.39

272.46
1473.03
426.69
653.12
1519.05

294.24
1590.78
460.87
705.36
1640.52

317.79
1718.1
497.72
761.76
1771.85

343.2
1855.5
537.56
822.73
1913.5

370.65
2003.9
580.55
888.55
2066.5

400.32
2164.3
627
959.6
2231.9

432.33
2337.35
677.17
1036.42
2410.42

Less change in NWC

800

93.03

426.51

86.85

112.66

121.47

131.33

141.65

153.03

165.45

178.44

Less Capital expenditure

1470

952

152

152

334

361

389

421

454