Deutsche Brauerei Case Analysis
...or the firm. I am particularly concerned with our distribution process in Ukraine, as well as our ROI risk associated with the Ukraine investment. I will also calculate the Deutsche Brauerei’s required rate of return for the project compared to our local competitors. Lastly, I will construct a compensation plan for Oleg Pinchuk which reflects the firm’s overall performance in Ukraine. ANALYSIS Deutsche Brauerei’s rapid growth in the past few years is due to the untapped market that Ukraine has opened. The recent surge in sales volume has increased net sales by 48% since the beginning of 1998 (See Exhibit 1), and during that time period 211 new accounts have been opened in Ukraine. In order to accommodate the increased sales volume the firm was forced to increase its short term borrowings at a compound annual rate of nearly 64% since the beginning of 1998 (See Exhibit 2). This is primarily caused by collection problems among Deutsche Brauerei’s distributors in Ukraine. The company’s credit policy in Germany has been 2 percent 10, net 40, where the distributors would buy the beer directly, and store it themselves until the product was sold. Deutsche Brauerei had to relax their credit policy to 2 percent 10, net 80, in order to enter the Ukrainian market, and even then distributors were asking for more time to pay. Since Deutsche Brauerei doubled the length of their credit policy, they were forced to increase their short term debt until the Ukrainian distributors paid their remaining balance. Deutsche Brauerei’s largest use of funds in 2000 was to increase inventories, which accounted for nearly half of its total uses (See Exhibit 3). Oleg predicts this figure to decrease the next two years; however, I believe changes will have to be made, other than increasing their credit policy to 90 days, in order for that to happen. The collections problem paired with the increase in inventories pose a major threat to Deutsche Brauerei’s financial health. Not only are they having collection problems in their Ukraine operations, they are also keeping the excess inventory on their on own financial statements in order to help out their distributors. This process has given Oleg, as well as Deutsche Brauerei, a false sense of security because their sales have skyrocketed, and their return on equity has steadily increased. The reason for in increase in return on equity is not due to increased profits because the Ukraine investment has not greatly affected net income. The increase is caused by the leverage factor since total assets have increased significantly due to increases in accounts receivable and inventories. Deutsche Brauerei’s financial ratios give further insight to their problems in Ukraine. The receivables growth rate for Ukraine jumps to 863.5% only one year into the project, while the average days in receivables jump from 36.3 to 85 days (See Exhibit 4). The current ratio steadily increases which tells a firms ability to pay off short term debt; however, this is only caused by the major increase in current assets. The return on sales for Deutsche Brauerei has decreased since the beginning of the Ukraine project mainly because there has been little effect on net income, but Oleg expects it to increase in the future. According to Oleg’s breakeven analysis (Exhibit 5), they must produce and sell 938,800 hectoliters of beer to become profitable. He calculated this figure by dividing Deutsche Brauerei’s fixed cost by the profit per hectoliter produced. However, this number is only good until 2001 when they plan to invest 7 million euros in a new production facility since the current one is near capacity. In Oleg’s analysis he calculated that Deutsche Brauerei’s return on their Ukraine investment is 130%, while their cost of funds on their short term borrowings is only 6.5 percent (See Exhibit 6). Oleg’s problem, however, is that he only accounted for their investment in accounts receivable. He should have included their entire Ukraine investment which includes accounts receivable, inventory, and capital expenditures. Had he calculated Deutsche Brauerei’s return on investment using their total investment, he would have realized returns between 27-50% (See Exhibit 7). Oleg also underestimated the allowance for doubtful accounts which he calculated at 2%. Deutsche Brauerei should also be concerned with their ROI risk associated their Ukr...