STUDY CASECAPITAL BUDGET ALLOCATION: EUROLAND FOODS S.A. (1988)

Financial Management CourseStudy Program of Economics

Sent by:

Acwin Hendra S. - 1993/IV-3/11

Eko Wicaksono - 1973/IV-3/11

Martin HL Tobing -1975/IV-3/11

Supriyasruri - 1992/IV-3/11

MASTER OF SCIENCE PROGRAM

FACULTY OF ECONOMICS AND BUSINESS

YOGYAKARTA

November, 2011

Euroland Foods S.A.

Senior manager’s of euroland was challenged to allocate limited spending on capital

project for only 120 million imposed by the boards of directors, in early January 2001. There

were 11 major projects that totaled 316 million and investment in this rate would represent a

major increase in firm’s current asset base of 965 million.

Euroland a Belgium multinational firms are the producer of high quality ice cream,

yogurt, bottled water, and fruit juice. Scandinavia, Britain, Belgium, the Netherlands,

Luxembourg, western Germany, and northern France are the market area for its products. Ice

cream leading on 60 percent of firm revenue; yogurt contributed approximately 20% and the

remaining 20% else divided equally between bottled water and fruit juice. Ice cream the

company’s leading product had a loyal based of customers. But since 1998 the Euroland Food’s

sales had been static. Management argued that low population growth in northern Europe and

market saturation caused this static sale. From outside views faulted recent failures in new-

product introductions. Most members of management wanted to expand the company’s presence

introduce more new products to boost sales that would improved the company’s market value.

Euroland Foods stock was currently 14 times earnings, just below book value. T his

price/earnings ratio was below the trading multiples of comparable company, and it gave little

value to company’s brands.

Source Allocation

Capital budget at Euroland Foods was prepared annually by a committee of senior managers,

who then presented it for approval to the board directors. As a matter of policy, investment

proposals wre subject to two financial test; payback and internal rate of return (IRR).

Type of Project

Minimum

Acceptable

IRR

Maximum Acceptable

Payback Year

1. New product or new markets 12% 6 year

2. Product or market extension 10% 5 years

3. Efficiency improvements 8% 4 years

4. Safety or environmental No test No test

Test or hurdles had been published in 1999 by the management committee and variate

among type of project.

The estimated weighted-average cost of capital (WACC) of Euroland was 10.6 percent published

in January 2001.

Ownership and The Sentiment Of Creditors and Investors

125 percent debt-equity-ratio of Euroland Foods was leveraged much more highly than its peer

in the European consumers-foods-industry. Management had relied on debt financing

significantly in the past few years to sustain firms capital spending and dividends during a period

of price war. And with the end of price war Eouroland bankers strongly urged an aggressive

program of debt reduction. in any event they were not prepared to finance increase in leverage

beyond the current level. 14 times of price earnings ratio, indicate shares of euroland Foods

common stock were priced below the average multiples of peer companies and the average

multiples of all companies on the exchanges where Euroland Foods was traded. At the

conclusion of the most recent meeting of the board directors, the board voted unanimously to

limit capital spending in 2001 to 120 M.

Members of The Senior-Management Committee

Heinz Klink

Profile

Position

Job Desk

Main Concern

: Managing Director for Distribution

: Oversaw transportation, warehousing, and order-fulfillment

: Spoilage, transport cost, stock-outs, and control system

Project

a. Replacement and expansion of truck fleet

Brief description:

Buy 100 refrigerated tractor-trailer trucks, 50 each in 2001 and 2002.

Objective:

Efficiency

Advantage:

- New trucks capacity 15% larger

- New Tractors will be more fuel and maintenance efficient

- More flexible scheduling and more efficient routing and servicing of the fleets.

- More frequent delivery to the company’s major market.

- Delivery change will be shorter

- Would reduce he loss of sales caused by stock-outs

b. Networked, computer-based inventory control system for warehouses, and field

representatives

Brief description

Setup networked, computer-based inventory control system to support supply chain

management.

Objective:

Efficiency

Advantages:

- Short term delay in ordering and order processing.

- Better control of inventory

- Reduction of spoilage

- Faster recognition of changes in demand at the customer level

Maarten LeydenProfile

PositionJob DeskMain Concern

: Managing Director for Production Purchasing: Managed production operation at the company’s 14 plants

: Production cost control

Project a. New plant

Brief description:Build new plant to produce ice cream and yoghurt in south eastern region to meet the market demand.Objective: Market extensionAdvantages:- Increase sales

- Reduce delivery cost

b. Expansion of a plant

Brief description:Expand plant to produce mineral water and fruit juice in southeastern region to increase production capacity.Objective: Market extension Advantages:- Increase production

- Scheduling of routine equipment maintenance become easier.c. Plant Automation and conveyor systems

Brief description:Automation production lineObjective : EfficiencyAdvantages : - Improve Speed in production

- Reduce Accident

- In turn will reduce potential cost related to compensation of injuryd. Effluent-water treatment at four plants

Brief description:Set up the water treatment equipment to reduce poisonous chemical.Objective : Society and Environment/meet legal requirementAdvantages:

- Potential cost reduction

- Maintain the company reputation

Fabienne Morin

Profile

Position : Managing Director for Marketing

Job Desk : Marketing research, new-product development, advertising, and brand

management

Main

Concern

: Production cost control

Project

a. Development and roll-out of snack foods

Brief description: Utilizing the excess capacity to prudoce dried fruit

Objective : New market/product

Advantages :

- Utilize the excess capacity

- Creating new market

- The plan based on experience of other companies

b. Development and introduction of new artificially sweetened yoghurt and ice cream

Brief description:

Objective : New product and efficiency

Advantages :

- Cost saving

- Stimulating demand for low-calorie products.

- Protecting market share

Marco Ponti

Profile

Position : Managing Director for Sales

Job Desk : Oversaw the field sales force of 250 representatives and planned

changes in geographical sales coverage

Main

Concern

: Rapid expansion and geographical positioning

Project

a. Market expansion in southward/eastward

Brief description:

The Company expanded its market southward including France, Switzerland, Italy,

and Spain and/or Eastward to include eastern Germany, Poland, Czechoslovakia,

and Austria.

Objective :

Market extension

Advantages :

- The time is right to expand yoghurt and ice cream geographically

Nigel Humbolt

Profile

Position : Managing Director for Strategic Planning

Job Desk : Set up strategic planning staff

Main

Concern

: Growth and Market share

Project

a. Acquisition of a leading schnapps brand and associated facilities

Brief description: Making diversifying acquisitions in an effort to move beyond

company’s mature core business

Objective : New product category

Advantages :

- Cordial and liqueurs offered unusual opportunities for real growth and market

protection through branding

POINT OF VIEW OF EACH MANAGER

Wilhelmina Verdin

As a PDG, Verdin is responsible for the whole company values. She concerns mainly on

company’s long term growth. The recent company’s difficulties are become her concern as well.

The previous three years financial reports show the Euroland’s low growth, earning per share,

and market value of the company. It is a bad sign for the company’s future operation continuity

and current performance. To increase the values, company must develop strategies by increasing

the growth.

Company’s growth had been static since 1998 because of the static sales. Either

management have a reason that the market saturation in a low population in northern Europe or

the outside observer have different reason that failures of new-product introduction are the

causes of the static sales and growth, it gives the same sign that Euroland must expand their main

products sales to increase the company’s growth. Geographically, it is the right time for company

to expand yoghurt and ice cream sales outside the existing saturated market, especially to

southward and eastward.

To fulfill the market demand resulted from the increasing sales, it must be supported with

the increasing production which can only be reached by developing new plants. The

development of new plants will also result in a decreasing delivery cost which is in line with the

company’s growth objectives. Company should also give an attention to expand of the plants in

southeastern region to produce mineral water and fruit juice because the existing plants had

reached the full capacity production. By doing so, the company could increase the production

capacity.

To support the whole objectives of the company and to maximize the stakeholder values,

the following capital budget proposal must be held by the company:

No

Project’s Name

Investment

(in €)

1 Expand Southward 30M

2 Expand Eastward 30M

3 New Plant 45M

4 Expanded Plant 15M

Trudi Lauf

As a Finance Director, Lauf is responsible for managing the modernization of financial

control and systems. Lauf had also been a vocal proponent of reducing company’s leverage and

voiced the stakeholder’s concerns and frustrations.

By expanding the market southward and eastward, it is support the company’s profitability,

which in turn increases the assets and equity balance and reduces the company’s leverage.

Company must aware of the cost efficiencies. The use of artificial sweetener for company’s

products will result in cost reduction. To reach the cost efficiencies, company must aware of the

supply chain management including short term delay in ordering and order processing, better

control of inventory, reduction of spoilage, and faster recognition of changes in demand at the

customer level.

European Community directives called for any waste-water containing even slight traces

of poisonous chemicals to be treated at the resources and gives company four years to comply.

Company needs effluent-water treatment at four plant to comply the the directives and to reduce

cost reduction. Euroland must keep the company’s image in the eyes of stakeholders, otherwise

company will receive bad image in the eye of consumer and at last reduce the stakeholder trust

which is feared to decrease the company’s market value.

To maintain the financial sustainability and to satisfy the stakeholder’s interests, the capital

budget would be as follow:

No

Project’s Name

Investment

(in €)

1 Expand Southward 30M

2 Expand Eastward 30M

3 Artificial Sweetener 27M

4 Inventory-Control System 22,5M

5 Effluent water 6M

Heinz Klink

Klink concerned with the product distribution of Euroland Foods. That's why he proposed

some projects that could improve the distribution process, such as replacement of the old truck

fleet and inventory-control system. The two projects proposed by him would help him to

improve his performance as managing director for Distribution in the company. We would like

to try to make an alternative capital budget that would be supported by Heinz Klink regarding his

position as managing director for Distribution.

First, Klink would place the replacement of the old truck fleets as the first choice. The

replacement could give some advantages for the company. Those advantages came from cost

efficiency and market expansion supported by the new fleets. Those advantages are as follow:

1. The new fleets would be more fuel and maintenance efficient

2. The new fleets could load more goods on each trip (15% increase)

3. More flexible scheduling and more efficient routing and servicing of the fleets

4. Shorter delivery times and cut inventories

5. More deliveries to company's major markets.

Those advantages could be used by Klink to defend his proposal on the board meeting. He would

reason that the project would be in line with the company's strategy, because it would improve

both cost efficiency and market expansion to support the growth of the company. The project

required 33M initial outlay with the yield of 11.6 M over the next seven years that would come

from cost saving and added sales potential.

Second, there was another project that was proposed by Klink. It is Networked,

computer-based control inventory-control system for warehouses and field representatives. The

project would support the distribution system of the company. There were several advantages of

the project, such as shorter delays in ordering and order processing, better control of inventory,

reduction of spoilage, and faster recognition of changes in demand at the customer level. The

investment required 22.5 initial outlay, with the benefit for the next three years, IRR of 16.2% ,

NPV at WACC of 1.75 and NPV at Minimum RoR of 2.67.ß

Third, the total projects proposed by Klink was 55.5 M. Regarding the capital budget of

120M, so the remaining budget would be 64.5 M, then Klink would support some projects that

could also improve the distribution system for the companies so that he could also get some

benefit from those projects because they would also support the improvement of his performance

as managing director for Distribution. One of the remaining nine projects that could support him

could be The New Plant in Dijon proposed by Leyden. The new plant could support the

distribution system in southeastern region by reducing shipping cost and lost of sales in the

region. The other project that would be supported by Klink would be the expansion of plant in

Nurenberg, Germany. The reason is because the expansion would improve the production

schedule then the improvement would also improve the schedule for distributing the product as

well.

No Project's Name Investment

1 Replacement and expansion of new truck fleet 33 M

2 Networked, computer-based control

inventory-control system for warehouses and

field representatives

22.5 M

3 A New Plant in Dijon 45 M

4 Expansion Plant in Nuremberg 15 M

Maarten Leyden

As managing director for producing and purchasing, Maarten Leyden concerned with the cost

of production in Euroland Foods. He is tough negotiator with unions and suppliers, his style

occurs because as producing and purchasing director and managed production operations at the

company’s 14 plants he gained a long life experienced about how to manage the cost of

production effective and efficient. We are not surprised when he proposed 4 projects that all

related in cost efficiency, the project are A new plant, Expansion of a plant , Plant automation

and conveyor systems, Effluent-water treatment at four plants. Considering the position of

Maarten Leyden as managing director for producing and purchasing we are trying to explain why

Maarten Leyden supported the project.

A new plant – as noted by him there a exceed the capacity of its Melun, France, manufacturing

and packaging plant for producing yogurt and ice-cream sales in the southeastern region. This

conditions induce the existing demand was being met by the newest plant located in Strasbourg,

it lead the additional cost of production because the shipping cost over that distance were high.

To take off this burden of shipping cost that will be disturbing the marketing effort because there

is no supporting from delivery Maarten Leyden proposed a new plant of manufacturing and

packaging be built in Dijon, France just at current southern edge of Euroland Food’s marketing

region. The cost of new plant would be 37.5 M and would entail 7.5 M for working Capital. The

new plant also would expected to yield after-tax cash flows 35.5 M and IRR 11.3 percent over

the next 10 years for gained from increasing sales and depreciation and also the decrease in

delivery cost. Maarten Leyden would defend this project for three main reasons; reducing the

delivery cost that means less in cost of production and the new plant would increase the company

sales in southeastern region and the last this project has 11.3% IRR above 10% of minimum

acceptable IRR. But southeastern region would be facing problems with the test or hurdles had

been published in 1999 by the management committee that just allow maximum acceptable

Payback period 5 years but a new plant project has Payback period 6 years.

Expansion of a plant - Considering full capacity of its Nuremberg, Germany plant and the need

of greater production capacity in Euroland Food's southeastern region Maarten Leyden proposed

expansion of plant project to eliminate production scheduling and deadline problems. The plant's

estimated would be expanded by 20% for 15 M and would be resulting additional production up

to 2.25 M a year, and yielding IRR 11.2 percent above 10% of minimum acceptable IRR. From

the calculation we found that this project resulting Profitability Index 1 that would be used by

Maarten Leyden to defend this project although it’s not meet the minimum acceptable payback

years of the project.

Plant automation and conveyor systems - To increase automation that would have a benefit of

cost production reduction Maarten Leyden also requested 21 M for plant automation and

conveyer systems. This projects benefit from improving production, reducing employee

accidents, spillage and production tie-ups. The conveyer systems would eliminated the need for

any heavy lifting by employees that will be giving the company cost savings and depreciation

totaling 4.13 M a year from average hourly total compensation 150,000 a year. The plant

automation and conveyer systems also increasing productivity by reduce the chance of injury by

employees. As stated that minimum efficiency acceptable IRR 8% this project is met by resulting

8.7 IRR, this is may be the reason that will be used by Maarten Leyden to defend this project.

Effluent-water treatment at four plants - As the environmental project would not be tested by

financial test this project proposed by Maarten Leyden tends to be speculated for preventing 15

M cost of equipment when immediate conversion became mandatory for the current cost of 6 M.

This project would be defending by Leyden by stated that in the intervening time, the company

would run the risks that European Community regulators would shorten the compliance time or

that the company pollution record would become public and impair the image of the company in

the eyes of the consumers. Bad branding is a sign to reducing in sales and would affect revenue

would not covering the production cost.

Computer-Based Inventory-Control System - the last project that would be supported by

Maarten Leyden was computer-based inventory-control system for the ware house. This project

would be met with Maarten Leyden main concern, reduction cost control because with this

computer-based inventory-control system the field of sales representatives, distributors, drivers,

warehouses, and possibly even retailers would be linked in one single system that means more

effective and efficient by shorter delays in ordering and order processing, better control of

inventory, reduction spoilage, and faster recognition of changes in demand at the customer level.

From the cash-flow forecast, it’s reflected an initial outlay of 18 M for the system, followed by

5.5 M in the next for ancillary equipment but Maarten Leyden must be careful to support this

project because there is the possibility of additional cost of system implementation and

mitigation costs for the system implementation failure due it will take time for workers to

understand and be able to operate the new system well.

Marco Ponti

Marco Ponti was managing director for Sales at Euroland Foods. He was one of the proponent of

the rapid expansion of the company which was in line with his responsibility as managing

director for Sales. Ponti proposed two projects that could improve the sales of the company, they

are market expansion southward and market expansion northward. Both of the projects would

support his performance as managing director for Sales if they were succesfully implemented.

Ponti would be the proponent of some other projects that would support the sales of the

company.

Ponti, of course, would support the two projects proposed by him. They would increase

the sales of the company which is the thing that he put more concerns because it was the

indicator of his performance. The greater the sales the better Ponti's performance as managing

director for Sales. Thus, both of the market expansions would be defended by Ponti in the

meeting. The two projects would have a total 60 M of initial outlay with a total of 105.1 M

after-tax cash flows.

However, Ponti pointed out that, it would hard for the sales and distribution organizations

to expand in both directions simultaneously. The southward expansion was riskier than the

eastward expansion though the IRR is higher than eastward expansion. But there were still some

other projects that could improve the distribution system that would indirectly support the market

extention. Those projects could also be supported by Ponti in the meeting.

The remaining budget would be 60 M if the two Ponti's projects were accepted. Then

Ponti would use the remaining budget for other projects that could support the sales

improvement. Some of those projects would be the two projects proposed by Henry Klink which

were the replacement of truck fleets and the inventory-control system. The two projects would

also support the sales expansion as well as distribution, therefore they would reduce the lost of

sales caused by the costly distribution costs and weak inventory control.

Therefore, the alternative capital budget proposed by Ponti would be as follow:

No Project's Name Investment

1 Market Expansion Southward 30 M

2 Market Expansion Northward 30 M

3 Replacement and expansion of new truck fleet 33 M

4 Networked, computer-based control

inventory-control system for warehouses and

field representatives

22.5 M

Fabienne Morin

With believe of “window of opportunity” for product expansion, Morin Introduce two projects

proposing new product. He proposed to Develop and roll out of snack foods and develop and

introduction of new artificially sweetened yogurt and ice cream With Following Financial

Performance calculation.

Indicator New Snack New

Artificial Sweetened

     Total Disbursement 27 27Net Present Value-WACC 3.74 13.43Net Present Value-ROR 1.79 10.97Internal Rate of Return 13.4 20.5Equity annuity 0.32 1.94Payback 7 5Profitability Index 0.64 1.66     

From the financial analysis above, she argued that both of those projects offered positive NPV as

well as IRR spread and profitability index. Thus, based on financial point of view, these projects

are feasible even though there is weakness in the payback period for the snack.

In addition, she also will argue from the view of non qualitative perspective. She believed that by

developing and rolling out of snack foods there will be some advantages as follows:

- Utilize the excess capacity at Antwerp spice and nut processing facility

- Creating new market

- The market has been tested by other companies

While by applying the development and introduction of new artificially sweetened yogurt and ice

cream she proposed following advantages:

- Cost saving with low cost sweetened yogurt

- Stimulating demand for low-calorie products.

- Protecting market share

She also remind the other manager that this innovative sweetened yoghurt can repeat the success

of the low fat dairy product that had been developed and introduced by the Company.

In order to support her marketing of the two new product, she also will support the project that

will expand the geographical market area of the company. Based on the information in article, it

have been explained that the most dairy product consumer were spread out in southward area,

while the market for frozen products were located in eartward area. Thus Morin will support the

Market expansions for southward and eastward proposed by Pontii with expenditure of 30

million Euro each. This project also parallel with Fabienne Morin tendetion to support growth

oriented project.

In addition, as a Marketing managing director, she also cares about image of the company in the

eyes of the consumer. Based on this opinion, most likely she will support the Fluent water

treatment at four plants that will give positive contribution for the environment as well as the

image of the company and retrench of budget. So as conclussion, Fabianne Morine will support 5

prjocets as follow:

No Project's Name Investment

1 Development and roll out of snack foods and 27 M

2 development and introduction of new

artificially sweetened yogurt and ice cream

27 M

3 Market Expansion Southward 30 M

4 Market Expansion Northward 30 M

5 Fluent water treatment 6 M

Nigel Humbolt

In the article, Nigel Humbolt described as a managing director for Strategic Planning that

supported Initiatives aimed at growth as well as market share and he also known for asking

difficult and challenging question about Euroland’s core business, its maturity and profitability.

From this description, we can say that Humbolt realize the importance of growth and from his

point of view, in the 2000s the company already on the peak of its business cycle curve. His

opinion can be supported by reported gross sales and net income. As been shown in Exhibit 2,

we can see that the growth of gross sales almost stagnant from 1999 until 2000. Worse condition

happened on Net income where the amount of Net Income constantly decreases from 1999 until

2000. This situation show that the product of this company already worn out, its market already

saturated and can not create better profit anymore.

Based on this argument, Humbolt suggested that the company should take an action to

“recycle” its business cycle by acquiring another growing profitable company with different

industry and of course different product. Based on his analysis, he proposed to Company to buy

leading schnapps brand. Depart from his opinion about recent company condition, He believe

that, combined with proven company’s branding skill, this diversification acquisition will

increase the profitability of the company, refresh the business cycle and finally will increase the

growth as well as the market share of the company.

He also prepared a financial performance analysis on this project as follow:

Indicator Value   Total Disbursement 60Net Present Value-WACC 69.45Net Present Value-ROR 59.65Internal Rate of Return 27.5Equity annuity 10.56Payback 5Profitability Index 1.82   

From the financial calculation He also was able to show that even though this project

need high initial investment, around €60 million but this amount will be compensated by high

cash inflow that together will result in high positive NPV, Internal Rate of Return and also good

profitability index (69.45, 27.5, and 1.82, respectively). This project also will be paid back in the

shorter time compared to maximum payback accepted. Given this analysis, He believe that this is

the most suitable project for the Euroland Foods.

In addition, since this project only required €60 million of Fund, so there will be idle fund

around 60 million that can be allocated to other projects. Recall his conviction that the business

and its products already on the peak of business cycle and product cycle, He will dismiss all of

the project that concern with efficiency as well as expansion of market for old product. In his

opinion, these kind of projects will give very small impact on the growth of the company. In

addition, given his concern on the market share, instead of those kind of projects, he will choose

the project that introduce new product with new product cycle and new opportunity of market

share. Based on that explanation, he will support the Development and introduction of new

artificially sweetened yogurt and ice cream and Development and roll out of snack food with

expenditure €27 million each. Given this decision, Nigel Humbolt proposes 3 kinds of project:

acquisition, new artificial sweetened yogurt and ice cream, and development snack food with

total expenditure amounting to €114 million.