The Brunswick case offers a good opportunity to look into the financial impact of a manager’s decisions on building an efficient value chain. The distribution company’s strong top line growth has not translated into solid financial return for the past few years. Based on suggestions from his two Vice Presidents, CEO James Brunswick has to decide whether invest in an additional warehouse or to invest in streamlining the order process. Ratio Analysis The ratio analysis based on the Financial Analyzer revealed a mixed result for the two options.
From a market performance perspective, the expansion case seems to be preferable to the streamlining cases as indicated by the high EPS of $8. 98/share compared to the basic and full streamlining cases at $7. 57 and $8. 46/share respectively. The better performance can be attributed to an increased business base as well as higher leverage. On the other hand, the streamlining option appears to be a better choice to increase the firm’s liquidity ratios and activity ratios.
Under the basic and full streamlining scenarios, the current ratio is respectively 0. 31 and 0. 52 higher than the expansion option. Fixed asset turnover is higher by 40. 9% with the basic option and 17. 4% with the full option. Cash Cycle, a measure of the ability to convert inventory into cash, is about 10 days less for streamlining cases than for the expansion case. One of Brunswick’s biggest concerns, inventory turnover, shows no significant improvement under either option. Finally, the Dupont Analysis offers some insights into the breakdown of ROE.
For the expansion case, the largest driving force of its better ROE (17. 8%) is the higher leverage. The net margin increases slightly while the total asset turnover is slightly lower than in the base case. This is also revealed by the identical ROA ratio, which is measured by operating income (EBIT) and total asset regardless of financial structure. For the streamlining cases, the full option is preferable because it has higher net margin (9. 0% vs. 8. 0%) and slightly higher leverage multiplier (200. 9% vs. 209. 3%). ROI Analysis
While ROE and ROA are commonly used by external financial analysts in assessing the firm’s profitability, ROI is typically employed internally as the basis for investment decisions and assessing manager’s performance. We calculated Brunswick’s ROI by dividing the incremental after-tax operating profit [EBIT*(1-t)] by the initial investment. It turns out that the full streamlining option offers the highest return based on ROI (12. 12%), and the basic streamlining option is the least preferable (8. 24%). Other Decision Criteria
The ROI methodology suffers from two shortcomings as an investment a decision criterion: it is based on accounting returns rather than cash flow; it also fails to take into consideration the time value of money. In order to address these two concerns, we also employed NPV and IRR methods to evaluate the two options at hand. This time, the two discounted cash flow methods give us a consistent ranking: NPVfull streamlining ($2,476,817) ; NPVbasic streamlining ($303,504) ; NPVexpansion ($-4,028,341); IRRfull streamlining (17. 05%) ; IRRbasic streamlining (12.95%) ; IRRexpansion (6. 32%).
Notice that NPVexpansion is a negative value and IRRexpansion is less than the 12% required return. In other words, if Brunswick chose the expansion option, it would decrease firm value. Value Chain Implication From a value chain perspective, the expansion case offers Brunswick an opportunity to serve more customers. However, the increased volume does nothing to add value to either customers or manufacturers. As indicated in the case, there has been a tendency for retailers to buy some products directly from manufacturers.
If distributors do not adopt a value-added strategy, they cannot stay competitive very long. The streamlining cases, on the other hand, are a good example of creating value for existing customers and manufacturers. By streamlining the ordering process, Brunswick would be able to promise a faster and more dependable delivery to retailers. The firm would also provide better sales forecast for manufacturers and enable them to cut down their inventory levels. Conclusion It is time for Brunswick to balance the two options at hand and decide how to turnaround the company.
Traditional ROE and ROI measure somewhat favor the expansion option for its higher return. However, relying solely ROE and ROI can be misleading since these ratios can be attributed to factors other than creating value such as high leverage (financial and operating). When we examine the two options from a discounted cash flow perspective, it is clear that the full streamlining case is the optimal choice. It not only adds value to the firm but it increases the firm’s value to the supply chain.
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