The Jacobs Division 2010
9 Pages Posted: 30 May 2017
This case examines the capital budgeting framework used in a large specialty chemical company. It presents the reader with issues related to using multiple discount rates to examine projects and how compensation policies can impact on managerial actions. A second use of the case is to introduce project-related real options.
Rev. Apr. 12, 2013
THE JACOBS DIVISION 2010
Richard Soderberg, financial analyst for the Jacobs Division of MacFadden Chemical Company, was reviewing several complex issues related to possible investment in a new product for the following year—2011. The product was a specialty coating material that qualified for investment according to company guidelines. But Jacobs Division Manager Mark Reynolds was fearful that it might be too risky. While regarding the project as an attractive opportunity, Soderberg believed that the only practical way to sell the product in the short run would place it in a weak competitive position over the long run. He was also concerned that the estimates used in the probability analysis were little better than educated guesses.
MacFadden Chemical Company was one of the larger chemical firms in the world whose annual sales were in excess of $ 10 billion. Its volume had grown steadily at the rate of 10% per year throughout the 1980s until 1993; sales and earnings had grown more rapidly. Beginning in 1993, the chemical industry began to experience overcapacity, particularly in basic materials, which led to price cutting. Also, for firms to remain competitive, more funds had to be spent in marketing and research. As a consequence of the industry problems, MacFadden achieved only modest growth of 4% in sales in the 1990s and experienced an overall decline in profits. Certain shortages began developing in the economy in 2002, however, and by 2009, sales had risen 60% and profits over 100%, as a result of price increases and near-capacity operations. Most observers believed that the “shortage boom” would be only a short respite from the intensely competitive conditions of the last decade.
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Keywords: capital budgeting budget cost discount rates
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