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Q:
Danforth &Donnalley Laundry Products
Company
 
Determining Relevant Cash Flows
At 3:00 p.m. on April 14, 2010, 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 1993 with the merger of Danforth Chemical
Company (producer of Lift-Off detergent, the leading laundry
detergent on the West Coast) and Donnalley Home Products
Company (maker 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, and
Wave was a more traditional powder detergent. Each line
brought with it considerable brand loyalty; and, by 2010, sales
from the two detergent lines had increased ten-fold from
1993levels, with both products now being sold nationally.
 
In the face of increased competition and technological
innovation, D&D spent large amounts of time and money over the
past 4 years researching and developing a new, highly
concentrated
liquid laundry detergent. D&D’s new detergent, which they
call Blast, had many obvious advantages over the conventional
powdered 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 with 8 to 12 ounces of powdered detergent. Moreover, being
a liquid, it was possible to pour Blast directly on stains and
hard-to-wash spots, eliminating the need for a pre-soak and giving
it cleaning abilities that powders could not possiblymatch. And,
finally, it 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 participants included 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 the D&D 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. To keep things clear, he passed out
copies of the projected cash flows to those present (see Exhibits
1and 2). In support of this information, he provided some
insights
 
Exhibit 1: D&D Laundry Products Company
Forecast of Annual Cash Flows from the Blast Product (Including
cash flows resulting from sales diverted from the existing product
lines.)
 
 

Year

Cash flows

Year

Cash flows

I

$280,000

9

$350,000

 

2

280,000

10

350,000

 

3

280,000

I I

250,000

 

4

280,000

12

250,000

 

5

280,000

13

250,000

 

6

35 0,000

14

250,000

 

7

350,000

15

250,000

 

8

350,000

 

 
 

 

 

 

 

 

 

 

 

 
Pg 2 of 3
 
Exhibit 2 D&D Laundry Products Company
Forecast of Annual Cash Flows from the Blast Product (Excluding
cash flows resulting from sales diverted from the existing product
lines.)
 

Year

Cash flows

Year

cash flows

I

$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
 
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 completed
in
June of the previous year, and $2 million for new specialized
equipment and packaging facilities. The estimated life for the
facilities was 15 years, after which they would have no salvage
value. This 15-year estimated life assumption coincides with
company policy set by Donnalley 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 (as shown
in Exhibit 1) at face value because portions of these cash flows
actually would be a result of sales that had been diverted from
Lift-Off and Wave. For this reason, Rainey also produced the
estimated annual cash flows that had been adjusted to include only
those cash flows incremental to the company as a whole (as shown in
Exhibit 2).
 
At this point, discussion opened between Donnalley and McDonald,
and it was concluded that the opportunity cost on funds was 10%.
Gasper then questioned 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% of capacity, and because
these facilities were suitable for use in the production of Blast,
no new plant facilities would need to be acquired for the
production of the new product line. It was estimated that full
production of Blast would only require 10% 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 there 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.
 
Donnalley argued that this project should be charged something
for its use of current excess plant facilities. His reasoning was
that if another firm had space like this and was willing to
rent
it out, it could charge somewhere in the neighborhood of $2
million. However, he went on to acknowledge that D&D had a
strict policy that prohibits renting or leasing any of its
production facilities to any party from outside the firm. If they
didn’t 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 question of
what to do about the lost contribution from other projects, the
test marketing costs, and the working capital.
 
 
QUESTIONS
 
 
1. If you were put in the place of Steve
Gasper, would you argue for 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
excess production facilities and building space?
 
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 of competitors introducing a
similar product if you did not introduce Blast, would this affect
your answer?
 
5. If debt were used to finance this project, should the
interest payments associated with this new debt be considered cash
flows?
 
6. What are the NPV, IRR, and PI of this project, both
includingcash flows resulting from sales diverted from the existing
product lines (Exhibit 1) and excluding 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?
 

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