IB Business Management SL 3.8 Investment Appraisal Topic Practice

Grunsburg Textiles (GT)


Grunsburg Textiles (GT) is a textile company founded by the paternalistic leader Henrik Steiner. As the company grew, it became very committed to corporate social responsibility (CSR). "Our aims," GT says on its website, "include making profits, providing safe and secure employment, contributing to society through investment in environmentally friendly production practices and supporting ethical causes". Many people believe that GTs success is tied to its reputation for taking care of its employees and for its commitment to CSR.
In 2015, GT purchased €44 million in new environmentally friendly equipment. It financed the purchase with a bank loan. GT originally forecasted that the new equipment would generate €8 million in annual net cash flow. Instead, the actual increase in GTs annual net cash flow from the new equipment was only € 6 million. The Chief Financial Officer (CFO), Elaine, warned Henrik that unless net cash flow increased significantly, the average rate of return (ARR) would be significantly lower than originally forecasted.
G T is struggling to make the loan payments and to have sufficient working capital. Elaine determined that one way to shorten the working capital cycle is debt factoring. However, when she approached several (debt) factors, she was discouraged by their proposed discount rates.
Elaine knows that the situation is worse than she had warned. If the economy were to weaken and revenue to decline, she believes that the company could go out of business. Proposals for a solution include cutting back on GTs commitment to its employees and CSR practices.

RDM is competitive within a 700-kilometre radius of Lobjanec because delivery costs depend mainly on weight and distance; it is less price-competitive in potentially lucrative Scandinavia, the Netherlands, Belgium, France and northern Italy. The CFO therefore proposes an additional European production facility to extend the market area. The order, manufacture and delivery process could still be performed in Lobjanec, so the new facility would require limited staff and most work would be done by robots. RDM could finance the expansion with share capital or loan capital; the cost may exceed what it can raise as a private limited company, so it may need to go public. RDM has no formal marketing strategy, corporate strategy, written operations-management strategy or human-resources plan, despite making good products at competitive prices and being responsive to customers' needs.

While identifying a location for the new factory, Zylstra Industries (ZI), a large manufacturing company located not far from Location A, presented RDM with another possibility: a strategic alliance. Thus, RDM have two options to consider.

Option 1: Purchase land and build a new automated factory. The potential location is summarized in Table 1.

Location A is in an economically depressed area of northwestern Europe, where land values nevertheless remain high. Location A has an old industrial tradition with a long tradition of poor industrial/employee relations.

Option 2: A ten-year strategic alliance with Z I. Z I has proposed that RDM uses some of its vacant manufacturing space in exchange for assistance in transforming Zl's manufacturing process into a highly automated one using robots. Twenty RDM engineers and computer scientists would:
- transform ZI's current factory into an automated one
- train ZI engineers
- monitor the factory for the duration of the strategic alliance.

ZI would pay all capital expenditures and RDM would employ the twenty engineers and computer scientists. Average salary and other financial rewards of one highly skilled employee would be $\$ 150000$ per year. In exchange, RDM would get free usage of factory floor space. RDM would buy its own equipment at a cost of $\$ 6000000$.

RDM estimates that leasing space similar to what Z I is offering would cost $\$ 3000000$ a year.

DA has a long-standing social commitment: employees live in Ville d'Ablet with subsidized rent and access to a hospital, school and leisure facilities. The proposed employment package would replace annual salary with low basic wages and profit-related bonuses, charge market rent and fees for facilities, and offer compensation payments to employees who leave. This could reduce employment costs but may damage morale, trust and DA's social values. DA has recently made losses, while its two strategic options have different risks. Option A would move DA from high-end niche markets to the mass market using the DuLow brand and outsourced mass production by SE. Option B would invest €500 million in cellular manufacturing and modular click-and-fix products. The option must be assessed against the cash inflows, finance, product life cycle, brand loyalty, innovation, production costs, environmental concerns and possible future demand.

DA's board must make two major decisions.

Decision 1: DA needs to reduce employment costs. A new system of pay and benefits is under consideration. This includes:
- changing from an annual salary to low basic wages with profit-related bonuses
- reducing social benefits for employees, such as paying market rents for the housing in Ville d'Ablet and having to pay for the use of the leisure facilities
- offering generous compensation payments to employees who are prepared to leave the business.

Decision 2: The three options from DA directors must be considered.
Immediately prior to the board meeting, Mia withdrew her proposal (Option C).
There is now additional information available on the remaining options.

Louise plans to target the mass market and proposes using the brand name DuLow for the redesigned products. She is planning for DA to outsource production to Star Electrics (SE). SE uses mass production together with some customization of products. SE keeps costs low by importing cheap raw materials and paying low wages.

Ben, the human resource management director, is concerned about the impact this change would have on DA's employees.

Salah's plan requires new production lines, one for each product. Salah proposes using cellular manufacturing. The investment cost is estimated to be € 500 million. Salah estimates the following net cash inflows (excluding the initial investment cost).

Louise thinks the option is expensive. Dodi, the finance director, thinks that the investment is too large and he believes that some shareholders are also concerned about the size of future dividends. Salah believes that shareholders will be pleased about the revenues that this investment will generate. Mia is worried that the products would be expensive to produce and that demand might fall in five to seven years.