Sweden.1 The board of directors of Svenska Livsmedel must consider
and approve the firm's capital budget for 2022 from a final list of
eleven project proposals. Many projects proposed by managers at
several facilities were initially submitted to the firm's capital
budgeting committee. These project proposals were further analyzed
and scrutinized by the firm's capital budgeting committee. The
committee has now finalized the proposed 2022 project list and has
thus submitted eleven project proposals to the board of directors
for final consideration for the 2022 capital budget. Due to
external factors, the directors have unanimously chosen to limit
the capital spending budget for 2022 to SEK 1.7 billion (SEK is
Swedish Kronor). The SEK 3.2 billion total cost for all eleven
proposals does exceed the constrained capital budget for 2022. The
company policy is driven by a goal to maximize shareholder value
with its investment policy. The company policy states that capital
budgeting tools based on Net Present Value or NPV are the only
tools that can measure the amount of shareholder value or wealth
created by any project. As the capital budget is limited to SEK 1.7
billion (SEK 1700 million), the final capital budgeting decision
enacted by the board of directors must choose the optimal
collection or bundle of projects that maximize the Net Present
Value or wealth created given the limited capital budget of SEK 1.7
billion. The Profitability Index (PI) scales the NPV by the size of
the project (e.g., NPV per $ spent), and is the method to be used
to choose the best bundle of projects given the limited capital
budget - rank projects from highest to lowest PI and choose from
the top on down until the budget is consumed. Svenska Livsmedel has
a formal policy that establishes the risk-based cost of capital or
discount rate used to analyze projects as shown in the table below.
The Excel sheet supplied for this case lists the classification of
each proposed project. The Excel sheet also contains the cash flows
of every project.
Project Classification
Classification or type of project
Cost of capital (hurdle rate)
1
New product or new markets
12%
2
Product or market extension
10%
3
Efficiency improvements
8%
4
Safety or environmental
10.5% (corporate WACC)
The eleven proposed projects are listed below. Note that
projects no. 6 and 7 are mutually exclusive projects - see the
special note on the following page. Also stated is each project's
total installed cost (total initial investment), also broken down
into the Plant Property and Equipment (capital expenditures or
PP&E) portion, and the increase in Net Working Capital (NWC)
portion. Cost figures are given in Swedish Kronor (SEK). For each
of the eleven projects, the entire project installation and
installed cost (initial investment) is incurred upfront (none
spreads or spills across to future time periods).
1. Purchase new Volvo trucks for the firm's transportation
distribution network. Total installed cost is SEK 330 million (300
million PP&E and 30 million NWC). 1 Svenska Livsmedel is a
fictitious firm. Any similarity between this fictitious firm and
actual firms is coincidental.
2. New yogurt plant in Malmö Sweden to supply markets in
Denmark, Germany, Norway, and Sweden. Total installed cost is SEK
450 million (375 million PP&E and 75 million NWC).
3. Expand butter production at the firm's plant in Karlstad
Sweden. Total installed cost is SEK 150 million (125 million
PP&E and 25 million NWC).
4. Herring and misc. seafood production project at the Göteborg
Sweden plant. Total installed cost is SEK 260 million (220 million
PP&E and 40 million NWC).
5. Upgrade/renovate the firm's bakery facility in Stockholm.
Total installed cost is SEK 210 million (all PP&E).
* Special note concerning projects 6 and 7 below: these two
projects are mutually exclusive; capacity exists to do one of these
two proposed projects, but not both projects.
6. Expand the firm's existing frozen dessert line (from
production capacity at the Göteborg, Karlstad, and Malmö plants) to
serve new markets in Germany and Denmark. Total installed cost is
SEK 300 million (250 million PP&E and 50 million NWC).
7. Expand the firm's existing frozen dessert line (from
production capacity at the Göteborg, Karlstad, and Malmö plants) to
serve new markets in Norway, Finland, and several nations along the
Baltic. Total installed cost is SEK 300 million (250 million
PP&E and 50 million NWC).
8. Project to produce Swedish meatballs and other food items
under contract for IKEA to be sold under the IKEA brand in IKEA
stores in Europe. Total installed cost is SEK 270 million (225
million PP&E and 45 million NWC).
9. Information system upgrade for the firm. Total installed cost
is SEK 250 million (all PP&E).
10. Acquisition of an existing Swedish firm that manufactures
the Akvavit spirit, schnapps, and liqueurs; offered as a project
that delivers higher future growth opportunity than the firm's
existing mature businesses. Total installed cost is SEK 600 million
(450 million PP&E and 150 million NWC).
11. Replace existing outdated lighting and electrical systems in
several of the firm's production facilities within Sweden. Total
installed cost is SEK 80 million (all PP&E).
Questions to answer for this assignment:
1. For each of the 11 proposed projects, calculate the project
IRR, the "spread" (difference between IRR and project cost of
capital, and the Profitability Index (PI) - P.I. being the crucial
capital budgeting decision tool in this scenario of a constrained
capital budget. Then rank the 11 project proposals on the both PI
and the "spread" between IRR and project hurdle rates. How closely
do ranking on PI versus "spread" match each other? It is best to do
this exercise using the Excel sheet - that way I can examine the
formulas used if necessary. You can also put no. 2 below on the
same Excel sheet.
2. Which set of projects should the board of Svenska Livsmedel
AB select for the capital budget for 2022, given that the firm's
capital budget constraint of SEK 1.7 billion? Or to put it another
way: which bundle of projects has the highest possible NPV? Ranking
projects by PI is the way to accomplish that task. How much NPV is
the firm expected to receive from your suggested collection of
projects?
- Svenska Livsmedel Ab Is A Foods Corporation Based In Stockholm Sweden 1 The Board Of Directors Of Svenska Livsmedel Must 1 (113.1 KiB) Viewed 47 times