Case Report: Hola-Kola-the Capital Budgeting Decision

Posted: August 26th, 2021

Case Report: Hola-Kola-the Capital Budgeting Decision

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Case Report: Hola-Kola-the Capital Budgeting Decision

Executive Summary

The investment under analysis is a five-year project that a company wishes to venture into, which manufactures zero-calories drinks. The idea seems to be an excellent investment opportunity due to the increasing demand for low-calorie drinks to counter the high obesity rates in Mexico. It is estimated that the obesity rate had tripled, with over 69.5% of individuals above 15 years being overweight or obese. This makesMexico the highest country with the most overweight and obesity rates. Besides, Mexico offered an excellent investment opportunity for zero-calories drinks as the Mexicans would regularly take the vibrant soda pop with high sugar levels due to lack of alternative, such as hygienic water of zero-calories drinks. Therefore, the high per capita consumption of soda pop has led to overweight issues in the country.

Introduction

The focus of the paper is to analyze the proposed investment by Bebida Sol in production of zero-calories drinks to establish whether it would penetrate the market that is highly dominated by Coca-Cola. Other market players include Pepsi-Cola, Grupo Penafiel, and Dr. Pepper Snapple that control a market share of approximately 90%. The market also provides revenues at a rate of 6.3%, with consumption volumes constantly growing at 4.5% between 2007 and 2011. Zero-calories drink has an opportunity to penetrate the market as thedominant market players demanded high prices for their drinks, thereby disadvantaging the poor. Hence, the zero-calories drink would produce lower-priced soda to target the poor masses. The discussion includes assessment of the current cash flows, sensitivity analysis, benefits as well as risks associated with the project.

Problem Identification and Analysis

Relevant Cash Flows

The relevant cash flows in the case that influence capital planning decisions in assessing the project include revenue and costs of the projects. These are the incremental costs in pesos. The costs involved in the project are energy, material, labor, administrative and selling as well as machine installation, overheads, building lease, and erosion cost. Other cash flows in the investment are machine salvage value, interest amounts, depreciation, and working capital. The following sections present an analysis of the case, highlighting requirements for investment, and performing sensitivity analysis to evaluate the investment viability. The amount is in Mexican pesos (MXN, $);

Sales

Sensitivity analysis

In scenario 1, the NPV of the project is MXN 49,424,374.88. Since it is a positive figure, the project should be implemented (See Excel Workings). In scenario 2, The NPVof the project when energy costs, labor costs, and material costs rise by 5% per annum. The adjusted NPV is MXN (75625.11942), implying the project should be rejected as it has a negative NPV (See excel workings). In scenario 3, the NPV of the project, when energy costs, labor costs, and material costs will rise by 5% per annum, increase prices by 5% per annum, but sales volume decrease by 2% per annum. The adjusted NPV is MXN (114275.9478), implying the project should be rejected as it has a negative NPV (see Excel workings).

Conclusion

Conclusions

The project’s most significant benefit is that it is a zero-calories investment that is currently favored by many individuals as it does not contain sugar additions. This will offer the project a ready market, especially to individuals who are cognizant about their health and body weight. More so, the youth will prefer the drink that is the most significant number of soda pop related to overweight and obesity since they are becoming highly conscious about their identity. On the other hand, the project’s risk is market penetration due to high competition from an already established brand that offers substitutes such as Pepsi-Cola, Grupo Penafiel, Dr. Pepper Snapple, and Coca-Cola. Therefore, this may hinder its success in the project.

Discussions

In the first scenario, the company should implement the investment as it has a positive NPV of MXN 49,424,374.88. However, in scenario 2 and 3, the company should reject the project as it has a negative NPV. In scenario 2, when energy costs, labor costs, and material costs are adjusted by 5% per annum, the project generates a negative NPV of MXN (75,625.11942), implying that the cash outflows of the project will be higher than the benefit realized from the project. Additionally, in scenario 3, when energy costs, labor costs, and material costs will rise by 5% per annum, increase prices by 5% per annum, but sales volume decrease by 2% per annum. The adjusted NPV is MXN (114275.9478), therefore, it implies the project should be rejected as it has a negative NPV.

Recommendations

According to Hayward et al. (2017), the net present value of a project is used in capital budgeting as it is a distinction on the present estimation of cash inflows, cash outflows, and resale or salvage value. NPV discounts the future cash inflows of a project to determine if the project is financially viable to undertake (Abor, 2017). Hence, the decision rule is to accept the investment if it yields a positive NPV and rejects the project if it has negative NPV.

References

Abor, J. Y. (2017). Evaluating Capital Investment Decisions: Capital Budgeting. In Entrepreneurial Finance for MSMEs (pp. 293-320). Palgrave Macmillan, Cham.

Carolyn Crist (2012). Mexico leads the world in soda consumption. Mexico Leads World in         Soda Consumption, World Health Organization Planning To Fight It.

Hayward, M., Caldwell, A., Steen, J., Gow, D., & Liesch, P. (2017). Entrepreneurs’ capital budgeting orientations and innovation outputs: Evidence from Australian biotechnology firms. Long Range Planning, 50(2), 121-133.