Answer the Following Questions based on the spreadsheet attached:

Part 6: The operating projections for each project to compute the NPV for each. Which project creates more value?

Part 7: Calculate the profitability index (PI) for each project. Which would you recommend based on the PI?

Part 8: What is the relationship between the NPV and the profitability index? Will they lead to the same conclusion? Why or why not?

Part 9: Compute the IRR for each project. Which project should be chosen based on IRR?

Part 10: What is the relationship between IRR, PI, and NPV? Will they lead to the same acceptance or rejection of the decision? Will they lead to the same ranking of projects? Why or why not?

Part 11: Compute the payback period for each project.

Part 12: What are the major drawbacks and advantages to using the payback period in decision making?

Part 13: What effect does the terminal value have on NPV and IRR? Would omitting or changing the terminal value change your decision?

Part 14: What additional information does Emily Harris need to complete her analyses and to compare the two projects? What specific questions should she ask each of the project sponsors?

Part 15: If Harris is forced to recommend one project over the other, which should she recommend? Why?

Match My Doll Clothing Line 2010 Revenue Revenue Growth Production Costs: Fixed Production Expenses (exclucing depreciation) Variable Produciton Costs Depreciaiton Total Production Costs Selling, General, and Admin. Expense Total Operating Expenses 2011 $ 2012 4,500 $ NA ` 6,860 $ 52.44% 2014 8,409 $ 22.58% 2015 2016 2017 2018 2019 2020 9,082 $ 8.00% 9,808 $ 7.99% 10,593 $ 8.00% 11,440 $ 8.00% 12,355 $ 8.00% 13,344 $ 8.00% 14,411 8.00% 575 -1201 575 587 598 610 2035 152 2,762 1155 3,917 1201 Operating Profit Operating Profit/Sales SG&A/Sales 2013 3404 152 4,131 1735 5,866 4291 152 5,030 2102 7,132 4669 152 5,419 2270 7,689 5078 164 5,852 2452 8,304 6,321 2648 674 6519 207 6,827 2860 8,969 660 9,687 7079 224 7685 242 7,374 3089 10,463 7,963 3336 11,299 8,601 3603 12,204 1,277 $ 15.19% 25.00% 1,393 $ 15.34% 24.99% 1,504 $ 15.33% 25.00% 1,624 $ 15.33% 25.00% 1,753 $ 15.32% 25.00% 1,892 $ 15.31% 25.00% 2,045 $ 15.33% 25.00% 2,207 15.31% 25.00% 3% 3% 59.2 x 7.7x 30.8x 3% 59.2 x 8.3x 30.9x 3% 59.2 x 12.7x 31.0x 3% 59.2 x 12.7x 31.0x 3% 59.2 x 12.7x 31.0x 3% 59.2 x 12.7x 31.0x 3% 59.2 x 12.7x 31.0x 3% 59.2 x 12.7x 31.0x 3% 59.2 x 12.7x 31.0x 3% 59.2 x 12.7x 31.0x Capital Expenditure Growth in Capex 1470 952 -35.24% 152 -84.03% 152 0.00% 334 119.74% 361 8.08% 389 7.76% 421 8.23% 454 7.84% 491 8.15% 530 7.94% Net Working Capital Accounts Cash Accounts Receivable Inventory Accounts Payable Net Working Capital Accounts Change in Net working Capital NWC/Sales 2010 2011 135 729 360 317 907 107 2012 206 1112 500 484 1334 428 2013 252 1363 396 593 1418 84 2014 272 1472 427 640 1531 113 2015 294 1590 461 692 1653 123 2016 318 1717 498 747 1786 133 2017 343 1855 538 807 1929 143 2018 371 2003 581 871 2084 154 2019 400 2163 627 941 2249 165 2020 432 2336 677 1016 2429 180 Free Cash Flows EBIT (1-t) plus depreciation less change in working capital less capital expenditures Free Cash Flow Terminal Value (3%) 2020 only 2010 -750 0 2011 350 152 -107 -952 -557 2012 596 152 -427 -152 169 2013 766 152 -84 -152 682 2014 835 152 -113 -334 541 2015 902 164 -122 -361 583 2016 974 178 -132 -389 630 2017 1052 192 -143 -421 680 2018 1136 207 -154 -454 735 2019 1227 224 -167 -491 793 2020 1325 242 -180 -530 857 16345 0.922509 -514 0.851023 144 0.785077 535 0.724241 392 0.668119 390 0.616346 388 0.568585 387 0.524524 386 0.483879 384 0.446383 7679 -750 Initial Outlays Net Working Capital Net property Plant and Equipment Discount factor 994 $ 6000 192 648 14.49% 25.29% 800 583 $ 5521 178 635 12.96% 25.67% Working Capital Assumptions: Minimum Cash Balance as % of Sales DaysSales Outstanding inventory Turnover (production cost/ending inventory ) Days Payable Outstanding (based on total operating expenses) $ 622 -800 -1470 8.40% 1 -3020 PV Cash Inflows NPV NPV without Terminal Value $7,150 ($146) IRR Analysis Cash Flows IRR -3020 24.00% -557 169 682 541 583 630 680 735 793 17202 Payback Analysis Cash Flows Cumalitive Cash Flow -3020 -3020 -557 -3577 169 -3408 682 -2726 541 -2185 583 -1602 630 -972 680 -292 735 443 793 17202 Payback Period 5 year Cumalitive EBITDA Profitability Index 2.37 6522 Design Your Own Doll 2010 Revenue Revenue Growth Production Costs: Fixed Production Expenses (exclucing depreciation) Variable Produciton Costs Depreciaiton Total Production Costs Selling, General, and Admin. Expense Total Operating Expenses 2011 2012 $ 2013 6,000 $ 1,201 1,201 (1,201) Operating Profit Operating Profit/Sales SG&A/Sales - 1,650 2250 310 4,210 1,240 5,450 - 550 9.17% 20.67% Working Capital Assumptions: Minimum Cash Balance as % of Sales DaysSales Outstanding inventory Turnover (production cost/ending inventory ) Days Payable Outstanding (based on total operating expenses) 14,360 $ 139.33% 2014 2015 2016 2017 2018 2019 2020 20,222 $ 40.82% 21,435 $ 6.00% 22,721 $ 6.00% 24,084 $ 6.00% 25,529 $ 6.00% 27,061 $ 6.00% 28,685 6.00% 1,683 7651 310 9,644 2,922 12,566 1,717 11427 310 13,454 4,044 17,498 1,751 12182 436 14,369 4,287 18,656 1,786 12983 462 15,231 4,544 19,775 1,822 13833 490 16,145 4,817 20,962 1,858 14736 520 17,114 5,106 22,220 1,895 15694 551 18,140 5,412 23,552 1,933 16712 584 19,229 5,737 24,966 1,794 12.49% 20.35% 2,724 13.47% 20.00% 2,779 12.96% 20.00% 2,946 12.97% 20.00% 3,122 12.96% 20.00% 3,309 12.96% 20.00% 3,509 12.97% 20.00% 3,719 12.96% 20.00% NA NA NA NA NA NA NA NA 3% 59.2x 12.2x 33.7x 3% 59.2x 12.3x 33.8x 3% 59.2x 12.6x 33.9x 3% 59.2x 12.7x 33.9x 3% 59.2x 12.7x 33.9x 3% 59.2x 12.7x 33.9x 3% 59.2x 12.7x 33.9x 3% 59.2x 12.7x 33.9x 3% 59.2x 12.7x 33.9x Capital Expenditure Growth in Capex 4610 0 310 310 0 2192 607.10% 826 -62.32% 875 5.93% 928 6.06% 983 5.93% 1043 6.10% 1105 5.94% Net Working Capital Accounts Cash Accounts Receivable Inventory Accounts Payable Net Working Capital Accounts Change in Net working Capital NWC/Sales 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020 0 180 431 607 643 682 723 766 812 861 973 2328 3278 3475 3683 3904 4139 4387 4650 346 786 1065 1130 1197 1269 1345 1426 1512 Free Cash Flows EBIT (1-t) plus depreciation less change in working capital less capital expenditures Fee Cash Flow Terminal Value (3%) 2020 only 474 IRR Cash Flows Cumalative Cash Flows Payback 5 Year cumaltive EBITDA 1598 1694 1796 1904 2018 2139 2267 1024 2410 3352 3553 3766 3992 4232 4486 4755 1000 24 1386 942 202 213 226 240 254 269 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020 -721 -261 330 1077 1634 1667 1767 1874 1986 2105 2231 0 310 310 310 436 462 490 520 551 584 -1000 -24 -1386 -942 -202 -213 -226 -240 -254 -269 -4610 0 -310 -310 -2192 -826 -875 -928 -983 -1043 -1105 -5331 -1261 306 -309 -1190 1076 1141 1210 1283 1359 9.00% ?????????????????????????????????????? 1 0.9174 0.8417 0.7722 0.7084 0.6499 0.5963 0.547 0.5019 0.4604 0.4224 -5331 -1157 258 -239 -843 700 681 662 644 626 11058 $7,058 ($3,391) 17.90% -5331 -1261 306 -309 -1190 1076 1141 1210 1283 1359 26176 -5331 -6592 -6286 -6595 -7784 -6708 -5566 -4357 -3074 -1715 24464 >10 Years 8778 Profitability Index NPV/Initial Investment 1441 24737 Initial Outlays Net Working Capital Net property Plant and Equipment Discount factor PV Cash Inflows NPV NPV without Terminal Value 1135 1000 1.32 4212 SEPTEMBER 15, 2010 TIMOTHY LUEHRMAN HEIDE ABELLI New Heritage Doll Company: Capital Budgeting In mid-September of 2010, Emily Harris, vice president of New Heritage Doll Company's production division, was weighing project proposals for the company's upcoming capital budgeting meetings in October. Two proposals stood out based on their potential to strengthen the division's innovative product lines and drive future growth. However, due to constraints on financial and managerial resources, Harris knew it was possible that the firm's capital budgeting committee would decline to approve both projects. She also knew that New Heritage's licensing and retail divisions would promote compelling projects of their own. Consequently, Harris had to be prepared to recommend one of her projects over the other. The Doll Industry Revenues in the U.S. toy and game industry totaled $42 billion in 2008 and were projected to increase by 4.6% per year to $52.5 billion by 2013. The market was divided into two broad segments: video games (48%) and traditional toys and games (52%). The second segment was further divided into infant/preschool toys (14.5%), dolls (14.1%), outdoor & sports toys (12.3%), and other toys & games (59.1%) including arts and crafts, plush toys, action figures, vehicles, and youth electronics. The U.S. market for toys and games was dominated by large global enterprises that enjoyed economies of scale in design, production, and distribution. Revenues were highly seasonal; the largest selling season in the United States coincided with the winter holiday period. Within the toy and game segment, U.S. retail sales of dolls totaled $3.1 billion in 2008 and were projected to grow by 3% per year to $3.6 billion by 2013. The doll category included large, soft, and mini dolls, as well as doll clothing and other accessories. The phenomenon of \"age compression\" the tendency of younger children to acquire dolls that had traditionally been designed for older girlsreduced growth in the \"baby-doll\" sub-segment. Competition among doll producers was vigorous, as a small number of large producers targeted similar demographics and marketed their dolls through the same media. Lasting franchise value for a branded line of dolls was rare; the enormous success of Barbie dolls was an obvious exception. More recently and on a much smaller scale, New Heritage also had created a durable franchise for its line of heirloom dolls. But the popularity of most doll lines waned after a few years. ________________________________________________________________________________________________________________ HBS Professor Timothy Luehrman and HBS MBA Heide Abelli prepared this case solely as a basis for class discussion and not as an endorsement, a source of primary data, or an illustration of effective or ineffective management. This case, though based on real events, is fictionalized, and any resemblance to actual persons or entities is coincidental. There are occasional references to actual companies in the narration. Copyright 2010 President and Fellows of Harvard College. To order copies or request permission to reproduce materials, call 1-800-545-7685, write Harvard Business Publishing, Boston, MA 02163, or go to http://www.hbsp.harvard.edu. This publication may not be digitized, photocopied, or otherwise reproduced, posted, or transmitted, without the permission of Harvard Business School. This document is authorized for use only by Kelly Weis (KELLY.WEIS@ALLIANZLIFE.COM). Copying or posting is an infringement of copyright. Please contact customerservice@harvardbusiness.org or 800-988-0886 for additional copies. 4212 | New Heritage Doll Company: Capital Budgeting New Heritage Dolls The New Heritage Doll Company was founded in 1985 by Ingrid Beckwith, a retired psychologist specializing in child development and the grandmother of two young girls. Dr. Beckwith believed the dolls produced by the major toy companies did little to develop girls' imagination or foster a positive self-image, so she created a line of dolls with unique storylines and wholesome themes. Dr. Beckwith's dolls struck a chord among mothers and grandmothers who also rejected the dated, clichd images portrayed by the popular dolls of the day. By 2009, New Heritage had grown to 450 employees and generated approximately $245 million of revenue1 and $27 million of operating profit from three divisions: production, retailing, and licensing. The production division, discussed further below, designed and produced dolls and doll accessories. The retailing division offered a unique \"intergenerational experience\" for grandmothers, mothers, and daughters, centered upon the character histories and storylines of the company's dolls and delivered through an online website (42%), a mail-order paper catalog (33%), and a network of retail stores (25%). In fiscal 2009, the retailing division generated roughly $190 million of revenue and $4.8 million of operating profit. The licensing division was started in 1998, and represented the company's newest and most profitable division. It sought to extend the New Heritage brand and capitalize on high levels of customer loyalty by selectively licensing the company's doll characters and themes to a variety of media that reached the firm's target demographic of toddler to pre-teen girls. In fiscal year 2009 the licensing division generated $24.5 million of revenue and $14.5 million in operating profit. New Heritage's Production Division Production was New Heritage's largest division as measured by total assets, and easily its most asset-intensive. Approximately 75% of the division's sales were made to the company's retailing division, with the remaining 25% comprising private label goods manufactured for other firms. Table 1 summarizes the division's various sources of revenue and operating income. Table 1 Production Division Data: Revenue ($ millions) Operating Income ($ millions) New Heritage Dolls Accessories 80 14 4.4 0.5 Private Label Dolls Accessories 26 5 2.3 0.3 Total $125 $ 7.5 New Heritage's dolls and accessories were offered under distinct brands with different price points, targeting girls between the ages of 3 and 12 years. The company's baby dolls were generally priced from $15-$30, and were offered to younger girls in earlier stages of development. These dolls typically came with a \"birth certificate\" and a short personal history. Dolls in the higher-end of this category incorporated technology that produced a limited amount of speech and motion. For the $75-$150 price range, New Heritage produced a line of heirloom-quality dolls and accessories. These were designed to appeal to older girls and to convey a sense of cultural and family tradition among grandmothers, mothers, and daughters. The heirloom dolls had more elaborate accessories and personal histories. Finally, the company offered a line of high-end dolls based on fictional \"celebrities,\" each associated with a charitable cause and embracing more contemporary fashion 1 The division revenue figures include approximately $95 million of internal sales within divisions which are eliminated when considering consolidated revenue for the company. 2 BRIEFCASES | HARVARD BUSINESS SCHOOL This document is authorized for use only by Kelly Weis (KELLY.WEIS@ALLIANZLIFE.COM). Copying or posting is an infringement of copyright. Please contact customerservice@harvardbusiness.org or 800-988-0886 for additional copies. New Heritage Doll Company: Capital Budgeting | 4212 trends. These dolls targeted girls in the so-called \"tween\" age range of 8-12 years, and also were priced from $75-$150. Like the heirloom dolls, celebrity dolls also came with more elaborate stories and accessories. New Heritage outsourced much of its production to a select number of contract manufacturers in Asia. To ensure product quality and safety, the company maintained a fulltime staff to oversee material sourcing, production, and quality control on site at each of its manufacturing partners. Manufacturing activities that required precise tolerances or proprietary processes, along with all the creative elements (design and product prototyping, for example), were handled in-house at the company's headquarters facilities in Sacramento, California. Capital Budgeting at New Heritage New Heritage's capital budgeting process retained some of the informality that characterized the company's early years as an innovative startup. As the company grew, deliberate steps were taken to decentralize some of the project approval process and increase spending authority at the division level. However, large and/or strategic spending proposals were reviewed at the corporate level by a capital budgeting committee consisting of the CEO, CFO, COO, the controller, and the division presidents. The committee examined projects for consistency with New Heritage's business strategy and sought to balance the needs and priorities of each division against practical financial and organizational constraints. The committee also sought to understand project interdependencies and the potential for a given investment to strengthen the whole company, not solely the division proposing it. New Heritage's capital budget was set by the board of directors in consultation with top officers, who in turn sought input from each of the divisions. The capital and operating budgets were linked; historically, the capital budget comprised approximately 15% of the company's EBITDA. The committee had limited discretion to expand or contract the budget, according to its view of the quality of the investment opportunities, competitive dynamics, and general industry conditions. Before being considered by the committee, projects were described, analyzed, and summarized in self-contained proposal documents prepared by each division. These contained business descriptions, at least five years of operating and cash flow forecasts, spending requirements by asset category, personnel requirements, calculations of standard investment metrics, and identification of key project risks and milestones. Financial Analyses Financial analysis began with operating forecasts developed with oversight from New Heritage operating managers. Revenue projections were derived from forecasts of future prices and volumes. Fixed and variable costs were estimated separately, by expense category. Forecasts of working capital requirements were likewise vetted by line managers, who paid particular attention to a project's requirements for various types of inventory. Forecasts for fixed assets and related depreciation charges were developed in cooperation with analysts reporting to the controller. Operating projections for a given project were used to develop cash flow forecasts that would underpin calculations of net present value (NPV), internal rates of return (IRR), payback period, and other investment metrics. Cash flow forecasts were intended to capture the incremental effect of a proposed project on the firm's cash flow for each year within the forecast period. That is, each project's cash flow forecasts excluded non-cash items, such as depreciation charges, and nonincremental items such as sunk costs (i.e., costs that would be incurred regardless of whether a given project was undertaken or not). The cash flow forecasts were computed on an after-corporate-tax HARVARD BUSINESS SCHOOL | BRIEFCASES 3 This document is authorized for use only by Kelly Weis (KELLY.WEIS@ALLIANZLIFE.COM). Copying or posting is an infringement of copyright. Please contact customerservice@harvardbusiness.org or 800-988-0886 for additional copies. 4212 | New Heritage Doll Company: Capital Budgeting basis, but excluded all financing charges. Some elements of the cash flow forecasts were prepared with assistance from treasury analysts, but most of the necessary adjustments were well understood by division staff. New Heritage assigned discount rates to projects according to a subjective assessment of each project's risk. High-, medium-, and low-risk categories for each division were associated with a corresponding discount rate set by the capital budgeting committee in consultation with the corporate treasurer. Assessments of each project's risk were made at the division level, but subject to review by the capital committee. Factors considered in the assessment of a project's risk included, for example, whether it required new consumer acceptance or new technology, high levels of fixed costs and hence high breakeven production volumes, the sensitivity of price or volume to macroeconomic recession, the anticipated degree of price competition, and so forth. In 2010, \"medium\"-risk projects in the production division received a discount rate of 8.4%. High- and low-risk projects were assessed at 9.0% and 7.7%, respectively. Projects that created value indefinitely, given continuing investment, were treated as going concerns with a perpetual life. That is, NPV calculations included a terminal value computed as the value of a perpetuity growing at a constant rate. However, to preserve an element of conservatism, the capital committee generally insisted on relatively low perpetual growth rates - lower than New Heritage's historical growth and lower than near-term growth forecasts for a given division. Investment Opportunities in the Production Division Emily Harris was focused on two of the production division's most attractive current proposals. The first involved expanding the successful Match My Doll Clothing Line to include matching allseason clothing for tween girls and their favorite dolls. The second involved a new initiative, the Design Your Own Doll line, which employed web-based doll-design software to let users \"customize\" a doll's features to the customer's specifications. Match My Doll Clothing Line Expansion The Match My Doll Clothing line originally consisted of a few sets of matching doll and child clothing and accessories for warm weather. It quickly became successful after the daughters of a few celebrities were spotted and photographed wearing items from the line, and girls' magazines included some of the line in \"what's hot to wear\" sections. Given recent publicity, Marcy McAdams, the brand manager responsible for the line, believed the timing was perfect to expand. Specifically, McAdams proposed to create an \"All Seasons Collection\" of apparel and gear covering all four seasons of the year. She expected the new offerings to be at least as profitable as the existing line, since its current popularity would make it possible to maintain premium prices. She also hoped to take advantage of off-peak discounts offered by some suppliers and contract manufacturers as they tried to smooth their capacity utilization. In the same fashion, McAdams argued the expansion would help reduce, or at least not exacerbate, the seasonality in New Heritage's sales and earnings. To exploit the current popularity of the original Match My Doll Clothing line, especially given the fickle nature of children's fashion trends, McAdams believed the opportunity had to be exploited without delay. Her investment proposal contained relatively large outlays for R&D, market research, and marketing to maximize the probability of quick acceptance and longer-term success for the follow-on line. Upfront investment expenditures are summarized in Table 2. 4 BRIEFCASES | HARVARD BUSINESS SCHOOL This document is authorized for use only by Kelly Weis (KELLY.WEIS@ALLIANZLIFE.COM). Copying or posting is an infringement of copyright. Please contact customerservice@harvardbusiness.org or 800-988-0886 for additional copies. New Heritage Doll Company: Capital Budgeting | 4212 Table 2 Match My Doll Clothing Extension Outlays Initial Expenditures ($ thousands) Upfront R&D Upfront Marketing Investment in Working Capital Property, Plant & Equipment Total 2010 $ 625 625 800 1,470 $ 3,520 The R&D and marketing expenditures would be deductible for tax purposes at New Heritage's 40% corporate tax rate. The property, plant and equipment was expected to have a useful life of 10 years; the associated depreciation charges, shown in Exhibit 1, were based on the modified accelerated cost recovery system (\"MACRS\") allowed by the IRS. Working capital requirements, shown in Table 2 for 2010 and in Exhibit 1 for subsequent years were based largely on recent historical experience with the original Match My Doll Clothing line. Finally, given the proven success of Match My Doll Clothing, Harris believed the project entailed moderate riskthat is, about the same degree of risk as the production division's existing business as a whole. Design Your Own Doll This initiative targeted existing New Heritage customers, many of whom owned several of the company's heirloom dolls. The company's research showed that, when asked what features (e.g., appearance, ethnicity, \"life story,\" etc.) New Heritage should give to future dolls, loyal customers' responses had a high correlation with their own personal data. That is, girls wanted dolls like themselves. Further research suggested that many loyal customers would purchase yet another doll if they could customize the doll's features to create a \"one-of-a-kind\" addition to a girl's or family's existing collection of dolls. It also promised to increase the girl's pride in and identification with the doll, both because of their shared features and because of the girl's participation in creating the doll. This in turn further cemented customer loyalty. The customization process would begin with a new section of New Heritage's website, where proprietary design software enabled the customer to select physical attributes of the doll such as hair color, hair length & style, skin color, eye shape, eye color, and other facial features. The software could combine selected features and produce a photo-realistic image showing the finished doll with user-selected accessories. The customer could zoom in or out on the image and rotate it to see different aspects. The software made it easy to try out different combinations of features and accessories before making a purchase. Elizabeth Holtz, brand manager for heirloom dolls, was very excited about the project. She observed, \"A girl's relationship with her favorite doll is often partly mommy and partly big sister. Either way, having your doll look more like you is really powerful. And there's excitement in the experience: exploring the website, naming the doll-to-be, selecting her first outfit...even the anticipation of waiting for the new doll to arrive. I really think this is big.\" Holtz also believed that the dolls could command a premium price. \"Customers will naturally expect to pay more [for a custom doll],\" she said. Market research with focus groups revealed significant enthusiasm for the product concept and supported the notion of premium prices. However, even a limited degree of customization increased manufacturing complexity and expense. Further, because of the low production runs and volume, fixed costs on a per unit basis were expected to be relatively high. Consequently, the breakeven volume for the project was also expected to be high. HARVARD BUSINESS SCHOOL | BRIEFCASES 5 This document is authorized for use only by Kelly Weis (KELLY.WEIS@ALLIANZLIFE.COM). Copying or posting is an infringement of copyright. Please contact customerservice@harvardbusiness.org or 800-988-0886 for additional copies. 4212 | New Heritage Doll Company: Capital Budgeting The web-based software tools and order entry system required New Heritage to make significant modifications to its existing technology infrastructure, expand its webhosting capacity, and modify the terms of its third-party service agreements to ensure a higher level of service quality. The majority of the R&D expenditures shown below were related to software development, hardware upgrades, and web design. The development time involved, including product testing, was expected to be approximately 12 months. Initial outlays, some of which occurred in 2010 and some in 2011, are summarized in Table 3. Table 3 Design Your Own Doll Outlays Initial Expenditures ($ thousands) 2010 2011 Upfront R&D Upfront Marketing Investment in Working Capital $ 841 $ 360 Property, Plant & Equipment Total $ 4,610 $ 5,811 $ 1,000 $ 1,000 As with Match My Doll Clothing, the required R&D and marketing costs would be tax deductible. Manufacturing equipment had to be ordered by the end of 2010 to be ready for production at the beginning of 2012. While New Heritage had the option to pay for custom equipment in quarterly installments, the firm could get a substantial discount by paying for the equipment up front, in 2010. Figures in Table 3 and Exhibit 2 reflect the discounted cost of the equipment. To support the forecasted level of sales, substantial investment in working capital (primarily work in process inventory of partially manufactured dolls) would be required beginning in 2011. And still more equipment would have to be purchased and installed no later than 2014. In years 2015 and following, investments in working capital and equipment would revert to patterns familiar from the production division's traditional lines of dolls. To complete development work, Holtz planned to use some of the company's existing IT staff. The majority of the work would take place during calendar 2011. The number of people and their fully loaded costs are shown Table 4. These costs were not included by Holtz in the initial outlays shown in Table 3 or in the forecasts presented in Exhibit 2. The development personnel Holtz needed were considered \"corporate\" resources and were almost certainly available to work on the project. Table 4 Design Your Own Doll Development Personnel, ($ 000s) Application Development Personnel Costs: Web Application Developers Database Manager Systems Integration Specialist Total Cost Number Salary Total 1 1 1 $ 150 160 $ 125 $ 150 160 125 $ 435 Finally, Holtz needed to give Harris her assessment of the project's riskiness. On the one hand, Design Your Own Doll had a relatively long payback period, introduced some untested elements into the manufacturing process, and depended on near-flawless operation of new customer-facing software and user interfaces. If the project stumbled for some reason, New Heritage risked damaging relationships with its best customers. On the other hand, the project had a relatively modest fixed cost ratio, and it played to the company's key strengthcreating a unique experience for its consumers. 6 BRIEFCASES | HARVARD BUSINESS SCHOOL This document is authorized for use only by Kelly Weis (KELLY.WEIS@ALLIANZLIFE.COM). Copying or posting is an infringement of copyright. Please contact customerservice@harvardbusiness.org or 800-988-0886 for additional copies. New Heritage Doll Company: Capital Budgeting | 4212 Harris's Decision Emily Harris still needed to complete her review and financial analysis of the two proposals. McAdams and Holtz were in frequent touch with Harris and both had offered to respond to any questions she might have about the proposals: the business case, the financial projections, the operating details, or anything else. Harris expected that she would indeed have some follow-up questions as she worked through her financial analyses. She also knew that her final recommendation might disappoint some executives within the division, who would scrutinize it closely. It had to be well-supported. HARVARD BUSINESS SCHOOL | BRIEFCASES 7 This document is authorized for use only by Kelly Weis (KELLY.WEIS@ALLIANZLIFE.COM). Copying or posting is an infringement of copyright. Please contact customerservice@harvardbusiness.org or 800-988-0886 for additional copies. This document is authorized for use only by Kelly Weis (KELLY.WEIS@ALLIANZLIFE.COM). Copying or posting is an infringement of copyright. Please contact customerservice@harvardbusiness.org or 800-988-0886 for additional copies. $ $ 952 3.0% 59.2x 7.7x 30.8x 583 $ $ 152 3.0% 59.2x 8.3x 30.9x 994 575 3,404 152 4,131 1,735 $ 5,866 575 2,035 152 2,762 1,155 $ 3,917 2012 $ 6,860 52.4% 2011 $ 4,500 2013 $ 152 3.0% 59.2x 12.7x 31.0x $ 1,277 587 4,291 152 5,029 2,102 $ 7,132 $ 8,409 22.6% Capital Expenditures Working Capital Assumptions: Minimum Cash Balance as % of Sales Days Sales Outstanding Inventory Turnover (prod. cost/ending inv.) Days Payable Outstanding (based on tot. op. exp.) $ 4,610 $ (1,201) Operating Profit 1,201 1,201 $ 2010 $ 0 $ 0 $ 0 $ $ 310 3.0% 59.2x 12.2x 33.7x 550 1,650 2,250 310 4,210 1,240 $ 5,450 0 0 0 0 0 2012 $ 6,000 0 2011 $ $ 310 3.0% 59.2x 12.3x 33.8x 1,794 1,683 7,651 310 9,644 2,922 $ 12,566 $ 14,360 139.3% 2013 Selected Operating Projections for Design Your Own Doll ($ in thousands) 1,470 Revenue Revenue Growth Production Costs Fixed Production Expense (excl depreciation) Variable Production Costs Depreciation Total Production Costs Selling, General & Administrative Total Operating Expenses Exhibit 2 Capital Expenditures $ $ (1,250) Operating Profit Working Capital Assumptions: Minimum Cash Balance as % of Sales Days Sales Outstanding Inventory Turnover (prod. cost/ending inv.) Days Payable Outstanding (based on tot. op. exp.) $ 0 1,250 1,250 2010 3.0% 59.2x 12.6x 33.9x 2,724 $ 2,192 $ 1,717 11,427 310 13,454 4,044 $ 17,498 $ 20,222 40.8% 2014 $ 334 3.0% 59.2x 12.7x 31.0x $ 1,392 598 4,669 152 5,419 2,270 $ 7,690 $ 9,082 8.0% 2014 2015 361 $ $ 826 3.0% 59.2x 12.7x 33.9x 2,779 1,751 12,182 436 14,369 4,287 $ 18,656 $ 21,435 6.0% 2015 $ 3.0% 59.2x 12.7x 31.0x $ 1,503 610 5,078 164 5,853 2,452 $ 8,305 $ 9,808 8.0% Selected Operating Projections for Match My Doll Clothing Line Expansion ($ in thousands) Revenue Revenue Growth Production Costs Fixed Production Expense (excl depreciation) Variable Production Costs Depreciation Total Production Costs Selling, General & Administrative Total Operating Expenses Exhibit 1 2016 $ $ 875 3.0% 59.2x 12.7x 33.9x 2,946 1,786 12,983 462 15,231 4,544 $ 19,775 $ 22,721 6.0% 2016 $ 389 3.0% 59.2x 12.7x 31.0x $ 1,623 622 5,521 178 6,321 2,648 $ 8,969 $ 10,593 8.0% 2017 $ $ 928 3.0% 59.2x 12.7x 33.9x 3,123 1,822 13,833 490 16,145 4,817 $ 20,962 $ 24,084 6.0% 2017 $ 421 3.0% 59.2x 12.7x 31.0x $ 1,753 635 6,000 192 6,827 2,860 $ 9,687 $ 11,440 8.0% 2018 $ $ $ 983 3.0% 59.2x 12.7x 33.9x 3,310 1,858 14,736 520 17,113 5,106 $ 22,219 454 3.0% 59.2x 12.7x 31.0x 1,893 $ 25,529 6.0% 2018 $ 648 6,519 207 7,373 3,089 $ 10,462 $ 12,355 8.0% $ 2019 $ $ 1,043 3.0% 59.2x 12.7x 33.9x 3,509 1,895 15,694 551 18,140 5,412 $ 23,553 491 3.0% 59.2x 12.7x 31.0x 2,045 660 7,079 224 7,963 3,336 $ 11,299 $ 27,061 6.0% $ 2019 $ 13,344 8.0% 2020 -8- $ 1,105 3.0% 59.2x 12.7x 33.9x 3,719 1,933 16,712 584 19,229 5,737 $ 24,966 $ 2,209 530 3.0% 59.2x 12.7x 31.0x $ 28,685 6.0% 2020 $ $ 674 7,685 242 8,600 3,603 $ 12,203 $ 14,411 8.0% 4212