CP 25-1 Ethics and professional conduct in business Danielle Hastings was recent
ID: 2561680 • Letter: C
Question
CP 25-1 Ethics and professional conduct in business Danielle 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?Explanation / Answer
In my opinion, Danielle should stick with his net present value analysis. He should discuss the assumptions made by him (while performing NPV analysis) with Jerrod, but should consider removal/elimination of only those assumptions which are found to be unreasonable or not as per industry standards. Storage of more goods in the warehouse will not necessarily generate additional sales. However, it will surely result in inventory carrying/holding costs (such as insurance) and other warehouse related expenses. Moreover, higher production and storage of goods (without a corresponding increase in sales) will result in additional money/funds blocked in inventory which could have been put to other productive uses. The sales would increase if the product meets the requirements of the customer (s). Therefore, I would not have agreed with the argument provided by Jerrod regarding an increase in sales because of construction of warehouse. Simply agreeing to something which is not supported by relevant numbers could affect the project valuation and can cause ethicals and financial concerns/issues later on.