Case study - Hola-kola the capital budgeting decision

The Proposal

Reading once again the executive summary of the report, Antonio recalled what his father told him several times during the two years he was working with him: "Don' t grow the company for the sake of growing. Invest only when you are confident there is sufficient demand for a new product, and also when you have the financial resources." As far as financial resources, Antonio felt the timing could not be better. Due to strong sales and profitability in the last few years, Bebida Sol had accumulated a sizable amount of cash. With solid financial performance and steady cash flows, his banker had agreed to extend him a five-year, 16% annual interest term loan to launch Hola-Kola. In the proposal, Pedro Cortez estimated that with 20% of the needed capital borrowed, the 20)80 debt-equity structure would result in an 18.2% weighted average cost of capital for this project.

The bigger question lingering in Antonio' s mind was whether there would be sufficient demand for this new, zero-calorie product line. Even though the demand for low-calorie sodas had increased in Mexico, they seemed to be consumed mainly by the middle-to-upper income segment of the population. The majority of the lower-income people still consumed only the regular, high-sugared carbonated soft drinks. It wasn' t clear whether this was because the low-income group lacked the awareness of the obesity problem, or because there were not too many low-priced, low-calorie soda options available. If it were the former, the outlook for low-price, low-calorie carbonated soft drinks might not be too promising at this time. If it were the latter, it might be the perfect timing for Bebida Sol to introduce Hola-Kola.

Pedro hired a consultant to do a market study right after Antonio discussed the idea of Hola-Kola with him. The consultant estimated that the company could sell a total of 600,000 liters of these zero-calorie carbonates a month, at a projected price of five pesos a liter. This volume of sales was expected for a period of five years at the same price. The market study took about two months to complete and cost the company five million pesos, which Pedro had paid shortly after its completion.

Attachment:- Hola-kola the capital budgeting decision.rar