UNIVERSITI UTARA MALAYSIA

FACULTY OF FINANCE AND BANKING

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SEMINAR IN FINANCE WFF 6013 CASE STUDY: 23
THEME: DANFORTH & DONNALLEY LAUNDRY PRODUCT COMPANY FOR : A. P. DR. NORAFIFAH AHMAD BY: MOHD AZEEZ IKHWAN B MORAD ROSNITA BT AHMAD ZURIAWATI BT ZAKARIA NOORUL AZWIN BT MD NASIR SALASIAH BT YUSOP SUBMISSION DATE : 24TH FEBRUARY 2007
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84865 86120 86895 86996 87060

Question and Answer (QnA). 1. If you were in Steve Gaspers place, would you argue to include the cost from market testing as a cash outflow? No. Cost from market testing was considered as sunk costs. A sunk cost is an outlay that has already occurred, hence is not affected by the decision under consideration. Since sunk costs are not incremental cost they should not be included in the analysis. In this case 500,000 for test marketing, which was conducted in the Detroit area and completed in the previous June was consider as a sunk cost and it will not affect Danforth & Donnalley Laundry future cash flows regardless of whether or not the new branch is built. 2. What would your opinion be as to how to deal with the question of working capital? Working capital management deals with the management of current assets which are cash, account receivable, and inventory, and also procedures financing these assets. In my opinion, working capital policy involves two basic questions: (i) What is the appropriate amount of current assets for the firm to carry both in total and for each specific account and (ii) How should current asset be financed. Therefore, the most important element in best buys working capital policy is its inventory management. Refer to the Danforth & Donnalley laundry, McDonald suggest to add another $200,000 in working capital, because they estimate this money would never leave the firm and would always be in liquid form, for the first time; it consider outflow but hence inflow. In my opinion, some additional cash is required to conduct operations in D&D laundry because additional some cash is needed in order to reserve for some contingency, or as a parking place for funds prior to an acquisition, a major capital investment program, or the like. That concept has been applied to more complex businesses, where it is used to analyze the effectiveness of a firms working capital management. Under relaxed current assets policy, D&D laundry would hold relatively large amounts of each type of current asset and under a restricted current

assets policy; company would hold minimal amounts of these items. Current assets are necessary, but there are costs associated with holding them. Therefore, if D&D can manage its current assets more efficiently and thereby operate with smaller investment in working capital; this will increase D&D laundry profitability. 3. Would you suggest that the product be charged for the use of excess production facilities and building? Would this opinion change under the hypothetical assumption that needed production facilities for the current line of powdered detergents were at 55 percent of capacity and expected to grow at a rate 20 percent a year and maximum production capacity was 100 percent? What would be the present value of this cash flow given the fact that the currently proposed new plant would involve cash outflows of $5 million in three years (assuming that acceptance of the Blast project would not affect the size of the proposed outlay, only the timing, and that the new plant and facilities would be operable indefinitely). (Hint: Assume that the introduction of Blast would only move the need for a new plant ahead by one year, that the cash outflow would remain at $5 million regardless of when incurred, and that the plant would operate indefinitely.) Situation 1: Usage capacity of Machine

Situation 2: Increment in Usage Capacity of Machine

Situation 3: Usage Capacity of Building

In our opinion, Blast must not be charged for the excess usage of production facilities and building. The reasons of this are:1. Cost has been calculated when the machine was bought for Lift-Off productions; and 2. No cash payment made in obtaining the machine and building for Blast productions The same rationale should be implemented for any changes in excess usage of production facilities and building. 4. Would you suggest that the cash flows resulting from erosion of sales from current laundry detergent products be included as a cash inflow? If there was a chance that competition would introduce a similar product were D&D to fail to introduce Blast, would this affect your answer? Yes, the reduction in the sales of the Lift-Off and Wave, referred to as erosion, should be treated as an incremental cash flow. These lost sales are included because it a cost (a revenue reduction) that the company must bear if it choose to produce the new product (Blast). It will not affect our answer if there was a chance that competition would introduce a similar product at time D&D fail to introduce Blast. This happen due to the fact that for constructs cash flow we ignore the competitor effect.

5. If debt is used to finance this project, should the interest payments associated with this new debt be considered cash flows? No. We discount project cash flows with a cost of capital that is the rate of return required by all investors (not just debtholders or stockholders), and so we should discount the total amount of cash flow available to all investors. They are part of the costs of capital. If we subtracted them from cash flows, we would be double counting capital costs. 6. What are the NPV, IRR, and PI of this project, including cash flows resulting from lost sales from existing product lines? What are the NPV, IRR, and PI of this project excluding these flows? Under the assumption that there is a good chance that competition will introduce a similar product if D&D doesnt, would you accept or reject this project?