Hola Kola The Capital Budgeting Decision Case Solution

1. What are the relevant cash flows? In the capital budgeting analysis of this low-price, low-calorie soda project, how shall we treat:

The initial investment of machinery, materials, and labor, as well as overhead charges, capital expenditures, working capital, and SG&A expenses, are all essential cash flows for this investment project.

a. The consultant’s market study cost?

Pedro Cortez hired a consultant to conduct a market study of the current low-calorie carbonated drink market to evaluate the effectiveness of the new investment project. The market study cost the company 5 million pesos which were shortly paid. This cost will be considered as a fixed incurred by the company for the evaluation of the project beforehand and will not be used in any financial indicators afterward or in the capital budgeting analysis.

b. The potential rental value of the unoccupied annex?

The unoccupied annex has been vacant since the death of Roberto Ortega. There was no revenue coming from it or expenses incurring from its maintenance. The unoccupied annex will essentially be used for the storing of the new investment’s finished products. In the capital budgeting analysis, we will compare the potential rental income coming from the annex for the next 5 years discounted to present value and the holding costs for the storing of the finished products in an alternative place for 5 years discounted to present value and analyze both. However, it should be treated as an opportunity cost with negative cash flow because essentially it is an opportunity lost.

c. The interest charges?

Bebida Sol's current financial status is fairly good, with potential for development in the next years, allowing them to amass further capital and generate significant cash-in-hand value. The loan is being acquired to finance the project at a 16% interest rate over 5 years. We will compare the expected cash inflows from the investment at present value and the total cash outflows for the loan over the next 5 years discounted at the company’s WACC to see if the liquidity of the company is suitable for it to take the loan at the stipulated interest rate. However, because the company's WACC already includes the cost of equity and debt, it is unnecessary to add them again.

d. Working capital?

The working capital was needed for smooth production and sales for the new product line. Raw materials will be retained at a level that corresponds to one month's worth of manufacturing. Furthermore, to attract the grocery stores to carry the new product line, the proposed collection period is 45 days, but the accounts payable period is still 36 days. In the capital budgeting analysis, potential accounts receivable and bad debt expense accounts will be accounted for, compared with the current cash-on-hand, and expected cash from sales to gauge for any risk of liquidity issues and compared with standard policies of the collection period. Moreover, the cost of working capital should be included in the capital budgeting analysis and the incremental value would be subtracted.

2. Should we consider the erosion of the existing product—the regular sodas—in the analysis? Why or why not?