Euroland Foods

Euroland Foods S.A.

Capital Budgeting and Resource Allocation

Angela Hamrick

Euroland Foods S.A.

I. Introduction

In January 2001, Euroland Foods has a committee of senior managers to prepare the capital budget on an annual basis, and it is then presented to the board of directors. Investment proposals are then solicited from the managing directors and include a financial analysis and a brief project description. The following proposals will be voted on at the next meeting:

Proposals Expenditures (euro millions)

1. Replacement and expansion of the truck fleet. 33

2. A new plant. 45

3. Expansion of a plant. 15

4. Development and roll-out of snack foods. 27

5. Plant automation and conveyor systems. 21

6. Effluent-water treatment at four plants. 6

7. Market expansion southward. 30

8. Market expansion eastward. 30

9. Development and introduction of new artificially sweetened

yogurt and ice cream. 27

10. Networked, computer-based inventory-control system for

warehouses and field representatives. 22.5

11. Acquisition of a leading schnapps brand and associated facilities. 60

After these proposals are introduced, they are then subject to two tests: internal rate or return (IRR) and payback. The determination of which projects to pursue is based on the acceptance of the IRR and payback methods. The project hurdles can be seen in Exhibit 1. The net present value of the projects and the profitability index should be examined. When determining which proposals should be adopted the company must consider the capital spending budget of 120 million EUR for 2001. When deciding which of these proposals the company should undertake, Euroland should consider reducing the leverage in order to keep the risk of the company reasonable. Euroland should select projects in order to attempt to build back the confidence of the company...