Savola Case
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
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