Projects With High Benefit And Low Costs example essay topic

EXECUTIVE SUMMARY Iskall Arno called a capital-budgeting meeting in January 1987. Certain business drivers were identified during and before this meeting and it was also noted that sales had reached a plato. The reason for meeting was to discuss possible business expansion projects as well as deciding how much of the capital budget to allocate to preventative maintenance, equipment replacement, safety enhancement, pollution control and efficiency improvements. Eleven projects were presented to the Board of Directors, however it was decided that only $80 million dollars would be made available for the capital budget. The projects presented totalled $208 million. There was uncertainty regarding which projects to accept and further analysis is required to determine the relative urgency of the projects and the likelihood of success of each project.

Each project is financially viable and whilst most can be quantified, there are also certain qualitative factors that needs to be considered. Firstly we will look at the background of the company, identifying the business drivers and the key issues faced by the organisation. Also included is an analysis of the life cycle of both the products and of the company as a whole. This is followed by situational analysis encompassing a project analysis where each of the following questions is answered: is the project based on facts, is it a core competency of the organisation, is there internal capabilities to implement the project, a rating of the risk of the project and a rating of the incremental risk of the project (i.e. what would the risk be of not implementing the project).

Here we also look at the qualitative factors impacting on each project. The results of each project's Cash Flow, Net Present Value and Internal Rate of Return is then graphically presented, indicating the relative positioning to acceptance according to the above factors. The analysis continues with a graphical presentation of the difficulty to implement vs. the strategic benefit to the organisation, where those projects with a high strategic fit and where difficulty to implement is low is identified. Then there is a graphical presentation of Cost vs. Benefit and here the projects with high benefit and low costs are identified. The last graphical presentation is aimed at identifying the riskiness of each project. A final positioning of the projects is then represented in a table, which summarises all the above.

The proposed projects are then identified and an attempt is made to educate the client on the value cycle spiral. Following this is the recommended approach where each of the projects are discussed and a brief overview is given of a suggested phasing in of the projects. This document is aimed at an overall look at each project in order to quantify and qualify and thereby recommend those projects that Iskall Anro should invest in. BACKGROUND Business Drivers It was recognised in the capital budgeting meeting, held on January 15th, 1987, that the objective of the board was growth for Iskall Arno. The following business drivers can be identified: . Expansion / Growth.

Operational Excellence. Possible Product Diversity Key Issues When analysing the current situation within the company the following key issues can be identified: . The board of directors is debt sensitive and would like to maintain a long-term debt-to-equity ratio of no more than 50%... The proposed projects amounts to a total $208 million and although all the projects proposed are financially viable, only $80 million dollars have been made available for the projects... The board of directors is undecided on project priorities...

It is apparent that there are diverse strategy issues and management ideas within the organisation... It seems as tough there is a difference between the family values and the commercial values... The sales of Iskall Arno have reached a plato, having remained more or less the same since 1984... The reasons for the slow down in sales can not be quantified and it is speculated that low population growth, market saturation in some areas and a weak advertising campaign could the reasons... Hurdles rates are not used consistently and the acceptance of projects is a subjective process. The Capital Budgeting Committee relies on intuition to choose projects...

A certain amount of political power play can be recognised... No guidelines exist for risk taking and the board's risk tolerance is low... A three-year budgeting cycle is used and only emergency requests will be considered... The possibility exists that Iskall Arno became too comfortable with the market and sales and no expansion has taken place outside of the current market... The Svalbard family has unrealistic expectancy of IRR's. The Southeast region of Iskall Arno already required greater capacity in production Product Lifecycle Whilst the majority of the board of directors believe that the products of Iskall Arno is in the competitive grace stage of product evolution (i.e. sole possession of a particular market segment), reality probably places it in the market leadership stage.

Industry / Company Lifecycle It should be assumed that Iskall Arno is in the mature stage of life cycle. Although this is a favourable position to be in, if no changes are implemented the risk of going into the later stages of life cycle i.e. 'death', is very high. There is however signs that in some areas they are still in the early stages of life cycle. Following is an analysis of the different areas in respect to life cycle: . Competitive Strength and Industry Attractiveness - it would be suggested that the company invest and grow, however the culture of Iskall Arno seems to be pushing for harvest, divest and selective investments... Investments - Iskall Arno is selective and minimises, when is should be maximising...

Risk - Their aptitude for risk suggests that they are in either the early or later stages of life cycle since they either avoid or limit their risk... Market Share - They are in the early stages i.e. target growth and protect position... Marketing - It has already been identified that a week advertising campaign is thought to be one of the reasons for lack of growth in sales. Iskall Arno should now move into the mature stage of building creativity and coverage... Management Style - An analysis of the organisation suggests that it is disciplined and that cost control does exist, pointing again to the later stage of life.

SITUATIONAL ANALYSIS Project Analysis Truck Fleet New Plant Cash Flow $7.70 Cash Flow $23.75 NPV (Risk Adjusted) ($3.12) NPV (Risk Adjusted) $0.43 IRR 7.8% IRR 11.3% Fact Based Yes Fact Based Yes Core Competency No Core Competency Yes Internal Capabilities Yes Internal Capabilities No Project Risk Low Project Risk Low Incremental Risk High Incremental Risk High Distribution is not a core competency of Iskall Arno. A suggestion would be to outsource the entire distribution department to ensure good coverage and frequent deliveries. Due to the production shortage that exists in the Southeast, this is ranked as a critical project. Expand Plant R & D Project Cash Flow $7.25 Cash Flow $22.50 NPV (Risk Adjusted) $0.23 NPV (Risk Adjusted) $2.07 IRR 11.2% IRR 17.3% Fact Based Yes Fact Based No Core Competency Yes Core Competency No Internal Capabilities No Internal Capabilities Yes Project Risk Low Project Risk High Incremental Risk Medium Incremental Risk Low The project will increase sales through additional production, but the problem is not at a critical stage yet. This project is not based on quantitative facts and is risky in terms of actual results.

It should be given some serious consideration however due to the possibility that other companies might gain market share if they are successful with artificial sweeteners. Conveyer System Pollution Trap Cash Flow $5.25 Cash Flow $ NPV (Risk Adjusted) ($1.04) NPV (Risk Adjusted) $ IRR 8.7% IRR % Fact Based Yes Fact Based Yes Core Competency Yes Core Competency No Internal Capabilities No Internal Capabilities No Project Risk Low Project Risk Low Incremental Risk High Incremental Risk Medium The project can be quantified, but there is an even bigger qualitative factor - that of the possibility of a lawsuit against injury. Iskall Arno can not afford the negative publicity or the possibility of a strike from the other employees. Although there is no positive cash flow connected to this project, it deserves a lot of attention. The cost will increase dramatically over the next 4 years to implement the project and the risk of being exposed is high. Expand East Expand South Cash Flow $37.50 Cash Flow $32.50 NPV (Risk Adjusted) $11.07 NPV (Risk Adjusted) $8.43 IRR 21.4% IRR 18.8% Fact Based No Fact Based No Core Competency Yes Core Competency Yes Internal Capabilities Yes Internal Capabilities Yes Project Risk Medium Project Risk Low Incremental Risk Low Incremental Risk Low Expanding East means running the risk of being ousted by the competitors already established in the market.

One would need to establish how big these competitors are and how they are likely to react. Distribution might be an issue, due to bigger area to be covered, which could increase costs. This is less risky project. New Product Ad Campaign Cash Flow $28.50 Cash Flow $4.00 NPV (Risk Adjusted) $7.88 NPV (Risk Adjusted) $0.58 IRR 20.5% IRR 16.2% Fact Based No Fact Based No Core Competency No Core Competency Yes Internal Capabilities No Internal Capabilities Yes Project Risk High Project Risk Medium Incremental Risk Low Incremental Risk Medium This project could enhance the company's reputation and could possibly increase sales amongst health-conscious consumers, but taking into account that only a limited amount has been made available, this project should be put on hold for the moment. The advertising campaign would have to be upgraded if any of the projects is accepted in order to maximise benefits. It is essential to build creativity and coverage in a mature stage of life cycle.

Theme Park Cash Flow $134.00 NPV (Risk Adjusted) $33.3 IRR 28.7% Fact Based No Core Competency No Internal Capabilities No Project Risk High Incremental Risk Low This project would promote awareness of the Iskall Anro name and could boost sales, but is expensive and risky and not a core competency of Iskall Arno. Graphical Presentation of Cash Flow / NPV / IRR Difficult to Implement vs. Strategic Benefit Cost vs. Benefit High Theme Park New Plant Cost Truck Fleet Expansion South Expansion East New Product Ad Campaign R&D Project Conveyer System Expand Plant Low Pollution Trap Low Benefit High Risk Tolerance - Low risk - Manageable risk - High Risk difficult to manage risk Summary Positioning of projects on the above analysis when 1 = 50, 2 = 40, 3 = 30, 4 = 20 and 5 = 10. The above positioning of projects is however based purely on the quantitative elements as well as benefit, cost and risk and does not take the qualitative issues into account. The projects I would suggest Iskall Arno invests in is as follows: . Expand the Market Base South.

Research & Development Project. Roll out a New Advertising Campaign. Build a New Plant The reason for excluding the production of a new product as well as the theme park is that these two projects are not core competencies of Iskall Arno and that the risk is too high. According to the Vice President of Sales the demand on the sales force would be too high if they expanded both east and south, and because the risks are lower and overall expanding south received more positioning, this would be the better project to invest in. The total cost of the above projects amount to exactly $80 million dollars. It is however recommended that Iskall Arno also accept the instalment of a pollution trap as well as a conveyer system.

The risks associated with not complying to legislation and the possibility of a lawsuit, not to mention the negative media coverage that could damage the reputation of the organisation, far outweighs the costs involved. Should a serious injury occur there is also the risk of the employees striking, which would have massive cost implications. Adding these to project thus amounts to a total cost of $98 million. However, I believe that the projects should be split into two groups (taking the business drivers into account), one being that of growth and expansion and the other being operational excellence.

Both the pollution trap and the conveyer system would then fall under operational excellence, and should not be measured against expansion and growth. PROPOSAL AND RECOMMENDATIONS The Value Cycle Spiral When looking at the value cycle spiral of an organisation, it becomes clear that access to capital markets is key in the success of a business. Through the critical analysis of Iskall Arno, it has become apparent that the culture of the organisation does not support this view. A culture change would thus be necessary in order to grow and expand the organisation to full potential. It is evident that expansion and growth is both possible and required. A majority of the projects is based on expansion of the company's market presence and an increase in sales figures.

Should these projects be allowed the result would be greater competitive positioning which would aid the profitability of the organisation and in turn would result in better internal cash flows. This would bring to bear an improvement of the company's market value, which then allows access to capital markets. Access to money improves competitive positioning which then allows the spiral to continue upwards. The Board of Directors of Iskall Arno needs to understand that being sensitive to debt could be one of the reasons that the growth of the organisation has not been satisfactory. Cost of capital can be decreased through structuring debt and equity instruments and making use of financial leverage. Recommended Approach Programme of Projects: The proposed projects are: .

Expansion of the market base southward. The likelihood of success for this project is high, as no other major competitors exists in this market and it has been mentioned that sales were increasing in the southeastern region of the company's market base. Building a new plant in the southeastern region as well as the new advertising campaign will also complement this project. A key issue in the implementation of this project would be distribution, which could be averted if distribution is outsourced. A change in culture would be required since the products of Iskall Arno have never been marketed outside the Midwest... Research and Development.

Although the likelihood of success for this project is not guaranteed the benefits that would arise from success is something that can not be ignored. A culture of innovation is required for this project to be accepted. One must bear in mind that the world is changing very fast and should the company not invest in innovation it could be left behind very easily, especially if a competitor should make a breakthrough first. The impact that a successful project would have on the organisation is enormous and protection of market share would be guaranteed, thus the urgency of this project is high...

Roll-out of a new advertising campaign. This project has a high likelihood for success and is relatively urgent for the organisation. The current campaign is aimed at an already saturated market. By aiming the advert at a new market, sales in the existing areas of operation can increase and awareness can be built in the new southern market.

The Board of Directors needs to realise the importance of marketing in order to increase sales... Building a new plant. Because of the increase in sales in the southeastern region this project is both highly likely to succeed and of critical urgency. It would take the pressure of the Terre Haute plant and the facility in Champaign, Illini os, which could then concentrate of delivering in its own area.

The new plant could then also assist the Sioux Falls plant in Iowa through absorbing some of the need for greater production capacity in the southeastern region. Phasing in the Projects: As depicted above the implementation of the four chosen projects should start immediately. The increased cash flows of these projects in the first year can then be used to implement the Pollution Trap. Similarly the increased profits for the second year can then be used for the implementation of the Conveyer System. This would not present a very positive cash flow for the end of year two, but overall an increase of $34 million will be the result at the end of the third year. CONCLUSION The status quo at Iskall Arno currently is that an increase in sales is required to continue to growth.

Currently there seems to be quality factors that have negatively impacted on distribution and an upgrade of the fleet is required to ensure more frequent deliveries. Because sales are increasing in the southeastern region a new manufacturing and packaging plant is required as well as an upgrade to one of the existing plants in order to handle the capacity. New conveyer systems in the company's 18 older factories is required to enhance operational efficiency. Expansion of the company's market base is possible in both an eastern and southern direction.

The advertising campaign that has been running for the past three years needs to be upgraded and because of current market saturation there is a need to look at new market segments. The ultimate goal of Iskall Arno is growth for the company and maintaining a payout ratio of 30%. The changes required to grow company would be investment in growth enhancing projects. Nine such projects where presented to the Capital Budgeting Committee, but not all of them can be accepted due to the self-imposed budget limit. It is suggested that four growth and expansion projects namely expanding the market base south, research and development, the rollout of a new advertising campaign and building a new plant, be implemented.

The positive cash flows of these projects can then be used to fund two of the operation excellence projects namely the conveyer system and the pollution trap. The combination of the above projects would ensure that production capacity is maintained, that a new market segment is targeted and than awareness is created of the Iskall Arno name. An investment in the future is also then taken into account with the research and development project and this will insure that Iskall Arno stays ahead of the competition and protects and grows it market share. To add to all of this, the products of Iskall Arno will also be marketed outside of the Midwest, broadening the market base and should this project proof to be successful one can look at also expanding to the East. LIST OF

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