Question

anielle Hastings was recently hired as a cost analyst by CareNet Medical Supplies Inc. One of Danielle's first assignments was to perform a net present value analysis for a new warehouse. Danielle performed the analysis and calculated a present value index of 0.75. The plant manager, Jerrod Moore, is very intent on purchasing the warehouse because he believes that more storage space is needed. Jerrod asks Danielle into his office and the following conversation takes place:

Jerrod: Danielle, you're new here, aren't you?

Danielle: Yes, I am.

Jerrod: Well, Danielle, I'm not at all pleased with the capital investment analysis that you performed on this new warehouse. I need that warehouse for my production. If I don't get it, where am I going to place our output?

Danielle: Well, we need to get product into our customers' hands.

Jerrod: I agree, and we need a warehouse to do that.

Danielle: My analysis does not support constructing a new warehouse. The numbers don't lie; the warehouse does not meet our investment return targets. In fact, it seems to me that purchasing a warehouse does not add much value to the business. We need to be producing product to satisfy customer orders, not to fill a warehouse.

Jerrod: The headquarters people will not allow me to build the warehouse if the numbers don't add up. You know as well as I that many assumptions go into your net present value analysis. Why don't you relax some of your assumptions so that the financial savings will offset the cost?

Danielle: I'm willing to discuss my assumptions with you. Maybe I overlooked something. Jerrod: Good. Here's what I want you to do. I see in your analysis that you don't project greater sales as a result of the warehouse. It seems to me that if we can store more goods, then we will have more to sell. Thus, logically, a larger warehouse translates into more sales. If you incorporate this into your analysis, I think you'll see that the numbers will work out. Why don't you work it through and come back with a new analysis. I'm really counting on you on this one. Let's get off to a good start together and see if we can get this project accepted.

What is your advice to Danielle? Consider everything that you have learned this semester and chose 1 aspect to comment on.

Answer 1

the statement of a larger warehouse translaes into more sales- is completely wrong. there are many factors show impact on sale of a product/ service, but not a bigger warehouse or godown. so, this assumption is completely wrong about sales. Next about assumptions of NPV, if the required rate of return is decreasing, then you can get the positive NPV from the project calculation. when the required rate (discount rate) is higher, the NPV will become down or negative. Hence, if you shown that your discounting rate is less, then your figures may postitive and you can support your statement.

The other assumption is volume of cash inflows: if you managed that the sales are increase, then the cash inflow will be increase leads to higher NPV and vice versa- the opposite is, if you are able to show that the investments are less than what you projected, the returns are same, then also your NPV will increase.

If your target is to manipulate the numbers to NPV positive or Profitablity Index more than 1, than you can manipulate the numbers, but it may not give the real picture to the stakeholders. If they realized your calculations are wrong, it becomes a threat and limiation to you in your future.