Question
Case # 1 Danforth & Donnalley Laundry Products Company Determining Relevant Cash Flows At 3:00 pm on April 14, 2010, James Danforth, president of Danforth
Case # 1
Danforth & Donnalley Laundry Products Company
Determining Relevant Cash Flows
At 3:00 pm on April 14, 2010, James Danforth, president of Danforth &
Donnalley (D&D)
Laundry Products Company, called to order a meeting for the fi
nancial directors. The purpose of
the meeting was to make a capital-budgeting decision with respe
ct to the introduction and
production of a new product, a liquid detergent called Blast.
D&D was formed in 1993 with the merger of Danforth Chemical Co
mpany (producer of Lift-Off
detergent, the leading detergent on the West Coast) and Donna
lley Home Products Company
(maker of Wave detergent, a major laundry product in the Mi
dwest). As a result of the merger,
D&D was producing and marketing two major product lines. Although there
products were in
direct competition, they were not without product differe
ntiation Lift-Off was a low-suds,
concentrated powder, and Wave was a more traditional powder de
tergent. Each line brought with
it considerable brand loyalty; and by 2010, sales from the t
wo detergent lines had increased ten-
fold from 1993 levels, with both products now being sold nation
ally.
In the face of increased competition and technological inn
ovation, D&D spent large amounts of
time and money over the past four years researching and de
veloping a new highly concentrated
liquid laundry detergent. D&D
s new detergent, which it called Blast, had many obvious
advantages over the conventional powered products. The company
felt that Blast offered the
consumer benefits in three major areas. Blast was so
highly concentrated, that only 2 ounces
were needed to do an average load of laundry, as compared wi
th 8 to 12 ounces of powdered
detergent. Moreover
,
being a liquid, it was possible to pour Blast directly on stain
s and hard-
to
-
wash spots, eliminating the need for a pre-soak and giving it cl
eaning abilities that powders
could not possibly match. And, finally, it would be packaged in a l
ightweight, unbreakable
plastic bottle with sure-grip handle, making it much easie
r to use and more convenient to store
than the bulky boxes of powdered detergents with which it woul
d compete.
The meeting participants included James Danforth, president
of D&D; Jim Donnelley, director of
the board; Guy Rainey, vice-president in charge of new product
s; Urban McDonald, controller;
and Steve Gasper, a new comer to the D&D financial staff who
was invited by McDonald to sit
in on the meeting. Danforth called the meeting to order, gav
e a brief statement of its purpose, and
immediately gave the floor to Guy Rainey.
Rainey opened with a presentation of the cost and cash f
low analysis for the new product. To
keep things clear, he passed out copies of the projected cas
h flows to those present (
se
e Exhibits
1 and 2). In support of this information, he provided some insight
s as to how these calculations
were determined. Rainey proposed that the initial cost for
Blast include $500,000 for the test
marketing, which was conducted in the Detroit area and comple
ted in June of the previous year,
and $2 million for new specialized equipment and packaging facil
ities. The estimated life for the
facilities was 15 years, after which they would have no salv
age value. This 15-year estimated life
assumption coincides with company policy set by Donnelley n
ot to consider cash flows
occurring more than 15 years into the future, as estimates
that far ahead
tend to become little
more than blind guesses
.
Rainey cautioned against taking the annual cash flows (as shown
in Exhibit 1) at face value
because portions of these cash flows actually would be a r
esult of sales that had been diverted
from Lift-Off and Wave. For this reason, Rainey also pro
duced the estimated annual cash flows
that had been adjusted to include only those cash flows incre
mental to the company as a whole
(as shown in Exhibit 2).
At this point, discussion opened between Donnelley and McDonald,
and it was concluded that
the opportunity cost on funds was 10 percent. Gasper then questio
ned the fact that no costs were
included in the proposed cash budget for plant facilities that
would be needed to produce the new
product.
Rainey replied that at the present time, Lift-Off
s production facilities were being used at only 55
percent of capacity, and because there facilities were su
itable for use in the production of Blast,
no new plant facilities would need to be acquired for the pro
duction of the new product line. It
was estimated that full production of Blast would only requi
re 10 percent of the plant capacity.
McDonald then asked if there had been any consideration of
increased working capital needs to
operate the investment project. Rainey answered that ther
e had, and that this project would
require $200,000 of additional working capital; however, as this
money would never leave the
firm and would always be in liquid form, it was not considered
an outflow and hence not
included in the calculations.
Donnelley argued that this project should be charged something f
or its use of current excess
plant facilities. His reasoning was that is another firm
had space like this and was willing to rent
it out, it could charge somewhere in the neighbourhood of
$2 million. However, he went on to
acknowledge that D&D had a strict policy that prohibits rent
ing or leasing any of its production
facilities to any party from outside the firm. If they di
dn
t charge for the facilities to any part
from outside the firm might end up accepting projects, he co
ncluded, the firm might end up
accepting projects that under normal circumstances would be r
ejected.
From here the discussion continued, centering on the ques
tion of what to do about the lost
contribution from other projects, the test marketing co
sts, and working capital.
Exhibit 1
: D&D Laundry Products Company Forecast of Annual Cash Flows
from the Blast
Product (Including cash flows resulting from sales diverted f
rom the existing product lines)
Year
Cash Flows
Year
Cash Flows
1
$280,000
9
350,000
2
280,000
10
350,000
3
280,000
11
250,000
4
280,000
12
250,000
5
280,000
13
250,000
6
350,000
14
250,000
7
350,000
15
250,000
8
350,000
Exhibit 2
: D&D Laundry Products Company Forecast of Annual Cash Flows
from the Blast
Product (Excluding cash flows resulting from sales diverted fr
om the existing product lines)
Year
Cash Flows
Year
Cash Flows
1
$250,000
9
315,000
2
250,000
10
315,000
3
250,000
11
225,000
4
250,000
12
225,000
5
250,000
13
225,000
6
315,000
14
225,000
7
315,000
15
225,000
8
315,000
Questions:
1)
If you were put in the place of Steve Gasper, would you argue fo
r the cost from market
testing to be included in a cash outflow?
2)
What would your opinion be as to how to deal with the question
of working capital?
3)
Would you suggest that the product be charged for the use of e
xcess production facilities
and building space?
4)
Would you suggest that the cash flows resulting from erosi
on of sales from current
laundry detergent products be included as a cash inflow? If
there was a chance of
competitors introducing a similar product if you did not intro
duce Blast, would this affect
your answer?
5)
If debt were used to finance this project, should the intere
st payments associated with this
new debt be considered cash flows?
6)
What are the NPV, IRR and PI of this project, both including c
ash flows resulting from
sales diverted from the existing product lines (Exhibit 1) and exc
luding cash flows
resulting from sales diverted from the existing product lines
(Exhibit 2)? Under the
assumption that there is a good chance that competition
will introduce a similar product if
you don
t, would you accept or reject this project?
Step by Step Solution
There are 3 Steps involved in it
Step: 1
Get Instant Access to Expert-Tailored Solutions
See step-by-step solutions with expert insights and AI powered tools for academic success
Step: 2
Step: 3
Ace Your Homework with AI
Get the answers you need in no time with our AI-driven, step-by-step assistance
Get Started