In this white paper, we describe how companies apply their capex process, and how universities teach us to make capex decision, leads to massive capital destruction. Almost all companies in all industries evaluate capex decisions in basically the same way.
After reading this white paper, you will change how you, as an experienced decision maker within a capital-intensive company, view your decisions. If you, in any way, are responsible for the capex process – you will get something to think about and having you want to take action.
Case Study-New Plant Building “Capex Sourcing in China”John William
China has become a major sourcing destination for capex sourcing. Capex sourcing plays an important role for building new plant. To get more information about capex sourcing in China visit: http://www.dragonsourcing.com/china-sourcing-company/
Many projects experience failures that result in poor project delivery performance or process capacity/reliability degradations after commissioning
Many studies have shown that 60% to 95% of equipment life cycle costs (TLCC) are a result of decisions made (in CAPEX) prior to handover/start-up and transfer to owners (maintenance or operations) in OPEX
Wouldn’t it make common sense to manage the risk of CAPEX project failures in advance and address equipment life cycle decisions in (CAPEX) rather than after commission handover phase (OPEX)?
Shouldn't owners "invest" in project success "insurance" to help ensure that these multi-billion dollar projects are delivered as they were intended?
The Dilemma at Day-Pro Comparison of Capital Budgeting Tec.docxcherry686017
The Dilemma at Day-Pro
Comparison of Capital Budgeting Techniques
The Day-Pro Chemical Company, established in 1995, has managed to earn
a consistently high rate of return on its investments. The secret of its success has
been the strategic and timely development, manufacturing, and marketing of
innovative chemical products that have been used in various industries. Currently,
the management of the company is considering the manufacture of a thermosetting
resin as packaging material for electronic products. The Company’s Research and
Development teams have come up with two alternatives: an epoxy resin, which
would have a lower startup cost, and a synthetic resin, which would cost more to
produce initially but would have greater economies of scale. At the initial
presentation, the project leaders of both teams presented their cash flow projections
and provided sufficient documentation in support of their proposals. However,
since the products are mutually exclusive, the firm can only fund one proposal.
In order to resolve this dilemma, Tim Palmer, the Assistant Treasurer and a
recent MBA from Drexel University, has been assigned the task of analyzing the
costs and benefits of the two proposals and presenting his findings to the board of
directors. Tim knows that this will be an uphill task, since the board members are
not all on the same page when it comes to financial concepts. The Board has
historically had a strong preference for using rates of return as its decision criteria.
On occasions it has also used the payback period approach to decide between
competing projects. However, Tim is convinced that the net present value (NPV)
method is least flawed and when used correctly will always add the most value to a
company’s wealth.
After obtaining the cash flow projections for each project (see Tables 1 & 2),
and crunching out the numbers, Tim realizes that the hill is going to be steeper than
he thought. The various capital budgeting techniques, when applied to the two
series of cash flows, provide inconsistent results. The project with the higher NPV
has a longer payback period as well as a lower Accounting Rate of Return (ARR)
and Internal Rate of Return (IRR). Tim scratches his head, wondering how he can
convince the Board that the IRR, ARR and Payback Period can often lead to
incorrect decisions.
Table 1. Synthetic Resin Cash Flows
Synthetic Resin
Year 0 1 2 3 4 5
Net Income
$150,000
$200,000
$300,000
$450,000
$500,000
Depreciation
$200,000
$200,000
$200,000
$200,000
$200,000
Net Cash Flow $(1,000,000)
$350,000
$400,000
$500,000
$650,000
$700,000
Table 2. Epoxy Resin Cash Flows
Epoxy Resin
Year 0 1 2 3 4 5
Net Income
$440,000
$240,000
$140,000 $ 40,000 $ 40,000
Depreciation
$160,000
$160,000
$160,000
$160,000
$160,000
Net Cash Flow $(800,000)
...
6.1 How to Compute Cash FlowsWe discussed how to use accou.docxevonnehoggarth79783
6.1
How to Compute Cash Flows
We discussed how to use accounting statements to estimate cash flows in Chapter 2. There we showed a simple approach that gave a reasonable approximation in most cases and a more complete approach. The simple approach just added depreciation expense back to net income to find an estimate of cash flow. This approach is usually fairly close to the exact value because depreciation is usually the primary account that causes net income and cash flow to differ.
The more complete approach begins with net income and subtracts increases in assets and adds increases in liabilities. Note that depreciation expense will be included in changes in fixed assets or property, plant, and equipment (PP&E), so is not treated separately as it was in the simple approach. If you are not comfortable with translating accounting data into cash flows, be sure to review the more detailed description of the process in Chapter 2.
The appropriate cash flows for evaluating a corporate investment decision are incremental after-tax cash flows. We will explain this definition in some detail as the chapter progresses. For now, let's look at the logic underlying each portion of this expression.
Incremental: This is similar to the concept of marginal in microeconomics. Economists make decisions by comparing marginal costs and marginal revenues. Recall that a product's marginal cost is the cost of making one more unit of the product. If the marginal cost is less than the marginal revenue (the price the unit will be sold for), then the company produces and sells that additional unit of production. Production continues as long as marginal cost is below marginal revenue. In finance we have adopted the concept underlying marginal analysis to evaluate corporate investment proposals. We compare the additional cash flow that the proposed project or product will generate to the additional costs that the investment requires.
After-tax: When we evaluate a project proposal, we do so from the perspective of the owners of the company. If the company is publicly traded, this means we evaluate from the shareholders' perspective. Owners receive their return from after-tax dollars. That is, shareholders have a claim on after-tax profits. These are often referred to as residual cash flows because they are left after all other obligations have been paid. We will see that taxes can have a large effect on cash flows, so they cannot be ignored.
Cash flows: As we discussed at the very beginning of this chapter (and in Chapter 2), it is cash that allows a company to pay its obligations—wages to employees, bills from suppliers, taxes, etc.—and remain financially viable.
Incremental Cash Flows
The use of incremental cash flows builds on the concept of marginal costs and revenues in economics. In corporate finance we don't deal with individual units of production, but rather with investments in assets and other expenditures (training, marketing, R&D, etc.) to make new .
Case Study-New Plant Building “Capex Sourcing in China”John William
China has become a major sourcing destination for capex sourcing. Capex sourcing plays an important role for building new plant. To get more information about capex sourcing in China visit: http://www.dragonsourcing.com/china-sourcing-company/
Many projects experience failures that result in poor project delivery performance or process capacity/reliability degradations after commissioning
Many studies have shown that 60% to 95% of equipment life cycle costs (TLCC) are a result of decisions made (in CAPEX) prior to handover/start-up and transfer to owners (maintenance or operations) in OPEX
Wouldn’t it make common sense to manage the risk of CAPEX project failures in advance and address equipment life cycle decisions in (CAPEX) rather than after commission handover phase (OPEX)?
Shouldn't owners "invest" in project success "insurance" to help ensure that these multi-billion dollar projects are delivered as they were intended?
The Dilemma at Day-Pro Comparison of Capital Budgeting Tec.docxcherry686017
The Dilemma at Day-Pro
Comparison of Capital Budgeting Techniques
The Day-Pro Chemical Company, established in 1995, has managed to earn
a consistently high rate of return on its investments. The secret of its success has
been the strategic and timely development, manufacturing, and marketing of
innovative chemical products that have been used in various industries. Currently,
the management of the company is considering the manufacture of a thermosetting
resin as packaging material for electronic products. The Company’s Research and
Development teams have come up with two alternatives: an epoxy resin, which
would have a lower startup cost, and a synthetic resin, which would cost more to
produce initially but would have greater economies of scale. At the initial
presentation, the project leaders of both teams presented their cash flow projections
and provided sufficient documentation in support of their proposals. However,
since the products are mutually exclusive, the firm can only fund one proposal.
In order to resolve this dilemma, Tim Palmer, the Assistant Treasurer and a
recent MBA from Drexel University, has been assigned the task of analyzing the
costs and benefits of the two proposals and presenting his findings to the board of
directors. Tim knows that this will be an uphill task, since the board members are
not all on the same page when it comes to financial concepts. The Board has
historically had a strong preference for using rates of return as its decision criteria.
On occasions it has also used the payback period approach to decide between
competing projects. However, Tim is convinced that the net present value (NPV)
method is least flawed and when used correctly will always add the most value to a
company’s wealth.
After obtaining the cash flow projections for each project (see Tables 1 & 2),
and crunching out the numbers, Tim realizes that the hill is going to be steeper than
he thought. The various capital budgeting techniques, when applied to the two
series of cash flows, provide inconsistent results. The project with the higher NPV
has a longer payback period as well as a lower Accounting Rate of Return (ARR)
and Internal Rate of Return (IRR). Tim scratches his head, wondering how he can
convince the Board that the IRR, ARR and Payback Period can often lead to
incorrect decisions.
Table 1. Synthetic Resin Cash Flows
Synthetic Resin
Year 0 1 2 3 4 5
Net Income
$150,000
$200,000
$300,000
$450,000
$500,000
Depreciation
$200,000
$200,000
$200,000
$200,000
$200,000
Net Cash Flow $(1,000,000)
$350,000
$400,000
$500,000
$650,000
$700,000
Table 2. Epoxy Resin Cash Flows
Epoxy Resin
Year 0 1 2 3 4 5
Net Income
$440,000
$240,000
$140,000 $ 40,000 $ 40,000
Depreciation
$160,000
$160,000
$160,000
$160,000
$160,000
Net Cash Flow $(800,000)
...
6.1 How to Compute Cash FlowsWe discussed how to use accou.docxevonnehoggarth79783
6.1
How to Compute Cash Flows
We discussed how to use accounting statements to estimate cash flows in Chapter 2. There we showed a simple approach that gave a reasonable approximation in most cases and a more complete approach. The simple approach just added depreciation expense back to net income to find an estimate of cash flow. This approach is usually fairly close to the exact value because depreciation is usually the primary account that causes net income and cash flow to differ.
The more complete approach begins with net income and subtracts increases in assets and adds increases in liabilities. Note that depreciation expense will be included in changes in fixed assets or property, plant, and equipment (PP&E), so is not treated separately as it was in the simple approach. If you are not comfortable with translating accounting data into cash flows, be sure to review the more detailed description of the process in Chapter 2.
The appropriate cash flows for evaluating a corporate investment decision are incremental after-tax cash flows. We will explain this definition in some detail as the chapter progresses. For now, let's look at the logic underlying each portion of this expression.
Incremental: This is similar to the concept of marginal in microeconomics. Economists make decisions by comparing marginal costs and marginal revenues. Recall that a product's marginal cost is the cost of making one more unit of the product. If the marginal cost is less than the marginal revenue (the price the unit will be sold for), then the company produces and sells that additional unit of production. Production continues as long as marginal cost is below marginal revenue. In finance we have adopted the concept underlying marginal analysis to evaluate corporate investment proposals. We compare the additional cash flow that the proposed project or product will generate to the additional costs that the investment requires.
After-tax: When we evaluate a project proposal, we do so from the perspective of the owners of the company. If the company is publicly traded, this means we evaluate from the shareholders' perspective. Owners receive their return from after-tax dollars. That is, shareholders have a claim on after-tax profits. These are often referred to as residual cash flows because they are left after all other obligations have been paid. We will see that taxes can have a large effect on cash flows, so they cannot be ignored.
Cash flows: As we discussed at the very beginning of this chapter (and in Chapter 2), it is cash that allows a company to pay its obligations—wages to employees, bills from suppliers, taxes, etc.—and remain financially viable.
Incremental Cash Flows
The use of incremental cash flows builds on the concept of marginal costs and revenues in economics. In corporate finance we don't deal with individual units of production, but rather with investments in assets and other expenditures (training, marketing, R&D, etc.) to make new .
Proposal For Business Trade PowerPoint Presentation SlidesSlideTeam
If your company needs to submit a Proposal For Business Trade PowerPoint Presentation Slides look no further. Our researchers have analyzed thousands of proposals on this topic for effectiveness and conversion. Just download our template, add your company data and submit to your client for a positive response. https://bit.ly/2WsVWg9
Business Proposal PowerPoint Presentation SlidesSlideTeam
If your company needs to submit a Business Proposal PowerPoint Presentation Slides look no further. Our researchers have analyzed thousands of proposals on this topic for effectiveness and conversion. Just download our template, add your company data and submit to your client for a positive response. https://bit.ly/38L9TdX
Agenda:
Modeling depleting items
Consistency in the format
Modeling the Taxes
Modeling of Debt and Cash Balances
Edupristine offers Financial Modeling Course in US a practical approach for financial analysts to come to the business valuation of any organization
More info take a look at:http://www.edupristine.com/ca/courses/financial-modeling/
Chapter 3 - Financial Benchmarking for Inventory Turns and Working CapitalSolventure
This article fits in a series of articles inspired by the book ‘Supply Chain Metrics That Matter’.
In her latest book Lora Cecere introduces ‘which are the metrics that matter’, ‘how to ensure strength, balance and resilience’, what are the ‘evolutions in different sectors’, …
In this third article, Bram tries to explore alternatives for measuring the cash side and the service-cost side of the supply chain triangle.
He compares inventory turns and CCC for the cash side. He compares EBIT and EBITDA for the service-cost side. We also derive the best practice curve amongst 3 benchmark companies and derive resulting targets for a combination of EBIT-inventory or EBIT-CCC.
We hope you enjoy the reading.
Business Proposal Powerpoint Presentation SlidesSlideTeam
Requests for business proposals are one of the most effective ways to generate and convert leads. It does the job tremendously well when it comes to sales optimization. However, preparing a business proposition requires skill, effort, and experience. Documenting the right things in the right proportion is the secret to a responsive proposal. As professional PowerPoint template innovators, SlideTeam has designed 1M+ templates. Our latest addition will satisfy the responsive business proposal needs of entrepreneurs across all domains. Whether solicited or unsolicited, you can use these business Proposal Powerpoint Presentation Slides to convert every opportunity. All the templates in this deck are designed in alignment with the industry specifics. Research experts gather the data featured in our PPT slideshow. It is then passed on to the designers, who use state-of-the-art tools to organize the content in a visually gripping manner. The cover letter included in this PowerPoint layout will present the whole project in a nutshell. Present a crisp executive summary by highlighting your services/products, business vision, and value proposition. Our business offer PPT format gives to access to infographic-style slides. Further, showcase the background of the business project. Present the problem statement and solution for the commercial business proposal. With the help of a labeled diagram represent the time duration of each business project activity. Utilize the tabular layout to illustrate the cost estimate for business activity. Elucidate the business project benefits like cost avoidance, productivity, and revenue. Familiarize your clients with your organization. Introduce your team for the project, along with their roles and responsibilities. Maintain business transparency by showcasing all the terms and conditions. This includes initial setup, monthly fee, cancellation, and more. Communicate the forthcoming steps involved in successfully delivering the project. You can brief about the budget approval, fund posting, and project plan finalization. So, hit the download icon to begin instant personalization. https://bit.ly/2RQlN26
Front End of Innovation Worlshop: Strategy tools - in action. Expanded versionEngage // Innovate
Strategy and innovation is changing. The world needs new strategy tools. We design tools to make strategy & innovation happen at your company. This hands-on workshop will give you five new tools for Strategic innovation, Business model innovation, Innovation mindset and Innovation mapping, with case studies on Tesla Motors, Google and Amazon. This action-driven workshop will provide you with emerging tools for strategic innovation. You will apply these to your ongoing innovation challenges – and put the tools to work in your own organization. Master new tools to change how your company works on innovation. Take-away your personal toolkit and "Dream Bigger: Your Personal Innovation Sketchbook"
Led by Christian Rangen, Elisabeth Ovstebo and Inger Hanne Vikshaland
Founders, Engage // Innovate & authors, Strategy Tools for the Next Generation.
Decision Making with Excel for ManagersAsen Gyczew
As a manager you will be tempted to trust your guts and use your experience to decide what and how to do it. Quite often this approach may be misleading. It is much better to use data driven approach and before you make the decision look at the potential consequences. In this course I will show you how to make more rational choices as a manger using Excel. We will go through a lot of case studies that will help you master this skill.
In the course you will learn the following things:
1. How to be data driven in solving problems
2. How to make better decisions using Excel
3. How to handle uncertainty when you are making decisions
4. Which method, framework you should use in a specific situation
You will learn how to make decisions using make or buy analysis, voting system, simulations, rankings, how to analyze the costs of different investments (aiming at cost reduction, removing bottlenecks, requested by the customers). We will also how to apply the portfolio decision making, value proposition alignment, strategic alignment frameworks.
For more check my course: https://bit.ly/DecisionMakingExcel
BUS 630 Week 1 Assignment Dell, Inc..doc
BUS 630 week 1 DQ 1 Theory of Constraints.doc
BUS 630 week 1 DQ 2 Kranbrack Corporation.doc
BUS 630 week 2 Assignment Basic CVP Analysis (Fashion Shoe Company).doc
BUS 630 week 2 DQ 1 Downsizing and fixed cost.doc
BUS 630 week 2 DQ 2 Direct Labor Variable or Fixed Cost.doc
BUS 630 week 3 Assignment JetBlue Airways.doc
BUS 630 week 3 DQ 1 Fixed Labor.doc
BUS 630 week 3 DQ 2 Profitability.doc
BUS 630 week 4 Assignment Master budget exercise.doc
BUS 630 week 4 DQ 1 Behavioral aspects of budgeting.doc
BUS 630 week 4 DQ 2 Critiquing a Cost Report.doc
BUS 630 week 5 Assignment FedEx Corporation.doc
BUS 630 week 5 DQ 1 Variance Analysis in a Hospital.doc
BUS 630 week 5 DQ 2 Perverse Affects of Some Performance Measures.doc
BUS 630 week 6 Assignment Final Project (Cost management).doc
BUS 630 week 6 DQ 1 Make Or Buy.doc
BUS 630 week 6 DQ 2 Net Present Value Analysis.doc
1. Payback Period and Net Present Value[LO1, 2] If a project with .docxpaynetawnya
1. Payback Period and Net Present Value[LO1, 2] If a project with conventional cash flows has a payback period less than the project’s life, can you definitively state the algebraic sign of the NPV? Why or why not? If you know that the discounted payback period is less than the project’s life, what can you say about the NPV? Explain.
Internal Rate of Return[LO5] Concerning IRR:
a. Describe how the IRR is calculated, and describe the information this measure provides about a sequence of cash flows. What is the IRR criterion decision rule?
b. What is the relationship between IRR and NPV? Are there any situations in which you might prefer one method over the other? Explain.
c. Despite its shortcomings in some situations, why do most financial managers use IRR along with NPV when evaluating projects? Can you think of a situation in which IRR might be a more appropriate measure to use than NPV? Explain.
14. Net Present Value[LO1] It is sometimes stated that “the net present value approach assumes reinvestment of the intermediate cash flows at the required return.” Is this claim correct? To answer, suppose you calculate the NPV of a project in the usual way. Next, suppose you do the following:
a. Calculate the future value (as of the end of the project) of all the cash flows other than the initial outlay assuming they are reinvested at the required return, producing a single future value figure for the project.
b. Calculate the NPV of the project using the single future value calculated in the previous step and the initial outlay. It is easy to verify that you will get the same NPV as in your original calculation only if you use the required return as the reinvestment rate in the previous step.
17. Comparing Investment Criteria Consider the following two mutually exclusive projects:
Year Cash Flow (A) Cash Flow (B)
If you apply the payback criterion, which investment will you choose? Why?
b. If you apply the discounted payback criterion, which investment will you choose? Why?
c. If you apply the NPV criterion, which investment will you choose? Why?
d. If you apply the IRR criterion, which investment will you choose? Why?
e. If you apply the profitability index criterion, which investment will you choose? Why?
5. Equivalent Annual Cost [LO4]
1. When is EAC analysis appropriate for comparing two or more projects?
2. Why is this method used?
3 .Are there any implicit assumptions required by this method that you find troubling? Explain.
6. Cash Flow and Depreciation [LO1] “When evaluating projects, we’re concerned with only the relevant incremental after tax cash flows. Therefore, because depreciation is a noncash expense, we should ignore its effects when evaluating projects.” Critically evaluate this statement.
QUESTION AND PROBLEMS
1. Relevant Cash Flows [LO1] Parker & Stone, Inc., is looking at setting up a new manufacturing plant in South Park to produce garden tools. The company bought some land six years ago for $5 ...
Proposal For Business Venture PowerPoint Presentation SlidesSlideTeam
If your company needs to submit a Proposal For Business Venture PowerPoint Presentation Slides look no further. Our researchers have analyzed thousands of proposals on this topic for effectiveness and conversion. Just download our template, add your company data and submit to your client for a positive response. https://bit.ly/2AscA7f
Digital Transformation and IT Strategy Toolkit and TemplatesAurelien Domont, MBA
This Digital Transformation and IT Strategy Toolkit was created by ex-McKinsey, Deloitte and BCG Management Consultants, after more than 5,000 hours of work. It is considered the world's best & most comprehensive Digital Transformation and IT Strategy Toolkit. It includes all the Frameworks, Best Practices & Templates required to successfully undertake the Digital Transformation of your organization and define a robust IT Strategy.
Editable Toolkit to help you reuse our content: 700 Powerpoint slides | 35 Excel sheets | 84 minutes of Video training
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Proposal For Business Trade PowerPoint Presentation SlidesSlideTeam
If your company needs to submit a Proposal For Business Trade PowerPoint Presentation Slides look no further. Our researchers have analyzed thousands of proposals on this topic for effectiveness and conversion. Just download our template, add your company data and submit to your client for a positive response. https://bit.ly/2WsVWg9
Business Proposal PowerPoint Presentation SlidesSlideTeam
If your company needs to submit a Business Proposal PowerPoint Presentation Slides look no further. Our researchers have analyzed thousands of proposals on this topic for effectiveness and conversion. Just download our template, add your company data and submit to your client for a positive response. https://bit.ly/38L9TdX
Agenda:
Modeling depleting items
Consistency in the format
Modeling the Taxes
Modeling of Debt and Cash Balances
Edupristine offers Financial Modeling Course in US a practical approach for financial analysts to come to the business valuation of any organization
More info take a look at:http://www.edupristine.com/ca/courses/financial-modeling/
Chapter 3 - Financial Benchmarking for Inventory Turns and Working CapitalSolventure
This article fits in a series of articles inspired by the book ‘Supply Chain Metrics That Matter’.
In her latest book Lora Cecere introduces ‘which are the metrics that matter’, ‘how to ensure strength, balance and resilience’, what are the ‘evolutions in different sectors’, …
In this third article, Bram tries to explore alternatives for measuring the cash side and the service-cost side of the supply chain triangle.
He compares inventory turns and CCC for the cash side. He compares EBIT and EBITDA for the service-cost side. We also derive the best practice curve amongst 3 benchmark companies and derive resulting targets for a combination of EBIT-inventory or EBIT-CCC.
We hope you enjoy the reading.
Business Proposal Powerpoint Presentation SlidesSlideTeam
Requests for business proposals are one of the most effective ways to generate and convert leads. It does the job tremendously well when it comes to sales optimization. However, preparing a business proposition requires skill, effort, and experience. Documenting the right things in the right proportion is the secret to a responsive proposal. As professional PowerPoint template innovators, SlideTeam has designed 1M+ templates. Our latest addition will satisfy the responsive business proposal needs of entrepreneurs across all domains. Whether solicited or unsolicited, you can use these business Proposal Powerpoint Presentation Slides to convert every opportunity. All the templates in this deck are designed in alignment with the industry specifics. Research experts gather the data featured in our PPT slideshow. It is then passed on to the designers, who use state-of-the-art tools to organize the content in a visually gripping manner. The cover letter included in this PowerPoint layout will present the whole project in a nutshell. Present a crisp executive summary by highlighting your services/products, business vision, and value proposition. Our business offer PPT format gives to access to infographic-style slides. Further, showcase the background of the business project. Present the problem statement and solution for the commercial business proposal. With the help of a labeled diagram represent the time duration of each business project activity. Utilize the tabular layout to illustrate the cost estimate for business activity. Elucidate the business project benefits like cost avoidance, productivity, and revenue. Familiarize your clients with your organization. Introduce your team for the project, along with their roles and responsibilities. Maintain business transparency by showcasing all the terms and conditions. This includes initial setup, monthly fee, cancellation, and more. Communicate the forthcoming steps involved in successfully delivering the project. You can brief about the budget approval, fund posting, and project plan finalization. So, hit the download icon to begin instant personalization. https://bit.ly/2RQlN26
Front End of Innovation Worlshop: Strategy tools - in action. Expanded versionEngage // Innovate
Strategy and innovation is changing. The world needs new strategy tools. We design tools to make strategy & innovation happen at your company. This hands-on workshop will give you five new tools for Strategic innovation, Business model innovation, Innovation mindset and Innovation mapping, with case studies on Tesla Motors, Google and Amazon. This action-driven workshop will provide you with emerging tools for strategic innovation. You will apply these to your ongoing innovation challenges – and put the tools to work in your own organization. Master new tools to change how your company works on innovation. Take-away your personal toolkit and "Dream Bigger: Your Personal Innovation Sketchbook"
Led by Christian Rangen, Elisabeth Ovstebo and Inger Hanne Vikshaland
Founders, Engage // Innovate & authors, Strategy Tools for the Next Generation.
Decision Making with Excel for ManagersAsen Gyczew
As a manager you will be tempted to trust your guts and use your experience to decide what and how to do it. Quite often this approach may be misleading. It is much better to use data driven approach and before you make the decision look at the potential consequences. In this course I will show you how to make more rational choices as a manger using Excel. We will go through a lot of case studies that will help you master this skill.
In the course you will learn the following things:
1. How to be data driven in solving problems
2. How to make better decisions using Excel
3. How to handle uncertainty when you are making decisions
4. Which method, framework you should use in a specific situation
You will learn how to make decisions using make or buy analysis, voting system, simulations, rankings, how to analyze the costs of different investments (aiming at cost reduction, removing bottlenecks, requested by the customers). We will also how to apply the portfolio decision making, value proposition alignment, strategic alignment frameworks.
For more check my course: https://bit.ly/DecisionMakingExcel
BUS 630 Week 1 Assignment Dell, Inc..doc
BUS 630 week 1 DQ 1 Theory of Constraints.doc
BUS 630 week 1 DQ 2 Kranbrack Corporation.doc
BUS 630 week 2 Assignment Basic CVP Analysis (Fashion Shoe Company).doc
BUS 630 week 2 DQ 1 Downsizing and fixed cost.doc
BUS 630 week 2 DQ 2 Direct Labor Variable or Fixed Cost.doc
BUS 630 week 3 Assignment JetBlue Airways.doc
BUS 630 week 3 DQ 1 Fixed Labor.doc
BUS 630 week 3 DQ 2 Profitability.doc
BUS 630 week 4 Assignment Master budget exercise.doc
BUS 630 week 4 DQ 1 Behavioral aspects of budgeting.doc
BUS 630 week 4 DQ 2 Critiquing a Cost Report.doc
BUS 630 week 5 Assignment FedEx Corporation.doc
BUS 630 week 5 DQ 1 Variance Analysis in a Hospital.doc
BUS 630 week 5 DQ 2 Perverse Affects of Some Performance Measures.doc
BUS 630 week 6 Assignment Final Project (Cost management).doc
BUS 630 week 6 DQ 1 Make Or Buy.doc
BUS 630 week 6 DQ 2 Net Present Value Analysis.doc
1. Payback Period and Net Present Value[LO1, 2] If a project with .docxpaynetawnya
1. Payback Period and Net Present Value[LO1, 2] If a project with conventional cash flows has a payback period less than the project’s life, can you definitively state the algebraic sign of the NPV? Why or why not? If you know that the discounted payback period is less than the project’s life, what can you say about the NPV? Explain.
Internal Rate of Return[LO5] Concerning IRR:
a. Describe how the IRR is calculated, and describe the information this measure provides about a sequence of cash flows. What is the IRR criterion decision rule?
b. What is the relationship between IRR and NPV? Are there any situations in which you might prefer one method over the other? Explain.
c. Despite its shortcomings in some situations, why do most financial managers use IRR along with NPV when evaluating projects? Can you think of a situation in which IRR might be a more appropriate measure to use than NPV? Explain.
14. Net Present Value[LO1] It is sometimes stated that “the net present value approach assumes reinvestment of the intermediate cash flows at the required return.” Is this claim correct? To answer, suppose you calculate the NPV of a project in the usual way. Next, suppose you do the following:
a. Calculate the future value (as of the end of the project) of all the cash flows other than the initial outlay assuming they are reinvested at the required return, producing a single future value figure for the project.
b. Calculate the NPV of the project using the single future value calculated in the previous step and the initial outlay. It is easy to verify that you will get the same NPV as in your original calculation only if you use the required return as the reinvestment rate in the previous step.
17. Comparing Investment Criteria Consider the following two mutually exclusive projects:
Year Cash Flow (A) Cash Flow (B)
If you apply the payback criterion, which investment will you choose? Why?
b. If you apply the discounted payback criterion, which investment will you choose? Why?
c. If you apply the NPV criterion, which investment will you choose? Why?
d. If you apply the IRR criterion, which investment will you choose? Why?
e. If you apply the profitability index criterion, which investment will you choose? Why?
5. Equivalent Annual Cost [LO4]
1. When is EAC analysis appropriate for comparing two or more projects?
2. Why is this method used?
3 .Are there any implicit assumptions required by this method that you find troubling? Explain.
6. Cash Flow and Depreciation [LO1] “When evaluating projects, we’re concerned with only the relevant incremental after tax cash flows. Therefore, because depreciation is a noncash expense, we should ignore its effects when evaluating projects.” Critically evaluate this statement.
QUESTION AND PROBLEMS
1. Relevant Cash Flows [LO1] Parker & Stone, Inc., is looking at setting up a new manufacturing plant in South Park to produce garden tools. The company bought some land six years ago for $5 ...
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2. | Copyright Weissenrieder & Co. 2017 | www.weissenrieder.com | contact@weissenrieder.com |
CONTENT
1. What really creates a short payback 1
1.1 The everyday capex situation 1
1.2 Misunderstanding the value of a capex project 3
1.3 Actually, reality is worse. 4
2. The tail wags the dog – how tactical capex decisions run company strategy 6
2.1 Competitiveness over a lifecycle 6
2.2 How capital and other resources are allocated in a system of mills 7
2.3 Why it goes wrong 9
2.4 The tail wags the dog 11
3. The “creative destruction” funnel 12
3.1 Began the work in 1994 12
3.2 Going concern – the route to capital destruction 13
3. Copyright Weissenrieder & Co. 2017
“We only do high NPV projects.”
“Only projects with short paybacks get approved.”
“Our business’/mill’s ROCE is higher than our cost of capital.”
Have you ever heard any of these comments in your company? Then this is for you
because your company keeps making value destroying capex decisions.
In this paper, we describe how companies apply their capex process, and how univer-
sities teach us to make capex decision, leads to massive capital destruction. Almost all
companies in all industries evaluate capex decisions in basically the same way.
After reading this paper, you will change how you, as an experienced decision maker
within a capital-intensive company, view your decisions. If you, in any way, are respon-
sible for the capex process –you will get something to think about and having you want to
take action.
It is tempting, as a reader, to think that your company’s capex management process
avoids the traps we will discuss. CFOs, VPs of Strategy, and individuals responsible for
the capex process often react like that. This is a defensive reaction and not helpful to any
company, its CEO, or its owners. If you, or those responsible for these decisions, are not
open to necessary changes to your capex process then someone else within your
company will soon learn from our descriptive articles and solutions and bring the
inevitable changes necessary to your company.
Since June of 1994, we have studied how capexes affect mill performance in real life.
Our work has centered mainly on the pulp and paper industry, but we have also worked
in other industries and the issues we have encountered are universal to capital-intensive
companies. Our projects are primarily carried out in North America, but we also work in
Europe. We have helped more than 450 mills/plants since 2004 when we more focused
started to implement our Asset Strategy projects.
How today’s capex process leads to massive capital destruction is easily understood
when visualized the way we do here. This text will change how you, as an experienced
decision maker within a capital-intensive company, view your decisions. We will give you
something to think about and something you have to act upon now.
1. WHAT REALLY CREATES A SHORT PAYBACK?
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4. Copyright Weissenrieder & Co. 2017
1.1 The everyday capex situation
For the purposes of this paper, all examples will be of mills/plants in the pulp and paper
industry. However, all principles, ideas, and concerns may be applied to any capital-intensive
industry.
Imagine a mill/plant, See Figure 1 below.
The mill, in our example, has been making money (cash flow, net after capexes) at a certain
level historically (A). Here illustrated as a normalized straight line, but it is volatile in reality. We
can assume the mill will continue to make money in the future at this level. Again, normalized
at this specific level.
At some point, the mill is likely to come to the Head Office and say: “Sure, we can continue to
make money at this level, but to do so, we need to fix this quality issue that we have.
Customers are complaining more and more often.”
Now, look at Figure 2.
To fix the issue the mill needs to invest in a solution, and the mill – following instructions –
does the math on this situation. If they make the capex, they will continue to make money as
expected (the straight full green line); if they don’t, they will follow the dashed green line. The
difference between these two lines is often referred to as the “delta”. The mill compares the
delta to the capex amount (green down arrow) and calculates an NPV, IRR, or Payback.
We assume here that all data is correct (i.e. what the mill assumes for the future is what later
comes true). Our experience is that the industry really doesn’t have much of a data issue. That
is not why things go wrong.
So far so good. The NPV/IRR/Payback is correctly calculated. NPV of 15 and a payback of 18
months in this case and the company is likely to go ahead with the decision. It makes sense.
Three months later (Figure 3), the mill again approaches the head office saying, “Sure, we will
make money at this level, but to do so we need to fix this cost issue that we have.”
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5. Copyright Weissenrieder & Co. 2017
1.2 Misunderstanding the value of a capex project
The sum of all individual capex projects’ NPV in the capex plan is 200. Now to something that
is interesting: The 200 in value (USD/EUR/GBP/DKK/…) is totally unrelated to the value of this
mill. There is no mathematical connection whatsoever.
Look at figure 1-4. Each capex project’s value is determined by the delta created between the
green full line and the green dashed line – here the red area – adjusted for the capex outlay.
How is the value of the mill determined in Figure 1-4?
Take the full green line (which also takes into account the annual capex level) and discount it
to today (same discount rate as for the capexes). That is more or less how most of us would
do it, for instance when calculating the fair market value or when looking at an acquisition.
We get an NPV of the mill but again, that is disconnected to whatever the value of the capex
plan. There is no connection. The capex plan can say whatever it says – and still be correctly
calculated.
Another way of viewing the issue is to look at each project’s delta (the area between the full
and the dashed line). The deltas for the projects overlap each other. In other words, the
company “mortgages” the value of the mill over and over again for each capex request.
Look at another example, Figure 1-5.
In about 80% of our projects, we have at least one mill that, going forward into the future, will
have a zero-cash flow or less. Here, that mill (Mill C) is illustrated below our original Mill B that
we have chosen to keep in the figure for comparison purposes.
Question: What is the Total NPV of Mill C’s capex plan if Mill C has the same projects as Mill
B?
After thinking about it for a while, it can only be 200. So, we have a mill with a zero or
negative value, but with a capex plan that – if implemented – has a value of 200. But the
capex plan will not change the value of the mill, it will still have a zero or negative value.
Why is this?
Well, the NPV of a capex is not at all determined by the green full line. The value of a capex is
determined by how quickly the green dashed line falls (and the capex amount, and the WACC).
Our third mill (Mill A) is now added into Figure 5.
Mill A is a high performing mill, with close to state of the art technology.
What is the value of Mill A’s capex plan in this case? Assuming the same projects the value will
still be 200.
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6. Copyright Weissenrieder & Co. 2017
4
So, we have three mills – performing very differently – but who may present identical/similar
opportunities/needs.
“This is theory” some might say. We understand objections based on the simplification of
things in the above presentation.
However, this isn’t theory. This is reality, it is just that there are other situations than the three
represented here, making the capex process even more difficult to control and manage. We
have seen many situations in the more than 450 mills/plants we have studied that would need
their own illustration, but in order to make our point, we do not need to get more complicated
than this. Some readers may be thinking, “Our company is different, this does not happen
here, we evaluate things differently” In our experience that is not the case; rethink. If we were
face to face with you, we would answer any comment, question or concern you would have –
believe us, we have heard them all over the decades. But it is difficult to cover all in this text.
1.3 Actually, reality is worse.
Getting back to our example, the next logical question is, “How does a company distribute
capital between mills that perform differently?”
We claim that in reality the three capex plans for Mills A, B, and C will not have similar values.
They will differ significantly and in the “wrong” direction.
If our first mill (Mill B) has a capex plan NPV of 200, then Mill C is likely to have a capex plan
value of 400 and Mill A 100. Why? Simply put, Mill C is further away from state of the art
technology. In a delta calculation Mill C has have more catching up to do for each questioned
piece of equipment. The gap in the delta calculation will be larger creating a higher NPV/IRR
or shorter payback, illustrated by Mill C’s dashed blue lines. The dashed lines will fall more
quickly in Mill C, creating a larger value in the capex plan. Mill C will also have more projects.
Not only projects 1-10, but 1 and 1b and 2 and 2b, and so on. The mill has more needs. The
capex plan’s value, therefore, increases even more.
In contrast to Mill C, Mill A will have a smaller gap to state of the art technology. Mill A’s dashed
line will fall more slowly, creating a lower NPV/IRR or longer payback. Also, Mill A will have less
needs (hence fewer capex proposals), all resulting in a lower “NPV total” in the capex plan of
Mill A.
Where is a company likely to invest if it has a capital restraint?
Will it chase the longer paybacks in sustainable mills or the shorter paybacks in mills that do
not seem to be very sustainable? We will discuss this in detail later.
For now, it is sufficient to keep this question in mind.
The term “payback” is, by the way, truly misleading. It is not about that. When does one see
the money return in Mill C? Never. The company keeps investing in “short payback projects”,
but the mill’s cash flow is still zero or less. The money is gone. The calculated payback simply
never happens – even if assumptions turn out to be true in the future.
7. Copyright Weissenrieder & Co. 2017
5
So, we seem to have a situation where companies’ capex plans indicate that a company
should invest where they are not making much money. This is bad enough, but it gets worse.
The thing is, that individual mills will not even present the capex plans to the head office that
aim at maximizing the company’s long term cash flow. How would they even know how to do
that? They don’t have the bigger picture, only the picture of their individual mill.
It gets even worse than that because the mill will not even supply the head office with the
capex plan that aims at maximizing the long term cash flow from their own mill. Mills will
suggest the capex plan that ensures mill sustainability, not maximized long term mill cash flow.
This can be debated, of course, but one proof is the following:
In North America and Europe at least 15% of all mills within the Pulp and Paper industry
should be closed within 5 years (if maximized company cash flow is to be achieved throughout
the industry). Realistically, mill managers will not come to the head office with the following
message: “We have analyzed all our options, and I, as a mill manager, can only come to the
conclusion that in order to maximize cash flow you should run us for cash for 3 years and then
shut us down.” Again, individual mills aim at sustainability – they are probably doing the right
thing when doing so. Sorting out where and when to invest from an ongoing consolidation
perspective is something that is not their responsibility, nor should it be.
Appendix 1-1
Mills/companies often assume or claim that mills will be making more money after a capex.
However, it is actually about not making less money. Many times, we have heard people in
companies talk about their capexes adding the NPVs they have been calculated, claiming that
the mill will improve.
Think about it: name a mill/plant whose EBITDA margin has continuously improved over the
last 10-20 years? If we examine it closely, currently operating mills with very few exceptions
steadily, as a trend, have decreased their margins. That’s nature. Sometimes one might
experience an improvement of a mill’s EBITDA margin due to and after a capex, but that will
be small and short lived. It will have the character of “catching up to the level where the mill
should have been”, but only for a short while.
We were at a meeting in a mill about 10 years ago, and had a discussion similar to this. The
controller at the mill said something that was both amusing and interesting. He said, “If we had
achieved all improvements that we have claimed in our capex requests over the last 10 years
we would have an EBITDA margin of 110% and we would have only one person working here”.
So, we claim that the capexes companies make in their mills are there to prevent the mills
from losing their ability to make money. Capexes are not made to make more money. Value is
not added; less value is lost. Even if decisions lead to costs being cut, quality being improved,
etc. All efforts are directed at trying to keep up with competition – because they develop. The
industry’s improvements are taken out in the price of the product to the customer.
There are two exceptions. The first is if one increases capacity. Then the mill potentially makes
more money; the value of the business increases, see Figure 1-8.
The second exception is if a mill can invest in an improvement that is unique for that mill. That
no other (or only a selected few) can implement. Then one will have an advantage, value is
added.
We have to admit to one simplification we have made. The full green line doesn’t look as we
have drawn it in Figure 1-7. They are not horizontal. They trend downwards, like the blue line
in Figure 1-7, and all the capexes made are to prevent the line from falling even more quickly.
We will talk more about that in chapter 2.
8. Copyright Weissenrieder & Co. 2017
2.1 Competitiveness over a lifecycle
An industry always improves, in the sense that it is always better at what it is doing today
than it was 10 years ago, because of technology development (the industry doesn’t,
however, make more money due to the real price decline). We illustrate this point with the
red line in Figure 2-1.
The red line is the industry average, so half of the industry’s capacity is above the red line
and half is below at every point in time.
At some point, a company will build a new mill, either a Brownfield or a Greenfield. Or it
will add a new production line in an existing mill. We illustrate that with the blue line
starting at point A, where the mill is new and state of the art. It is clearly above the red
line. Over time, the mill will be improved (the blue line goes up) but it can never follow
industry average. At some point, it will cut across the red line and become less
competitive than the industry average. Decades later, the company will come to the
conclusion that it is better to shut down the mill because the gap between it and the
industry average has become too large. This is a simple illustration of a life cycle of a mill.
A mill will slowly travel along the blue line to the right. Most mill investments will, at best,
2. THE TAIL WAGS THE DOG –
HOW TACTICAL CAPEX DECISIONS RUN COMPANY STRATEGY
6
9. Copyright Weissenrieder & Co. 2017
slow down the loss in relative competitiveness, not improve it. Only a few investments will take
it to the left (improve mill competitiveness), and then in almost all cases it will only be a small
shift. For example, a company makes a really large replacement capex in a mill. It replaces
10% of the mill with state of the art technology (like a so-called recovery boiler in a pulp mill).
The time from the decision to invest in the mill to turn key (completion of investment) is often
1-3 years. Replacing 10% of the asset base shifts the mill to the left, but 90% of the mill ages
another 1-3 years in the process. The net effect for the mill from the point of decision to turn
key is not very large.
2.2 How capital and other resources are allocated in a system of mills
We will use Figure 2-2 for our discussion about allocation of capital. Let’s say we run a
business with 10 mills. They are all making more or less the same type of product aiming at a
certain market. We assume that our portfolio of 10 mills, on average, is exactly on the industry
average (i.e. we have half of our capacity in mills that perform better than the industry average,
and half of our capacity in mills that perform below industry average).
Therefore, it is not unlikely that we would have 3 mills (making up 50% of our capacity) that
are the more competitive mills, and 7 that are less competitive. Let’s categorize the 10 mills.
We have our Category C mill, the mill we understand we will close in 1-3 years since it isn’t
performing well at all. We have our three close to state of the art Category A mills. Finally, we
have our six Category B mills, good providers of our product mix, etc., but to different degrees
less competitive.
How would a company within the capital-intensive industry today act in these categories with
its resources? Having worked with dozens of companies within the capital-intensive industry
we have an opinion on this. To understand how companies today allocate resources we ask
three questions:
Question 1: “In a normal year, how would your company invest in those 10 assets?”
Most companies do not have relevant information to make the categorization, but let’s give this
a try. We exclude possible investments in Brownfields/Greenfields, we just look at those 10
assets.
If we begin with Category C, it contains the mill that we know we will not keep for very long.
We would prefer to spend 0% of capexes on this mill, but we need to spend some capital in
that mill for it to stay open another quarter, another year. Most companies spend 3-5% of their
capital on this category of mills.
How about Category A?
That category is relatively close to state of the art technology. They “need” less capital.
Additionally, the opportunities for this category are perceived to be not that many (since they
already are relatively good). They have less environmental issues, fewer safety issues, etc.
On the other hand, they represent 50% of the capacity – clearly the need to invest here exists.
Most companies would invest 20%, sometimes up to 25% in this category.
Finally, we have Category B. Six mills (twice as many as in Category A) with an increasing
technology gap (aging assets). Often these are relatively complex mills – 2 or 3 of everything
instead of 1 – and not always a “linear” layout. There are usually environmental and safety
issues. Category B gets 75% of the capital.
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10. Copyright Weissenrieder & Co. 2017
The percent split between the categories should not surprise anyone. Category A doesn’t really
need money. The desire might not be there, but some investment must be put into Category C.
Category B definitely requires capital.
Some companies say they don’t invest like this. A few of those companies might not, but in our
experience, the vast majority of companies do invest this way. However, it is common for
companies to get the categories of the mills mixed up, they think a Category B mill is a
Category A mill, etc. We even came across a company who thought one of their Category A
mills was a Category C mill.
Question 2: “How much of the next 10 years’ cash flow do you expect to receive from each
category?”
While the split of capital spent between the categories is similar between companies, the split
of future cash flow between the three categories isn’t, since it depends on what type of assets
a company actually has.
If lucky, Category C will produce 0%.
Category A’s mills have a higher EBITDA and margin than Category B (and C) as well as
lower capexes. So, this category will clearly provide the company with the highest cash flow (if
not, they have been assigned to the wrong category. This is the common mistake, mentioned
above). In our experience, the average cash flow from these mills is about 80%. We have seen
anything from 60% to 300% for Category A (please do the math on Categories B and C in the
latter case).
Category B will provide an average of 20%, after capexes.
Question 3: “Pick your 100 most important/valuable resources in the company. Exclude hours
spent on budgets, reports, etc. and only look at their quality time. How much of their quality
time goes into each of the three categories A, B, and C?”
Category C gets a shocking 30%.
When considering the answer to Question 3, a company must include all the discussions/ana-
lyses/etc. on, “Should we close or keep, should we make another investment?” In considering
this question, include the time spent trying to fix the mill, evaluating closure costs, and even-
tually when the mill closes. We had a client once who hesitated over a Category C mill for a
long time. Once they even had one of their senior VPs on the corporate jet going to the mill to
communicate its closure. When he landed, he got the message, “We got another large order,
come back home.” This can go on for years, which is why we see such a high percentage of
resources allocated to Category C mills.
Category A doesn’t need resources.
Those mills are working just fine. In a project, we had a number of years ago, the project
8
11. Copyright Weissenrieder & Co. 2017
manager from the client’s side had been a mill manager for their best Category A mill for five
years. He told us that the head office hadn’t contacted him even once during those years.
Category B gets 65% of the resources.
When we read the pink pages we often read about CEOs from the capital-intensive industry
explaining the quarter’s poor performance with reasons such as prices not developing the way
they expected, increased costs, and shaky demand. Certainly, one can explain a quarter or two
with those factors, but the capital-intensive industry often fails in delivering shareholder value
year in, year out. To blame the above factors for more than a couple of quarters is like saying
that one lost a sailing race due to a head wind.
Prices not developing as expected, costs being up and demand being shaky is nature. It is a
fact for all players in a capital-intensive industry. Technology development, even if slow, brings
down prices compared to costs for existing assets – this is a fact. Companies invest in better
technology in an attempt to avoid that.
Now, we cannot say that this table, for a certain company, in a certain year is “incorrect”. All we
can say is that if one spends his/her resources like this over time; one will eventually ruin his/
her company.
We would say that all companies and all CEOs we have worked with for the last 23 years have
had the ambition to do well. They want to do the right thing, to have the company make more
money, but too many organizations fail.
There are several reasons for why many companies don’t deliver expected returns or fail. Why
over time they don’t follow the stock market’s index, as an example. But here we show you all
you need to drain a company of cash flow, and even sometimes, as shocking as it sounds, run
them into the ground: All that is needed is to have the company’s future somewhere (green),
but spend its resources elsewhere (red). Done year in and year out, decade after decade,
results in a poor performing company. Or a company in Chapter 11.
This is all that is required to make a company fail, even if the intentions are the best.
If a company has an aggressive acquisition strategy one might make things even worse (i.e.
acquiring a large set of Category B mills. Acquired Category B mills usually consume more
capital than the net cash flow gain from an acquisition – we have seen this countless of times.
Why do companies end up in this situation, where resources are being allocated as in above
table? They want to do the right thing, but the result is poor. For every little (and large) decision
they make they do their homework, and they normally fulfill the benefits they claim in the capex
request. Still, the company doesn’t succeed. How is this possible?
2.3 Why it goes wrong
We were engaged in answering this question in the late 90s. We came up with a long list of
reasons but pared the list down to three basic reasons why companies fail.
The first two reasons are present in all companies, and they have to be there. They cause an
extremely costly problem, but they have to be there.
The third reason is anything from somewhat present to very present in almost all companies.
Although it doesn’t have to be present at all, companies can throw it out today – there is no
point whatsoever having it involved in the capital allocation process.
Reason 1: The capex process is a bottom-up process.
It has to be. The mill knows the issues and how to fix it (supported by central technology/ma-
nufacturing resources). So, the mill manager will come to the head office and say “I have an
issue, and now I know how to solve it”. This issue could be quality, cost, safety, environmental,
etc. The head office will say “We know. We have been discussing this now for two years”. On
paper, the capex necessary to fix the issue makes sense.
Reason 2: Delta calculations are used to evaluate the benefit of a capex project, and the
projects are evaluated one by one, in isolation.
Going back to what we discussed in part 1, basically, all companies do what the textbook says,
what we have been taught to do: they calculate the payback/NPV/IRR for each capex project
individually, in “isolation” (we assume all data is accurate and correct).
So, a mill manager comes to the head office saying: “I have an issue, and now I know how to
solve it. The payback is two years.” The head office is likely to reply “We know. We have been
discussing this for three years. The payback makes sense; it even looks a bit conservative.”
They respond this way because an individual analysis of the issue tells the company the
manager’s solution is an appropriate and reasonable way to proceed.
Reason 3: ROCE (or ROOC, Re, EVA, or any other P&L and balance sheet based
measure) is used to prove the performance of the mill.
It is bad enough that companies use these measures at the group level. Some claim that the
errors in these measures are canceled out when applied on the company/group level. This is
incorrect, and to use any of these measures on a mill level gives totally corrupt information. (It
doesn’t matter how many adjustments you make in, for instance, EVA.)
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Let us give you a relevant example*:
Take the blue line from Figure 2-5 (above). It represents the life cycle of a mill, let’s say 60
years. We lay it out as the X-axis in a graph, with the categorizations A, B and C.
How does an EBITDA margin look for a mill over its lifecycle?
It would be very volatile, but for the purpose of our example, we can “normalize” it. Look at
Figure 2-7 whose EBITDA margin development represents a mill from its Greenfield state to
closure 60 years later.
From a poor, but normal start-up, this mill is at its peak competitiveness after about 5 years.
After that, the EBITDA margin will slowly but surely decline until closure. This represents
lowered relative competitiveness over time. This continues to be true even if capital is spent
on the mill. In fact, the mill will decline like that because capital is spent on it. If capital is not
spent, the EBITDA margin will fall even quicker and the mill will be closed a lot earlier.
In reality, the EBITDA margin will jump up and down. One can work in a mill for 20 years
without noticing the EBITDA margin trending downwards.
How will the ROCE (or ROOC, Re, EVA, or any other P&L-balance sheet based measure)
look for this mill? The ROCE is simply a mathematical consequence of the development of the
EBITDA margin and accounting rules for depreciation. See Figure 2-8. Look at it for a while.
What does it really say about “performance” according to ROCE in our three categories?
The mill carries a lot of initial capital in the first 15 years (accounting rules), but cash flow from
year five is superior to any other year after that. The EBITDA margin is at its peak.
Approximately at the point when it goes from being competitive to less competitive than the
industry average, the mill’s accounting based performance measures will skyrocket. (If you are
ever to take the seat as a mill manager, make sure you do this a year before the initial capex
has been written off in the books. Then make sure your bonus is set on ROCE or EVA; you’ll
be rich. Cash flow and EBITDA margin will be down, but you’ll be just fine.)
*For more detail on “Reason 3” read “Value Based Management: Economic Value Added or Cash Value Added?” or “Why Current Profitability Measures Destroy Billions in the Industry” at www.ssrn.com.
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So, with “Reason 3” a mill manager comes to the head office saying: “I have an issue, and now
we know how to solve it. The payback is 2 years. And, we still contribute well to the company’s
ROCE”. Why would anyone ever say no to a capex with those attributes? No red flags
anywhere in sight.
2.4 The tail wags the dog
Any business wants to think that it sets a system-wide strategy for its assets and that its
capexes follow that strategy, right? Like this:
However, our wide experience – and anecdotal evidence – is that it is not at all like that. The
capex process is a well-established and truly “powerful” process in companies. An institution.
Lots of people are involved with their respective responsibilities, rules not to be messed with,
there are set structures for approvals, etc.
We claim that the capex process is so strong that it actually sets the strategy for the assets,
in our example, the mills. The result of the selected capexes for a mill year in and year out
determines the strategy of that mill and as a result, the whole company, (however, it does not
determine the fate of a mill. Even stronger external forces determine that).
So, it is not that an asset strategy determines which capexes are chosen for a mill.
Companies don’t even have well-established, uniform and thorough processes for setting the
asset strategy for their system of mills, (the reader may think “but we do in our company”,
especially if said reader is responsible for that process – we’ll challenge any day).
So, the picture actually looks like this:
We call this – when the capex process determining the strategy – for “the tail wags the dog”,
a common term for when something is backward. Our experience is that a company loses a
value of at least 30% of its capexes every year. At least. As we discussed earlier in this paper,
it is tempting to think that one’s own company’s capex management process avoids these
traps. Individuals responsible for the capex process often react that way (CFO’s, VPs of
Strategy, etc.). If this is the reader’s reaction, then he/she is acting defensive and not helping
his/her company (or its CEO or owners). In that case, somebody in the company, other than
the reader, will soon educate themselves from our descriptive articles and solutions, and bring
the inevitable changes to the company.
All companies that invest capital in fixed assets (even if they are not necessarily capital-
intensive) need to fix this issue. All companies have to have an Asset Strategy that governs the
capex allocation.
But the way to achieve it is not at all the way one might think it should be done.
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3. THE “CREATIVE DESTRUCTION” FUNNEL
3.1 Began the work in 1994
Mr. Fredrik Weissenrieder started working on what we do now, in 1994. He was finalizing
his Master in Finance and Economics studies at Gothenburg School of Economics. Mr.
Weissenrieder’s thesis dealt with how companies should calculate their capexes, etc., but
also discussed inconsistencies in his finance classes, such as why companies evaluate
capexes with for instance IRR, but when the capex is behind them, they evaluate the
business using ROCE (two totally different mathematics).
To cut a long story short, a European Pulp and Paper company called him the day before
he was about to get his degree. They had read his thesis and had a project for him.
Anyways, the person calling said “We have this mill. They show us capex plans who’s
capexes average an IRR of 40%. We don’t doubt the 40% because we have been
following up on capexes there for some years and they basically deliver. If they say they
are going to take out 10 people they do that, cut power consumption on the PM by 3%
they do that, etc. So, ‘check’ on the 40%. The mill has averaged an ROCE <25% over
the last 15 years. It all looks fine, right? However, we want you to explain to us why the
average cash flow from the mill has basically been zero over the last 15 years.”
So, Mr. Weissenrieder dug into cash flow data going back decades. It took him 4 months,
but he eventually worked out what had been going on in that mill. Since then, we have
been working as independent consultants within this field.
This is how it all started. While investigating the mill, Mr. Weissenrieder carried out a
number of interviews. He interviewed the mill’s controller and asked him the question
“what is your philosophy when you invest in the mill?”
His answer has haunted us for more than 20 years. Because he answered, “We invest
according to the going concern principle”.
Mr. Weissenrieder had to ask him what he meant by that since he was into finance, not
accounting. The controller said, “We invest in order to make the mill sustainable”. In
other words, they invested to ensure the mill remained viable. In the summer of 1994, Mr.
Weissenrieder thought his answer made sense. It took him about 4 years until he realized
that this was the number one problem in the industry when it came to decision making.
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3.2 Going concern – the route to capital destruction
Look at Figure 3-1.
Each line represents 3-4 pulp mills in Sweden. Forty years ago, Sweden had about 110 pulp
mills (including all technologies and integrated mills). Now there are about 30 pulp mills. Today,
those 30 mills make twice as much pulp as the 110 did 40 years ago. They are making more
with less resources thanks to technology development.
So, the Swedish industry shut 80 pulp mills. Are there 80 reasons for that?
No, there are only two reasons.
The first reason is that pulp prices are down (as a trend) in real terms every year, that is the
red line going down in Figure 3-2. The second reason is that costs (for each existing mill, in
relation to the pulp price) are up (the red line going up in Figure 3-2). There is a margin
squeeze over time (as also illustrated in Figures 1-7, 2-1 and 2-7.
80 mills could not survive the margin squeeze so they were shut. See Figure 3-3.
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16. Copyright Weissenrieder & Co. 2017
Is it a problem for Sweden that it shut 80 mills out of 110?
No, it is great from the nation’s point of view. This is growth; making more out of fewer
resources. We should all welcome this as it provides a nation with more resources for health-
care, education, etc. This is nature. It is destructive to a country’s development if a government
tries to stop this type of development because mechanisms of nature and development are
taken out of play.
Is it destructive for a corporation? If the corporation has several (in this case pulp) mills?
No, it is fantastic. It provides the corporation with several consolidation opportunities, capital
allocation opportunities, etc.
However, this is where it all goes wrong.
Think back to Figure 2-5. The mills in categories A and B are all treated as going concern mills.
They are treated more or less as if they are going to live forever. Not the mill in the C category,
but in the A and B categories.
What else does Figure 2-5 say?
It says that 75%, or so, of the company’s resources are put into what is not sustainable in the
long term. In fact, the capital-intensive industry has a reputation for investing heavily in mills
2-8 years before they close – when those mills appear to be providing a reasonable ROCE/
EVA/etc. with several investment opportunities offering quick payback (in other words, a poor
Category B-mill). At that point, would not many question that mill’s sustainability. Several
people with some years in the industry provide us with examples of that in a discussion. It feels
“safe” to invest in a mill like that. Who can say they’re doing the wrong thing? It looks great on
paper – it has no sustainability, but that was never considered when making the decision.
Companies put 20-25% of their resources into assets that are sustainable long term. How
competitive are those mills after 10 or 20 years when new, highly competitive Category A mills
are built? What if the resources are spent on mills that will not survive when these new
Category A mills are built in, for instance, South America or Asia?
The question for an individual who is part of the decision process is, how will your company
deal with the future? The company certainly has a process that in the future will direct
resources towards less competitive assets, assets that are “the next Category C mills”. How
does one create a company that allocates capital to the right assets (which may well be one or
more Category B mills, but which ones, how and when?).
This paper has discussed the challenges and situations companies face when assessing a
capex request. It has not provided a solution. Our experience tells us that there is no point in
discussing solutions if one cannot agree on the issues/problems/challenges, therefore
solutions have no part in this paper.
As a reader, it is tempting for you to think that your own company’s capex management
process avoids the traps described in this paper. You then need to rethink. All companies have
the possibility to fix the issues that are discussed in this paper. Weissenrieder have applied the
solution for years – it works. Contact us for a discussion about our solution that can help you
make informed decisions on how to best allocate funds and improve your company’s long term
cash flow.
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17. About Weissenrieder & Co.
Weissenrieder & Co is an international leader in Asset Strategy and Capex Management. For more than 20-years, we serve the
capital-intensive industry globally. Our unique methods and systems enable industrial companies to optimize their Asset Strategy
and capital allocation in order to maximize their total cash flow.
Weissenrieder & Co has helped to establish long term asset strategies for over 450 production sites, with a total replacement cost exceeding
€80.000.000.000, and a total investment value within the immediate five-year period of more than €7.000.000.000.
For more information, visit the company’s website www.weissenrieder.com, or on LinkedIn.
| Copyright Weissenrieder & Co. 2017 | www.weissenrieder.com | contact@weissenrieder.com |
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