Hola Kola Case Study

1. What are the relevant cash flows? In the capital budgeting analysis of this low-price, low-calorie soda project, how should we treat:

The relevant cash flows are:

1. The cash inflows and outflows that occur in the future, are incremental and after-tax.
2. Those that are specific to the Hola Kola investment
3. Used for Capital investment appraisal purposes

The relevant cash flows for Hola-Kola project are:

1. Expected revenue from the project
2. Interest charges
3. Potential value of the annex that is unoccupied
4. Working capital
5. adjustments for non-cash charges such as depreciation          

1.a: How shall we treat the consultant’s market study cost?

The consultants cost of market study constitutes the two month period prior to the start of investment project. Although the study cost was necessary and relevant for feasibility analysis and cost value proposition, however, it won’t be considered while making the investment decision because:

1. It has occurred in the past and the study has already been completed
2. Outflow of cash has already taken place
3. The acceptance and rejection of project will not reverse the cost

1.b:  How shall we treat the potential rental value of the unoccupied annex?

The potential rental value of the unoccupied annex will be considered as a relevant cost while making the investment decision because of the following factors:

1. The unoccupied annex was built years ago by Antonio’s father when he planned to venture into mineral water business
2. The annex has been vacant ever since it was built as Antonio’s father died before he could execute his plan
3. Antonio recently received an offer to lease out the space for 60,000 pesos a year. Thus the opportunity cost of not being able to let the annex rented out and earn the rental income becomes a relevant cost for investment decision

1.c. How shall we treat the The interest charges?

There is a 16% interest charge on loan per annum and the WACC is 18.2% for this project. The WACC includes the cost of debt and cost of equity, hence it is unncessary to include them again.

1.d. How shall we treat the Working capital?

The cash inflow and outflow must be incremental in order to be relevant to the investment decision. The incremental working capital will be deducted, hence they should be included in the evaluation.