Beruflich Dokumente
Kultur Dokumente
Part I
(How to evaluate the profitability of investment in a new company) 1
The background
Healthy Milk Indonesia (Milkindo) Plc is a company operates in a food and beverage
industry, which produces mainly baby foods, including dairy products. It established
at the end of fifties, and the main brand name, Bayi Sehat Indonesia (BSI), has
achieved quite successful results and become well known in the market particularly
for middle-low income consumers. During the first years of operation the sales were
very good, the sales growth reached more than 15% annually. For a new company, the
market share enjoyed by the company was quite satisfactory.
However, started at the beginning of sixties, the Indonesian economy had faced hard
times. The government deficit, which was financed by printing money, triggered
inflation. Moreover, the export - which was still relied on raw materials and agricultural
products - could not generate enough foreign exchange to finance the imports. The
depletion of foreign exchange reserves led the government to impose foreign exchange
control. As a result, the imported materials became less and less available in the
market, and sometimes they simply disappeared from the market.
This situation created a big headache for companies use imported materials. The
problem was also faced by Milkindo since it could not buy skim milk, sugar, and tin
package. As a result, the production decreased substantially. Although some
modification of the raw materials used in the production processes had been made, the
company was forced to operate on very low capacity.
However, the situation was much different in the seventies. The development of the
Indonesia economy had a positive impact to the businesses. The availability of
imported goods and materials in the market relieved the company. When the company
decided to go public by issuing new stocks at the end of 1980s (hence it becomes a
public limited company [Plc.]), more than 70 percent of revenue and income was
generated from the brand name of Bayi Sehat Indonesia (BSI) (although it also launched
several products and brand names).
1
The case was prepared by Suad Husnan for the purpose of discussion, not to show the correct or
incorrect practices. It is based on real problem although some names and financial information have
been changed to protect confidential information without altering the nature of managerial decisions.
Table 1
Summary of Balance Sheets Milkindo Plc, 2003 and 2004 (in billion rupiah)
2003 2004 2003 2004
Current assets* 850 961 Current liabilities 127 170
Non-Current assets 268 259 Non-current 16 29
liabilities
Equity** 975 1.021
Total assets 1.118 1.220 Total equity & liab. 1.118 1.220
*Notes: The cash and equivalent is Rp590 and Rp620 billion in 2003 and 2004 respectively
** 940 million shares issued and outstanding
The current liabilities consist mainly of trades payable and accrued expenses, while
non-current liabilities consist mainly of provision of employees benefits. The sales, cost,
expenses and profit for the year 2003 and 2004 are presented in Table 2.
Table 2
Summary of Income Statement for the year 2003 and 2004 (in billion rupiah)
2003 2004
Net sales 1.100 1.250
Cost of goods sold 575 670
Gross profit 525 580
Operating expenses 195 230
Operating income 330 350
Net Income 220 240
The founders, who control 70% of the listed shares, also own other businesses. The
dividend policy of Milkindo is determined by the need for the cash for other businesses
in the group. When the businesses in the group do not need external financing, usually
the payout ratio of Milkindo is very low which was practiced for 1999-2002. However,
when the group needs rather substantial funds (for example in 2003 and 2004), the
profitable companies in the group are requested to pay rather generous dividend to
finance the cash need businesses. This policy has been carried out for the last ten years,
and is expected to continue.
Table 3
Estimates of net operating working capital, gross fixed assets, and EBIT (in billion
rupiah) for the distribution company
Year 0 1 2 3 4
(when the
company
starts)
Net operating working capital 24 30 36 40 44
Gross fixed assets 26 30 34 39 44
Depreciation - 2 3 4 5
Operating Income (EBIT) 10 12 15 18
It is expected that after year 4, the net operating capital (net operating working
capital plus net fixed assets) and the operating income (EBIT) will grow by 5%
annually indefinitely. The distribution company will be financed entirely by equity.
Table 4
Estimates of equity betas, rates of return, and other data
Value
Beta of equity of Milkindo 1.00
Beta of equity of distribution companies (average) 1.10
Debt to equity ratio of distribution companies (average) 0.70
Market (represented by IHSG*) rate of return (annually) 16.0%
Risk free rate of return (represented by SBI) (annually) 9.0%
*Market Composite Index
The production director commented that it seemed that the new distribution
company would have a little bit higher risk compared to the baby food business.
Although the size of the distribution company is small compared to the baby food
company, does it mean that the new company will contribute to the higher risk of
the group?
The president director was rather surprised that the discussion was mainly on the
profitability of the distribution company. He thinks that something is missing in the
discussion.
The task
After listened to the discussion, the president director then assign a report of the
profitability of the new distribution company, which should address the following
questions.
1. Is the argument put forward by the marketing director, which is the
distribution company is profitable because the average ROE is higher than
the SBI rate, correct? Does reporting higher profit increase share price? Why?
---sh---
Yogyakarta, August 2010