Anheuser-Busch - Casebook

Short-term Asset Management: The Baumol Model

Brewing beer has always been the core business of Anheuser-Busch Companies, Inc. The industry leader since 1957, Anheuser-Busch currently owns 45% of the domestic beer

market. This represents annual sales of 88.5 million barrels of beer. Market share has grown so much that Anheuser-Busch now has a larger portion of the market than their next four largest competitors combined.

International sales are no different. Anheuser-Busch International remains the leading exporter of beer from the United States with sales in more than 65 countries.

Microbreweries, or microbrews for short, have been gaining attention in recent years.

Microbrews are defined as breweries that produce less than 15,000 barrels a year. The strength of microbrews is their philosophy that beer should be of the highest quality.

Microbrews are only made with malted barley, hops, water, and yeast, the only four

ingredients found in the purist German beers. Mass bottled beers usually add rice and corn to minimize costs. The drawback of microbrews is their cost. The more expensive ingredients make microbrews cost an average of 60% more than mass bottled beers.

Beer is not like wine which gets better with age. Instead, it is a food that should be consumed as soon after production as possible. As such, beer pubs or microbrews that produce beer on the premises, are the hottest new trend with an average of four new pubs popping up every week. Sales have grown an average of 40% per year. This figure is extremely impressive when one considers that the beer market as a whole is shrinking. Even with this success, microbrew sales represent only two percent of the $50 billion dollar beer market.

In their relentless pursuit to continue to dominate all sectors of the beer market, Anheuser-Busch has tapped into the microbrewing trend. They have recently bought a stake in the Seattle based Red Hook Ale micro-brewery. The new products introduced into the regional and mainstream specialty beer segment include Red Wolf, Elk Mountain Red, Elk Mountain Amber Ale, and Elephant Red.

Since microbrews are typically produced regionally, Anheuser-Busch is developing regional manufacturers and distributors. As such, they must decide on the best way to handle their short-term cash needs for purchasing inventory in these small plants. Anheuser-Busch has decided to use the Baumol model to determine the level of cash to keep on hand versus the amount to keep in marketable securities.

Anheuser-Busch can earn 7% if they keep their funds in marketable securities. Every time

http://wps.aw.com/aw_gitman_pmf_10/0,6047,347212-,00.html (1 of 2) [11/27/2002 12:20:39 AM]

aw_gitman_pmf_10|Case Studies in Finance|Case 29: Anh euser-Busch

they convert their marketable securities to cash, it costs them $25. Finally, they anticipate their total cash outlays over the next year to be $2,000,000.

Questions

1.

Using the Baumol Model, what is the economic conversion quantity (ECQ) that will maximize the firm's value given their short-term cash needs? Why is it important for a business to correctly determine their ECQ?

2.

Based on your answer from question 1, how many times will Anheuser-Busch convert marketable securities into cash per year?

3.

What is the average cash balance the firm will hold throughout the year, assuming the cash outflows will occur on a consistent or smooth basis?

4.

What is the total cost associated with managing these short-term funds? How can you be sure this is the optimal ECQ?

5.

In the above analysis, we have not considered a level of safety stock. Why is safety stock so important? What primary factor will determine the amount of safety stock for each specific firm?

aw_gitman_pmf_10|Case Studies in Finance|Case 30: Pepsi

Home > Case Studies in Finance > Case 30: Pepsi >

Case Studies in Finance

Case 30: Pepsi

Short-term Cash Management: Managing the Cash Conversion Cycle

Pepsi is a multinational company who operates within three primary industry segments:

beverages, snack foods, and restaurants. The primary products sold in the beverage segment include Pepsi, Diet Pepsi, 7UP, and Mountain Dew. Frito-Lay represents the domestic snack food business, while PepsiCo's restaurant segment consists primarily of Taco Bell, Pizza Hut, and Kentucky Fried Chicken (KFC). Pepsi also engages in several joint ventures around the world, each within one of the three industry segments.

Because Pepsi is such a large manufacturer and distributor, they spend millions of dollars each year on salaries trying to keep track of orders, payments, and receipts for each of their three lines of business.

Todd Rovelstad, a manager in Financial Services at Pepsi's Phoenix plant, has discovered a way to reduce the time required to log orders, payments, and receipts. His idea is simple, yet innovative. Todd uses bar codes to sort paperwork.

Just as bar codes are used in a grocery store to identify each item and its price, Todd can use bar codes to identify where orders are sent to and from, the product that is being referred to, and the amount of the product to be bought, sold, or shipped.

This idea has several positive attributes. First, the Pepsi employees will be able to do their logging up to four times faster than they are able to under the current system. Today, receipts for payment are left stacked until a processor can get to them. This also allows employees to concentrate more on other ways in which the company can save money. Second, the

accuracy rate under the bar code system is 99.99%. While keying in codes is relatively accurate also, Pepsi has been experiencing problems because their workers are putting in too much over time and fatigue has increased the error rate.

Todd did not stop at bar codes for processing accounts receivables. He also saw the

usefulness of bar codes for mail. The post office now sorts mail electronically by bar codes for those letters that have them. Pepsi can use coded envelopes to speed up the return time when its customers pay for shipments. These funds can then be deposited into PepsiCo's account much sooner than they currently can be. Even though interest is earned on only one to two additional days, when considering the size of Pepsi, this will translates into big savings.

Pepsi wants to determine just how much these new programs will save the company. To

determine the amount, they have disclosed the following information concerning the operating cycle. Pepsi's average payment period is 29 days. Their average age of inventory is 42 days.

http://wps.aw.com/aw_gitman_pmf_10/0,6047,347213-,00.html (1 of 2) [11/27/2002 12:20:42 AM]

aw_gitman_pmf_10|Case Studies in Finance|Case 30: Pepsi

And the average collection period is 39 days.

Pepsi feels that with the new system in place, it can speed up the average collection period by 12 days. This figure reflects the fact that the employees will not only receive the payments earlier, but more importantly, they will be able to start processing the receipts much sooner than they are currently able to do. The average age of the inventory and average payment period are assumed to remain unchanged.

Pepsi currently spends $28,000,000 per year on its operating cycle investments. Funds used for financing the operating cycle cost 12% per annum. Todd feels the additional annual cost of $50,000 will be sufficient to pay for the added hardware necessary to use bar codes. This expense does not take into consideration the additional salary expenses that will be avoided due to a reduction in overtime costs.

Questions

1.

Calculate Pepsi's current operating cycle, cash conversion cycle, and need for short-term financing of the cash conversion cycle (i.e. What is Pepsi's negotiated financing need?).

2.

Calculate the operating cycle, cash conversion cycle, and need for short-term financing of the cash conversion cycle if Pepsi decides to implement the use of bar codes.

3.

If the bar codes are used in the future, what will be the annual savings stemming specifically from the cash conversion cycle financing reduction?

4.

Considering the annual costs associated with implementing the bar code system, should Pepsi change their logging systems?

5.

Assume the cost of implementing the bar code system exceeds the savings in

reduction of short-term financing needs. Should Pepsi decide not to change systems?

Discuss.

6.

Define the cash conversion cycle and explain why it is so important. Do you think cash conversion cycles should be different for different industries (HINT - consider a

manufacturer versus a retailer).

7.

What are the three ways to speed up the cash conversion cycle?

aw_gitman_pmf_10|Case Studies in Finance|Case 31: Inn-Room Safe

Home > Case Studies in Finance > Case 31: Inn-Room Safe >

Case Studies in Finance

In document Casebook_FINANCE (Page 61-65)