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PDF Project Selection Case Pan Europa DD
PDF Project Selection Case Pan Europa DD
The Company
Pan-Europa Foods, headquartered in Brussels, Belgium, was a multinational
producer of high-quality ice cream, yogurt, bottled water, and fruit juices. Its
products were sold throughout Scandinavia, Britain, Belgium, the Netherlands,
Luxembourg, western Germany, and northern France. (See Exhibit 1 for a map of
the company’s marketing region.)
The company was founded in 1924 by Theo Verdin, a Belgian farmer, as an
offshoot of his dairy business. Through keen attention to product development,
and shrewd marketing, the business grew steadily over the years. The company
went public in 1979 and by 1993 was listed for trading on the London, Frankfurt,
and Brussels exchanges. In 1992, Pan-Europa had sales of almost EUR 1.1 billion.
Ice cream accounted for 60 percent of the company’s revenues; yogurt, which was
introduced in 1982, contributed about 20 percent. The remaining 20 percent of
sales was divided equally between bottled water and fruit juices. Pan-Europa’s
flagship brand name was “Rolly,” which was represented by a fat, dancing bear in
farmers’ clothing. Ice cream, the company’s leading product, had a loyal base of
customers who sought out its high butterfat content, large chunks of chocolate,
fruit, nuts, and wide range of original flavors.
Pan-Europa sales had been static since 1990 (see Exhibit 2), which management
attributed to low population growth in northern Europe and market saturation in
some areas. Outside observers, however, faulted recent failures in new product
market presence and introduce more new products to boost sales. These managers
hoped that increased market presence and sales would improve the company’s
market value. Pan-Europa’s stock was currently at eight times earnings, just below
book value. This price/earnings ratio was below the trading multiples of
comparable companies, but it gave little value to the company’s brands.
EXHIBIT 2
2 Summary of Financial Results (all values in
millions except per-share amounts)
Fiscal Y
Year
ear Ending December
December 31
1990 1991 1992
Gross sales 1,076 1,072 1,074
Net income 51 49 37
81721_Ch02
_ iindd 89 9/16/08 11:36:06 PM
Earnings per share 0.75 0.72 0.54
Dividends 20 20 20
Total assets 477 580 656
Shareholder
Share holders’
s’ equity 182 206 235
(book value)
Shareholders’ equity 453 400 229
(market value)
Resource Allocation
The capital budget at Pan-Europa was prepared annually by a committee of senior
managers who then presented it for approval by the board of directors. The
committee consisted of five managing directors, the président directeur-général
(General Director President - PDG), and the finance director. Typically, the PDG
1.
2. New product
Product or new
or market markets
extension 12%
10% 6
5 years
years
3. Efficiency improvements 8% 4 years
4. Safety or environmental No test No test
In January 1993, the estimated weighted-average cost of capital (WACC) for Pan-
Europa was 10.5 percent. In describing the capital-budgeting process, the finance
director, Trudi Lauf, said, “We use the sliding scale of IRR tests as a way of
recognizing differences in risk among the various types of projects. Where the
company takes more risk, we should earn more return. The payback test signals
that we are not prepared to wait for long to achieve that return.”
81721_Ch02 indd 90 9/16/08 11:36:06 P
multiples of all companies on the exchanges where Pan-Europa was traded. This
was attributable to the recent price wars, which had suppressed the company’s
profitability, and to the well-known recent failure of the company to seize
significant market share with a new product line of flavored mineral water. Since
January 1992, all of the major securities houses had been issuing “sell”
recommendations to investors in Pan- Europa shares. Venus Asset Management in
London had quietly accumulated shares during this period, however, in the
expectation of a turnaround in the firm’s performance. At the most recent board
meeting, the senior managing director of Venus gave a presentation in which he
said:
At the conclusion of the most recent meeting of the directors, the board voted
unanimously to limit capital spending in 1993 to EUR 80 million.
reducing leverage on the balance sheet. Also had voiced the concerns and
frustrations of stockholders.
• Heinz Klink
Klink (German), managing director for Distribution, age 49.
Oversaw the transportation, warehousing, and order-fulfillment activities in
the company. Spoilage, transport costs, stock-outs, and control systems
were perennial challenges.
• Maarten Leyden
Leyden (Dutch), managing director for Production and
Purchasing, age 59. Managed production operations at the company’s 14
plants. Engineer by training. Tough negotiator, especially with unions and
suppliers. A fanatic about production-cost control. Had voiced doubts
d oubts about
its Melun, France, manufacturing and packaging plant. At present, some of the
demand was being met by shipments from the company’s newest, most efficient
facility, located in Strasbourg, France. Shipping costs over that distance were high,
however, and some sales were undoubtedly being lost when the marketing effort
could not be supported by delivery. Leyden proposed that a new manufacturing
and packaging plant be built in Dijon, France, just at the current southern edge of
Pan-Europa’s marketing region, to take the burden off the Melun and Strasbourg
plants.
The cost of this plant would be EUR 25 million and would entail EUR 5 million
for working capital. The EUR 14 million worth of equipment would be amortized
over seven years, and the plant over ten years. Through an increase in sales and
depreciation, and the decrease in delivery costs, the plant was expected to yield
after-tax cash flows totaling EUR 23.75 million and an IRR of 11.3 percent over
the next ten years. This project would
w ould be classified as a market extension.
3. Expansion of a plant.
and the plant over ten years. The increased capacity was expected to result in
additional production of up to EUR 1.5 million per year, yielding an IRR of 11.2
percent. This project would be classified as a market extension.
4. Development and introduction of new artificially sweetened yogurt and ice
cream.
Fabienne Morin noted that recent developments in the synthesis of artificial
sweeteners were showing promise of significant cost savings to food and beverage
producers as well as stimulating growing demand for low-calorie products. The
challenge was to create the right flavor to complement or enhance the other
ingredients. For ice-cream manufacturers, the difficulty lay in creating a balance
that would result in the same flavor as was obtained when using natural
sweeteners; artificial sweeteners might, of course, create a superior taste.
EUR 15 million would be needed to commercialize a yogurt line that had received
promising results in laboratory tests. This cost included acquiring specialized
production facilities, working capital, and the cost of the initial product
savings and depreciation totaling EUR 2.75 million per year for the project were
expected to yield an IRR of 8.7 percent. This project would be classed in the
efficiency category.
6. Effluent water treatment at four plants.
Pan-Europa preprocessed a variety of fresh fruits at its Melun and Strasbourg
plants. One of the first stages of processing involved cleaning the fruit to remove
dirt and pesticides. The dirty water was simply sent down the drain and into the
Seine or Rhine rivers. Recent European Community directives called for any
waste water containing even slight traces of poisonous chemicals to be treated at
the sources and gave companies four years to comply. As an environmentally
oriented project, this proposal fell outside the normal financial tests of project
Marco Ponti pointed out that eastward expansion meant a higher possible IRR but
that moving southward was a less risky proposition. The projected IRRs were 21.4
percent and 18.8 percent for eastern and southern expansion, respectively. These
projects would be classed in the new market category.
9. Development and roll-out of snack foods.
Fabienne Morin suggested that the company use the excess capacity at its Antwerp
spice and nut processing facility to produce a line of dried fruits to be test-
marketed in Belgium, Britain, and the Netherlands. She noted the strength of the
Rolly brand in those countries and the success of other food and beverage
companies that had expanded into snack-food production. She argued that Pan-
Europa’s reputation for wholesome, quality products would be enhanced by a line
of dried fruits and that name association with the new product would probably
even lead to increased sales of the company’s other products among health-
conscious consumers.
Equipment and working capital investments were expected to total EUR 15
million and EUR 3 million, respectively, for this project. The equipment would be
depreciated over seven years. Assuming the test market was successful, cash flows
from the project would be able to support further plant expansions in other
strategic locations. The IRR was expected to be 20.5 percent, well above the
required return of 12 percent for new-product projects.
10. Networked, computer-based inventory-control system for warehouses and field
representatives.
Heinz Klink had pressed for three years unsuccessfully for a state-of-the-art
computer-based inventory-control system that would link field sales
representatives, distributors, drivers, warehouses, and even possibly retailers. The
benefits of such a system would be shortening delays in ordering and order
processing, better control of inventory, reduction of spoilage, and faster
recognition of changes in demand at the customer level. Klink was reluctant to
quantify these benefits, because they could range between modest and quite large
amounts. This year, for the first time, he presented a cash-flow forecast, however,
that reflected an initial outlay of EUR 12 million for the system, followed by EUR
3 million in the next year for ancillary equipment. The inflows reflected
depreciation tax shields, tax credits, cost reductions in warehousing, and reduced
inventory. He forecasted these benefits to last for only three years. Even so, the
project’s IRR was estimated to be 16.2 percent. This project would be classed in
determined that cordials and liqueurs offered unusual opportunities for real growth
and, at the same time, market protection through branding. He had identified four
small producers of well-established brands of liqueurs as acquisition candidates.
Following exploratory talks with each, he had determined that only one company
could be purchased in the near future, namely, the leading private European
manufacturer of schnapps, located in Munich.
The proposal was expensive: EUR 15 million to buy the company and EUR 25
million to renovate the company’s facilities completely while simultaneously
expanding distribution to new geographical markets. The expected returns were
high: after-tax cash flows were projected to be EUR 134 million, yielding an IRR
Conclusion
Each member of the management committee was expected to come to the meeting
prepared to present and defend a proposal for the allocation of Pan-Europa’s
capital budget of EUR 80 million. Exhibit 3 summarizes the various projects in
terms of their free cash flows and the investment-performance criteria.
project.
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