Business Management Project - Strategic and Operational Issues - Math Problem Example

344833 - BUSINESS MANAGEMENT PROJECT: STRATEGIC AND OPERATIONAL ISSUES Second Question- Identify two strengths The two strengths of Leeuwin Estate company are as follows: 1. Capacity to producing premium quality wine Producing premium qualify wine is sign of company that has long been there in business. It therefore symbolizes a name for the company that could entail wide and loyal patronage by wine drinkers. As wine gets more value as they age in years, so with the name of the company. This assertion is supported by the case facts that Leeuwin is one of the most advanced wineries in the southern hemisphere as it able to incorporate state of the art technology and old world techniques to develop world class wines. The company is thus known for producing premium Cabernet Sauvignon, Shiraz, Sauvignon Blanc, Riesling, Cabernet Merlot and Sauvignon Blanc Semillon, it is Chardonnay, particularly the Art Series, which remains the flagship for the winery (Case facts) At the great quantity of wines produced at around 600,000 bottles per year, the company has really made a name of its own in the industry Although the amount of production per year is somewhat a negligible amount when compared to Australia’s largest producers such as Jacobs Creek, who in 2000 were exporting 48,000,000 bottles or Casella Wines which has the capacity to bottle 65,000 bottles of wine per hour (Case facts), it may be argued that being known to be one of the most advanced wineries in the southern hemisphere as it able to incorporate state of the art technology and old world techniques to develop world class wines, is itself an evidence of its strength to be performing better than competitors. It may be argued that being a producer of premium quality wine in Australia, it may be inferred it has created its own economies of scales; hence its cost of production is lower than those of competitors. This strength has become more manifest in the light of the WET, an advalorem, which is enforced by the Australian government. As against medium small size wine companies, Leeuwin are more strategically positioned (Byars, 1991), hence its position as such is helping the company to perform better. The fact of is strategic position as premium wine maker is further supported by the case facts that that Leeuwin Estate has the capacity to enhance the global standing of Australian wine and boost exports in an increasingly competitive global market. It was indeed provided that the company could bypass the WET issue altogether by selling 100% of its wine in overseas markets however the loss of the domestic market, which accounts for around 60% of Leeuwin Estates sales. That would of course be strategically risky decision but yet it may have the size and tax advantages afforded to the 20 largest producers in the domestic Australian market. This latter advantage would make it advantageous for the company over small to medium producers which may find difficult to compete domestically (Case facts). 2.2 Strategic Location of its business The company appears to be located in or near the Margaret River, where wineries in Australia are best known. This strategic location is enabling the company to produce the quality of wine that matches that is described as of premium quality. This is supported by the case facts that “Margaret River today is a global brand synonymous with the production of premium wine. The region produces some of the world’s finest Chardonnay, Semillon, Cabernet Sauvignon, Shiraz, Sauvignon Blanc and Merlot.” Although Leeuwin Estate may not be the biggest wine company in Australia, it has the advantage of being found with best wine producers in the world. The favorable situation of Margaret River as a wine growing region is described have the following unique climatic advantages: “(1) the maritime climatic influence that moderates daylight temperatures and cools the grapes at night, (2) the region experiences slightly more sunshine hours than Bordeaux and (3) is free from the risk of frost. To paraphrase Denis Horgan, the average weather conditions in Margaret River are conditions Bordeaux experiences in only its best years.” (Case facts) The increasing number of wineries in Margaret over the years could only speak for the continued strength of their location for tragedies business decisions. Case fact support this assertion since by 1986, vines has accounted for 400 hectares of Margaret River. This was further increaser to 1,000 hectares by 1990 and 4,000 hectares in 2004 with around 100 wineries. To know further that despite the significant increase in the number of wineries, and the majority having remained boutique, producing high quality wine but in relatively low quantities is a sign of resiliency despite the strong competition. This further confirmed by the case fact that Margaret River produces just 3% of Australia’s grapes and 1% of total wine output, yet produces 25% of the nation’s super premium wine. Since Leeuwin Estate is a producer of super premium wine, then by all means it must have the strength to ward off weak competitors or to go along with even bigger producers of the same quality. To further strengthen its strategic location that is making the company profitable is the added case fact that Leeuwin Estate is not just about wine. The company attempts to sell itself not an isolated pleasure for wine appreciation but an essential way of living to have a lifestyle that fuses fine wine, fine food and fine art. Thus in the company’s attempt to bring these complimentary elements together, the Leeuwin Estate shows off its award winning restaurant, complete the best of amenities in the world. Third Question: An analysis of the available information reveals the payback period of the project is four years and three months and the net present value is $972,000. In no more than 800 words, provide a recommendation on whether Leeuwin Estate should proceed with the proposed accommodation. Your answer should address both quantitative and qualitative considerations. Leeuwin Estate should proceed with the project since the Net present value is already positive at $972000 and its payback period is four years and three month. As to why should be the case is explained below. A positive net present value is an indication that the proposal is acceptable based on cost capital and net cash inflows. A payback period of four years and three months may be considered acceptable in the lights of the life of the proposed project, which is 25 years. Each is further explained below with support. Companies may typically use the following investment appraisal techniques in evaluating the acceptability of projects: (1) Payback Method (PB), Accounting Rate of Return (ARR), Net Present Value (NPV), and Internal Rate of Return (IRR). For purpose of this paper, discussion will only be made with NPV and payback methods. Starting with NPV, it may be stated that this requires an understanding the meaning of cost of capital, which is defined as the firm's cost of capital or the rate of return that could be earned by a company. It is sometimes called the opportunity cost and it is used to discount the net cash flows generated and used in project proposals. To illustrate, a businessman borrows money to put some business at say 10% interest rate. This rate is the discount rate or cost of capital that the said businessperson must earn in the conduct of his business, other wise he should not go into business because he will be just wasting money and resources. A deeper understanding of the cost of capital requires understanding the concept of Time Value of Money and Discounted cash flows. This could be illustrated by looking at the value of say $1,000. It is not difficult to understand that $1000 to be received now is not the same as $1,000 to be received 1 year from now. The second amount must be discounted using the cost of capital or discount rate and definitely the value would be lower than $1,000. Let us assume the present value is $909.09 the discount rate therefore is the rate used to bring the value of $1,000 1 year from now to its present value. Viewed differently, one having $909.09 now may have to invest said money at a rate that would produce an accumulated amount of $1,000 after one year. The rate that needed to generate the desired is 10%, which may be viewed as cost of capital. To apply now the principle in the instant case, it may state that there are a series of cash inflows and outflows; hence there is now a need to have a discounted cash flow. To apply now in the instant case, it may be argued that the proposal involved several cash outflows at different periods and they include the following: Construction (inclusive of solar cells, rain water tank and recycling facility), $ 350,000; Electric Fireplace $4,000; Wine Fridge, $500 and other expenses. These and other expenses involving cash out flows will be discounted together with the cash inflows that would be generated from revenues that would come from room nights rent that would come from the use of the would-be constructed bungalows. Case facts say that the standard rate per night for each bungalow is $260 and that given the limited number of bungalows available and their unique nature there is not expected to be any seasonal fluctuation in demand and hence no variation from the standard rate throughout the year. This figure will have to be considered in computing the total revenues by multiplying the same with 3,650 room nights per year (taken by the number of bungalows available multiplied by 365 days). Price increases for the coming years will also be factored in including the fact of discounted rates for the Leeuwin’s friends. The changes in occupancy rates over the years should also be factored in. All these revenue-producing cash inflows and expenses- producing cash outflows will just have to used in the computation to produce the net cash inflows and eventually to be discounted to produce the net present value of the proposal. Since the case facts provide the project already has a positive NPV (Bernstein, 1993; Brigham and Houston, 2002), it follows that the company has discounted the net cash flows to generate the amount of $972,000 using its discount rate. With the assumption that the discount rate used in arriving at the Net Present value by the company is the company’s correct cost of capital, it may be argued that the project proposal is acceptable and should be pursued. As far as the use of payback period is concerned there is no company policy stated in the case facts as to what is the criteria in number of years as far payback period method is concerned. Since the payback method does not normally consider the time value of money its value for evaluation may just be limited depending on the company policy. But in the absence of basis that project should rejected if they have payback period of 4 years and 4 months or more, then the project proposal should be accepted. References: Bernstein (1993) Financial Statement Analysis, IRWIN, Sydney, Australia Brigham and Houston (2002) Fundamentals of Financial Management, Thomson South-Western, US Byars, L. (1991) Strategic Management, Formulation and Implementation – Concepts and Cases, New York: HarperCollins Read More