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Euro Land

Euro Land

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Published by vishaaal69

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Published by: vishaaal69 on Apr 10, 2010
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07/24/2013

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case are (in descending order): (1) to explore the problem of resource allocation withincorporations; (2) to illustrate and assess the impact of capital rationing on capital-investmentdecisions; (3) to exercise and interpret the implications of classic tools of investment analysis(e.g., net present value [NPV], internal rate of return [IRR], payback), and to consider possibleadjustments for differences among the projects in risk (e.g., through the use of risk-adjusteddiscount rates), size (e.g., through the profitability index), and life (e.g., through using equivalentannuities, replacement chains, or both); (4) to consider the impact of behavioral influences onfinancial decision making.
Case #23Euroland FoodSynopsis and Objectives
In January 2001, the senior management committee of this company has to decidewhich major projects should be funded for implementation by the company starting in2001. The board of directors has arbitrarily set a limit of (euros) EUR120 million to bespent on capital projects in 2001. Various managers, however, have proposed projectstotaling EUR316 million. The task is to evaluate the completed discounted cash flow(DCF) analyses which the case presents, along with qualitative factors (mainly strategicconsiderations and internal politics of the company), and to choose the projects to beapproved.The main objectives of this case are (in descending order):
To explore the problem of resource allocation within corporations.
To illustrate and assess the impact of capital rationing on capital investmentdecisions. The results usually reveal selection of economically suboptimal capital budgets.
To exercise and interpret the implications of classic tools of investment analysis(e.g., net present value [NPV], internal rate of return [IRR], payback), and toconsider possible adjustments for differences among the projects in risk (e.g.,through the use of risk-adjusted discount rates), size (e.g., through the profitabilityindex), and life (e.g., through using equivalent annuities, replacement chains, or  both).
To consider the impact of behavioral influences on financial decision making. Theroles in this case are overlaid with numerous possible conflicts among thedecision makers: cross-cultural, cross-functional, and political. The caseillustrates the potential effect of those conflicts, and provides some insights intoremedies.
Suggested Questions
 
1.Prepare to discuss the strengths and weaknesses of the various measures of investment attractiveness as used by Euroland Foods. Will all of the measuresrank the projects identically? Why or why not?2.Please rank the 11 proposals on the basis of purely economic considerations. Thenrank them a second time based on any other considerations that you believe areimportant. Are the rankings identical? Why or why not?3.Which set of projects should Wilhelmina Verdin recommend to the board of Euroland Foods for the capital budget for 2001?
Capital Rationing
Exists whenever enterprises cannot, or choose not to, accept all value-creatinginvestment projects. Possible causes:
 banks and investors say “No”
managerial conservatism
Analysis is required. One must consider sets of projects, or “bundles,” rather thanindividual projects. The goal should be to identify the value-maximizing bundleof projects.
The danger is that the capital-rationing constraint heightens the influence of nonfinancial considerations, such as the following:
competition among alternative strategies
corporate politics
 bargaining games and psychologyThe outcome could be a suboptimal capital budget, or, worse, one that destroysvalue
Some remedies are the following:
relax or eliminate the budget constraint
manage the process rather than the outcomes
develop a corporate culture committed to value creation

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