INSTITUTE OF BUSINESS ADMINISTRATION

UNIVERSITY OF DHAKA

M 601: Corporate Finance

Case on

HOLA KOLA: THE CAPITAL BUDGETING DECISION

Submitted to Submitted by
Dr. Md. Rezaul Kabir Group 1
Associate Professor Mashrur Navid (61E – 01)
Institute of Business Administration Nafis Erfan (61E – 02)
University of Dhaka Fariha Haider (61E – 11)
Minhajul Bashir (61E – 16)

Date of Submission: 19 April, 2021

1) What are the relevant cash flows? In the capital budgeting analysis of this low-price,
low-calorie soda project, how shall we treat:
a) the consultant’s market study cost?
b) the potential rental value of the unoccupied annex?
c) the interest charges?
d) working capital?

ANSWER:
Relevant cash flows for a project are those that change as a result of accepting the project.
Relevant cash flows for Hola-Kola project are –
o Revenue generated
o Product costs (raw materials + labor + energy)
o Administrative and selling expenses
o Overhead cost
o Tax
o Opportunity cost of rental of annex
o Salvage value of equipment
o Erosion of other products
o Initial investment
o Working capital

The different costs mentioned should be treated as follow:

a) The consultant’s market study cost: This cost is not relevant, as the market study
cost has already been incurred and paid prior to the project.
b) The potential rental value of the unoccupied annex: It is an opportunity cost,
which has to be forgone if the project is taken. Therefore. it is relevant.
c) The interest charges: It is a relevant cash flow, as the company is obliged to pay the
interests to the debtholders. However, it is implicitly considered in the capital
budgeting while discounting the cash flow by WACC.
d) Working capital: Working capital will be used for the operations of the project. So, it
is a relevant cash flow. It is calculated from accounts receivable, accounts payable
and inventory.

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

ANSWER:
The erosion of existing product will result in a negative cash flow for the company as both
products belong to the same company. It is an opportunity cost for Hola-Kola. Thus the
erosion should be considered.
The erosion can be ignored in the following scenarios:

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 In a scenario where Hola Kola was being produced by a different company than Bebida
Sol, this erosion of Bebida Sol due to production of Hola Kola would not be considered
as negative cash flow for the project of Hola Kola as they do not belong to the same
company.
 In a scenario where the entry barrier in the soda drink market is very low, this erosion can
be ignored. This is because any competitor can start manufacturing sugar drinks, and this
competition may lead to more sale in the sugar drinks market.

3) Calculate the project's NPV, IRR, payback period, discounted payback, and
profitability index.

ANSWER:

4) Perform sensitivity analyses on sales volume, price, direct labor, materials, and
energy cost. What do you observe?

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Scenario 1: Perform a capital budgeting analysis with the information provided in the
case.

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ANSWER:
WITHOUT ADJUSTING DEPRECIATION WITH RESALE VALUE

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WITH ADJUSTING DEPRECIATION WITH RESALE VALUE

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Scenario 2: You have been advised by the consultants that the energy costs, the labor costs, and the material costs are likely to rise by
5% a year, starting in Year 2. The consultants do not think that you can pass the extra cost through. What do you observe?
ANSWER:

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Scenario 3: You have been advised by the consultants that the energy costs, the labor costs, and the material costs are likely to rise by
5% a year, starting in Year 2. The consultants think that you can pass part of the extra cost through. You should be able to increase the
price per unit by 5%, but the volume would decrease by 2%. What do you observe?
ANSWER:

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

ANSWER:
Benefits:
1. Increased market share for Bebida Sol
2. Potential increase in net income
3. Line filling/ Portfolio diversification
Risks:
1. No existing demand in the current market
2. Decreased cash flow
3. Potential erosion/cannibalism of existing products
4. Opportunity cost of leasing the annex forgone for the project

6) Should Bebida Sol undertake this project?

ANSWER:

We judge the feasibility of undertaking a project by the value of NPV or PI. If the NPV is
greater than or equal to 0 or the PI is greater than or equal to 1, then the project is considered
to be feasible. Here, none of the scenarios satisfy these requirements. Hence, we cannot
advise the undertaking of the project in any of the given scenarios.

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