HOLA-KOLA - The Capital Budgeting Decision Case Solution
Problem statement
The new product seemed to be successful as per the market study. The company required financial resources to launch the product. However, the analysis has to be made in order to evaluate its profitability and capability of generating return. The growth should not be in terms of production expansion but in terms of return and value addition. Net present value and internal rate of return analysis will reveal the product potential.
It has excess of cash and the company has brand recognition in the local middle class and lower income customer segment. The economic and environmental conditions are also in favor of the company. The financial health allows the company to make huge investment in a new product. Therefore, the company has potential to go for its expansion project.
Industry Overview
The industry has been dominated by some multinational companies, while the company has grew at a great pace, aided by the economic crisis. The company products have low tagged price. It is preferred over other costly brands. The current issue the obesity and other diseases caused by the sugar-carbonated drinks. Therefore, the company is considering launching a calorie free carbonated drink. The drink will be offered at low prices, while the current industry and market study confirm its feasibility.
Risks and benefits of investment
Several risks and benefits are associated with the investment. First of all, there is a risk of failure of the product. The middle and specially lower class of population does not care about obesity or any other health hazards and thus, the zero calorie carbonated drink might not get enough popularity among them. There is a risk of product failure. The company can use its cash surplus to invest some at other options to generate return; the annex location can be rented out to earn some rentals. All opportunities will also be lost.
Besides this, market study confirms product feasibility, and it is a perfect time to launch a new product. The new product will bring more revenues to the company and will increase its product portfolio. The company can attract potential health conscious customers as well.
Relevant Cash Flows and key factors
The project evaluation has been made using the relevant cash flows. The manufacturing cost is the relevant cash flow, which is specific to the project. This includes the raw material cost, Labor cost, Energy cost, and depreciation cost. All these costs will be incurred for producing the new product. Besides this, the incremental General, Selling, and Admin cost is also a relevant cost. Overhead cost that will be based on the sales as per management policy will also be a relevant cash flow.
The market study cost is irrelevant. This cost has been incurred and paid already; the decision on the project will have no effect on that incurred cost. This is classified as sunk cost. Annex rental is considered as opportunity cost and has been included in the projection. Since this source of cash inflow will be lost if the project is taken; Cannibalization cost, which is the loss of revenue from other products, is also a relevant cost for this project. The company will lose its part of sales because of this project..........................
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