Pan Europa Foods is company, located in Brussels, Belgium, producing high-quality ice cream, yogurts, bottled water and fruit juices. Its products are sold throughout Scandinavia, Britain, Belgium, the Netherlands, Luxemburg, western Germany and northern France. In January 1993, the senior-management committee of Pan-Europa Foods must decide which major projects to fund for that year. The available funds for implementation is set as 80 million euros. However various managers, have proposed projects totalling 208 million euro. Capital rationing has been identified as the main problem that the management of the company has to deal with. The management has to identify projects that would best achieve benefits of strategic importance. Problem statement
According to case there is no evidence that projects would be proposed with some alignment to any strategy, mission or vision. There are only few criteria defined that projects should apply to, like Minimum Payback period, expected IRR, etc. There is no strictly defined project selection methodology in place. The project selection is based on the discussions and voting by the seven managing directors. The financial tests were the payback period and internal rate of return, which meant that the time value of money was ignored. Analysis
The current funding for Pan Europa is mainly rooted in debt financing – debt-to-equity ratio is 125%, that is more higher than most of they peers have. After price war is over, Pan Europa bankers strongly recommended to reduce debt level significantly. Therefore company should pay attention on actions how to decrease capital spending. There might be several finance based methods for project evaluation in place, like NPV, Annuity (due to project characteristics), IRR, etc. And the results for evaluation might differ significantly. Like, if we are looking for long term activities, then, using annuity calculation we will find that preferred project would be the Strategic Acquisition. Projects sorted by this figure would be: Strategic Acquisition
Expansion Inventory Control System
New Plant Expanded
Conveyor System Expand
Truck Fleet Effluent Treatment Program (which has no NPV) While the Effluent Treatment Program has no formal NPV it can be considered an investment of 4M now to save a cost of 10M in 4 years. In fact, there are many aspects that could invalidate the simple NPV analysis of the projects. They include Risk Political considerations Regulatory issues including health, safety and environmental Incompatibility with corporate strategy Resource availability Strictly speaking there are no ‘must to do’ projects on the desk. Water treatment project (Effluent Treatment) is upcoming in nearest future. But right now there is no evidence that this project has to be started right now. The new regulation might come in 4 years, but might be postponed as well. Of course this project shouldn’t be forgotten. All existing project might be split in a following sections: Increase efficiency
Extension (either new plant building or new market capturing) R&D
Regarding risk assessment, Projects that involve small technology changes like expanding the truck fleet would have low risk. Increasing levels of technological sophistication such as automation or introducing artificial sweeteners into products would also increase implementation risks. From financial perspective as the risk area we should consider that any producer in a capitalist environment is attempting to increase markets with new products in new areas. The prospective customers may simply choose to not buy the product. There are many risks regarding project implementation itself, like project size, complexity and length of the period of return, etc. Meanwhile tangible risks, there are several aspects, like correlation between several projects.
For instance market expansions will come together with necessity to increase ability to deliver goods to consumers location (most probably truck fleet upgrade will be required). All projects mentioned in case are evaluated against financial figures, but besides financial aspects, there are several non-quantitative points included. Projects that impact the company’s regulator compliance such as effluent treatment (environment) and warehouse automation safety. Several of the projects could impact the company’s image. For example, the focus on low fat products (artificial sweetener project) might increase companies reputation. Prospective Project evaluation should be done based on several factors. One of the most important points is financial benefits evaluation. There might be following characteristics taken in account for evaluation: Does the project fits in corporate strategy?
Expected cost level, does it exceeds Tolerable Cost Value.
Maximum payback period analysis.
IRR evaluation, does the project meet minimum IRR?
Risk analysis – does the project incur high risk?
Financial characteristics were chosen due to significant information presence in case. Besides financial aspects several other might be taken in consideration, for instance – social factors (staff treatment), then company would focusses more on projects improving environment for labor force. Applying screens and criteria mentioned above and strictly following companies internal rules, the following projects would be eliminated outright: Truck Fleet upgrade because it does not meet the minimum IRR and exceeds the maximum payback period dictated by company policy. New Plant, Plant Expansion, Artificial Sweetener and Plant Automation all because they exceed the maximum payback period dictated by company policy. Strategic Acquisition would be eliminated due to excessive risk.