Savola Case

Topics: Corporate finance, Net present value, Cash flow Pages: 13 (3845 words) Published: November 28, 2014
A09-05-0018

Eskandar Tooma
Aliaa I. Bassiouny

Valuation of an Increased Capacity
Project Using Real Option Analysis:
The Case of Savola Sime Egypt
“Our profits almost doubled last financial year; however, I don’t think we can expect the same increase this year,” said Karim Reda, production manager for Savola Sime Egypt, in September 1997. “We simply don’t have the capacity to produce more.” He was speaking to Mohamed Sallam, CFO of Savola. Over the past month, Sallam’s office had witnessed extensive activity, with the finance department preparing the pro forma financial statements for the following year. However, Sallam had more on his mind. Mainly, how could Savola Sime increase its sales and profits, if it could not increase production. Mr. Reda stated that the factories were operating at maximum capacity. He proposed that the company seriously consider expanding the current production by increasing capacity. Sallam very energetically said he would be on top of the matter and that he would study the proposed suggestion. The young CFO knew that this would require a careful financial assessment of the proposed capacity increase. From previous experience in the industry, Sallam knew that a capacity-increasing project at Savola would cost millions of dollars. A rough estimate for such projects is that they usually cost around US $20 million, a huge investment for a company with around US $100 million in revenues. This proposed project would require a rigorous financial assessment, since any flaw could generate a stream of losses. So in order for Sallam to ensure objectivity in taking on such a large capital-intensive project, he formed two separate teams of the top financial analysts in the company. Sallam assigned one of Savola’s senior financial experts to lead the first team, and chose a junior financial analyst, a rising star in the finance department, to head the second team. Each team would then individually embark on their own analysis of the project’s feasibility. Both teams were given a one-month deadline.

History and Background of Savola Egypt
Savola Sime Egypt (SSE) was established in 1992 as a subsidiary of Savola Edible Oils (SEO) Saudi Arabia,1 with a capital of US $23 million. This invested capital was used to build two plants in Egypt for the production of edible oils, initially producing close to 112,800 tons of edible oil per year. The commercial operations of the Egyptian company started in late 1994 with the production of various ghee and oil products. The core activities of Savola Egypt’s value chain are summarized in the following steps (Exhibit 1):

1

Savola Web site is www.savola.com.

Copyright © 2005 Thunderbird, The Garvin School of International Management. All rights reserved. This case was prepared by Eskandar Tooma and Aliaa I. Bassiouny (MBA), American University in Cairo, for the purpose of classroom discussion only, and not to indicate either effective or ineffective management.

1. Importing of edible oils from various oil producers.
2. Refining and processing the oil using specialized capital-intensive machinery imported from the United States. These machines can be adjusted to demand and have the flexibility of switching from the production between various types of oils and ghee products, thus allowing the flexibility of producing products that have highest demand on them.

3. Packaging, distribution, and marketing of edible oil products. Savola had several brand names for its edible oil product range, with product as well as target market variety. Exhibits 2 and 3 show some of Savola’s brands.

Edible Oil Industry in Egypt
The Egyptian edible oil and ghee market can be categorized into three main segments: 1. Animal ghee (the Middle Eastern version of butter)2
2. Shortening (vegetable based made out of palm oil)3
3. Consumer edible oils (mainly sunflower oil)
The size of the Egyptian edible oil industry in 1997 is summarized in Exhibit 4. Consumer edible...
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