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Case Analysis

on

PEPSICO CHANGCHUN JOINT VENTURE:

CAPITAL EXPENDITURE

ANALYSIS

Case Analysis on PEPSICO CHANGCHUN JOINT VENTURE: CAPITAL EXPENDITURE ANALYSIS 1
Case Analysis on PEPSICO CHANGCHUN JOINT VENTURE: CAPITAL EXPENDITURE ANALYSIS 1

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Case Analysis on PEPSICO CHANGCHUN JOINT VENTURE: CAPITAL EXPENDITURE ANALYSIS

Submitted to:

M. Sadiqul Islam, Ph.D. School of Business

Submitted by: (Section B) SherminaPerveen

-

Protap Kumar Roy

-

112 131 049 112 131 050

Thofa Tazkia

- 112122029

Case Analysis on PEPSICO CHANGCHUN JOINT VENTURE: CAPITAL EXPENDITURE ANALYSIS Submitted to: M. Sadiqul Islam, Ph.D.

United International University

Date of Submission: 1 st September, 2014

Case Analysis on PEPSICO CHANGCHUN JOINT VENTURE: CAPITAL EXPENDITURE ANALYSIS Submitted to: M. Sadiqul Islam, Ph.D.

2

  • 1 st September, 2014

M. Sadiqul Islam, Ph.D. School of Business United International University

Letter of Transmittal

Subject: Request to Accept Term Paper

Dear Sir,

We are very pleased to submit the term paper on Case Analysis on PEPSICO CHANGCHUN JOINT VENTURE: CAPITAL EXPENDITURE ANALYSIS ”. We were assigned to prepare and submit this term paper as the partial fulfilment of the course entitled Capital Investment Decision (FIN - 622).We have tried our best to solve this case perfectly.

We would request you to please accept this term paper. We are ready to make you clear regarding any confusion or further clarification from this paper.

Sincerely yours,

--------------------------------------------

SherminaPerveen ID: 112 131 049; Section: B Program: M.B.A; Semester: Fall 2013 (On behalf of the group)

1 September, 2014 M. Sadiqul Islam, Ph.D. School of Business United International University Letter of Transmittal

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ACKNOWLEDGEMENT

At first we want to thank the almighty GOD for his endless blessings and mercy. The almighty gave us enough hardworking capability and persistence which allowed us to complete this business plan.

It is a real pleasure to express our deepest appreciation, sincere gratitude and heartiest gratefulness to our course instructor M. Sadiqul Islam, Ph.D.for his constant guidance, helpful suggestion and valuable assistance. He helped us by giving his valuable time throughout this course. His encouragement and motivation helped us to overcome all the difficulties.

Finally our deepest thanks to all of our friends for life long encouragement.

ACKNOWLEDGEMENT At first we want to thank the almighty GOD for his endless blessings and mercy.

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COPYRIGHT

This is to inform you that this Case Analysis on Pepsico Changchun Joint Venture: Capital Expenditure Analysis has prepared by the student of M.B.A as a requirement of our Capital Investment Decision (FIN - 622)course under course instructor’s (M. Sadiqul Islam, Ph.D.) guidance and it is fully academic basis. So copying a sentence or any part of the paper is strictly prohibited without prior permission from the authority.

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SherminaPerveen ID: 112 131049; Section: B Program: M.B.A; Semester: Fall -2013 (On behalf of the group)

COPYRIGHT This is to inform you that this “ Case Analysis on Pepsico Changchun Joint Venture:

v

Table of Content

Sl.

Particular

Page

  • 01 Introduction

:

07

  • 02 Analysis of Economy

:

08

  • 03 Analysis of Industry

:

 
  • 3.1 Porter’s Five (05) Factors:

:

09

  • 3.2 PESTEL analysis

:

13

  • 04 Analysis of Company

:

 
  • 4.1. Ratio Analysis

:

15

  • 4.2. Du-Point Analysis

:

16

  • 4.3. Capital Budgeting

:

17

  • 4.4. Weighted Average Cost of Capital (WACC)

:

19

  • 4.5. Risk Analysis

:

21

  • 4.6. SWOT

:

22

  • 05 Statement of the Problem

:

23

  • 06 Alternative Courses of Action

:

24

  • 07 Analysis of Each Alternative

:

25

  • 08 Recommendation:

:

29

Appendix

Table of Content Sl. Particular Page 01 Introduction : 07 02 Analysis of Economy : 08

vi

1. Introduction

Donald M. Kendall of Pepsi-Cola and Herman W. Lay of Frito-Lay founded PepsiCo, Inc. through the merger of both companies in 1965. Caleb Bradham, who was a N.C.pharmacist, created the Pepsi-Cola company itself during the 1890s .The Frito-Lay, Inc. was formed during 1961 through a merger of the Frito Company and the H. W. Lay Company. Herman Lay is the chairman of the Board of Directors of the newly created PepsiCo company while Donald M. Kendall is president and chief executive. The new company has 19,000 employees and sales of over 500 million dollars per year. Some of the products of the Pepsi-Cola Company are Pepsi-Cola which was developed in1898, Diet Pepsi developed in 1964 and Mountain Dew, created in 1948.

PepsiCo is currently involved in 7 Joint ventures in People’s Republic of China (PRC) and is in the proposal process of investing into an equity joint venture in the city of Changchun.This proposal

would be one of the first two green field equity joint venture with PepsiCo having control over both the board and day-today managmenet. PepsiCo uses capital budgeting tools such as NPV and IRR to systematically evaluate their investment project. Using this evaluation method Mr Hawaux, vice president of Finance for PepsiCo East Asia, was wondering whether this project would be profitable and if PepsiCo should proceed with the Changchun Joint Venture. The Central Government of PRC had made it difficult for foreign compaies to enter the PRC market. The only acceptable method of entry was through a joint venture with a local chinese firm. To attract foreign investors, the equity joint venture was established. This meant that the foreign company would invest a maximum of 60% ownership share into the entity, while the remaining 40% would be invested by the local chinese

company. PepsiCo’s equity joint venture is proposed to be with two local chinese companies.

PepsiCo would hold 57.5% interest in the joint venture, while 37.5% by Second Food Factory and the remaining 5% by Beijing Chong Yin Industrial & Trading Company. Mr. Hawaux needs to determine

the attractiveness of the project’s risk and return prospects.

1. Introduction Donald M. Kendall of Pepsi-Cola and Herman W. Lay of Frito-Lay founded PepsiCo, Inc.

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2. Analysis of Economy

Real GDP of Germany grew by 1.5 percent in 1999 with activity accelerating in second half of the year. The upswing is export driven, but domestic demand is also gaining strength. Buoyant incoming orders, both domestic and foreign, improving business sentiment and rising capacity utilization all point to a further acceleration of activity. Stronger consumption and investment are underpinned by phased income tax reductions for both households and business. Growth is therefore expected to accelerate to around 3 percent in 2001.

Sales to the dynamic Asian countries and Japan as well as to Latin America and Eastern Europe improved markedly, and stronger growth in the European Union also supported German exports. Activity was underpinned by steady growth of private consumption, which benefited from increasing real disposable income. Investment in equipment also remained robust though continuing to slow down in the second half. The recession in the construction appears to have ended.

Industrial production continued to rise and forward looking indicators suggest that the upswing is continuing. Incoming orders in manufacturing have been buoyant since mid-1999, indicating acceleration in domestic demand. Capacity utilization in manufacturing has risen to its highest level since 1991, and business sentiment has improved substantially.

2. Analysis of Economy Real GDP of Germany grew by 1.5 percent in 1999 with activity

8

3. Analysis of Industry

3.1 Porter’s Five (05) Factors:

The Porter Model is a depiction of the five forces that influence the competitive environment within the beer industry. The collective strength of these forces determines the ultimate profit potential of an industry. The main goal is to find a position in the industry where the company can either best defend it against the industry forces or gain benefits from them. The intra-industry rivalry lists the companies that the strategic business unit directly competes within the industry. Here the strategic business unit is Deutsche Brauerei. Its rivals are domestic and foreign beer companies. The model also identifies the suppliers and buyers that influence the competitive nature of the industry. It also shows substitute products and services as well as potential new entrants that can be seen as potential threats to the industry.

 

SUPPLIER POWER

 

Supplier concentration Importance of volume to supplier Differentiation of inputs Impact of inputs on cost or differentiation Switching costs of firms in the industry Presence of substitute inputs Threat of forward integration

Cost relative to total purchases in

industry

THREAT OF

NEW ENTRANTS

THREAT OF NEW ENTRANTS
 

Barriers to Entry

Absolute cost advantages Proprietary learning curve Access to inputs Government policy Economies of scale

THREAT OF SUBSTITUTES

-Switching costs -Buyer inclination to substitute

Capital requirements

-Price-

Brand identity

performance

Switching costs

trade-off of

Access to distribution

substitutes

Expected retaliation Proprietary products

 

BUYER POWER

DEGREE OF

Bargaining leverage

RIVALRY

Buyer volume Buyer information Brand identity

-Exit barriers -Industry concentration

Price sensitivity

-Fixed costs/Value

3. Analysis of Industry 3.1 Porter’s Five (05) Factors: The Porter Model is a depiction of

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Threat of backward integration Product differentiation Buyer concentration vs. industry Substitutes available

added -Industry growth -Intermittent overcapacity -Product differences -Switching costs -Brand identity -Diversity of rivals

-Corporate stakes

  • Intra-Industry Rivalry

Competition among sellers in the Beer Industry is based primarily on brand, quality, and packaging with price not embodying the most important factor. In recent years, the industry has also consolidated quite notably with the top four brewersAB Inbev, MillerCoors, Heineken, and Carlsberg--controlling 50% of the global share. With this consolidation and the resulting stronghold over the market, competition is increasing within the Beer Industry for distribution, raw material access, and customer loyalty.

The rise of the craft-brewing sector is another notable competitive development. The smaller brewer segment has gone from only 50 in 1983 to 828 in 2000. This segment continues to grow/gain share and has outperformed the overall beer category for 6 straight years as consumers are looking for newness, experimentation, and supporting smaller local brewers. Retail support has also been strong for this segment given its relatively higher margins as well as the four straight years of double digit growth the segment has seen in the supermarket venue. However, while the share of craft brewers has grown to 3% in 2000 from 0.6% in 1990, it is still dwarfed by the top four and often seen as a breeding ground for potential acquisitions for the large breweries as they look to find growth.

Lastly, import brand is another competitive set in the Beer Industry. Recent data shows imports are perceived as a higher-end product which appeals to the consumerimport share in the European market was up 1.9% in 2000 vs. domestic down 2.6%.

  • The Bargaining Power of Buyers (Customers)

Threat of backward integration Product differentiation Buyer concentration vs. industry Substitutes available added -Industry growth -Intermittent

10

The three components that make up the “buyers” of beer are made up of

distributors/wholesales, retailers/restaurants, and consumers. Distributor/wholesalers embody an essential link in the market channel for breweries here in the European market given regulations prohibiting the sale of beer directly to both retailers and consumers. Thus,

distributors/wholesalers have quite a bit of bargaining power and can impact market share by way of their support, marketing, and promotions depending on the incentives offered by the manufacturer.

Retailers and restaurants are another cog of the buyer channel. The main goal of the retailer is to drive traffic through their stores in order to improve sales and, coincidentally, balancing profit margins. As a result, retailers are looking to stock their shelves or bars with the beer products that are selling with a recent focus on more sub-premium brands due to the recent economic situation, as well as supporting their growth of craft beers which have been outgrowing the industry and offer higher average selling prices as well as higher margins.

Lastly, consumers ultimately drive the preferences of both the distributor and the retailer

channel as they are the end “user” of the beer beverage. With the plethora of beverage

choices in the market, both alcoholic and non-alcoholic, along with the consumer becoming increasingly knowledgeable, several themes have played out impacting the industry: As noted above, consumers are trading up to craft beers given consumers are drinking less as a whole and looking for more flavour when they do. Thus, the newness, interest in experimentation with unusual flavours, and, often, the desire to support local business is driving a shift to the smaller brewers. At the same time, the beer consumer is also economically sensitive so a trade down to less expensive sub-premium beers is occurringthus, squeezing the middle tier brands/players. Notable here is beer prices have grown ahead of inflation over the last 5-6 years and increasing excise taxes are also impacting the affordability of beer. Health and wellness (believe it or not) is also a theme playing out in the beer industry with strong consumer appeal for lower calorie, ultra-light beer.

  • The Bargaining Power of Suppliers

Competitive pressure from supplier bargaining power is considered to be generally low with respect to the industry as a whole. However, due to the high commodity raw material exposurearound 58% of industry cost of goods soldwhich include packaging

The three components that make up the “buyers” of beer are made up of distributors/wholesales, retailers/restaurants,

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(glass/aluminium/cardboard), barley, sugar, malt, corn, rice, wheat, hops and preservatives-- uncertainty regarding cost swings is high. Suppliers of these materials would include hops and grains suppliers, wheat and barley farmers, flour millers, corn/wheat/soybean wholesalers, sugar processors, wood pallet suppliers, cardboard box/container manufactures,

and glass product manufacturers. Thus, when recent “shocks” hit the commodities market,

i.e. Russia placing an export ban on wheat, brewers see their costs rise in accordance.

  • Possible New Entrants

While the Beer Industry has seen a boom of craft brewers enter the marketplace over the last five years, the barriers to entry still remain fairly high. The big brewers have significant economies of scale, the ability to spend large amounts on branding, marketing, and promotions, as well as somewhat of a lock on both the limited shelf space of the retailer as well as the distributor/wholesale channel with regulations limiting the number of distribution agreements on a regional basis. In addition, the process of brewing beer is very capital intensive with the manufacturing process and the branding involved. Lastly, as alluded to above, the industry is highly regulated and taxed on both a federal, state, and even local level.

  • Threat of Substitute Products and Services

The pressure from sellers of substitute products is considered medium to increasing. Recent data suggests both the wine and spirits industry are gaining share at the expense of beer. A 2000 Gallup Poll noted 36% of those surveyedpreferred beer to wind and liquordown from 41% in 1999. Within that, the all important 18-34 year old group saw its beer preference fall from 51% to 39%. Also notable, the per capital consumption of malt beverages has been steadily decliningfrom 24.6 gallons in 1981 to 22.6 gallons in 2000. The drivers to this include both the wine and spirits industries have increased both their promotions and pricing more aggressively versus beer, the growing perception of beer being less healthy and exotic than wine and spirits, demographics, and both increased alcoholic and non-alcoholic beverage competition.

(glass/aluminium/cardboard), barley, sugar, malt, corn, rice, wheat, hops and preservatives-- uncertainty regarding cost swings is high.

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3.2 PESTEL Analysis 3.2PESTEL analysis The PESTEL analysis is related to the structuring of the relationship

3.2 PESTEL Analysis

3.2PESTEL analysis

The PESTEL analysis is related to the structuring of the relationship between a business and its environment. The business environment which is ever changing can offer both opportunities and threats for any industry. It is essential for Deutsche Brauerei to study and understand their business environment by using the PESTEL framework. Changes in these external forces affect the types of products produced, the position of them, market strategies, types of services offered and choice of business.

P Political E Economic S Social T Technological E Environmental L Legal

Political

3.2 PESTEL Analysis 3.2PESTEL analysis The PESTEL analysis is related to the structuring of the relationship

Government organizing public events in order to make public aware about the effects

of alcohol consumption on the health. Government is imposing restrictions on consumption of beer and alcohol products.

If anyone is influenced by alcohol in doing crime they are fined with high penalty.

This initiative taken by the government was one of the reasons that transformed the buying behaviour of European market. Though would be classified under the head of social analysis the government intervention has caused the change in buying behaviour.

3.2 PESTEL Analysis 3.2PESTEL analysis The PESTEL analysis is related to the structuring of the relationship

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Economical

The government restrictions have lead to increase in sales of alcohol in supermarket.

Government campaigning and restriction on drinking resulted in decrease in the sale

of alcohol product consumption in clubs and pubs. Companies are trying to achieve economic of scale through cost reduction.

Brewing companies are engaged in various marketing strategy to grow their market

through acquisition, mergers and introducing premium products. Super markets are offering cut price offers.

Social

Growing number of people aware of health conscious and fitness

Because of beer side affect such as bloating, weight gain and gas people could have

been swayed to consume other alcohol beverages The trend in drinking at home is rising because of the government intervention

Technological

Technology had brought in efficiency and improved production.

Technology had definitely helped in receiving information.

Technology had helped in various departments. However as a result of incessant research and development the manufacturing units not only were able to obtaining the economies of scale but also over produced. This actually encouraged players to search for the market.

Environment

Pollution (A large number of glass and can consuming increases the environmental pollution)

Legal

Legal issues affect for beer industry when packaging, advertising and labelling. When

advertising beer products target consumer age must be over 21 years. Some of the countries such as Middle East and other Islamic countries advertising for beer products are banned.

Economical  The government restrictions have lead to increase in sales of alcohol in supermarket. 

14

15

15

4. Analysis of Company

4.1.Ratio Analysis:Ratios are standardizednumber which facilitates comparison. By

comparison, we can highlight the company’s performance at a glance. Here we also

used some traditional ratios to measure the financial performance of Deutsche Brauerei.

Actual Expected
Actual Expected
Actual Expected
Actual Expected
Actual Expected
Actual Expected
Actual Expected
Actual Expected
Actual Expected
Actual Expected
Actual Expected
Actual Expected
Actual Expected
 

Actual

Expected

1997

1998

1999

2000

2001

2002

2003

2004

2005

2006

2007

2008

2009

2010

1.32

1.03

1.15

1.34

1.27

1.25

1.21

1.18

1.15

1.12

1.10

1.08

1.07

1.05

0.88

0.73

0.84

0.88

0.84

0.84

0.83

0.81

0.79

0.77

0.75

0.74

0.73

0.72

10.11

10.45

10.46

7.14

7.14

7.14

7.01

6.60

6.20

5.81

5.42

5.05

4.70

4.35

39.83

40.30

49.30

52.98

56.42

59.03

60.03

63.77

67.88

72.45

77.55

83.23

89.56

96.60

1.77

2.18

3.02

4.37

4.97

5.76

6.97

8.68

10.81

13.46

16.77

20.88

26.01

32.39

1.10

1.20

1.38

1.48

1.54

1.60

1.63

1.64

1.63

1.60

1.54

1.48

1.40

1.32

53%

52%

53%

54%

57%

59%

68%

73%

78%

82%

85%

88%

90%

92%

3.83

4.80

4.65

4.66

4.90

5.06

4.52

4.52

4.52

4.52

4.52

4.52

4.52

4.52

23.58

30.85

36.74

35.06

36.51

38.01

10.02

8.94

8.07

7.37

6.81

6.36

6.00

5.71

3.58%

3.95%

2.82%

3.17%

3.52%

3.62%

3.47%

3.47%

3.47%

3.47%

3.47%

3.47%

3.47%

3.47%

8.03%

9.12%

8.20%

9.80%

10.46%

11.09%

11.21%

11.28%

11.19%

10.95%

10.58%

10.13%

9.61%

9.05%

3.93%

4.73%

3.89%

4.70%

5.41%

5.78%

5.67%

5.71%

5.67%

5.54%

5.36%

5.13%

4.86%

4.58%

8.40%

9.77%

8.35%

10.26%

12.70%

14.18%

17.97%

21.33%

25.33%

30.07%

35.71%

42.40%

50.34%

59.77%

2.14

2.07

2.15

2.19

2.35

2.45

3.17

3.73

4.47

5.43

6.66

8.27

10.35

13.05

19.65

23.43

20.45

25.80

32.97

38.17

41.72

47.57

54.23

61.82

70.48

80.35

91.61

104.44

11.91

10.39

12.38

10.20

8.30

7.46

7.30

6.85

6.43

6.04

5.67

5.32

4.99

4.68

40.21

45.27

43.41

54.07

65.51

73.73

83.08

94.72

107.98

123.11

140.35

160.01

182.42

207.97

5.82

5.38

5.83

4.87

4.18

3.86

3.67

3.44

3.23

3.03

2.85

2.67

2.51

2.35

2.35
                           

SL

Ratios

1

Current Ratio (Times)

2

Quick Ratio (Times)

Inventory Turnover Ratio

3

(Times)

4

Days Sales Outstanding (Days)

5

Fixed Asset Turnover (Times)

6

Total Asset Turnover (Times)

7

Debt Ratio (%)

Time Interest Earned Ratio

8

(Times)

EBITDA Coverage Ratio

9

(Times)

10

Profit Margin (%)

11

Basic Earning Power (%)

12

Return on Asset (%)

13

Return on Equity (%)

14

Equity Multiplier

15

EPS

16

Price Earning Ratio

17

Cash Flow Per Share

18

Price Cashflow Ratio

Stock Price

234

243

253

263

274

285

305

326

349

373

399

427

457

489

Number of Share Outstanding

112936

112936

112936

112936

112936

112936

112936

112936

112936

112936

112936

112936

112936

112936

Stock Price 234 243 253 263 274 285 305 326 349 373 399 427 457 489
Stock Price 234 243 253 263 274 285 305 326 349 373 399 427 457 489
Assumptions:
Assumptions:
  • Liquidity Ratios: Liquidity ratio generally includes Current Ratio and Quick Ratio. In case of Deutsche Brauerei, liquidity position is sufficient and stable. Its Current Ratio& Quick Ratio moves from 1.07 to 1.34 and from 0.72 to 0.88 respectively.From our point of view this is a good liquidity position because for Tk 1 of Liability, they have 1.21 (Avg.) of Current Asset and 0.8 (Avg.) Quick Asset.

  • Asset Management Ratios:Asset Management ratio generally includes Inventory turnover ratio, Days sales outstanding, Fixed asset turnover and total asset turnover ratio.Deutsche Brauerei’s inventory turnover ratio range is from 4.35 to 10.46 and it is increasing gradually day by day. Though it is a bad signal for the firm but as a independent distributor they must keep a certain amount of inventory. The DSO is also increasing because the strategy of Oleg Pinchuk (Sales & Marketing Manager) is Credit sales to increase its sales. Their credit policy is from 2/10, net 40 to 2/10, net 80 even they allow for 90 days for repayment. In this way, DSO increases. If

4. Analysis of Company 4.1. Ratio Analysis: Ratios are standardizednumber which facilitates comparison. By comparison, we

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we look at the Fixed asset turnover and Total asset turnover, both is increasing at a

increasing trend and it’s a good sign for the firm.

  • Debt Management Ratios: Debt management ratio includes Debt ratio, Time interest earned (TIE) ratio, and EBITDA Coverage ratio. In case of Deutsche Brauerei, the debt is increasing day by day with is ultimately increase its risk and reduce value. At the same time, TIE ratio is in increasing trend which shows its ability to cover interest expense by EBIT.

  • Profitability Ratio:Profit Margin ratio, Basic Earning Power, ROA and ROE indelicate the Profitability Position of a firm. The key profitability ratios those are ROA & ROE gives us a positive signal for the firm. That means return on asset and equity is increasing significantly in upcoming years.

  • Market Value Ratio:It consists of P/E Ratio and P/CF Ratio. For Deutsche Brauerei, the P/E ratio is decreasing. The main that we assume that it is the result of depending on Debt aggressively. But cash flow per share also increasing.

4.2. Du-Point Analysis:(For the year of 2001) = 0.1274

Profit Margin

Total Asset Turnover

Equity Multiplier

3.52%

1.54 times

2.35 times

Cost Control

Asset Utilization

Debt Utilization

  • Profit Margin: Profit margin generally shows the cost control system of a firm. Here, 3.52% of sales are Net Income & over the year it is increasing at a stable rate. (Details in ratio No. 10).

  • Total Asset Turnover: Asset utilization is shown by Asset Turnover Ratio which indicates Tk 1 investment in Total Asset will generate sales of Tk 1.54. Though is increasing but in a slower late.

  • Equity Multiplier:It is basically an indicator of Debt utilization. As Deutsche Brauerei, highly dependent on debt as a result their Equity multiplier is also increasing at a higher rate.

we look at the Fixed asset turnover and Total asset turnover, both is increasing at a

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4.3. Capital Budgeting:Capital Budgeting is the entire process of analysing a project and deciding on whether they should be included in the capital budget.

We refer to our case where the Management Budgeted for Investment of €7 million in a new plant and equipment.So, we want to analyze whether this decision would be right decision or wrong decision for the firm. To analyze this, we use capital budgeting technique at the same time we calculate the NPV and MIRR of this project.

Initial Investment

Initial Investment
Initial Investment

Plant & Equipment

7,000

Working Capital

9,477

Total

16477

Plant & Equipment 2008 2003 2004 2005 2006 2007 2002 2009 2010 4 20 4 20
 
Plant & Equipment
Plant & Equipment
2008 2003 2004 2005 2006 2007 2002 2009 2010 4 20 4 20 420 420 4
2008
2003 2004
2005
2006
2007
2002
2009
2010
4 20
4 20
420
420 4 20
4 20
4 20
4 20
4 20
4 20
2001
2001 2002 2003 2004 2005 2006 2007 2008 2009 2010

2001

2002

2003

2004

2005

2006

2007

2008

2009

2010

Net Sales

105,682

118,971

135,634

154,630

176,287

200,977

229,125

261,215

297,799

339,508

Less: Production costs and Expenses

61,393

71,609

73,569

83,873

95,620

109,012

124,279

141,685

161,529

184,152

Less: Admin and selling expenses

18,500

18,500

26,333

30,021

34,226

39,020

44,484

50,715

57,818

65,915

Less: Excise duties

11,625

13,087

17,558

20,017

22,821

26,017

29,661

33,815

38,551

43,950

Less: Depreciation

4

20

4

20

420

4

20

4

20

4

20

4

20

4

20

4

20

4

20

Profit Before Tax

13,744

15,355

17,753

20,299

23,200

26,508

30,280

34,580

39,482

45,070

Less: Tax

4,810

5,374

6,214

7,105

8,120

9,278

10,598

12,103

13,819

15,775

Profit After Tax

8,934

9,981

11,540

13,194

15,080

17,231

19,682

22,477

25,663

29,296

Add: Depreciation

4

20

4

20

420

4

20

4

20

4

20

4

20

4

20

4

20

4

20

Operating Cash Flow

9,354

10,401

11,960

13,614

15,500

17,651

20,102

22,897

26,083

29,716

Residual Value of plant & Equipment

 

2,450

Recovery of Working Capical

2

07

(761)

(681)

(563)

(457)

(362)

(277)

(202)

(135)

12,708

Net Operating Income

9,561

9,640

11,279

13,051

15,043

17,288

19,825

22,695

25,948

44,874

44,874
Year Cash Flow Discounted Cash Flow

Year

Cash Flow

Discounted Cash Flow

2000

(16,477)

(16,477)

 

2001

9,561

8,616

 

2002

9,640

7,830

 

2003

11,279

8,256

 

2004

13,051

8,610

 

2005

15,043

8,945

 

2006

17,288

9,264

 

2007

19,825

9,575

 

2008

22,695

9,878

 

2009

25,948

10,178

 

2010

44,874

15,864

 

NPV @ 10.96%=

80,539

80,539
 

Year

Cash Flow

Furure Value

 
  • 2001 9,561

24,373

 
  • 2002 9,640

9,640

 
  • 2003 11,279

11,279

 
  • 2004 13,051

13,051

 
  • 2005 15,043

15,043

 
  • 2006 17,288

17,288

 
  • 2007 19,825

19,825

 
  • 2008 22,695

22,695

 
  • 2009 25,948

25,948

 
  • 2010 44,874

44,874

Terminal Value =

204,015

MIRR =

28.61%

28.61%
4.3. Capital Budgeting: Capital Budgeting is the entire process of analysing a project and deciding on

18

From the above calculation, we can find that NPV of the project is 80,539 and Terminal Value is 204,015. The Marginal Rate of Return (MIRR) is 28.61%. As NPV and MIRR both are positive so we can accept this proposal which is Investment of €7 million in a new plant and equipment.

[N:B: Here we use our proposed WACC which is 10.96% as Discounting Rate]

Note 01:

11,732 11,275 10,712 10,031 9,270 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010
11,732
11,275
10,712
10,031
9,270
2000
2001
2002
2003
2004
2005
2006
2007
2008
2009
2010
12,094
(457)
9,477
Incremental of Working Capital
12,708
(135)
(202)
(277)
(362)
Working Capital
(563)
(681)
207 (761)
(9,477)
0
12,708
12,573
12,371

Note 02:

Tax on Capital Gain
Tax on Capital Gain

Cost of Plant & Equipment

7,000

 

Less: Accumulated Depreciation

4,200

 

Book Value

2,800

 

Sales Proceeds

2,450

 

Profit / (Loss) =

(350)

(350)
 
From the above calculation, we can find that NPV of the project is 80,539 and Terminal

19

4.4.Weighted Average Cost of Capital (WACC):

Cost of Debt (Kd)

=

0.10×(1-0.35)

0.0650

 

=

15÷(100×(1-0.06))

0.1596

Cost of Preferred Stock (Kp) Cost of Common Equity (Ke)

=

(0.03+((0.1-0.03)*1.1))+0.015

0.1220

Assumptions:

Cost of Debt = 10%, [We assume this interest rate for long term debt because we know that interest rate for long term debt is higher than interest rate for short term debt. From our case, we got that interest rate for short term debt is 6.5% at the same time we found that the interest rate in Euro zone is generally lower than Asia zoned like Bangladesh.]

Rate of Preferred Stock = 15%, [We propose to issue 15% tk 100 preferred stock, where Flotation Cost is 6% ]

Risk Free Rate = 3%, [the Govt. Bond Rate in Germany is close to this percentage on an average.]

Market Interest Rate = 10%,

Beta = 1.1

Flotation Cost Adjustment Factor for Common Stock = 1.5%

Alternative 01:

Cost of Debt

0.00

0.0650

0.0000

Cost of Prefered Stock

0.25

0.1596

0.0399

Cost of Common Equity

0.75

0.122

0.0915

 
 

WACC

(Alternative 01) =

0.1314

0.1314
Weight (W) Cost of Capital (K) W × K

Weight (W)

Cost of Capital (K)

W × K

Alternative 02:

Cost of Debt 0.33 0.0650 0.0215 Cost of Prefered Stock 0.17 0.1596 0.0271 Cost of Common
Cost of Debt
0.33
0.0650
0.0215
Cost of Prefered Stock
0.17
0.1596
0.0271
Cost of Common Equity
0.50
0.1220
0.0610
WACC
(Alternative 02) =
0.1096
Weight (W)
Cost of Capital (K)
W × K

Alternative 03:

Weight (W) Cost of Capital (K) W × K Cost of Debt 0.45 0.0650 0.0293 Cost
Weight (W)
Cost of Capital (K)
W × K
Cost of Debt
0.45
0.0650
0.0293
Cost of Prefered Stock
0.37
0.1596
0.0590
Cost of Common Equity
0.18
0.1220
0.0220
WACC
(Alternative 03) =
0.1103

WACC at a glance:

4.4.Weighted Average Cost of Capital (WACC): Cost of Debt (Kd) = 0.10×(1-0.35) 0.0650 = 15÷(100×(1-0.06)) 0.1596

20

13.14% 10.96% 11.03%
13.14%
10.96%
11.03%
(Alternative 01) = WACC WACC WACC (Alternative 03) = (Alternative 02) =
(Alternative 01) =
WACC
WACC
WACC
(Alternative 03) =
(Alternative 02) =

In alternative 01, where company use NO DEBT, the WACC is 13.14%. In this situation, company has no financial risk but Cost of Capital is higher. Then we restructure the Capital Components, where Debt is 33% and Equity is 67% (Alternative 02). In this case, the WACC has reduced to 10.96%. In alternative 03, we again rearrange the capital component in order to reduce the WACC. But the ultimate result has reversed. When we increase the Debt to 45%, it increases the WACC which is 11.03%.

From the above analysis, we come to a decision that the Optimal Capital Structure for Deutsche Brauerei should be:

33% 17% 50%
33%
17%
50%
Cost of Debt Cost of Prefered Stock Cost of Common Equity
Cost of Debt
Cost of Prefered Stock
Cost of Common Equity

In this capital structure the WACC is lower as well as it makes the company less attractive for LBO to acquisition firm. But we will be confident enough regarding this decision if this structure maximizes the value of the firm. [Will be discussed in later on]

13.14% 10.96% 11.03% (Alternative 01) = WACC WACC WACC (Alternative 03) = (Alternative 02) = In

21

4.5. Risk Analysis

4.5.1. Business Risk

  • Demand variability

The demand of Deutsche Brauerei’sbeerwas increasing for the past years, so there is a low degree of business risk.

  • Sales price variability

Deutsche Brauerei’sbeer is very high in quality and taste, and for this reason the company can

charge whatever price it wants. So Deutsche Brauerei’sbeer is exposed to a low degree of business risk.

  • Input cost variability

Deutsche Brauerei’s input costs are certain and exposed to a low degree of business risk.

  • Ability to adjust output prices for changes in input costs

Deutsche Brauereiis able to raise their beer’s output prices when input costs rise. So in this

segment they have lowered the degree of business risk.

  • Ability to develop new products in a timely, cost-effective manner

Deutsche Brauereibeer has the ability to develop new products in a timely with cost effective

manner.

  • Foreign risk exposure

Deutsche Brauerei generates a high percentage of their earnings overseas are subject to earnings declines due to exchange rate fluctuations. So Deutsche Brauerei has business risk in this segment.

Degree of Operating Leverage:

Net Sales (in €) Degree of Operating Leverage (DOL) Net Sales (in Unit) Operating Profit
Net Sales (in €)
Degree of
Operating
Leverage (DOL)
Net Sales (in Unit)
Operating Profit
1,970 2,246 2,561 2,919 1,728 10,697 9,383 8,327 7,398 6,106 4,325 3,794 18,071 92,063 118,971 135,634
1,970
2,246
2,561
2,919
1,728
10,697
9,383
8,327
7,398
6,106
4,325
3,794
18,071
92,063
118,971
135,634
154,630
176,287
200,977
229,125
261,215
297,799
339,508
0.9986
13,903
15,851
105,682
20,602
23,487
1.4304
12,195
0.9055 1.0000
1.0000 1.0000
1.0000 1.0000
1.0000 1.0000
3,328
1,173
1,346
1,516
Net Sales (in €) Degree of Operating Leverage (DOL) Net Sales (in Unit) Operating Profit 1,970
2004 2001 2002 2000 2003 2009 2010 2007 2008 2005 2006
2004
2001 2002
2000
2003
2009 2010
2007 2008
2005 2006
4.5. Risk Analysis 4.5.1. Business Risk  Demand variability The demand of Deutsche Brauerei ’sbeerwas increasing

22

Degree of Financial Leverage:

2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010
2000
2001 2002
2003 2004
2005 2006
2007 2008
2009 2010
2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 1.0000 1.0000 8,267 7,197 6,082
1.0000 1.0000 8,267 7,197 6,082 4,865 5,106 4,536 54 62 42 48 33 38 26 70
1.0000 1.0000
8,267
7,197
6,082
4,865
5,106
4,536
54 62
42 48
33 38
26
70
20 23
1.0000 1.0000
1.0602 0.7395
1.0474 1.5162
9,307
1.5313
15,722
13,790
12,096
10,610
2.6984
2 0
EPS Degree of Financial Leverage (DFL) EBIT
EPS
Degree of
Financial
Leverage (DFL)
EBIT

Degree of Combined Leverage:

 

2000

2001

2002

2003

2004

2005

2006

2007

2008

2009

2010

EPS

20

23

2

0

26

33

38

42

48

54

62

70

Net Sales (in Unit)

1,173

1,346

1,516

1,728

1,970

2,246

2,561

2,919

3,328

3,794

4,325

Degree of

                     

Combined

1.3008

(1.0129)

1.8708

1.9847

1.1255

0.6641

1.0000

1.0000

1.0000

1.0000

Leverage (DCL)

4.5.2. Financial Risk: Due to use of debt, firm is facing financial risk.

4.6. SWOT

Degree of Financial Leverage: 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 1.0000

Strengths

Weaknesses

 

1. Deutsche Brauerei’s beer is very high quality

1.

The

company

is

highly

product

reliable on debt financing.

 

2. The company

had been doing business for 12

2.

Large

investments

for

the

generations in the Schweitzer family. It earned

Germany and it manages to capture a good

company on

accounts

a very strong brand image.

receivables.

3. Deutsche Brauerei has a large market share in

market share in Ukraine.

 

Opportunities

Threats

 

1. Expansion opportunity in abroad.

1.

Bad

debt

amount

 

may

2. High demand of product in coming years.

increase.

 

2.

Potential

entrance

 

of

competitors.

 

5. Statement of the Problem

Degree of Financial Leverage: 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 1.0000

23

During analyzing this case study we have used a logical approach to draw the problem statement. Our analyzed problem statements are conducted by theories, assumptions and the overall management activity described in the case. From our hypothetical analysis, we have found the following situations of Deutsche Brauerei :

The Main Problems:

  • Approval of the 2001 financial budget

  • Declaration of the quarterly dividend

  • Adoption of a compensation scheme for Oleg Pinchuk, the company’s sales-and- marketing manager.

To take the decisions to the above situation, Greta Schweitzer was invited by her uncle, Lukas Schweitzer- Managing Director of the company, to join in the board meeting.

Apart from the above, Greta Schweitzer had to take her complements on the following issues also:

  • Decision on investment in New Plant & Equipment of € 7 Million in 2001

  • Decision on Oleg’s proposal regarding € 6.8 Million investment in Ukraine Project.

  • Decision about to take long term debt for further business expansion.

During analyzing this case study we have used a logical approach to draw the problem statement.

24

6. Alternative Courses of Action

For 2001 Financial Budgeting:

For plotting capital structure we can rearrange the percentage of capital component in order to reach in optimal capital structure will maximize the value of the firm.

In alternative 01: We avoid debt financing and depend fully of Preferred Stock and Common stock. In this situation firm will face lower risk, specially NO FINANCIAL RISK. It holds only BUSINESS RISK. But it can be more attractive for LBO.

In alternative 02:To become less attractive for LBO, we use 33% Debt Financing. But it will generate financial risk that ultimately will increase Total Risk for the firm.

In alternative 03:In this situation we again rearrange the capital Component where our debt was 45% and rest are financed by Preferred Stock & Common Equity.

For Quarterly Dividend:

In previous years, company used to declare 75% Dividend for the Common Stock holders, who are actually the aged family members and heavily dependent on dividend. But this huge Payout ratio may discourage the Debt holders and they can charge abnormal interest rate. The reason behind this behaviour is in time of financial distress, debt holder will get almost nothing from the business.

For Compensation Scheme for Oleg Pinchuk:

From our judgement; we think that Mr. Oleg is currently getting handsome base salary but we think company should reschedule his incentive percentage which is currently 0.5% of sales. But sales should not be base for incentive percentage. If situation is like this, then manager will try to increase the sales. It can be even credit sales that ultimately increase DSO and bad debt.

6. Alternative Courses of Action  For 2001 Financial Budgeting: For plotting capital structure we can

25

7. Analysis of Each Alternative

For 2001 Financial Budgeting:

Under Alternative: 01

4,467 3,918 3,437 3,015 5,093 15,266 1,785 1,585 22,003 19,300 16,929 2,644 13,025 11,425 10,021 8,790
4,467
3,918
3,437
3,015
5,093
15,266
1,785
1,585
22,003
19,300
16,929
2,644
13,025
11,425
10,021
8,790
7,448
6,766
2001
2002
2003
2004
2005
2006
2007
2008
2009
2010
1,356
3,395
2,978
2,612
2,291
2,010
1,763
1,546
47,362
1,190
1,057
109,012
83,873
73,569
71,609
61,393
339,508
297,799
124,279
62,065
200,977
Net Sales
Less: Production costs
and Expenses
Gross Profit
Less: Admin and selling
expenses
Less: Excise duties
Less: Depreciation
Earning Before
Interest and Tax
Less: Tax
EBIT (1-Tax)
Add: Depreciation
Less: Investment in
CAPEX
Less: Increase in NWC
FCFF
Terminal Value
Total FCFF
Discounting @ WACC=
0.1314
229,125
2,035
176,287
154,630
135,634
118,971
105,682
261,215
95,620
44,289
184,152
161,529
141,685
26,333
5,548
4,866
4,268
3,744
3,284
2,914
57,818
50,715
44,484
39,020
34,226
30,021
6,325
18,500
18,500
65,915
155,356
136,270
119,529
104,845
91,965
80,667
70,757
33,815
16,929
23,487
20,602
18,071
15,851
13,903
12,195
2,589
9,383
8,327
7,398
22,003
19,300
13,025
8,220
11,746
10,303
9,037
7,927
6,953
6,099
5,413
4,809
14,849
7,211
8,185
25,246
22,145
19,424
17,038
14,945
13,109
11,498
9,886
8,000
85,057
8,311
8,248
19,424
8,123
8,061
8,933
7,939
7,723
7,895
292,330
25,246
22,145
14,849
2,319
20,017
11,425
10,021
8,790
7,448
6,766
43,950
38,551
13,391
29,661
26,017
22,821
10,697
17,558
13,087
11,625
28,782
17,038
14,945
13,109
11,498
9,886
8,933
263,548
Value of Firm (Under Alternative 1) 157,544
Value of Firm (Under
Alternative 1)
157,544

Under alternative 01(with No Debt), the total value of the firm is €157,544. To find out this valuation we consider some assumptions which are as follows:

  • Increase in CAPEX is 1.5% of Sales. The prime reason behind this assumption is - we know that to avail the growth of sales, company must incur some additional capital expenditure that we assume as 1.5% of sales.

  • Increase in New Working Capital is 1% of Sales. Like capital expenditure, to avail the incremental sales, company need to increase its working capital as well.

  • Growth of WACC is 2%, we use this growth to calculate the terminal value of the firm for rest of the year.

  • Finally, WACC value for discounting the cash flow is 13.14% under alternative 01 of WACC Calculation.

7. Analysis of Each Alternative  For 2001 Financial Budgeting: Under Alternative: 01 4,467 3,918 3,437

26

Under Alternative: 02

3,918 3,437 3,015 4,467 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 Net Sales
3,918
3,437
3,015
4,467
2001
2002
2003
2004
2005
2006
2007
2008
2009
2010
Net Sales
Less: Production costs
and Expenses
Gross Profit
Less: Admin and selling
expenses
Less: Excise duties
Less: Depreciation
Earning Before
Interest and Tax
Less: Tax
EBIT (1-Tax)
Add: Depreciation
Less: Investment in
CAPEX
Less: Increase in NWC
FCFF
Terminal Value
Total FCFF
Discounting @ WACC=
0.1096
1,356
1,585
22,003
19,300
16,929
2,644
13,025
11,425
10,021
8,790
7,448
6,766
15,266
3,395
2,978
2,612
2,291
2,010
1,763
1,546
62,065
1,190
1,057
5,093
124,279
95,620
83,873
73,569
71,609
61,393
339,508
141,685
70,757
200,977
261,215
229,125
1,785
176,287
154,630
135,634
118,971
105,682
297,799
109,012
47,362
44,289
184,152
161,529
34,226
5,548
4,866
4,268
3,744
3,284
2,914
18,500
65,915
57,818
50,715
44,484
39,020
6,325
30,021
26,333
18,500
155,356
136,270
119,529
104,845
91,965
80,667
38,551
13,025
16,929
23,487
20,602
18,071
15,851
13,903
12,195
2,589
9,383
8,327
7,398
22,003
19,300
11,425
8,220
11,746
10,303
9,037
7,927
6,953
6,099
5,413
4,809
14,849
7,211
8,123
22,145
19,424
17,038
14,945
13,109
11,498
9,886
8,000
103,733
8,311
8,248
8,185
25,246
8,061
8,933
7,939
7,723
7,895
356,515
25,246
22,145
14,849
2,319
2,035
17,558
10,021
8,790
7,448
6,766
43,950
13,391
33,815
29,661
26,017
22,821
20,017
10,697
13,087
11,625
28,782
17,038
14,945
13,109
11,498
9,886
8,933
327,733
19,424
Value of Firm (Under Alternative 2) 176,219
Value of Firm (Under
Alternative 2)
176,219

Under alternative 02(with 33% Debt), the total value of the firm is €176,219. To find out this

valuation we consider some assumptions which are as follows:

  • Increase in CAPEX is 1.5% of Sales. The prime reason behind this assumption is - we know that to avail the growth of sales, company must incur some additional capital expenditure that we assume as 1.5% of sales.

  • Increase in New Working Capital is 1% of Sales. Like capital expenditure, to avail the incremental sales company need to increase its working capital as well.

  • Growth of WACC is 2%, we use this growth to calculate the terminal value of the firm for rest of the year.

  • Finally, WACC value for discounting the cash flow is 10.96% under alternative 02 of WACC Calculation.

Under Alternative: 02 3,918 3,437 3,015 4,467 2001 2002 2003 2004 2005 2006 2007 2008 2009

27

Under Alternative: 03

3,437 3,015 3,918 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 Net Sales Less:
3,437
3,015
3,918
2001
2002
2003
2004
2005
2006
2007
2008
2009
2010
Net Sales
Less: Production costs
and Expenses
Gross Profit
Less: Admin and selling
expenses
Less: Excise duties
Less: Depreciation
Earning Before
Interest and Tax
Less: Tax
EBIT (1-Tax)
Add: Depreciation
Less: Investment in
CAPEX
Less: Increase in NWC
FCFF
Terminal Value
Total FCFF
Discounting @
WACC= 0.1103
3,395
22,003
19,300
16,929
2,644
13,025
11,425
10,021
8,790
7,448
6,766
15,266
1,356
2,978
2,612
2,291
2,010
1,763
1,546
47,362
1,190
1,057
5,093
4,467
83,873
73,569
71,609
61,393
339,508
297,799
109,012
62,065
176,287
229,125
200,977
1,585
154,630
135,634
118,971
105,682
261,215
95,620
44,289
184,152
161,529
141,685
124,279
26,333
5,548
4,866
4,268
3,744
3,284
2,914
57,818
50,715
44,484
39,020
34,226
30,021
6,325
18,500
18,500
65,915
155,356
136,270
119,529
104,845
91,965
80,667
70,757
33,815
13,025
16,929
23,487
20,602
18,071
15,851
13,903
12,195
2,589
9,383
8,327
7,398
22,003
19,300
11,425
8,220
11,746
10,303
9,037
7,927
6,953
6,099
5,413
4,809
14,849
7,211
8,061
19,424
17,038
14,945
13,109
11,498
9,886
8,000
103,020
8,311
8,248
8,185
8,123
22,145
8,933
7,939
7,723
7,895
354,065
25,246
22,145
14,849
2,319
2,035
1,785
13,087
10,021
8,790
7,448
6,766
43,950
38,551
13,391
29,661
26,017
22,821
20,017
17,558
10,697
11,625
28,782
17,038
14,945
13,109
11,498
9,886
8,933
325,283
19,424
25,246
Value of Firm (Under Alternative 3) 175,506
Value of Firm (Under
Alternative 3)
175,506

Under alternative 03 (with 45% Debt), the total value of the firm is €175,506. To find out this

valuation we consider some assumptions which are as follows:

  • Increase in CAPEX is 1.5% of Sales. The prime reason behind this assumption is - we know that to avail the growth of sales, company must incur some additional capital expenditure that we assume as 1.5% of sales.

  • Increase in New Working Capital is 1% of Sales. Like capital expenditure, to avail the incremental sales company need to increase its working capital as well.

  • Growth of WACC is 2%, we use this growth to calculate the terminal value of the firm for rest of the year.

  • Finally, WACC value for discounting the cash flow is 11.03% under alternative 03 of WACC Calculation.

Under Alternative: 03 3,437 3,015 3,918 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010

28

Company Value Comparison under different alternative of Capital Structure

Capital Structure

45%

Alternative 01:
Alternative 01:

Alternative 01:

Weight

176,219

Weight

Value

Debt

0%

Prefered Stock

25%

Common Equity

75%

Capital Structure

Debt

Value

Debt

33%

Prefered Stock

17%

Common Equity

50%

Capital Structure

Weight

Value

Comparison:

Prefered Stock

37%

Common Equity

18%

Company Value Comparison

Alternative 02:

Alternative 03:

157,544

175,506

Company Value Comparison under different alternative of Capital Structure Capital Structure 45% Alternative 01: Weight 176,219

Based on our valuation we should select the alternative 02 of Capital Structure where Debt=33%, Preferred Stock= 17%, and Common Stock = 50%. In this capital structure, company can get its maximum value. If we look at the other two alternatives, the WACC under alternative 01 & 03are 13.14% and 11.03% respectively. As well as the value

under alternative 01 & 03 are €157,544 and €175,506 respectively. But in our alternative 02, WACC is 10.96% and the Value is €176,219.

Company Value Comparison under different alternative of Capital Structure Capital Structure 45% Alternative 01: Weight 176,219

29

For Quarterly Dividend:

If Dividend Payout Ratio is 70%:

Value of Firm (Under 70% Dividend)

178,602

8,232 15,146 13,285 11,653 10,028 9,055 105,131 8,423 8,359 8,295 17,267 Net Sales 105,682 118,971 135,634
8,232
15,146
13,285
11,653
10,028
9,055
105,131
8,423
8,359
8,295
17,267
Net Sales
105,682
118,971
135,634
154,630
176,287
200,977
229,125
261,215
297,799
339,508
Less: Production costs and Expenses
61,393
71,609
73,569
83,873
95,620
109,012
124,279
141,685
161,529
184,152
Gross Profit
44,289
47,362
62,065
70,757
80,667
91,965
104,845
119,529
136,270
155,356
Less: Admin and selling expenses
18,500
18,500
26,333
30,021
34,226
39,020
44,484
50,715
57,818
65,915
Less: Excise duties
11,625
13,087
17,558
20,017
22,821
26,017
29,661
33,815
38,551
43,950
Less: Depreciation
6,766
7,448
8,790
10,021
11,425
13,025
14,849
16,929
19,300
22,003
Earning Before Interest and Tax
7,398
8,327
9,383
10,697
12,195
13,903
15,851
18,071
20,602
23,487
Less: Tax
2,589
2,914
3,284
3,744
4,268
4,866
5,548
6,325
7,211
8,220
EBIT (1-Tax)
4,809
5,413
6,099
6,953
7,927
9,037
10,303
11,746
13,391
15,266
Add: Depreciation
6,766
7,448
8,790
10,021
11,425
13,025
14,849
16,929
19,300
22,003
Less: Investment in CAPEX
1,585
1,785
2,035
2,319
2,644
3,015
3,437
3,918
4,467
5,093
Less: Increase in NWC
1,057
1,190
1,356
1,546
1,763
2,010
2,291
2,612
2,978
3,395
Add: Additional Investment (30% Retention Ratio)
1 22
142
155
177
201
230
262
298
340
388
2001
2002
2003
2004
2005
2006
2007
2008
2009
2010
FCFF
Terminal Value
Total FCFF
Discounting @ WACC= 0.1096
15,146
8,108
8,046
7,834
8,003
361,319
25,586
22,443
19,686
17,267
10,028
13,285
11,653
8,170
9,055
332,149
29,170
25,586
22,443
19,686
Previous Firm Value 176,219

Previous Firm Value

176,219

5372

Net Earnings

3724

4311

4712

6982

11795

10346

9075

7960

6124

If Dividend Payout Ratio is 60%:

18,071 7,211 6,325 5,548 4,866 4,268 13,391 3,284 23,487 20,602 8,220 15,851 13,903 12,195 10,697 9,383
18,071 7,211 6,325 5,548 4,866 4,268 13,391 3,284 23,487 20,602 8,220 15,851 13,903 12,195 10,697 9,383
18,071 7,211 6,325 5,548 4,866 4,268 13,391 3,284 23,487 20,602 8,220 15,851 13,903 12,195 10,697 9,383
18,071 7,211 6,325 5,548 4,866 4,268 13,391 3,284 23,487 20,602 8,220 15,851 13,903 12,195 10,697 9,383
18,071
7,211
6,325
5,548
4,866
4,268
13,391
3,284
23,487
20,602
8,220
15,851
13,903
12,195
10,697
9,383
2,035
2,291
2,010
1,763
22,542
8,460
8,396
8,332
8,269
8,206
8,144
8,082
362,920
25,700
1,546
19,773
17,344
3,744
11,746
10,303
9,037
7,927
6,953
6,099
19,300
1,356
5,093
4,467
3,918
3,437
3,015
2,644
2,319
22,003
2,612
16,929
14,849
13,025
11,425
10,021
8,790
15,266
10,021
176,287
154,630
135,634
22,821
19,300
16,929
14,849
13,025
11,425
200,977
8,790
43,950
38,551
33,815
29,661
26,017
20,017
17,558
65,915
161,529
155,356
136,270
119,529
104,845
91,965
80,667
70,757
62,065
184,152
57,818
141,685
124,279
95,620
83,873
73,569
339,508
297,799
261,215
229,125
454
25,700
22,542
19,773
17,344
15,213
13,344
11,705
15,213
517
29,299
398
349
306
268
236
207
3,395
2,978
105,596
2007
50,715
44,484
39,020
34,226
30,021
26,333
2010
2009
2008
109,012
2006
2005
2004
2003
22,003
13,344
11,705
333,621
1,785 7,871 8,040 5,413 4,809 EBIT (1-Tax) 2,914 2,589 Less: Tax 8,327 7,398 Earning Before Interest
1,785
7,871
8,040
5,413
4,809
EBIT (1-Tax)
2,914
2,589
Less: Tax
8,327
7,398
Earning Before Interest and Tax
1,190
1,057
Less: Increase in NWC
Value of Firm (Under 60% Dividend)
1,585
Less: Investment in CAPEX
7,448
6,766
Add: Depreciation
FCFF
Terminal Value
Total FCFF
Discounting @ WACC= 0.1096
Less: Excise duties
44,289
Gross Profit
Less: Admin and selling expenses
71,609
61,393
Less: Production costs and Expenses
118,971
7,448
6,766
Less: Depreciation
105,682
13,087
11,625
47,362
18,500
18,500
Net Sales
2002
2001
10,075
10,075
9,096
9,096
189
1 63
Add: Additional Investment (40% Retention Ratio)
179,396
Previous Firm Value 176,219

Previous Firm Value

176,219

4712

4311

3724

Net Earnings

5372

6124

6982

7960

9075

10346

11795

If we decrease the dividend pay-out ratio by 60% that means increase retention ratio up to 40%, it will increase the value of Deutsche Brauerei because it can invest this additional fund for further business expansion and it will get at least 10.96% return. Simultaneously this reduction will help them to get the Long Term Loan.

 For Quarterly Dividend: If Dividend Payout Ratio is 70%: Value of Firm (Under 70% Dividend)

30

For Compensation Scheme for Oleg Pinchuk:

If base salary increase:

175,642

Value of Firm (if base salary increase)

Less: Excise duties Less: Depreciation Earning Before Interest and Tax Less: Tax EBIT (1-Tax) Add: Depreciation
Less: Excise duties
Less: Depreciation
Earning Before Interest and Tax
Less: Tax
EBIT (1-Tax)
Add: Depreciation
Less: Investment in CAPEX
Less: Increase in NWC
FCFF
Terminal Value
Total FCFF
Discounting @ WACC= 0.1096
2,644
3,015
3,437
11,425
2001
2002
2003
2004
2005
2006
2007
2008
2009
2010
Net Sales
105,682
118,971
135,634
154,630
176,287
200,977
229,125
261,215
297,799
339,508
Less: Production costs and Expenses
61,393
71,609
73,569
83,873
95,620
109,012
124,279
141,685
161,529
184,152
Gross Profit
44,289
47,362
62,065
70,757
80,667
91,965
104,845
119,529
136,270
155,356
Less: Admin and selling expenses
18,500
18,500
26,333
30,021
34,226
39,020
44,484
50,715
57,818
65,915
Less: Excess Base Salary of Oleg Pinchuk
1 02
102
102
102
102
102
102
102
102
102
2,319
10,021
8,866
9,820
11,432
13,043
22,003
6,766
7,448
8,790
11,425
13,025
14,849
16,929
19,300
1,585
1,785
2,035
29,661
38,551
43,950
6,766
7,448
8,790
10,021
26,017
13,025
3,395
33,815
11,625
13,087
17,558
20,017
22,821
3,708
9,820
11,432
13,043
14,878
16,972
19,358
22,078
14,878
5,346
355,694
4,233
4,830
5,512
6,289
7,175
8,185
4,742
3,248
8,289
7,837
7,671
7,894
7,960
8,026
8,091
25,180
8,223
6,033
103,494
8,866
16,972
19,358
22,078
25,180
28,716
326,978
1,057
17,969
20,500
23,385
2,554
2,879
2,291
4,467
5,093
15,749
1,190
1,356
1,546
1,763
2,010
3,918
2,612
2,978
14,849
6,887
7,861
8,971
10,237
11,680
13,325
15,200
12,093
8,157
16,929
19,300
22,003
7,296
8,225
9,281
10,595
13,801
Previous Firm Value 176,219

Previous Firm Value

176,219

 For Compensation Scheme for Oleg Pinchuk: If base salary increase: 175,642 Value of Firm (if
 For Compensation Scheme for Oleg Pinchuk: If base salary increase: 175,642 Value of Firm (if
 For Compensation Scheme for Oleg Pinchuk: If base salary increase: 175,642 Value of Firm (if
 For Compensation Scheme for Oleg Pinchuk: If base salary increase: 175,642 Value of Firm (if

If Deutsche Brauerei increase the Base salary of Mr. Oleg by €102000 yearly [(€48500- €40000)×12)] then the overall value of the firm will decrease.

If Incentive percentage increases:

174,867 Value of Firm (if incentive increase) 8,790 8,102 4,740 5,335 6,011 6,853 7,812 8,907 7,292

174,867

Value of Firm (if incentive increase)

8,790 8,102 4,740 5,335 6,011 6,853 7,812 8,907 7,292 23,147 10,021 11,425 13,025 14,849 16,929 19,300
8,790
8,102
4,740
5,335
6,011
6,853
7,812
8,907
7,292
23,147
10,021
11,425
13,025
14,849
16,929
19,300
22,003
8,208
2,552
26,017
29,661
33,815
38,551
43,950
6,766
7,448
7,106
9,247
2,873
3,237
3,690
4,207
4,796
5,468
6,233
2001
2002
2003
2004
2005
2006
2007
2008
2009
2010
10,543
12,019
13,702
15,622
17,809
20,304
Net Sales
105,682
118,971
135,634
154,630
176,287
200,977
229,125
261,215
297,799
339,508
Less: Production costs and Expenses
61,393
71,609
73,569
83,873
95,620
109,012
124,279
141,685
161,529
184,152
Gross Profit
44,289
47,362
62,065
70,757
80,667
91,965
104,845
119,529
136,270
155,356
Less: Admin and selling expenses
18,500
18,500
26,333
30,021
34,226
39,020
44,484
50,715
57,818
65,915
Less: Excess Incentive of Oleg Pinchuk
1 06
119
136
155
176
201
229
261
298
340
Less: Excise duties
Less: Depreciation
Earning Before Interest and Tax
Less: Tax
EBIT (1-Tax)
Add: Depreciation
Less: Investment in CAPEX
Less: Increase in NWC
FCFF
Terminal Value
Total FCFF
Discounting @ WACC= 0.1096
22,821
8,864
11,576
13,197
15,046
6,766
7,448
8,790
10,021
11,425
13,025
14,849
16,929
19,300
22,003
1,585
1,785
2,035
8,061
2,319
2,644
3,015
3,437
3,918
4,467
5,093
1,057
1,190
21,975
1,546
1,763
2,010
2,291
2,612
2,978
3,395
11,410
19,275
21,975
25,053
28,561
10,154
325,220
8,864
9,809
16,907
13,008
14,830
16,907
20,017
11,625
13,087
17,558
8,122
25,053
353,782
7,835
7,663
7,879
7,939
8,000
19,275
1,356
8,185
8,247
102,938
9,809
11,410
13,008
14,830
Previous Firm Value 176,219

Previous Firm Value

176,219

 For Compensation Scheme for Oleg Pinchuk: If base salary increase: 175,642 Value of Firm (if
 For Compensation Scheme for Oleg Pinchuk: If base salary increase: 175,642 Value of Firm (if
 For Compensation Scheme for Oleg Pinchuk: If base salary increase: 175,642 Value of Firm (if
 For Compensation Scheme for Oleg Pinchuk: If base salary increase: 175,642 Value of Firm (if

If Deutsche Brauereiincrease the incentive percentage of Mr. Oleg from 0.5% of sales to 0.6% of sales then the overall value of the firm will also decrease.

If Incentive percentage is 5% of Net Income

 For Compensation Scheme for Oleg Pinchuk: If base salary increase: 175,642 Value of Firm (if

31

33,168 56,031 155,356 25,519 29,094 37,814 43,110 49,147 136,270 63,878 0.15 0.20 0.25 0.30 0.35 12,027
33,168 56,031 155,356 25,519 29,094 37,814 43,110 49,147 136,270 63,878 0.15 0.20 0.25 0.30 0.35 12,027
33,168 56,031 155,356 25,519 29,094 37,814 43,110 49,147 136,270 63,878 0.15 0.20 0.25 0.30 0.35 12,027
33,168 56,031 155,356 25,519 29,094 37,814 43,110 49,147 136,270 63,878 0.15 0.20 0.25 0.30 0.35 12,027
33,168
56,031
155,356
25,519
29,094
37,814
43,110
49,147
136,270
63,878
0.15
0.20
0.25
0.30
0.35
12,027
13,712
15,632
184,152
154,630
339,508
0.45
0.50
297,799
261,215
229,125
200,977
176,287
135,634
2010
2009
2008
2007
2006
2005
2004
2003
80,667
73,569
83,873
95,620
109,012
124,279
141,685
161,529
0.40
62,065
70,757
3,395
91,965
104,845
119,529
8,790
6,628
10,021
17,558
20,017
22,821
26,017
29,661
33,815
38,551
43,950
7,556
19,638
11,425
13,025
14,849
16,929
19,300
22,003
10,197
11,625
13,253
13,025
8,933
7,836
6,873
6,029
5,288
4,069
3,569
25,523
22,388
14,552
15,109
11,425
10,021
8,790
16,590
17,225
12,764
11,196
9,821
8,614
3,918
8,693
108,504
16,929
19,300
22,003
2,035
2,319
2,644
3,015
3,437
8,627
4,467
5,093
1,356
1,546
1,763
2,010
2,291
2,612
2,978
30,106
14,849
26,407
23,163
20,317
17,822
15,632
13,712
12,027
372,912
342,807
4,638
26,407
23,163
20,317
17,822
8,305
8,368
8,432
8,497
8,562
Less: Production costs and Expenses Less: Excise duties Less: Depreciation Earning Before Interest and Tax Less:
Less: Production costs and Expenses
Less: Excise duties
Less: Depreciation
Earning Before Interest and Tax
Less: Tax
EBIT (1-Tax)
Add: Depreciation
Less: Investment in CAPEX
Less: Increase in NWC
FCFF
Terminal Value
Total FCFF
Discounting @ WACC= 0.1096
Less: Admin and selling expenses
17,866
17,786
Less: New Incentive of Oleg Pinchuk
0.05
0.10
61,393
71,609
Gross Profit
44,289
47,362
2001
2002
105,682
118,971
Net Sales
10,350
3,164
2,811
7,448
6,766
5,876
11,625
13,087
6,766
7,448
8,032
9,041
9,345
5,221
8,259
8,086
Value of Firm (Under New incentive)
184,332
1,057
1,585
1,785
1,190
9,345
10,350
Previous Firm Value 176,219

Previous Firm Value

176,219

33,168 56,031 155,356 25,519 29,094 37,814 43,110 49,147 136,270 63,878 0.15 0.20 0.25 0.30 0.35 12,027
33,168 56,031 155,356 25,519 29,094 37,814 43,110 49,147 136,270 63,878 0.15 0.20 0.25 0.30 0.35 12,027
33,168 56,031 155,356 25,519 29,094 37,814 43,110 49,147 136,270 63,878 0.15 0.20 0.25 0.30 0.35 12,027
33,168 56,031 155,356 25,519 29,094 37,814 43,110 49,147 136,270 63,878 0.15 0.20 0.25 0.30 0.35 12,027

In the time of taking decision regarding Mr. Oleg salary package, Deutsche Brauerei, should keep the base salary as it is and fro incentive package it should be 5% of Net Income. This new incentive package will increase the value of the firm as well as it will decrease the DSO.

33,168 56,031 155,356 25,519 29,094 37,814 43,110 49,147 136,270 63,878 0.15 0.20 0.25 0.30 0.35 12,027

32

8. Recommendation:

After analysing the overall scenario of Deutsche Brauerei, we have come to a discrete conclusion regarding Financial Budget of 2001, Dividend Policy and Compensation package of Mr. Oleg Pinchuk. As per our company valuation, Deutsche Brauerei should follow the capital structure of Debt=33%, Preferred Stock= 17%, and Common Stock =

50% because it maximizes its value. At the same time, this capital structure makes the company less attractive for LBO. In alternative 03 of capital structure, we tried to increase the Debt but the result was not in our favour. The incremental debt decreases

company value. We also support the investment of €7 million in plant & equipment

because this the Net Present Value of this investment will be €80,539,000 and MIRR is 28.61% which is higher than WACC. Now if we look at the Dividend Policy of Deutsche Brauerei, they are maintaining the stable payout policy which is about 75%. But, this huge payout ratio may discourage the debt holder as company is thinking to take long term debt for further business expansion as well as new investment. So our recommendation is to reduce the Dividend payout ratio by 60% which will also increase the value of Deutsche Brauerei. We also need to consider the issue that the family members depend on this dividend because most of them are retired person. But we are hopeful that for the long term benefit of the company the members of Board of Director will tolerate this reduction of Dividend. Last but not the least issue is the Compensation Package of Mr. Oleg Pinchuk where currently he is enjoying €40,000 as base salary & incentive payment of €410,440 (0.5% of annual sales). We deeply keep in mind his performance and enormous contribution towards the company in especially current years. But, we are not interested to increase his base salary; rather we can increase his incentive package in a different way. Mr. Oleg will get 5% of Net Income as incentive payment. We are sure that this new incentive package will reduce his initiative for credit sales that ultimately reduce the sales of Deutsche Brauerei. But, the no. of DSO and Bad Debt also reduce.

Capital Budget

Debt=33%, Preferred Stock= 17%, and Common Stock = 50%

Dividend Policy

Dividend Payout ratio = 60%

Mr. Oleg’s Compensation

Base Salary = €40000 and Incentive Payment = 5% of Net Income

8. Recommendation: After analysing the overall scenario of Deutsche Brauerei, we have come to a discrete

33

Appendix

Appendix xxxv

xxxv

 

11,795

8,857

2,938

 

10,346

7,769

2,577

 

9,075

6,814

2,260

(213,274)

7,960

5,977

1,983

(187,073)

6,982

5,243

1,739

(164,091)

6,124

4,599

1,525

(143,933)

5,372

4,034

1,338

(126,251)

4,712

3,538

1,174

(110,644)

4,311

3,234

1,077

(98,284)

3,724

2,793

931

2009 243,374 213,475 187,250 164,246 144,068 126,370 110,845 68,203 2010 277,459 2008 2007 2006 297,799 261,215
2009
243,374
213,475
187,250
164,246
144,068
126,370
110,845
68,203
2010
277,459
2008
2007
2006
297,799
261,215
200,977
176,287
154,630
135,634
13,961
(3,760)
(3,298)
(2,893)
(2,537)
(2,322)
(2,005)
229,125
18,146
15,916
118,971
12,246
10,742
9,422
8,264
7,249
6,633
5,729
70,249
2004
2003
2002
2001
339,508
24,788
105,682
2005
62,049
54,426
47,740
41,875
36,731
32,218
28,260
(4,286)
48,722
37,479
18,500
8,327
7,398
(316,021)
(277,198)
(243,144)
109,012
30,021
26,333
18,500
9,383
184,152
161,529
141,685
124,279
34,226
95,620
83,873
73,569
71,609
12,195
38,551
33,815
29,661
26,017
22,821
20,017
17,558
13,087
11,625
61,393
(60)
(201)
23,487
20,602
18,071
15,851
13,903
10,697
(1,634)
(1,468)
(5,150)
(4,518)
(3,963)
(3,476)
(3,049)
(2,674)
(2,346)
(2,058)
(5,571)
(191)
(168)
(147)
(129)
(113)
(99)
(87)
(4,886)
(76)
7,448
22,003
19,300
16,929
14,849
13,025
11,425
10,021
8,790
43,950
6,766
65,915
57,818
50,715
44,484
39,020
(6,351)
Expected
(1,510) 4,778 (1,132) (1,396) (1,864) (1,185) (1,064) (1,046) (1,304) 3,819 3,351 4,042 550 92,063 1997 1998
(1,510)
4,778
(1,132)
(1,396)
(1,864)
(1,185)
(1,064)
(1,046)
(1,304)
3,819
3,351
4,042
550
92,063
1997
1998
1999