Fonderia Del Piemonte Case Study PDF

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Fonderia Del Piemonte Case Study Write Up...

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Case Studies in Finance

Fonderia del Piemonte Case Study

I.

Summary

Fonderia del Piemonte is located in Turin, Italy. The company specializes in manufacturing sand molds that are then used to cast iron casts. Currently, the firm prides itself on high-quality products, which have been satisfying many clients. The managing director of the firm, Martina Bellucci, wants to make a capital expenditure to replace the semi-automatic machines that are currently being used in Fonderia’s production chain. She is considering buying a Thor MM-9, which is a completely automatic machine to replace the existing ones. In the past, the board members of the company have turned down some ideas regarding machine replacement given the economic turmoil in Europe and their concerns about the company's finances. Hence, Bellucci needs an estimation on the cost of the Thor MM-9 in comparison to the benefits it offers to have the most comprehensive overview of whether or not Fonderia Del Piemonte should invest in this project for the future of the company. From our analysis, Fonderia should make the investment on the Thor MM-9 since the benefits it may bring to the firm outweigh the current machines they are utilizing. In this paper, we will provide key points on the company's history and specifically their perspective on decisions related to capital investments. We will then go deep into analyzing the status of the firm’s current machines and how this option is compared to the Thor MM-9. We will also take into consideration the fluctuation in the internal rate of return of the project when the number of shifts and value of labor factor change with a sensitivity analysis. Finally, we will provide our recommendation along with rationale for why Fonderia Del Piemonte should invest in the new machine, and how they can optimize this option for the maximum benefit and future outcomes of the firm.

II.

Identification of Key Problems and Questions

Company background Fonderia del Piemonte is known for their quality and, given how fast the new machine is able to operate, they are worried about the quality control of their products. Three proposals to increase quality control have all been rejected by the board members. The sales for the past year for Fonderia del Piemonte totaled 1.3 billion euros. The company is listed on the Milan stock exchange, however, the family still owns 55% of the outstanding common shares with a beta of 1.25. The firm has not changed its 7% hurdle rate for projects in many years. Currently, they pay 2.5% on their loans which require a payback period of 5 years at maximum. Finally, the company has a required return rate of 12% a figure that has not been adjusted since Bento Bellucci, the grandfather of Martina Bellucci, led the company. The Current Machines

The current semi automatic machines require a minimum of 12 workers per shift with 2 machine workers to run. These 12 workers each receive a pay rate of 14.66 euros an hour and the 2 machine workers earn 15.70 euros per hour. The machines stamp impressions of sand and adhesive with heat and pressure, a process which is very labor-intensive and requires multiple employees. The training of these employees is very important to the firm given the high-quality expectations from their clients. Due to the quantity of people with labor-intensive jobs required, the number of medical claims within the company has doubled since 2012. These six machines, that currently have a remaining lifespan of six years, cost the firm 423,000 euros with a cumulative deprecation of 169,200 euros. In addition, these machines cost 15,300 euros per year in electricity expenditures and also 6,000 euros per year in maintenance costs. Bellucci received an offer to sell the machines for 130,000 euros. The important question for the company to analyze is whether the current costs of running these machines and the remaining lifespan of these machines justify the purchase of a new machine, the Thor MM-9. The Thor MM-9 This machine is made in the United States and Fonderia del Piemonte was offered to buy it at 1.8 million euros. The machine itself is a totally automatic machine, which requires only 1 skilled operator per shift. Apart from paying this worker 22.77 euros an hour, the company will also pay an estimated 120,000 euros in yearly maintenance and 40,000 euros yearly in electric costs if they choose to invest in this new machine. Besides these costs, the installation process which requires a rewiring of the facility will cost an additional amount of 100,000 euros. The shipping, installation, and testing are going to cost Fonderia del Piemonte 50,000 euros, making the total installation and purchase of the Thor MM-9 equal 1.95 million euros. The firm can then depreciate the machine over its useful life of 8 years and after the 8th year, it would need to be replaced. Bellucci believes that this automatic machine can save them a minimum of 30,000 euros each year with much lower labor costs. She also thinks that the quality will increase since the human element will be minimized, which certainty holds promising opportunities for expansion. Currently, the old machines are working at 90% capacity whereas the Thor M-99 has a max capacity of 30% higher than the 6 machines right now based on this 90% capacity. Economic Situation Fonderia del Piemonte has worries about the economic future of Europe and Italy in general. This has predominantly been the reason for not investing in new and different machines based on the failure of the past three proposals. Overall, the company management board was unsure if making these investments would add value since they might face more challenges after making huge capital investments in the case of an economic downturn. In addition to the uncertainty of the future economy, Italy also has extremely strict labor laws. Bellucci is unsure about how their labor union will react when they want to figure the current 24 operators for both shifts on the old semi-automatic machines. She is not sure about how many of these workers can the company cut down on while still compromising with the law. There are opportunities within the company in different jobs, but they only pay 9.13 euros per hour in comparison to the 14.66 euros per hour they were getting.

III. Analysis of Alternatives There are two alternatives for Fonderia to consider, which are to purchase the Thor MM-9, or to continue with the current ones until the end of their life. The two options with their pros and cons are described in detail as follows. If they choose to purchase the new machine, they will benefit from an increase in both their quality and efficiency, but will also face certain cons. On one hand, Fonderia can save about 30,000 euros on labor costs since the new machine is completely automatic, which will greatly decrease their operating costs (see Exhibit 1). The firm can also increase their capacity and quality of casting since there will be less human intervention. By acquiring the Thor MM-9, Fonderia will also benefit from a longer PPT lifetime of the machine, compared to the old ones which need to be replaced after 6 years of use. On the other hand, the upfront investment amount of the new machine is very high, which totals 1.95 million euros. The firm will also face a significant increase in power cost of 40,000 euros, compared to the old ones with 15,300 euros of electricity cost. Given the complexity and uncertainty of the future Italian and European economy, Fonderia might have to consider this option very carefully since it entails huge investments for them to bear.

Exhibit 1

The second option they have is to stay with the machines they have been using. On the bright side, the firm can avoid a risky capital expenditure of 1.95 million euros on the new machine as well as the included costs such as maintenance and energy costs. They will also be able to ensure that the labor law is strictly followed in compliance with the local authority’s guidelines. However, the company will continue to spend a great amount on labor costs while having to renew their machines every 6 years, which ultimately will cause them to suffer higher operating costs compared to the first option (see Exhibit 2).

Exhibit 2

Considering both alternatives, it can be seen that the first option will result in less operating fees for Fonderia. Additionally, if the firm makes their decision to buy the new machine, they can have some different ways to change the number of shifts and labor factors to maximize the company’s return.

Fonderia will need to examine closely how many percent of labor should be retained and how many shifts they should work. A detailed lay-out of these options can be seen in this following table, showing how the internal rate of return for this option may fluctuate based on changes in labor factors and number of shifts (see Exhibit 3).

Exhibit 3

IV. Recommended Solution(s) From both the valuation model and our EAA analysis (see Exhibit 4), Fonderia del Piemonte should move forward with the decision to purchase the Thor MM-9 automated molding machine. Ultimately, the investment will improve product quality and allow for an increase in capacity. The future of Europe’s economy is uncertain and unstable due to a forecasted slowdown. With the Thor MM-9, there would be a decrease in labor expense creating cost efficiency and allowing for additional assets to be used in the case of an economic slowdown. Additionally, the purchase of the Thor MM-9 would alleviate the labor-intensive aspect of the production of castings and guarantee a higher quality product and lower scrap rate consistent with the quality awards Fonderia has received from BMW, Ferrari, and Peugeot. In this competitive industry, the increase of quality and decrease of scraps could have the potential to give Fonderia an important advantage over their competitors and increase their customer appeal. The increase of workers suffering from back injuries incurred in the molding shop would decrease leading to a decrease in medical claims and labor costs. With an increase in labor efficiency, Fonderia would save an estimated €30,000 per year. Furthermore, the addition of the new molding machine would replace six semi automated stamping machines freeing up 15% of the foundry’s floor space which could be used in a more efficient manner. In order to implement the Thor MM-9 for Fonderia’s use in the production of castings Fonderia’s first step would be to sell the current six semi automated stamping machines, and then make the purchase of the new Thor MM-9 machine. The market value of the existing semi automated machines would be 130,000 and the tax on the sale of the asset would be 53,234. The purchase of the new Thor MM-9 machine would be 1,800,000 with 130,000 of the total amount coming from the sale proceeds of the existing semi automated machines. The tax shield would be 53,234 which would lead to a net investment of 1,766,766 in the purchase of the Thor MM-9. Overall, the purchase of the Thor MM-9 machine would decrease labor intensive activity, allow for lower operating costs, and lead to higher product quality. In the result of an economic slowdown in Europe’s economy, the implementation of the new machine would lead to reduced labor expenses which would provide Fonderia with additional financial means. The result of an increase in 15% of the foundry’s floor space could allow Fonderia to dedicate the capacity for efficient

use. In the result of no economic slowdown and a stable European economy, Fonderia could retain employees and prevent unemployment, as well as have the financial means to purchase additional Thor MM-9 machines. With the purchase of additional Thor MM-9 machines, Fonderia could increase their product output and profits.

Exhibit 4

V. Conclusion Based on the projection models and the known information, the decision to purchase the new, automatic Thor MM-9 machine is the better option when compared to the alternative of sticking with the current operating system. As mentioned before, this is because this option is more cost efficient in the long run as it significantly reduces the labor costs while also maintaining the top notch quality that Fonderia customers expect. This will be done by selling the current semi automatic machine, laying off the operators, and purchasing and implementing the Thor MM-9 machine into the company’s operations. The expected effects of this decision are not only the reduction in the intensiveness of the labor and a reduction in the operating costs due to the laying off of the employees, but also a reduction in the amount of medical claims which come about as a result of the employees operating the semi automatic machine. When considering the opportunities that the Fonderia del Piemonte company is faced with, it is important to note the difficulties that come along with forecasting the outcomes of each decision. The first of these difficulties comes from the instability of the European and Italian economy and it affects the degree of certainty with which one is able to forecast the outcomes of these decisions. For instance, should Fonderia find themselves in a situation where the economy takes a down downturn, a large purchase like the Thor MM-9 machine would not make sense, and depending how severe the down turn is, may result in the failure of the company. On the other hand, should the state of the economy stay constant or improve, then the Fonderia del Piemonte company will be able to better capitalize on their business opportunities and result in them being able to make more money with this investment. A second difficulty that presents itself when forecasting the outcomes is how the labor laws within Italy and the presence of a worker’s union within Fonderia will affect the plan to fire the current operators of the semi automatic machine and

replace them with the automatic Thor MM-9 in an effort to cut operating costs. Should the company make the decision to buy the new machine on the assumption that their current employees can be fired and later find out that they cannot do so, then the forecasted operating cost would be thrown off, making the decision to buy the Thor MM-9 less desirable....