What are the relevant cash flows?

There are many relevant cash flows for this investment project such as the initial investment of
machines, materials, labour, overhead expenses, capital expenditures, and working capital and SG&A
expenses.

How shall we treat?

Market study cost

The market study cost is a past cost which has been incurred before the appraisal of the project
has been performed; therefore, it is a sunk cost and should not be considered in the investment
appraisal.

Potential rental value of the unoccupied annex

This is the opportunity lost therefore, this should be treated as a negative cash flow as
opportunity cost.

The interest charges

The cost of financing of debt and equity is included in the weighted average cost of capital
therefore; there is no need to include them again.

Working capital

This should be included in the appraisal. Only the incremental working capital would be deducted.

b. Should we consider the erosion of existing product – the regular soda – in the analysis? Why or
why not?

Yes, the erosion of the existing product as a result of the introduction of new zero calorie
carbonates should be considered as the cannibalization cost in the analysis as the sales of this product
are going to erode the sales of the existing products of the company, which is regular soda.
Furthermore, these costs are going to have a significant impact on the earnings of the company
therefore, they should be included in the NPV analysis.

c. Calculate the project’s NPV, IRR, payback period, discounted payback, and profitability index.

The NPV of the project has been calculated to be $ -1.72 million, its IRR is 17%, payback period is
3 years and 5 months approximately, discounted payback period is more than 5 years approximately
which means never and profitability index is almost 1. The calculations are shown in the excel
spreadsheet.

d. Perform sensitivity analyses on sales volume, price, direct labour, materials, and energy costs.
What do you observe?
 The sensitivity analysis has been performed in the excel spreadsheet and it has been observed
from the analysis that the raw material costs, labour costs, sales revenues and other operating expenses
such as the energy costs impact significantly on the NPV of the new product. Furthermore, it is
recommended for the company to increase the selling price of the new product by 0.5 pesos.

e. What are the “benefits” and “risks” of undertaking this project?

Benefits

The benefits of investing in the Hola-Kola product would be increased market share for the
company. The sales of the company would also increase and as a result, the earnings of the company
would also grow. Furthermore, more production space would be created and efficiency would be
introduced in the production processes of the company.

Risks

The risks associated with this product are that it might cause the erosion of the existing products
of the company. The second risk is that there might not be significant demand for this product in the
market despite the findings of the market study. Furthermore, the government might introduce new
regulations regarding soda and the competitors might also lower the prices of their products.

f. Should Bebida Sol undertake the project? Justify

The net present value of this project is lower and its internal rate of return is lower than the
company’s cost of capital, therefore, if the company undertakes this project, then it is going to destroy
the wealth of the shareholders. Furthermore, the project is also sensitive to many key inputs therefore;
Bebida Sol should not undertake this project. On the other hand, Ortega needs to consider the
opportunity that had also been considered by his father, which was to venture into the mineral water
business.