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SEITO

Case Study

PROJECT FOR PERFORMANCE, MEASUREMENT & CONTROL SYSTEMS

ESADE MSC IN FINANCE 2018/19

GEORG SCHNEIDER
PAUL HOFER
JEKATERINA SMERTJEVA
ROGER FILLET BATISTA
Prepare the financial statements and calculate the ROIs for the option B. For
simplification purposes, consider that the investment is made at the beginning of the
year and it is paid cash using equity funding. Table III shows the financial data of option
A and can be used as a guidance.

The financial statements and ROI calculation of Option B can be found in the third tab
or our excel file. The option was evaluated under the assumption that both divisions
require stable cash accounts for operations and the 600,000€ investment needs to be
100% finance through equity and not the depletion of cash reserves.

Analyze the two options by Pau; identify advantages and disadvantages of each; and
decide which one you think is a better option for Seito

In our opinion, Pau proposes two very ambitious scenarios where he would have to
perform exceptionally well in order to reach his sales targets. Since the company did
not manage to sell units to its full capacity of 50,000 in 2017, the target of 70,000 units
in 2018 is slightly farfetched. With the predictions given by Pau, Option A gives a ROI
of 21.5% and Option B gives a ROI of 22.8%. However, if the sales volume only
reaches 60,000 units in 2018 – a sales increase of 33% compared to 2017 - Option A
gives 17.9% while Option B would only provide a ROI of 17.2%. Therefore, we would
recommend Seito to implement Option A for the year 2018 and see whether Pau´s
ambitious sales targets can be met.
Option A, producing 50,000 units in Seito and buying the additional units required on
the market, offers a higher production flexibility, is less sensitive to a lower sales
output, is likely to be implemented faster than the new investment and it requires
slightly lower working capital than Option B. Furthermore, both siblings can reach a
satisfactory ROI in this scenario.
On the other hand, Seito would have to give up part of its control over the production
process and product quality when buying additional products on the free market. It
might as well have to share its proprietary furniture designs and put its intellectual
property at risk, while forgoing some profits for the company as the production costs

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per unit are lower internally than the 24€/unit on the market. Also, the different prices
for the marketing unit when buying internally or externally make this option sub-optimal.
Option B offers a higher total ROI for the company with full control over production,
quality and intellectual property, while not exposing Seito to additional supplier and
delivery risk from its competitors. The option might also be an attractive way to grow
the business organically and increase the pie that has to be shared by the two
successors and their families, which did only have to support one owner family before.
The 24€/unit transfer price is also fair in this scenario as it proposes an arm’s length
deal between the two divisions at an objective market price.
However, option B also requires a high upfront investment from the owners in order to
increase capacity. This would in turn reduce Seito´s flexibility to react to a lower
demand, which is especially important keeping in mind that the potential sales of
70,000 are not proven yet. This option would also require a slightly higher working
capital on top of the expansion investment and require substantial management
attention until the new machinery is setup and new personnel is hired and trained.
Additionally, this option would substantially reduce Laia´s ROI as she has to take on
the additional investment while Pau´s risk would substantially increase as he has to
buy the full capacity produced even when he is not able to increase the sales by 25,000
units.
To summarize, we recommend Tomeu and Sandra to revise the sales predictions
made by Pau and rote for Option A, buying additionally required units from the market
at first. Once Pau has proven to be able to consistently sell 70,000 units annually an
expansion of the firm´s capacity might be an interesting opportunity, but until then it is
a project too risky to undertake.

Propose changes in the transfer pricing policy in order to overcome the problems
identified in part 2.

In order to obtain a transfer pricing policy that is suitable to overcome the problems
identified and discussed above, we propose a linear decrease of the current price of
€26 to €24, or any other current market price, over the following 4 years. The
advantages of this change are twofold.
First, it provides the manufacturing division with the right incentive to change its cost
structure and allocation of resources, as we assume that there are currently some

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inefficiencies since the division needs the higher than market transfer prices to reach
a satisfactory ROI. Although the ROI is currently set to be 19% in the first year, which
is above the required level to obtain a bonus, improvements are required in the
following years to maintain this target. By lowering the internal price over a longer
period instead of over one year, achieving the ROI target should be possible in the
future as well, as the cost reductions and efficiency gains don’t have to materialize
immediately.
Consequently, by slowly switching the internal price to the market price, we create an
arm’s length deal situation, in which manufacturing department is responsible for being
at least as efficient as the external market.
Second, although the ROI of the marketing division is higher than the ROI of the
manufacturing division, with the gap widening over the following years due to the
decrease in the transfer price, it is also a lot more sensitive to changes in the demand.
If the demand decreases exemplary to 60,000 in Option A, the ROI decreases to
14,9%, which is significantly below the target of 18% to obtain the bonus payment.
Summing up, as the overall performance of the company is strongly driven by the
capability of the marketing division to sell the product, we propose a solution that
mirrors the success of the division to the bonus payments. With the slow decrease of
the inter-company price we obtain a solution the requires the manufacturing division to
increase their efficiency and find solutions that allow the company to produce its goods
at market price, while simultaneously allowing for continuous bonus payments.

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