Svenska Livsmedel AB is a foods corporation based in Stockholm Sweden.[1] The board of directors of Svenska Livsmedel must consider and approve the firm’s capital budget for 2018 from a final list of eleven project proposals. Many projects proposed by managers at several facilities were initially submitted to the firm’s capital budgeting committee. These project proposals were further analyzed and scrutinized by the firm’s capital budgeting committee. The committee has now finalized the proposed 2018 project list and has thus submitted eleven project proposals to the board of directors for final consideration for the 2018 capital budget.

Due to external factors, the directors have unanimously chosen to limit the capital spending for 2018 to SEK 1.5 billion (SEK is Swedish Kronor). The SEK 3.165 billion cost for all eleven proposals exceeds the constrained capital budget for 2018. The company policy is driven by a goal to maximize shareholder value with its investment policy. The company policy states that capital budgeting tools based on Net Present Value or NPV are the only tools that can measure the amount of shareholder value or wealth created by any project.

As the capital budget is limited to SEK 1.5 billion (SEK 1500 million), the final capital budgeting decision enacted by the board of directors must choose the optimal collection or bundle of projects that maximize the Net Present Value or wealth created given the limited capital budget of SEK 1.5 billion. The Profitability Index (PI) scales the NPV by the size of the project (e.g., NPV per $ spent), and is the method to be used to choose the best bundle of projects given the limited capital budget.

Svenska Livsmedel has a formal policy that establishes the risk-based cost of capital or discount rate used to analyze projects as shown in the table below. The Excel sheet supplied for this case lists the classification of each proposed project. The Excel sheet also contains the cash flows of every project.

Project Classification	Classification or type of project	Cost of capital (hurdle rate)
1	New product or new markets	12%
2	Product or market extension	10%
3	Efficiency improvements	8%
4	Safety or environmental	10.5% (corporate WACC)

The eleven proposed projects are listed below. Note that projects no. 6 and 7 are mutually exclusive projects. Also stated is each project’s total installed cost (total initial investment), also broken down into the Plant Property and Equipment (capital expenditures or PP&E) portion, and the increase in Net Working Capital (NWC) portion. Cost figures are given in Swedish Kronor (SEK). For each of the eleven projects, the entire project installation and installed cost (initial investment) is incurred upfront (none spreads or spills across to future time periods).

1. Purchase new Volvo trucks for the firm’s transportation distribution network. Total installed cost is SEK 330 million (300 million PP&E and 30 million NWC).

2. New yogurt plant in Malmö Sweden to supply markets in Denmark, Germany, Norway, and Sweden. Total installed cost is SEK 450 million (375 million PP&E and 75 million NWC).

3. Expand butter production at the firm’s plant in Karlstad Sweden. Total installed cost is SEK 150 million (125 million PP&E and 25 million NWC).

4. Herring and misc. seafood production project at the Göteborg Sweden plant. Total installed cost is SEK 270 million (225 million PP&E and 45 million NWC).

5. Upgrade/renovate the firm’s bakery facility in Stockholm. Total installed cost is SEK 210 million (all PP&E).

* Special note concerning projects 6 and 7 below: these two projects are mutually exclusive; capacity exists to do one of these two proposed projects, but not both projects.

6. Expand the firm’s existing frozen dessert line (from production capacity at the Göteborg, Karlstad, and Malmö plants) to serve new markets in Germany and Denmark. Total installed cost is SEK 300 million (250 million PP&E and 50 million NWC).

7. Expand the firm’s existing frozen dessert line (from production capacity at the Göteborg, Karlstad, and Malmö plants) to serve new markets in Norway, Finland, and several nations along the Baltic. Total installed cost is SEK 300 million (250 million PP&E and 50 million NWC).

8. Project to produce Swedish meatballs and other food items under contract for IKEA to be sold under the IKEA brand in IKEA stores in Europe. Total installed cost is SEK 270 million (225 million PP&E and 45 million NWC).

9. Information system upgrade for the firm. Total installed cost is SEK 225 million (all PP&E).

10. Acquisition of an existing Swedish firm that manufactures the Akvavit spirit, schnapps, and liqueurs; offered as a project that delivers higher future growth opportunity than the firm’s existing mature businesses. Total installed cost is SEK 600 million (450 million PP&E and 150 million NWC).

11. Replace existing outdated lighting and electrical systems in several of the firm’s production facilities within Sweden. Total installed cost is SEK 70 million (all PP&E).

Questions to answer for this assignment:

(75-points)

1. For each of the 11 proposed projects, calculate the project IRR, the “spread” (difference between IRR and project cost of capital, and the Profitability Index (PI) – P.I. being the crucial capital budgeting decision tool in this scenario of a constrained capital budget. Then rank the 11 project proposals on the both PI and the “spread” between IRR and project hurdle rates. How closely do ranking on PI versus “spread” match each other?

It is best to do this exercise using the Excel sheet – that way I can examine the formulas used if necessary. You can also put no. 2 below on the same Excel sheet.

(25-points)

2. Which set of projects should the board of Svenska Livsmedel AB select for the capital budget for 2018, given that the firm’s capital budget constraint of SEK 1.5 billion? Or to put it another way: which bundle of projects has the highest possible NPV? How much NPV is the firm expected to receive from your suggested collection of projects?