STUDY CASE

CAPITAL BUDGET ALLOCATION: EUROLAND FOODS S.A. (1988)

Financial Management Course

Study 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 managers 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 firms 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
companys leading product had a loyal based of customers. But since 1998 the Euroland Foods
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 newproduct introductions. Most members of management wanted to expand the companys presence
introduce more new products to boost sales that would improved the companys 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 companys 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).
Minimum
Type of Project

1.
2.
3.
4.

Acceptable

Maximum Acceptable

Payback Year
IRR
New product or new markets
12%
6 year
Product or market extension
10%
5 years
Efficiency improvements
8%
4 years
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

: Managing Director for Distribution

: Oversaw transportation, warehousing, and order-fulfillment
: Spoilage, transport cost, stock-outs, and control system

Main Concern
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 companys 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 Leyden
Profile
Position
: Managing Director for Production Purchasing
: Managed production operation at the companys 14 plants
Job Desk
Main Concern : 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 extension
Advantages:
- 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 line
Objective : Efficiency
Advantages
:
- Improve Speed in production
- Reduce Accident
- In turn will reduce potential cost related to compensation of injury
d. Effluent-water treatment at four plants
Brief description:
Set up the water treatment equipment to reduce poisonous chemical.
Objective :
Society and Environment/meet legal requirement
Advantages:
- 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

Main

management
: Production cost control

Concern
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

Main

changes in geographical sales coverage

: Rapid expansion and geographical positioning

Concern
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
Job Desk
Main

: Managing Director for Strategic Planning

: Set up strategic planning staff
: Growth and Market share

Concern
Project
a. Acquisition of a leading schnapps brand and associated facilities
Brief description: Making diversifying acquisitions in an effort to move beyond
companys 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
companys long term growth. The recent companys difficulties are become her concern as well.
The previous three years financial reports show the Eurolands low growth, earning per share,
and market value of the company. It is a bad sign for the companys future operation continuity
and current performance. To increase the values, company must develop strategies by increasing
the growth.
Companys 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 companys 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
companys 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
1
2
3
4

Investment
Projects Name
Expand Southward
Expand Eastward
New Plant
Expanded Plant

(in )
30M
30M
45M
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 companys leverage and
voiced the stakeholders concerns and frustrations.
By expanding the market southward and eastward, it is support the companys profitability,
which in turn increases the assets and equity balance and reduces the companys leverage.
Company must aware of the cost efficiencies. The use of artificial sweetener for companys
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 companys 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 companys market value.
To maintain the financial sustainability and to satisfy the stakeholders interests, the capital
budget would be as follow:
No
1
2
3
4
5

Investment
Projects Name
Expand Southward
Expand Eastward
Artificial Sweetener
Inventory-Control System
Effluent water

(in )
30M
30M
27M
22,5M
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.
2.
3.
4.
5.

The new fleets would be more fuel and maintenance efficient

The new fleets could load more goods on each trip (15% increase)
More flexible scheduling and more efficient routing and servicing of the fleets
Shorter delivery times and cut inventories
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.
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
1
2

Project's Name
Replacement and expansion of new truck fleet
Networked, computer-based control inventorycontrol

3
4

system

for

warehouses

representatives
A New Plant in Dijon
Expansion Plant in Nuremberg

and

Investment
33 M
22.5 M

field
45 M
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
companys 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 Foods 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 its 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, its 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
1
2
3
4

Project's Name
Market Expansion Southward
Market Expansion Northward
Replacement and expansion of new truck fleet
Networked, computer-based control inventorycontrol

system

for

warehouses

and

Investment
30 M
30 M
33 M
22.5 M

field

representatives

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
Net Present ValueWACC
Net Present Value-ROR
Internal Rate of Return
Equity annuity

27

27

3.74
1.79
13.4
0.32

13.43
10.97
20.5
1.94

Payback
Profitability Index

7
0.64

5
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 products, 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 tendention 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 conclusion, Fabianne Morine will support 5
projects as follow:
No

Project's Name

Investment

1
2

Development and roll out of snack foods and

27 M
development and introduction of new 27 M

3
4
5

artificially sweetened yogurt and ice cream

Market Expansion Southward
Market Expansion Northward
Fluent water treatment

30 M
30 M
6M

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 Eurolands 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 cannot 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 companys 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
Net Present Value-WACC
Net Present Value-ROR
Internal Rate of Return
Equity annuity
Payback
Profitability Index

60
69.45
59.65
27.5
10.56
5
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 believes 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 kinds 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 kinds 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.