The Nutrition Division of Regal Foods focuses on health-related products. Historically, the Nutrition Division has been an excellent contributor to group performance, with annual growth rates of up to 12 per cent for the period 2006 to 2012, and revenues exceeding $2 billion. However, divisional manager Bruce Buncle has found growth increasingly difficult to maintain.

An increasingly crowded market for health and nutritional products seems to be the main driver of these difficulties. As a consequence, debt levels of the division seem to be rising. However, Buncle is conscious that he needs to develop new products and markets in line with company objectives. 

Regal currently uses a common capital investment evaluation process for all investment projects in excess of $10 million. A summary of key criteria includes the following.

• Projects must generate a positive NPV over the life of the project.

• A minimum annual return on investment (ROI) of 10 per cent must be achievable within two years of the project commencing.

• Project proposals must be presented in standard format with supporting calculations. Buncle cites the following example to illustrate his frustrations with the current process. Buncle and his management team have been considering a range of investment opportunities and have been contemplating a major investment in the bottled water industry. While the industry has its challenges (for example, environmental opposition to the use of plastic bottles, tightening environmental regulations and the expectation of reduced carbon emissions), Buncle and his management team see a lot of potential with such a strategic move. However, where significant capital expenditure is required, Buncle finds the company investment decision-making processes frustrating.

The management team within the Nutrition Division has identified a new spring water source in a regional area — Hepburn Shire. The division plans to build a new water bottling plant to take advantage of the springs. The local authorities are happy to support the project. In fact, the local authorities are willing to forgo local taxes and provide subsidies to ensure the plant is built. The region has experienced relatively high levels of unemployment in recent years and the new plant will generate some 100 local new jobs. While there is some local opposition to the new facility on environmental grounds, Buncle considers these to be manageable. While he knows the project’s financial benefit looks not all that favourable, he believes the investment is a good strategic move for his division (particularly with the synergies expected with other parts of the division) and aligns with the company’s growth strategy. A summary of the project’s details is provided in the table.

Bottled water project at Hepburn Shire — summary data
Life ........................................................ 10 years
Cost ....................................................... $28.2 million
NPV ......................................................... ($0.6 million)
Average ROI over 10 years ................... 12%
ROI in year 1 ........................................... 6%
Average ROI over first three years ........ 8%

Buncle has raised his frustrations with senior management, arguing that projects such as his bottled water project are never going to meet the strict and somewhat narrow criteria currently used by Regal. He has been asked to come up with an alternative model for evaluating these types of strategic investments. He hopes to use the bottled water project to demonstrate his suggested model.

Buncle has come to you for some advice on the development of a new model.

Required

(a) Outline the key components of your proposed model for evaluating strategic investments at Regal Foods.

(b) Use the bottled water project of the Nutrition Division to illustrate the benefits of your model. On the basis of your analysis, would you recommend the investment be undertaken?