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HOLA-KOLA

THE CAPITAL BUDGETING DECISION


Submitted to Prof. Kavitha Ranganathan

FAS AN1

Ankur Inani-18S711
Darshika Goel-18S716
Mayur Phalak-18S726
Prithviraj Padgalwar-18S734
Thomas Kuncheria-18S758
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?

Relevant Cash Flows

Cash flow is the net amount of cash and cash-equivalents being transferred into and out of a business.
It’s very important to identify relevant cash flows in order to use them in the context of investment
decisions. Relevant cash flows state that there must be cash flows that occur in the future and are
incremental in nature. Relevant cash flows are related to a specific investment project. In short for a
cash flow to be relevant, cash inflow and outflow must arise in the future and the cash flows must be
incremental in order to be relevant to a specific investment decision.

Consultant’s market study cost

Consultant’s market study cost of 5 million pesos must be treated as a sunk cost. Therefore, it’s an
irrelevant cost. The market study cost has occurred in the past and the study was already completed.
Also given in the case is Pedro has paid for it shortly after its completion.

The potential rental value of the unoccupied annex

60,000 pesos of potential rental value which was offered for the unoccupied annex must be treated
as an opportunity cost and is a relevant cost. He could have used this rental opportunity instead of
housing his new machines at that place. Therefore, it must be considered for the investment decision.

The interest charges

Weighted Average Cost of Capital (WACC) consists of the cost of equity and cost of debt. 16% of an
interest charge on loan per annum is applicable. The WACC of the project is given as 18.2% which
consists of 20-80 debt and equity structure. Thus, it becomes an irrelevant cost for the investment
decision by adding it again.

Working capital

Working capital must be treated as a relevant cost to the investment decision. The incremental
working capital will be incurring and hence must be included for the evaluation.