1

Case Analysis
on

PEPSICO CHANGCHUN JOINT VENTURE:
CAPITAL EXPENDITURE ANALYSIS






2

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 - 112 131 049
Protap Kumar Roy - 112 131 050
Thofa Tazkia - 112122029





United International University
Date of Submission: 1
st
September, 2014


iii

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

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)



iv

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.



v

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 instructors (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.













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




vi

Table of Content
Sl. Particular Page

01 Introduction : 07
02 Analysis of Economy : 08
03 Analysis of Industry :
3.1 Porters 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

7

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 Peoples 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. PepsiCos 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 projects risk and return prospects.

8

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.


9

3. Analysis of Industry
3.1 Porters 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
Barriers to Entry
Absolute cost advantages
Proprietary learning curve
Access to inputs
Government policy
Economies of scale
Capital requirements
Brand identity
Switching costs
Access to distribution
Expected retaliation
Proprietary products

THREAT OF
SUBSTITUTES
-Switching costs
-Buyer inclination
to
substitute
-Price-
performance
trade-off of
substitutes

BUYER POWER
Bargaining leverage
Buyer volume
Buyer information
Brand identity
Price sensitivity
DEGREE OF
RIVALRY
-Exit barriers
-Industry
concentration
-Fixed costs/Value

10

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)

11

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 occurring
thus, 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

12

(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.

13










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
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.

14


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.

15




16

4. Analysis of Company
4.1.Ratio Analysis:Ratios are standardizednumber which facilitates comparison. By
comparison, we can highlight the companys performance at a glance. Here we also
used some traditional ratios to measure the financial performance of Deutsche Brauerei.























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 Brauereis 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
SL Ratios 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010
1 Current Ratio (Times) 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
2 Quick Ratio (Times) 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
3
Inventory Turnover Ratio
(Times) 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
4 Days Sales Outstanding (Days) 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
5 Fixed Asset Turnover (Times) 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
6 Total Asset Turnover (Times) 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
7 Debt Ratio (%) 53% 52% 53% 54% 57% 59% 68% 73% 78% 82% 85% 88% 90% 92%
8
Time Interest Earned Ratio
(Times) 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
9
EBITDA Coverage Ratio
(Times) 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
10 Profit Margin (%) 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%
11 Basic Earning Power (%) 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%
12 Return on Asset (%) 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%
13 Return on Equity (%) 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%
14 Equity Multiplier 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
15 EPS 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
16 Price Earning Ratio 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
17 Cash Flow Per Share 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
18
Price Cashflow Ratio
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
Actual Expected
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
Assumptions:
Stock Price

17

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



18

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.








Plant & Equipment 7,000
Working Capital 9,477
Total 16477
Initial Investment
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 420 420 420 420 420 420 420 420 420 420
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 420 420 420 420 420 420 420 420 420 420
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 207 (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
Depreciation Calculation:
2001 2002 2003 2004 2005 2006 2007 2008 2009 2010
Plant & Equipment 420 420 420 420 420 420 420 420 420 420
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
80,539 NPV @ 10.96%=
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
204,015
28.61%
Terminal Value =
MIRR =

19

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:



Note 02:



7,000
4,200
2,800
2,450
(350)
Tax on Capital Gain
Profit / (Loss) =
Cost of Plant & Equipment
Less: Accumulated Depreciation
Book Value
Sales Proceeds
2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010
Working Capital 9,477 9,270 10,031 10,712 11,275 11,732 12,094 12,371 12,573 12,708 0
Incremental of Working Capital (9,477) 207 (761) (681) (563) (457) (362) (277) (202) (135) 12,708

20

4.4.Weighted Average Cost of Capital (WACC):


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:



Alternative 02:



Alternative 03:



WACC at a glance:
Cost of Debt (Kd) = 0.10(1-0.35) 0.0650
Cost of Preferred Stock (Kp) = 15(100(1-0.06)) 0.1596
Cost of Common Equity (Ke) = (0.03+((0.1-0.03)*1.1))+0.015 0.1220
Weight (W) Cost of Capital (K) W K
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
0.1314 WACC (Alternative 01) =
Weight (W) Cost of Capital (K) W K
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
0.1096 WACC (Alternative 02) =
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
0.1103 WACC (Alternative 03) =

21


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:

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]

WACC (Alternative 01) = 13.14%
WACC (Alternative 02) = 10.96%
WACC (Alternative 03) = 11.03%
Cost of Debt 33%
Cost of Prefered Stock 17%
Cost of Common Equity 50%

22

4.5. Risk Analysis

4.5.1. Business Risk

Demand variability
The demand of Deutsche Brauereisbeerwas increasing for the past years, so there is a low
degree of business risk.

Sales price variability
Deutsche Brauereisbeer is very high in quality and taste, and for this reason the company can
charge whatever price it wants. So Deutsche Brauereisbeer is exposed to a low degree of
business risk.

Input cost variability
Deutsche Brauereis 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 beers 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:




2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010
Net Sales (in ) 92,063 105,682 118,971 135,634 154,630 176,287 200,977 229,125 261,215 297,799 339,508
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
Operating Profit 6,106 7,398 8,327 9,383 10,697 12,195 13,903 15,851 18,071 20,602 23,487
Degree of
Operating
Leverage (DOL)
1.4304 0.9986 0.9055 1.0000 1.0000 1.0000 1.0000 1.0000 1.0000 1.0000

23

2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010
EPS 20 23 20 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
Leverage (DCL)
1.3008 (1.0129) 1.8708 1.9847 1.1255 0.6641 1.0000 1.0000 1.0000 1.0000
Degree of Financial Leverage:






Degree of Combined Leverage:






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





4.6. SWOT

Strengths
1. Deutsche Brauereis beer is very high quality
product
2. The company had been doing business for 12
generations in the Schweitzer family. It earned
a very strong brand image.
3. Deutsche Brauerei has a large market share in
Germany and it manages to capture a good
market share in Ukraine.
Weaknesses
1. The company is highly
reliable on debt financing.
2. Large investments for the
company on accounts
receivables.

Opportunities
1. Expansion opportunity in abroad.
2. High demand of product in coming years.

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

24

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 companys 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 Olegs proposal regarding 6.8 Million investment in Ukraine
Project.
Decision about to take long term debt for further business expansion.


25

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.



26

7. Analysis of Each Alternative
For 2001 Financial Budgeting:
Under Alternative: 01

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.

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: 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
FCFF 8,933 9,886 11,498 13,109 14,945 17,038 19,424 22,145 25,246 28,782
Terminal Value 263,548
Total FCFF 8,933 9,886 11,498 13,109 14,945 17,038 19,424 22,145 25,246 292,330
Discounting @ WACC=
0.1314 7,895 7,723 7,939 8,000 8,061 8,123 8,185 8,248 8,311 85,057
Value of Firm (Under
Alternative 1) 157,544

27

Under Alternative: 02


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.

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: 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
FCFF 8,933 9,886 11,498 13,109 14,945 17,038 19,424 22,145 25,246 28,782
Terminal Value 327,733
Total FCFF 8,933 9,886 11,498 13,109 14,945 17,038 19,424 22,145 25,246 356,515
Discounting @ WACC=
0.1096 7,895 7,723 7,939 8,000 8,061 8,123 8,185 8,248 8,311 103,733
Value of Firm (Under
Alternative 2) 176,219

28

Under Alternative: 03


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.

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: 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
FCFF 8,933 9,886 11,498 13,109 14,945 17,038 19,424 22,145 25,246 28,782
Terminal Value 325,283
Total FCFF 8,933 9,886 11,498 13,109 14,945 17,038 19,424 22,145 25,246 354,065
Discounting @
WACC= 0.1103 7,895 7,723 7,939 8,000 8,061 8,123 8,185 8,248 8,311 103,020
Value of Firm (Under
Alternative 3)
175,506

29

Company Value Comparison under different alternative of Capital Structure











Comparison:
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.
Capital Structure Weight Value
Debt 0%
Prefered Stock 25%
Common Equity 75%
Capital Structure Weight Value
Debt 33%
Prefered Stock 17%
Common Equity 50%
Capital Structure Weight Value
Debt 45%
Prefered Stock 37%
Common Equity 18%
C
o
m
p
a
n
y

V
a
l
u
e

C
o
m
p
a
r
i
s
o
n
Alternative 02:
Alternative 03:
157,544
175,506
176,219
Alternative 01:

30

For Quarterly Dividend:
If Dividend Payout Ratio is 70%:

If Dividend Payout Ratio is 60%:

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.
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: 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) 122 142 155 177 201 230 262 298 340 388
FCFF 9,055 10,028 11,653 13,285 15,146 17,267 19,686 22,443 25,586 29,170
Terminal Value 332,149
Total FCFF 9,055 10,028 11,653 13,285 15,146 17,267 19,686 22,443 25,586 361,319
Discounting @ WACC= 0.1096 8,003 7,834 8,046 8,108 8,170 8,232 8,295 8,359 8,423 105,131
Value of Firm (Under 70% Dividend) 178,602
Previous Firm Value 176,219
Net Earnings 3724 4311 4712 5372 6124 6982 7960 9075 10346 11795
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: 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 (40% Retention Ratio) 163 189 207 236 268 306 349 398 454 517
FCFF 9,096 10,075 11,705 13,344 15,213 17,344 19,773 22,542 25,700 29,299
Terminal Value 333,621
Total FCFF 9,096 10,075 11,705 13,344 15,213 17,344 19,773 22,542 25,700 362,920
Discounting @ WACC= 0.1096 8,040 7,871 8,082 8,144 8,206 8,269 8,332 8,396 8,460 105,596
Value of Firm (Under 60% Dividend) 179,396
Previous Firm Value 176,219
Net Earnings 3724 4311 4712 5372 6124 6982 7960 9075 10346 11795

31

For Compensation Scheme for Oleg Pinchuk:
If base salary increase:

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:

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
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 102 102 102 102 102 102 102 102 102 102
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 7,296 8,225 9,281 10,595 12,093 13,801 15,749 17,969 20,500 23,385
Less: Tax 2,554 2,879 3,248 3,708 4,233 4,830 5,512 6,289 7,175 8,185
EBIT (1-Tax) 4,742 5,346 6,033 6,887 7,861 8,971 10,237 11,680 13,325 15,200
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
FCFF 8,866 9,820 11,432 13,043 14,878 16,972 19,358 22,078 25,180 28,716
Terminal Value 326,978
Total FCFF 8,866 9,820 11,432 13,043 14,878 16,972 19,358 22,078 25,180 355,694
Discounting @ WACC= 0.1096 7,837 7,671 7,894 7,960 8,026 8,091 8,157 8,223 8,289 103,494
Value of Firm (if base salary increase) 175,642
Previous Firm Value 176,219
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 Incentive of Oleg Pinchuk 106 119 136 155 176 201 229 261 298 340
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 7,292 8,208 9,247 10,543 12,019 13,702 15,622 17,809 20,304 23,147
Less: Tax 2,552 2,873 3,237 3,690 4,207 4,796 5,468 6,233 7,106 8,102
EBIT (1-Tax) 4,740 5,335 6,011 6,853 7,812 8,907 10,154 11,576 13,197 15,046
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
FCFF 8,864 9,809 11,410 13,008 14,830 16,907 19,275 21,975 25,053 28,561
Terminal Value 325,220
Total FCFF 8,864 9,809 11,410 13,008 14,830 16,907 19,275 21,975 25,053 353,782
Discounting @ WACC= 0.1096 7,835 7,663 7,879 7,939 8,000 8,061 8,122 8,185 8,247 102,938
Value of Firm (if incentive increase) 174,867
Previous Firm Value 176,219

32


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.

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 17,866 17,786 25,519 29,094 33,168 37,814 43,110 49,147 56,031 63,878
Less: New Incentive of Oleg Pinchuk 0.05 0.10 0.15 0.20 0.25 0.30 0.35 0.40 0.45 0.50
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 8,032 9,041 10,197 11,625 13,253 15,109 17,225 19,638 22,388 25,523
Less: Tax 2,811 3,164 3,569 4,069 4,638 5,288 6,029 6,873 7,836 8,933
EBIT (1-Tax) 5,221 5,876 6,628 7,556 8,614 9,821 11,196 12,764 14,552 16,590
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
FCFF 9,345 10,350 12,027 13,712 15,632 17,822 20,317 23,163 26,407 30,106
Terminal Value 342,807
Total FCFF 9,345 10,350 12,027 13,712 15,632 17,822 20,317 23,163 26,407 372,912
Discounting @ WACC= 0.1096 8,259 8,086 8,305 8,368 8,432 8,497 8,562 8,627 8,693 108,504
Value of Firm (Under New incentive) 184,332
Previous Firm Value 176,219

33

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 ulti mately
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. Olegs Compensation Base Salary = 40000 and Incentive Payment = 5% of Net Income


xxxiv

Reference:
i. http://markets.ft.com/RESEARCH/Markets/Interest-Rates
ii. http://aswathdamodaran.blogspot.com/2010/02/thoughts-on-riskfree-rate.html
iii. http://www.investing.com/indices/cxpfx
iv. http://www.boerse-frankfurt.de/en/start
v. http://www.marketwatch.com/investing/index/dax?countrycode=dx


xxxv


Appendix

xxxvi







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xxxvii



























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A
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xxxviii




Cash 31%
Accounts Receivable
Germany 25%
Ukraine 13%
Allowance for doubtful accounts 1%
Inventories 32%
Investments & other assets 12%
Accumulated depriciation 58%
Net property, plant, & equipt. 88%
Bank borrowings (short term) 45%
Acounts payable 18%
Other current liabilities 38%
Long term debt: Bank borrowings 20%
Shareholders' equity 80%
Growth for Coming Years (Balance Sheet)
Net Sales 14%
Production costs 54%
Admin and selling 19%
Depreciation 6%
Excise duties 13%
Interest expense 2%
Income Taxes 35%
Dividends to all common 75%
Retained Earnings 25%
Growth for Coming Years (Income Statement)