All questions are in the world doc. I need answers for 7 questions, conclusions and references for Monday night

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Table of Contents

 

Issues………………………………………………………………………………………………………………….1

 

Facts……………………………………………………………………………………………………………………2

 

Analysis……………………………………………………………………………………………………………….3

 

 

 

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Conclusion…………………………………………………………………………………………………………11

Issues

1.  What are the goals & objectives of Axeon’s strategic planning?

2. Is the establishment of a new factory in the UK in the best interest of Axeon?

3. If the factory were not established in the UK & AR-42 were shipped from the Netherlands, what should be the transfer price between the parent & UK sub?

4. What taxes would be paid in the Netherlands & in the UK as a result of your selection of a transfer price?

5. a. How could Mr. Wallingford’s original AR-42 proposal have been improved? b. Should the boards for Hollandsworth & Axeon have accepted Wallingford’s proposal for the UK establishment? c. What action should Mr. van Leuven take in respect to Mr. Wallingford?

6. What should be done to avoid creating similar dilemmas in the future?

7. What affect would Brexit (add commentary to Facts) have on Wallingford’s proposal? N.B.: Brexit is the U.K. exit from the European Union on 10/31/19.

 

Facts

Textbook Solutions

Expert Q&A

In October 1998, Anton Van Leuven, managing director of Axeon N.V a large Dutch chemical company, was faced with a difficult decision. Ian Wallingford, managing director of Axeon´s British subsidiary, Hollandsworth, Ltd, and Jeremy Noble, a member of the subsidiary board of directors, were frustrated that an investment proposal that had been presented some time ago had not yet been approved. The board member had even threatened to resign his post. But Mr. Van Leuven had received advice from some of his other managers to reject Hollandworth proposal.

​ Axeon N.V was headquartered in the Netherlands. The company produced an extensive product line of industrial chemicals in 24 factories. Over the years, Axeon acquired some foreign companies such as Saraceno, S.p.A (Milan), Hollandshworth, Ltd (London) and KAG Chemicals, AB (Gothenburg and Sweden). To take advantage of the geographical expertise in these acquired companies, each of these subsidiaries was asked to assume responsibility for sales of all Axeon products in their assigned territory: Southern Europe for Saraceno, the United Kingdom for Hollandsworth and Scandinavia for KAG, respectively, accounted for 8%, 14% and 6& of total sales. All the other sales were handled by the company in the Netherlands.

​ The style of Axeon´s top-level managers were to emphasize a high degree of decentralization. Hence, the subsidiary managers had considerable autonomy to decide what to sell in their territories. For products produced in the Netherlands, the Axeon Dutch sales organization would quote the subsidiaries the same prices as they quoted agents in all countries. The subsidiaries could bargain, but if, in the end, they did not like the price, they did not have to sell the product.

​In some cases, the foreign subsidiaries produced products that competed with those produced by Axeon factories in the Netherlands. To date, little attempt had been made to rationalize the company´s production. The subsidiaries could continue to produce whatever mix of products they deemed appropriate.

​The subsidiary managers were also encouraged to propose the development of new products, and they could build their manufacturing plants if they could justify the investment in their own markets.

​ Management personnel included in a bonus plan that provided rewards based on achievement of divisional revenue growth and economic profit target as a part of the company´s annual planning and budgeting process. Economic profit was defined as operating profits less a capital charge on the division´s average assets, computed monthly.  The capital charge was adjusted annually based on Axeon´s weighted average cost of capital. In 2002, the annual charge was set at 10%. In prior years, it had been as high as 14%. Achievement of the annual targets could earn divisional managers bonuses of 50% or more of base salary. If they exceeded their targets, they could more than double their base salaries.

Hollandsworth, LTD. 

 

​ Hollandsworth was purchased by Axeon in 1992. During the first 3 years of Axeon´s ownership, the sales were in slow decline. In 1996, they totaled L 111 million. Boards of director decided that the company needed a new management team and a major overhaul. Mr. Ian Wallingford, a 39-year-old with university degrees in engineering and commerce, was hired. He had experience as a manufacturing engineer, a marketing manager for a British subsidiary of an American company, and profit center manager in a large U.K industrial company.

​ In the first 4 years of Ian´s presidency, the sales increased to L 160 million, and profits improved markedly, to levels that Axeon´s management deemed acceptable. The board concluded that several factors contributed to Hollandsworth´s turn-around. An important part was Ian´s ambition, hard work and management skill. Ian made some good personnel hires and implemented several affective changes in production methods, marketing strategy, market research, and financial planning and organization structure. In addition, industrial activity in the U.K increased significantly during this period.

The proposal 

​ In 1998, Ian informed the Hollandsworth board that he proposed to study the feasibility of constructing a factory in England to manufacture a protective coating chemical known as AR-42. He explained that Hollandsworth´s product engineers had developed a new way of helping users to store and apply this coating. In his judgment, Hollandsworth could develop a market in the U.K that would be almost as large as Axeon´s present worldwide market of AR-42. Approximately 600 tons of AR-42 was then being produced annually in an Axeon plant in the Netherlands, but none of this output was being sold in the U.K. Ian observed that the board seemed enthusiastic at this initial meeting, but they wanted to see the detailed plan. Hollandsworth managers developed the proposal over the following 6 months. They interviewed potential customers and conducted trials in the factories of 3 of them and proved that the large cost savings would indeed materialize. In the end, they estimated the total U.K market potential for AR-42 like coatings at 800 tons per year. If they could sell the product for 3,700 pounds per ton per year, they would capture half of the total market, or 400 tons per year, within a 3-year period.

​ Ian asked the head of the Corporate Engineering Division in Netherlands for help in designing a plant to produce 400 tons of AR-42 per year and in estimating the cost of the investment. A team comprised of engineers from both Corporate Engineering and Hollandsworth estimated that the plant could be built for 1,400,000 pounds.

​In July 1998, Ian presented the results of the analysis, the net-present-value calculations and supporting explanations (Exhibit 2- 5) at a Hollandsworth board meeting. With Ian were his directors of manufacturing, sales and finance.

Exhibit 2 explains that the company would obtain a rate of return of 20% and a present value of 916,000 pounds for an initial investment of 1,400,000 pounds for equipment and 160,000 pound for working capital. Ian used an 8% discount rate because he could borrow money in English at that rate to fund this project.  Exhibit 3 shows operating cash flows that they expect from the AR-42 project in each of the 7 years.  The sales forecast for the 7 years is shown in row 2, and the estimated variable cost of 2,000 pound per ton shown in row 3 which is considered an estimate of the full operating cost of manufacturing AR-42 in England (This figure takes into account out-of-pocket fixed costs such as plant supervision excluding depreciation).  Row 4 shows that the selling price is 4,000 pound per ton, but in order to gain market share and achieve full penetration, they would reduce the selling price to 3,700 pound at the beginning of the 2nd year.  The variable profits are shown in row 5 and 6. Row 7 presents the marketing expenditures that are needed to promote the product and achieve the forecasted sales levels. Row 8 shows the net operating cash flows before tax, based on figures in the preceding columns.  The cost of the plant can be written off for tax purposes over 5-year period. In row 9, the taxable income figures computed by subtracting this amount from the before-tax cash flow. The tax in row 10 is the subtracted from the before-tax cash flow to yield the after-tax cash flow in row 11.

​ Exhibit 4 summarizes the estimates of the requisite in working capital. It will be needed 160,000 pounds to start with plus small additional amounts of working capital in the next 2 years. Altogether, the working capital requirements will add up to 190,000 pounds by the end of the second full year of operations. Finally, exhibit 5 shows some asset recovery values. At the end of 7 years, the plant should be a worth 1,400,000 pounds. They would have to pay tax on that because the plant would be fully depreciated, but this would still leave the company with a positive cash flow of 840,000 pounds. So that the total value at the end of 7 years would thus be 1,030,000 pounds.

​After a week later, Mr. van Leuven called Ian and explained to him that he had been through some additional discussions with product and marketing people in the Netherlands, and he talked to him that even though they agree with his engineering design and plan cost projections, they consider he is too optimistic on his sales forecasts. Ian pushed for an immediate meeting with his key functional directors and 4 Axeon managers based in Heerlen which was schedule for the next week. During the meeting Mr. De Rijcke said that Axeon´s current total worldwide market for AR-42 for Axeon was only 600 tons a year, that it was being produced in the Netherlands at that level, and that it was inconceivable that U.K alone could take 400 tons, and Mr. Oosterling said AR-42 production was complicated, even with trained workers who have long experience. At the end the meeting was frustrated to Ian. He returned home to London and reported the meeting to his own staff to the English members of his board.  They were extremely disappointed. Mr. Noble, the English banker on the Hollandsworth board said that he was surprised because he had studied the proposal very carefully. He considered that this would be business for Hollandsworth, and AR-42 will help to build one more growth company in the English company.

​Mr. Noble sent a letter to Mr. van Leuven. After Leuven received the letter, he contacted Messrs, Backer, Oosterling, and De Rijcke and Koonts. He told then that English AR-42 project had become a matter of key importance for the whole company because of its implications for company profits and for the autonomy and morale of subsidiary management. Meanwhile, he sent the following message that various members of the division and corporate headquarters were studying the proposal, and that he would hear from him within about 6 weeks regarding his decision.

​ A month later, Oosterling, the director of manufacturing, sent Mr. van Leuven a memorandum explaining his reasons for opposing the U.K AR-42 proposal. He explained that he found highly uneconomical to manufacture this product in England for 2 reasons: overhead costs and variable cost would be higher than projected, and the AR-42 could be produced in the Netherlands with less overhead cost. Suppose that Hollandsworth does sell 400 tons per year so that their worldwide sales increase to 1,000 tons. They can produce the whole 1,000 tons in the Netherlands with basically the same capital investment as they have now. If the produce 1,000 tons, their fixed costs would decrease by 240 per ton which means 144,000 pounds in savings on production for domestic and export to countries other than the U.K and 240,000 pounds for worldwide production including the U.K (1000 tons). Regarding the variable costs, if they were to produce the extra 400 tons in the Netherlands, the total production of 1,000 tons per year would allow them to have longer production runs, lower set-up costs, and large raw material purchases, which lead to mass purchasing and material handling and lower purchase prices. His accounting department has studied this and concludes that their average variable costs would decrease from 1,900 pound to 1,860 pounds per ton (Exhibit 6). This 40 pound-per-ton difference would save 24,000 pound on Dutch domestic production assuming that the U.K takes 400 tons per year. There would be some additional shipping and duty costs, but these would be negligible. Taxes on these added profits are about the same in the Netherlands as in the U.K.

The same day, Mr. van Leuven received the memorandum from Koonts (VP-Finance) which he sent estimates of the working capital requirements if Axeon increases its production of AR-42 in their Dutch plant from 600 to 1000 tons per year (Exhibit 7) . Initially, they would need 120,000 pounds mostly for additional inventories. By the end of the 2nd year, this would have increased to 160,000 pounds, and that he had also looked at Marc´s calculation for the fixed and variable manufacturing costs, and he was in full agreement with them.

 

Conclusion

Ian should have provided a SWOT analysis (Strengths, weakness, opportunities and threats) because it would have been easy for him to detect issues and define plans to eliminate, control or reduce issues. The proposal should not have been accepted by the Hollandsworth and Axeon boards of directors, considering some missing important information about it.

He should have provided details of everything that he researched, prepared charts related to financial analysis and defined clearly strengths, weakness, opportunities and threats. Moreover, it would be healthy for subsidiaries to carry out ideas which all can win because all build one big intuition even though all are legally managed independently. The construction of the new factory in the UK is the best interest of Hollandsworth. However, it’s not the best interest of Axeon

As the role of a Managing Director (MD), Mr. Van Leuven in this proposal case, two things should be considered seriously, one is to really figure out which side can reach the goal of most cost effective and time efficient, the other one is to lead the autonomy and morale of subsidiary management in the right way.

Related to the first one, we come out with the decision that it is better for Hollandsworth to buy AR-42 product from Netherland than investing a plant themselves. For the second one, we think that communication should be the only way and the best way to minimize the negative impact of this event. Autonomy and morale are important for the subsidiary to achieve the “economic profit”. Better communication and encouragement is necessary.

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