Hola-Kola

FMV/Sept-Oct 2021

Section: E05

Group number: G04

Name of participants:

1. David LIN
2. Monica MELENDEZ FLORES
3. Suvinay SETH
4. Preona SIHOTA
5. Anye TAMAMBANG

Grade:

Comments:
Approach

In order to conduct a risk assessment of launching Hola-Kola in the Mexican market, we are
evaluating the NPV* and FCFF* of the following scenarios:

1. Base Case: No annual growth in cost of product, operating expenses, or price

2. Conservative Case: Labour costs, energy costs, and material costs likely to increase
by 5% per year. It might be difficult to offset increased costs in this scenario.
3. Optimistic Case: Labour costs, energy costs, and material costs likely to increase by
5% per year. Price also can be increased by 5%, however, the volume would
decrease by 2%.

With the above three scenarios in mind, the following steps were undertaken to compute
NPV and FCFF:

1. Created Income Statements with associated COGS, Operating Expenses, and

Revenue
2. Computed EBIT and NOPAT
3. Computed NWC (Net Working Capital) from DIO, DSO, and DPO
4. Computed FCFF (Free Cash Flow to the Firm) across years
5. Computed NPV and IRR for each scenario

The following assumptions were made:

1. Depreciation of new current assets follow a straight-line depreciation

2. The money spent on the study was considered as sunk cost as it cannot be recovered
and hence should not influence future investment decisions
3. Days of the year have been assumed to be 365
4. The analysis is independent of marketing and advertising expenses
5. The unutilised annex has been considered as an opportunity cost while analysing
FCFF to consider the impact on the cash flow
6. The interest rates are an important consideration in analysis of whether the project
will be viable. If the rate of return of the project is lesser than the market interest
rate (or the rate of return for an alternate cash investment), the project is not viable
and should not be undertaken
7. We have also assumed as mentioned in the cash of the potential cannibalisation of
the existing product line due to launch of Hola-Kola. This has been considered while
calculating FCFF
8. We have assumed that the accounting overhead charges of 1% (of revenue) are
incremental in nature

We will now be explaining each scenario based on our financial analysis with the given data.

Base Case

Income Statement            
In k Peso Y0 Y1 Y2 Y3 Y4 Y5
Revenue   36 000 36 000 36 000 36 000 36 000
    ASP (in Peso)   5 5 5 5 5
    Q (in k Liter)   7 200 7 200 7 200 7 200 7 200
Cost of Goods Sold   (24 920) (24 920) (24 920) (24 920) (24 920)
  Material Cost   12 960 12 960 12 960 12 960 12 960
    ASC (in Peso)   1,8 1,8 1,8 1,8 1,8
    Q (in k Liter)   7 200 7 200 7 200 7 200 7 200
  Labor Cost   2 160 2 160 2 160 2 160 2 160
  Energy Cost   600 600 600 600 600
  Depreciation Expense   9 200 9 200 9 200 9 200 9 200
Gross Margin   11 080 11 080 11 080 11 080 11 080
Gross Margin (%)   29% 29% 29% 29% 29%
Operating Expense   660 660 660 660 660
  Accounting Exp.   360 360 360 360 360
  Other SG&A   300 300 300 300 300
Operating Profit Before Tax (EBIT) 10 420 10 420 10 420 10 420 10 420
EBIT Margin   28,9% 28,9% 28,9% 28,9% 28,9%
Tax Expense   3 126 3 126 3 126 3 126 3 126
NOPAT: EBIT*(1-tax)   7 294 7 294 7 294 7 294 7 294
                 
Net Working Capital
(NWC)            
In k Peso Y0 Y1 Y2 Y3 Y4 Y5
(+) Accounts Receivable   4 438 4 438 4 438 4 438 4 438
(+) Inventory   1 065 1 065 1 065 1 065 1 065
(-) Accounts Payable   1 278 1 278 1 278 1 278 1 278
Net Working Capital   4 225 4 225 4 225 4 225 4 225
                 

Free Cash Flow to the Firm (FCFF)          

In k Peso Y0 Y1 Y2 Y3 Y4 Y5
NOPAT 0 7 294 7 294 7 294 7 294 7 294
Add: Depreciation
Expense 0 9 200 9 200 9 200 9 200 9 200
Deduct: Cannibalisation 0 (800,0) (800) (800) (800) (800)
Deduct: Opportunity Cost 0 (60) (60) (60) (60) (60)
Deduct: CAPEX (50 000) 0 0 0 0 0
Deduct: Changes in
NWC n/a (4 225) 0 0 0 0
Econ. Residual Value n/a n/a n/a n/a n/a 4 000
Invested NWC n/a n/a n/a n/a n/a 4 225
FCFF (50 000) 11 409 15 634 15 634 15 634 23 859
Year Y0 Y1 Y2 Y3 Y4 Y5
                 
Net Present Value (1 340)        
Internal Rate of Return 17,1%          
As can be seen in the tables and charts above, the NPV for this investment is negative and
the rate of return (17,1%) is lesser than the market rate of interest (18,2%). Hence, this
project should not be undertaken due to the high associated risk.

Conservative Case

Labour costs, energy costs, and material costs likely to increase by 5% per year. It might be
difficult to offset increased costs in this scenario.

Income Statement            
In k Peso Y0 Y1 Y2 Y3 Y4 Y5
Revenue   36 000 36 000 36 000 36 000 36 000
    ASP (in Peso)   5 5 5 5 5
    Q (in k Liter)   7 200 7 200 7 200 7 200 7 200
Cost of Goods Sold   (24 920) (25 706) (26 531) (27 398) (28 308)
  Material Cost   12 960 13 608 14 288 15 003 15 753
    ASC (in Peso)   2 2 2 2 2
    Q (in k Liter)   7 200 7 200 7 200 7 200 7 200
  Labor Cost   2 160 2 268 2 381 2 500 2 625
  Energy Cost   600 630 662 695 729
  Depreciation Expense   9 200 9 200 9 200 9 200 9 200
Gross Margin   11 080 10 294 9 469 8 602 7 692
Operating Expense   660 660 660 660 660
  Accounting Exp.   360 360 360 360 360
  Other SG&A   300 300 300 300 300
Operating Profit Before
Tax   10 420 9 634 8 809 7 942 7 032
Tax Expense   3 126 2 890 2 643 2 383 2 110
NOPAT   7 294 6 744 6 166 5 559 4 923
                 
Net Working Capital
(NWC)            
In k Peso Y0 Y1 Y2 Y3 Y4 Y5
(+) Accounts Receivable   4 438,4 4 438,4 4 438,4 4 438,4 4 438,4
(+) Inventory   1 065,2 1 118,5 1 174,4 1 233,1 1 294,8
(-) Accounts Payable   1 278,2 1 342,2 1 409,3 1 479,7 1 553,7
Net Working Capital   4 225,3 4 214,7 4 203,5 4 191,7 4 179,4
                 
Free Cash Flow to the Firm (FCFF)          
In k Peso Y0 Y1 Y2 Y3 Y4 Y5
NOPAT 0 7 294 6 744 6 166 5 559 4 923
Depreciation Expense 0 9 200 9 200 9 200 9 200 9 200
Cannibalisation 0 (800) (800) (800) (800) (800)
 Opportunity Cost 0 (60) (60) (60) (60) (60)
CAPEX (50 000) 0 0 0 0 0
Changes in NWC n/a (4 225) 11 11 12 12
Econ. Residual Value n/a n/a n/a n/a n/a 4 000
Invested NWC n/a n/a n/a n/a n/a 4 179
FCFF (50 000) 11 409 15 094 14 517 13 911 21 454
                 
Net Present Value (3 661)          
Internal Rate of Return 14,6%          

As can be seen in the tables and charts above, the NPV for this investment is negative and
the rate of return (14,6%) is lesser than the market rate of interest (18,2%). Hence, this
project should not be undertaken due to the high associated risk. Moreover, the higher
costs associated with no increase in prices makes this project extremely unviable.

Optimistic Case:

Labour costs, energy costs, and material costs likely to increase by 5% per year. Price also
can be increased by 5%, however, the volume would decrease by 2%.

Income Statement            
In k Peso Y0 Y1 Y2 Y3 Y4 Y5
Revenue   36 000 37 044 38 118 39 224 40 361
    ASP (in Peso)   5 5 6 6 6
    Q (in k Liter)   7 200 7 056 6 915 6 777 6 641
Cost of Goods Sold   24 920 25 434 25 965 26 516 27 085
  Material Cost   12 960 13 336 13 723 14 121 14 530
    ASC (in Peso)   2 2 2 2 2
    Q (in k Liter)   7 200 7 056 6 915 6 777 6 641
  Labor Cost   2 160 2 268 2 381 2 500 2 625
  Energy Cost   600 630 662 695 729
  Depreciation Expense   9 200 9 200 9 200 9 200 9 200
Gross Margin   11 080 11 610 12 153 12 708 13 276
Operating Expense   660 670 681 692 704
  Accounting Exp.   360 370 381 392 404
  Other SG&A   300 300 300 300 300
Operating Profit Before
Tax   10 420 10 940 11 472 12 016 12 573
Tax Expense   3 126 3 282 3 441 3 605 3 772
NOPAT   7 294 7 658 8 030 8 411 8 801
                 
Net Working Capital
(NWC)            
In k Peso Y0 Y1 Y2 Y3 Y4 Y5
(+) Accounts Receivable   4 438,4 4 567,1 4 699,5 4 835,8 4 976,0
(+) Inventory   1 065,2 1 096,1 1 127,9 1 160,6 1 194,2
(-) Accounts Payable   1 278,2 1 315,3 1 353,5 1 392,7 1 433,1
Net Working Capital   4 225,3 4 347,8 4 473,9 4 603,7 4 737,2
                 
Free Cash Flow to the Firm (FCFF)          
In k Peso Y0 Y1 Y2 Y3 Y4 Y5
NOPAT 0 7 294 7 658 8 030 8 411 8 801
Depreciation Expense 0 9 200 9 200 9 200 9 200 9 200
Cannibalisation 0 (800) (800) (800) (800) (800)
Opportunity Cost 0 (60) (60) (60) (60) (60)
CAPEX (50 000) 0 0 0 0 0
Changes in NWC n/a (4 225) (123) (126) (130) (134)
Econ. Residual Value n/a n/a n/a n/a n/a 4 000
Invested NWC n/a n/a n/a n/a n/a 4 737
FCFF (50 000) 11 409 15 875 16 244 16 621 25 745
                 
Net Present Value 524,9          
IRR 18,6%          
In this scenario, the rate of return is higher than the market rate of interest, indicating
chances of success and profit by introducing this product line. However, this rate is only
marginally better and still involves risk as the price increase is a bold and uncertain
assumption for Mexico. Moreover, Bebido Sol has been successful owing to the low-cost it
offers to most customers, who might now shift to the bigger players given lack of incentive
to stick to the product.

Peripheral Concerns

Apart from the poor NPV and rate of returns observed above, other peripheral concerns
that might impact cash flows and launch of Hola-Kola are unaccounted expenses such as
Marketing and Advertising expenses. Moreover, expenses relating to distribution will also
further inflate the cost of the product resulting in an extremely risky business model.

Recommendations

Based on the above financial analysis, Bebido Sol should not invest in the new product line –
Hola Kola for the following reasons:

1. Rate of return in normal and conservative scenario is less than the market rate of
return
2. NPV of the two scenarios are negative
3. Other overhead expenses such as logistics, channel, and awareness costs have not
been accounted for and will further raise the risk of the project

In the short-term, Bebida Sol should instead lease the vacant annex to start earning leasing
income, or consider expanding the manufacturing of existing products.

In the longer-term, Bebida Sol needs to start considering alternatives to high sugar sodas in
a more economic way. Possibilities of reducing sugar content in existing product can also be
considered. Instead of investing in the project, an investment can be made in R&D to come
up with better and cheaper alternatives.

Moreover, they should also observe how competitors are entering into the low-sugar soda
space, and whether they are targeting customers currently being served by Bebido. In such
a scenario, an opportunity cost from a customer acquisition perspective must also be
considered in the financial analysis.