Background
Discuss about the Memorandum for Chemical Manufacturing Firm Axon N. V.
The chemical manufacturing firm Axon N. V. which is a multinational company wanted to construct a new manufacturing company in U.K. They had a proposal on how it would be profitable, but the board held a meeting and questions the success of this proposal. They undergo a case analysis saying that not only is the proposal incorrect constructed and it’s also unprofitable and would not have been recommended if enough research would have taken place to write the proposal. This memo depicts primary reason of the proposal being rejected to implement effective performance and ensure that the company’s goal adheres too.
There was a lot of issues and needed decisions of opening a new manufacturing firm in the United Kingdom. The proposal was to look at the production of AR-42 in the company as well as the cash flows and the capital required. As the product was a high demand in the country hence they should construct it. Their subsidiary plan was based on a new technology designed by the corporate engineering which claimed that they would manufacture this product to 400-ton annual market using the new technology. The U.K managing director accepted the plan and presented to the board of Netherlands where they refused the proposal saying it was uneconomical and would not bring any profit but losses to the company. The decision is evaluated taking into consideration pros and cons of the situation analysis.
For Reasons for not setting up unit
- Economical for taxes: The board of directors of Netherlands thought that it would be more economical if they purchased the product from the Netherlands and later sell it in the UK. Their arguments were based on the fact that if they produced an extra 400 tons, there would be a total increase in production. This would allow more extended production runs, lower set up costs, and larger raw material purchase. This would lead to mass purchasing, effective material handling, and lower purchase price. The variable cost would decrease from thousand nine hundred to one thousand six hundred the 40-ton difference would save 24000 on Dutch domestic production and the taxes for shipping is almost the same as that of Netherlands.
- Loss of Profits: The UK manager brought the decision on the board claiming that manufacturing the AR-42 in England would be profitable. He took their proposal to the board of Netherlands where they did their research, analyzed and found out that the proposal was so wasteful. It would not bring any profit to the company but will lead to various losses. This is the reason why the board rejected the proposal.at first they had accepted the proposal but later due more meetings they decided to reject it.
- High Cost of Investment:The Holland managers developed this proposal over the last six months in which they interview potential customers and conducted the trials three of the factories and proved that the significant cost savings would indeed materialize the project. The head of corporate engineering division in Heerlen helped in designing the project and how it could produce 400 tons of AR-42 per years showing the cost of investments.
This is the analysis of the net present value that was written by Ian and his directors of manufacturing, sales and finance came up within the proposal. This would be a profitable project since they will get a return of 20% and a present value of €916000 for an initial investment of €1400000 for equipment and €160000 for working capital and used an 8% discount rate so that they can borrow money from England. They showed cash flows in the AR-42 project for seven years claiming that the technology would improve and they don’t see if demand would either decrease in these seven years. The plant would be worth€ 1400000, and after paying the tax due to depreciation the flow of capital is estimated to €840000 and hence the total value of the seven years would be €1030000. A brief calculation is attached in the appendix.
Issues and Decisions
They estimation only shows the variable cost of€2000 of full operation of the cost of manufacturing in England, but they exclude depreciation costs on considering the out-of-pocket fixed costs such as supervision. They think that they should enter the market €4000 per ton for them to gain the market share and full market penetration after gaining this the second year they could reduce it to € 3700. They say they will only need 160000 to start with but in the next two years their capital will add up to €190000
In case they decide to ship the product from the Netherlands and sell it in England, the total variable cost would be €824000 after deducting the import duty cost and the shipment cost of the chemical and sell it 400 tons. This was what was concluded by the Dutch and seems to be profitable as compared to the Holland proposal that was very difficult to analyses their calculations to get the right figures
- Presence of Competition amongst Units: The subsidiaries compared with one another and managers were rewarded according to the performance of their subsidiaries and not as a whole Axon. This created a new manufacturing style and would only cause competition from one another and Netherlands would manufacture the 400 tons, since it has experience and market. Thus it would stop investing in U.K. and this company will start unhealthy competition so as to honor one another
- Lack of Demand in UK: The cardinal analysis the proposal to manufacture AR-42 in the UK, will bring down the control system and presentation the united kingdom company will undergo difficulties in selling the AR-42 product according to Mr. de Rijcke was not convinced that UK alone would be able to sell 400 tons while the current market was 600 tons he saw this as not realistic at all and that Mr. Wallingford did not convince him well of the figures he brought on the proposal. He said that it was inconceivable that UK would take alone 400 tons.
- Lack of experienced staffs at UK: The manager and the subordinates in the UK do not have any experience in selling and manufacturing. They still are inexperienced in how to sell the AR-42 chemical while in the Netherlands they have this experiences and can decide to fabricate all the united kingdom products and sell it to other of their subsidiary companies and neglect the England one and also they can sell those products without investing in that company.
MR Oosterling claimed that they had difficulties in producing the chemical in Netherlands in spite of the trained workers and the long experience but the Holland team claimed that they would use a new and improved technology system which they only rationalized and can never be true. If this technology was there why could not they give the Netherlands team and their argument of only needing five trained workers which they only require two from Netherlands was not even convincing to the panel group how could they manage and produce the 400 tons?
- Economical Transportation: The transit factor was not a critical issue due to the geographical area of Netherlands and United Kingdom. Transporting the product from England was more economical then them fabricating its own system. The transport cost we find is €100 per ton while also the import duty is €100 per ton which we found out it is more economical to this country than them manufacturing it
- Financial Analysis:According to the financial analysis where we analyzed the proposal that was set by the United Kingdom subsidiary and we find out that the proposal saying it would be profitable they didn’t take much time on their proposal and several issues merged such as
- The NPV is lowered this is because the calculation of the future flow cash required a rate of 12% but not the 8% loan interest
- The plan would need renovation in the seven years they calculated hence they did not mention the relevant outflow they only consider the selling price of the old one and do not show the new price and also they consider the monetary value and dent consider the history monetary value hence lowering the NPV
- The proposal work of depreciation is so fast and we see the depreciation should be equal. To calculate depreciation is: annual depreciation=(original cost-residual cost)/(service life) or we could say (€1400000-€1030000)/7 years =€52000 which is less as used in the proposal that it is €280000 it lowers the proposals tax shield and hence lowers the NPV
- The proposals claim that they will borrow the capital and in the proposal they don’t mention how they will repay the money they borrowed hence it’s uneconomical and the NPV will be a negative if accurate calculations is considered. And the IRR will only be 8% not the 12% they said.
Considering the finance analysis we see that the proposal should be rejected in constructing the AR-42 in United Kingdom since its cost was miscalculated but it is also uneconomical and will lead to lots of loses in the company (Kilian & Schindler, 2014). When the proposal decide that they will sell the €4000 to€3700 they did not consider the competitors price and also the riskiness of the product
The UK team were constrained even to show us the conservative estimate and a conservative transition period of how they could produce the 400 tons they also don’t have a clue on where to get the finance to produce their products. They say after manufacturing the product is when they consider borrowing loans from banks these does not look realistic with how they will start producing it without capital. The proposal was not explicitly stated but it could be a market leader in the industrial chemical industry in organic growth and preposition of using to technology systems.
- Reputation: The qualitative analysis should consider the external reputation, labor, creditors, and quality. In introducing a new manufacturing system, people will not value it as they value the one in the Netherlands since it is been there and the products are good hence this will not bring any profit to the new one, and the market will be low. People will be employed in this manufacturing company but they will not receive an excellent salary because it just only begun and they will be made to work more hours so as to achieve the goal of manufacturing the product as per the target, the quality of the product will not be as best as that one in the Netherlands because most people working in this manufacturing industry will not be as experienced as those that will be working in the Netherlands. The company will have not many creditors since most investors will want to work with the Netherlands Company. The qualitative method was the best way to analyses this proposal because it would aid to decision making here we found out that the proposal was not only uneconomical but also would lead to the companies loss and unfavorable market competitions hence it was rejected.
- Shareholder’s Return Consideration: It is recommended that the primary goal in all proposals should be to optimize shareholders returns and not short-term profits since the shareholder value represents the net present value of future earnings. It is recommended that the need to measure and evaluate business unit performance every once a year so as to get the management feedback and control systems this will ensure a short-term gain in the unit of managers but a long-term profit of the whole company. Thus a measurement and evaluation of business unit managers using measures that are both financial and non-financial this will ensure that businesses are rewarded on the basis of finance, customers, innovation in the business and also learning this would create the subsidiaries in the Axon to work in harmony towards a common goal of maximizing share value and this will eliminate unfavorable competition and redundancy.
However, there are possible cons for proposing setting up of manufacturing unit in UK as well they are as below;
- Decentralization:The Company could have been able to expand their business in UK as well with setting up of a manufacturing unit. Decentralization over longer period of time would have allowed the Company to diversify the business and eventually become more profitable in the long term.
- No Sensitivity Analysis:The meeting held evaluated the proposal from all possible perspective and undertaken financial consideration. However, there was no sensitivity analysis conducted for projected sales volume. A sensitivity analysis could have revealed in a better manner project viability and sustainability. Thus, this would have allowed a better evaluation of the project as considered to all financial evaluations.
- Expanding Market:Though currently there is absence of much demand and transportation costs remains insignificant. But with revision of Brexit and considering rise in fuel costs in the future. It could have provided beneficial for setting up a manufacturing unit in the UK. UK market is characterized by increasing number of immigrant population, which provides an expanding market. Therefore, in the long-run the proposal which currently seems unviable could have emerged to be more profitable in the future.
The management should handle their issues well this is what brought about a proposal that took a lot of time rejecting it and discussing it because of the print and subsidiary management. These companies could work as one but not compete for one another. It is recommended an increase in the production in the Netherlands and distributes it to the United Kingdom which will bring about capacity availability, and there will be no need of borrowing which will bring about the risks and implications in the final decision. I am happy to write this report on showing why the proposal was rejected and we consider your decisions and please let me know if you have questions. Therefore, evaluating the possible benefits against the losses, it can be stated that it is in best interests of the Company currently to continue manufacturing at Holland and not start manufacturing at UK. The various shareholders of the Company can evaluate the possible judgment at a later period of time when costs might seem to be unviable again. This would offer potential for the Company to expand and set up operations elsewhere apart from UK. Moreover, the Company can also consider manufacturing its products at other countries where costs are relatively less as compared to developed countries.
Best,
Ian Wallingford
Managing Director Holland’s Worth Limited
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