The Euroland Foods Case Study
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The Background
The Euroland Foods case study provides a summary of the company as of 2001. Over the past few years, the company had been struggling to stimulate an increase in revenues. Euroland has intentions of investing in a variety of projects in hopes of achieving this stimulation, but the company is severely overleveraged. The budget for near-future investments reflects this leveraging. In an attempt to lower the debt-to-equity ratio, the budget was set not to allow any new debt financing. The following case analysis will provide a synopsis of the company, a brief overview of the proposed projects, and a recommendation as to what will be the most profitable course of action for the company while staying within the proposed budget.
Euroland Foods is a multinational corporation in the business of producing flavored water, fruit juice, high quality ice cream, and yogurt. It was established by Theo Verdin , in 1924, as an extension of his existing dairy business. As a result of Verdins attention to product development and marketing strategies, the business developed steadily over the years. In 1979, the Euroland went public, and by 1993 it was being traded on the Frankfurt, London, and Brussels exchanges. In 2000, Eurolands sales had realized sales of almost 1.6 billion euros.
The primary markets for Euroland are Belgium, where the company is headquartered, Britain, northern France, western Germany, the Netherlands, and Luxembourg. Ice cream is the companys primary revenue generator, with 60% of revenues attributed to its sales. Yogurt sales accounted for 20% of revenue, and the remaining 20% of sales was split equally between fruit juices and bottled water. A loyal customer base that enjoyed the product drove ice cream sales. They enjoyed the product for its range of original flavors, its high butterfat content, and other notable ingredients.
The companys sales had not increased since 1998. Management believed it to be partially because of low population growth in northern Europe. Euroland was operating in the midst of a highly saturated market. Outside observers had a different opinion. These observers suspected it was due to the fact that there had been a lack of successful recent product introductions. In order to boost sales, management wanted to address the two issues that were within Eurolands control. Managers wanted to expand the companys market and introduce new products to stimulate an increase in revenue. In addition to increasing revenue, management hoped that these actions would increase the companys market value. The companys P/E ratio is lower than its competitors, and its brands have minimal market value.
A committee of senior managers prepares a capital budget annually. This committee consists of the President Director General (PDG), the Director of Finance, and five other managing directors. The PDG would receive project recommendations from the managing directors. These recommendations would include a short explanation of the project, financial projections, and a discussion of different strategies that could be involved. Per Eurolands policy, there were two financial tests to which each proposal was subject: internal rate of return (IRR) and payback period. The management committee had established these tests in 1999. The tests differed depending on the type of project. This can be seen in Figure 1. The WACC, as of January 2001, was 10.6%. Trudi Lauf, Director of Finance, explained that the company uses the sliding scale IRR as a means of recognizing the levels of risk associated with each type of project proposal. The company expects to earn more return when taking on more perceived risk. She additionally explained that the company uses the payback test because Euroland is prepared to wait only a certain amount of time before achieving that return.
Euroland Foods board of directors consists of 12 members. Five members are prominent managers or figures in northern Europe, four are members from Eurolands management team, and three are members of the Verdin family. Twenty percent of the shares outstanding belong to members of the Verdin family. Executives of the company own another ten percent of the shares. A London-based mutual fund management company, by the name of Venus Asset Management, holds twelve percent of the shares, and Banque du Bruges et des Pays Bas owns nine percent as well as maintain one position on the board of directors. A wide range of investors holds the forty-nine percent of the company not owned by these members. Shares of the firm are traded throughout Germany, Brussels, and Frankfurt.
There are seven senior members of the management team who will be responsible for preparing the capital budget for the year. Each of the proposed investments is required to be sponsored by one of the managers. The team will decide on projects through a discussion period, then they will vote on at least two alternative budgets. Given the fact that the company has a debt-to-equity ratio of 125%, Eurolands bankers suggest Euroland embark on a plan to reduce its debt. For the company, this means avoiding any increase in debt until the ratio is at a more viable level. For 2001, the board of directors voted and unanimously agreed upon a capital budget of 120 million euros. Investment proposals that will be considered when deciding to allocate the capital budget can be seen in Figure 2.
The Proposals
Proposal 1: Replacement and Expansion of the Truck Fleet
Proposal one comes from Heinz Klink, Managing Director of Euroland foods. Klink would like to acquire 100 new trucks that are designed for refrigerating the distributed goods. This purchase would take place in two segments. The first segment would require the purchase of 50 trucks in 2001, and the second segment would require the purchase of another 50 trucks in 2002. This purchase would allow the company to sell the old, fully depreciated trucks over the two-year time span for just over 4 million euros. The newly purchased trucks would be larger and would allow a 15% increase of goods shipped each trip. The increase from 60 to 100 trucks would make for a more efficient distribution method, as schedules could be more flexible, delivery times could be cut, and loss of inventories could be reduced. In addition, the new trucks would be more fuel-efficient and costs could be cut in that aspect.
Figure 2 shows that the investment would cost 30 million euros and it would offer an increase of working capital equal to 3 million euros. An estimated savings and sales increase of 11.6 million euros would span a seven year time period. The IRR was an estimated 7.8%, which is slightly below the company required 8%. There