FIN 486 Week 1 Strategic Financial Management and the Case Example

Where Lakeshore Packaging Creates Value and Where It Does Not: Setting the Financial Goal, Mapping Value Drivers and Measuring the Spread Between Return on Capital and Its Cost

[Student Name]

University of Phoenix

FIN/486: Strategic Financial Management

Week 1 Assignment

[Instructor Name]

[Date]

Lakeshore Packaging and all figures are composites written for a model paper; frameworks and research findings come from the sources listed.

Lakeshore Packaging, a composite publicly traded company in Green Bay, Wisconsin, makes molded fiber trays, clamshells, cups and bowls from recycled paper and plant fibers. As states and cities restricted single-use plastics and large restaurant chains set targets for recyclable packaging, its revenue grew from $640 million to $1.1 billion in five years. The stock price followed, to about $45 a share. The new chief financial officer, hired from a larger consumer products company, told the board in her first meeting that rapid growth had hidden a question no one had asked: which parts of the business were actually creating value? Growth is visible in every quarterly report; value creation shows up only when returns are compared with what capital costs. This paper answers her question.

The Objective

Strategic financial management connects a company's competitive strategy with its investment, financing and payout decisions so that the firm creates long-run value. Jensen (2001) argued that firms need a single objective to make tradeoffs coherently and that long-run value maximization, pursued with attention to customers, employees and communities whose support the firm needs, serves that purpose better than a list of stakeholder goals with no way to weigh them. Lakeshore's board adopted that framing: maximize long-run value per share, recognizing that the company's sustainability position depends on customers and regulators.

Why Not Earnings?

Earnings per share grew 14 percent a year, but earnings ignore the capital consumed to produce them. A business that borrows to build plants earning 6 percent while capital costs 8.6 percent reports rising earnings while destroying value. Rappaport (1986) made this the core argument for shareholder value analysis: earnings omit risk, the time value of money and the investment required for growth.

The Value Drivers

The value of the company depends on a small set of drivers: revenue growth, operating margin, the capital needed per dollar of revenue, the tax rate and the cost of capital. Return on invested capital, operating profit after tax divided by invested capital, combines margin and capital efficiency. When it exceeds the cost of capital, growth adds value; when it falls short, growth subtracts value (Koller et al., 2020).

The Company as a Whole

Lakeshore's operating income last year was $121 million, an 11 percent margin. After its 24 percent tax rate, operating profit after tax was about $92 million. Invested capital, plants, equipment and working capital, minus excess cash, was about $820 million. Return on invested capital was about 11.2 percent. Against a blended cost of capital near 8.6 percent, estimated from its beta, its bond yields and its market value weights, the company earns a spread of 2.6 points. Economic profit, the spread times invested capital, was about $21 million.

By Business Line

The company reports three product lines. Food service containers for restaurant chains, about 55 percent of revenue, earn a return on invested capital near 15 percent, well above the cost of capital, thanks to long contracts and high plant utilization. Grocery trays for meat and produce, about 30 percent, earn about 10 percent. Custom molded packaging for consumer electronics and cosmetics, about 15 percent of revenue and the fastest growing line, earns only about 4.5 percent, because each design requires costly molds, orders are small and plants switch between jobs often.

What the Lines Mean

Food service creates most of Lakeshore's value: about $26 million of economic profit on about $400 million of capital. Grocery adds about $3 million on $230 million. Custom packaging destroys about $8 million a year on about $190 million of capital it ties up in molds, equipment and inventory. The three lines sum to the company's $21 million. The fastest growing line is the one losing value, and its growth was celebrated in the last annual report.

The Strategic Position

Lakeshore's advantage lies in its recycled fiber supply, its plants near customers and its relationships with chains that need assured supply of compliant packaging. Its weaknesses are rising fiber costs, competition from larger paper companies entering molded fiber and the poor economics of custom work. The strategic question is how to deploy capital toward the advantage and away from the drain.

How the Line Got This Way

The custom line's weak return is not a failure of effort. Electronics and cosmetics brands order many small runs of distinct shapes, each needing its own molds, which cost $30,000 to $80,000 and often serve only one product generation. Plants switching between short runs lose hours to changeovers, and inventory piles up for customers who change designs. Sales teams were paid on revenue, so they pursued every order. The economics were invisible because the company reported profit by line but not capital by line. Once capital was assigned, the line's true return became clear, which is why measuring invested capital by line was the chief financial officer's first change.

Market Expectations

At $45 a share and 30 million shares, the equity is worth about $1.35 billion; with $270 million of net debt, enterprise value is about $1.62 billion, roughly 9 times EBITDA (operating earnings before depreciation and amortization) of $176 million. That valuation assumes continued growth at positive spreads, which only food service currently delivers.

Four Decisions Ahead

The diagnosis frames the course's decisions. First, should Lakeshore build a proposed plant in Georgia to serve food service chains in the Southeast? Second, how should it finance that plant and manage fiber price risk? Third, how should it weigh shareholders and other stakeholders as it fixes or exits custom packaging and sets payouts? Fourth, how do these choices combine into a five-year financial strategy?

Conclusion

Lakeshore's growth has hidden a split business: food service creates substantial value, grocery roughly earns its cost and custom packaging destroys value. Measuring return on invested capital against the cost of capital by line, and expressing the gap as economic profit, turns a story of growth into a set of strategic financial decisions.

References

Jensen, M. C. (2001). Value maximization, stakeholder theory, and the corporate objective function. Journal of Applied Corporate Finance, 14(3), 8-21. https://doi.org/10.1111/j.1745-6622.2001.tb00434.x

Koller, T., Goedhart, M., & Wessels, D. (2020). Valuation: Measuring and managing the value of companies (7th ed.). John Wiley & Sons.

Rappaport, A. (1986). Creating shareholder value: The new standard for business performance. Free Press.