Danforth & Donnalley Laundry Products Company

On April 17, 2013, James Danforth, president of Danforth & Donnalley (D&D)

Laundry Products Company, called to order a meeting of the financial directors. The

purpose of the meeting was to make a capital budgeting decision with respect to the

introduction and production of a new product, a liquid detergent called Blast.

D&D was formed in 1985 with the merger of Danforth Chemical Company,

headquartered in Seattle, Washington, producers of Lift-Off detergent, the leading

detergent on the West Coast; and Donnalley Home Products Company, headquartered in

Detroit, Michigan, makers of Wave detergent, a major Midwestern laundry product. As a

result of the merger, D&D was producing and marketing two major product lines.

Although these products were in direct competition, they were not without product

differentiation: Lift-Off was a low-suds, concentrated powder, while Wave was a more

traditional powder detergent.

In the face of increased competition and technological innovation, D&D had spent

large amounts of time and money over the past four years researching and developing a

new, highly concentrated liquid laundry detergent. D&Ds new detergent, which they

called Blast, had many obvious advantages over the conventional powdered products. It

was felt that with Blast the consumer would benefit in three major areas. Blast was so

highly concentrated that only 2 ounces was needed to do an average load of laundry as

compared with 8 to 12 ounces of powdered detergent. Moreover, because it was a liquid,

it was possible to pour Blast directly on stains and hard-to-wash spots, eliminating the

need for a presoak and giving Blast cleaning abilities that powders could not possibly

match. And finally, Blast would be packaged in a lightweight, unbreakable plastic bottle

with a sure-grip handle, making it much easier to use and more convenient to store than

the bulky boxes of powdered detergents with which it would compete.

The meeting was attended by James Danforth, president of D&D; Jim Donnalley,

director of the board; Guy Rainey, vice president in charge of new products; Urban

McDonald, controller; and Steve Gasper, a newcomer to D&Ds financial staff, who was

invited by McDonald to sit in on the meeting. Danforth called the meeting to order, gave

a brief statement of its purpose, and immediately gave the floor to Guy Rainey.

Rainey opened with a presentation of the cost and cash flow analysis for the new

product, and passed out copies of the projected cash flows (see Exhibits 1 and 2). In

support of this information, he provided some insight into how these calculations were

determined. Rainey proposed that the initial cost for Blast included $500,000 for the test

marketing, which was conducted in the Detroit area and completed in the previous June,

and $2 million for new specialized machinery and packaging equipment. The estimated

life for the machinery and equipment was 15 years, after which they would have no

salvage value. This 15-year estimated life assumption coincides with company policy set

by Donnelley not 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 shown in Exhibit 1 at face

value since portions of these cash flows actually are a result of sales that had been

diverted from Lift-Off and Wave. For this reason, Rainey also produced the annual cash

flows shown in Exhibit 2, which had been adjusted to include only those cash flows

incremental to the company as a whole.

At this point, discussion opened between Donnalley and McDonald, and it was

concluded that the opportunity cost of funds (cost of capital) is 10%. Gasper then

questioned the fact that no costs were included in the proposed cash budget for plant

facilities (buildings and structures), which would be needed to produce the new product.

Rainey replied that, presently, Lift-Offs production facilities were being utilized

at only 55% of capacity, and since these facilities were suitable for use in the production

of Blast, no new plant facilities other than the specialized machinery and packaging

equipment mentioned above need to be acquired for the new product line. It was

estimated that full production of Blast would only require 10% of the plant capacity.

McDonald asked if there had been any consideration of increased working capital

needed to operate the investment project. Rainey answered that there had and that this

project would require $200,000 of additional working capital at the start of the project.

Further, at the end of projects estimated life, this money would be transferred to other

projects and thus will never leave the firm and will always be in liquid form; therefore it

was not considered an inflow in fifteen years and, hence, the recovery of working capital

at the end of projects estimated life was not included in the calculations.

Donnalley argued that this project should be charged something for its use of the

current excess plant facilities. His reasoning was that if an outside firm tried to rent this

space from D&D, it would be charged somewhere in the neighborhood of $100,000

annually, and since this project would compete with other current projects, it should be

treated as an outside project and charged as such. However he went on to acknowledge

that D&D has a strict policy forbidding the renting or leasing out of any of its production

facilities. If they didnt charge for facilities, he concluded, the firm might end up

accepting projects that under normal circumstances would be rejected.

From here, the discussion continued, centering on the questions of what to do

about the lost contribution from other projects, the test marketing costs, the working

capital, and opportunity cost of renting existing excess plant facilities.

QUESTIONS

1. If you were in Steve Gaspers place, would you argue to include the cost from market

testing as a cash outflow?

2. What would your opinion be as to how to deal with the question of working capital?

3. What would be your opinion about charging the project for the use of excess plant

facilities? Would this opinion change if the firm had abolished its policy forbidding the

renting or leasing out of any of its production facilities?

EXHIBIT 2 D&D Laundry Products Company Incremental Annual Cash Flows from the Acceptance of Blast (not including thoseflows resulting from sales diverted from the existing product lines) Cash Flows S250.000 250,000 250,000 250,000 250,000 315,000 315,000 315,000 315,000 315,000 225,000 225,000 225,000 225,000 225,000 Year 4 6 10 12 13 15 EXHIBIT 2 D&D Laundry Products Company Incremental Annual Cash Flows from the Acceptance of Blast (not including thoseflows resulting from sales diverted from the existing product lines) Cash Flows S250.000 250,000 250,000 250,000 250,000 315,000 315,000 315,000 315,000 315,000 225,000 225,000 225,000 225,000 225,000 Year 4 6 10 12 13 15