Question

Sangria Topochico - The Capital Budgeting Decision In December 2012, María Guadalupe, the owner of Sidral Mundet Sol, had just finished reading a report done by his general manager, Francisco Javier, about the possible investment in a new product line, Sangria Topochico. The idea of Sangria Topochico came about three months earlier when María attended a seminar on youth obesity organized by a local high school that his two children attended. Even though he had often heard of the rising obesity problem in Mexico, María was still very disturbed by the statistics indicating how the obesity rate in Mexico had tripled since 1980, and that 69.5% of the people 15 years and older were either obese or overweight. Even more shocking to María, based on this statistic, Mexico now had the highest overweight rate in the world, surpassing the United States. After the seminar, María discussed the idea of Sangria Topochico, a low-price, zero-calorie carbonated soft drink, with Francisco Javier, Francisco was excited about the idea, and liked the opportunity to launch something new, especially given that the company had not introduced a new product in the last five years. However, Francisco thought a market study should be done to gauge the potential demand before the firm undertook the investment. Company Background Sidral Mundet Sol is a small, privately owned carbonated soft drink company based in Puebla, Mexico. A retired executive from a popular fast-food restaurant chain, Juan Manuel, founded it in 1998. During his career as a restaurant executive, Juano learned that Mexicans, regardless of social status, loved their soda pop. Many would drink soda to quench their thirst on a regular basis, due to the lack of hygienic, drinkable water. With the influx of international brands f soda pop, Mexico now had the highest consumption of carbonated soft drinks per capita in the world. The average per capita consumption was 40% higher than the United States, at 163 liters (43 gallons) per year, while the United States consumed 118 liters (31 gallons), according to statistics presented by the international organization Oxfam and the Mexican NGO Consumer's Power. Due to the high obesity problem, health and consumer groups in Mexico had demanded that the government impose a 20% tax on soft drinks, claiming that it would not only reduce consumption, but the tax revenue could also be used to fight health problems that soft drinks generated.

Answer 1

1. The investment environment was such that the company had not done introduced a product line in the last 5 years and launching a new line in the zero-calory seemed like a good idea. Because if we go by the fact the obese had tripled in Mexico and had the highest overweight rate in the world.

Talking about the Soda, it is known that the Mexicans loved their 'Soda Pop' and would drink it regularly due to lack of hygienic water. And the high per capita consumption (163l) resulted in obesity problems. In this category Coca-Cola, Pepsi-Cola, Dr. Pepper Snapple and Grupo Penafiel were the market leaders with 90% share and Coca-Cola being more dominant than the others. The revenues at the rate of 6.3% and consumption volumes grew at 4.5% between 2007-11. Though there was a dominant share of these players they commanded high prices and there was a gap in which the poorer people could be targeted with lower-priced soda.

2. The relevant cash flows in evaluating the project are : (only incremental cash flows) in pesos

• Sales - 7,200,000 litres per year (600,000 * 12) @ 5 = 36,000,000 per year
• Market Study - (5,000,000)
• Capex - (50,000,000)
• Depreciation - (9,200,000) per year
• Resale Value - 4,000,000 at the end of 5th year

Raw material - (7,200,000) * 1.8 = 12,960,000 per year

labour cost - (180,000 * 12) = 2,160,000 per year

Energy cost = (50,000 * 12) = 600,000 per year

Administrative and General expenses = 300,000 per year

Accounting = (1% * 3,600,000) = 360,000 per year

Erosion = 800,000 per year

3. Erosion of existing product should be taken into consideration as the incremental cash flows to the firm decreases by that amount. Had that project not been undertaken by the company the firm would have earned the amount bu now it would have to forgo that amount and hence should be taken into consideration.

4.

2013 2014 2015 2016 2017 Revenue 36000000 36000000 36000000 36000000 36000000 less: production expenses Raw Material Labour Energy Depreciatiomn Production Expenses - sum(D9:012) 12960000 12960000 12960000 12960000 2160000 2160000 2160000 2160000 600000 600000 600000 600000 9200000 9200000 9200000 9200000 24920000 24920000 24920000 24920000 12960000 2160000 600000 9200000 24920000 less : Operarting Expenses Administrative and General expenses Accounting (1% ogf Sales) Erosion Operating Expenses - sum(D16:D18) 300000 360000 800000 1460000 300000 360000 800000 1460000 300000 360000 800000 1460000 300000 360000 800000 1460000 300000 360000 800000 1460000 Operating profit (D6-D13-D19) 9620000 9620000 9620000 9620000 9620000 Working Capital Raw Material invetory (600,000*1.8) Receivables (36000000/365)*45 Payables (12960000/365)*36 Net working capital - D25+D26-D27 1080000 4438356 1278247 4240110 1080000 1080000 1080000 1080000 4438356 4438356.2 4438356.2 4438356.2 1278247 1278246.6 1278246.6 1278246.6 4240110 4240109.6 4240109.6 4240109.6 Estimation of Net Cash Flows PBIT Tax PBIT(1-t) Add: Depreciation Operating profit D35+36 Less: Change in net working capital Less: Capex Less: Market Study Add: Resale Net cash flow 9620000 9620000 9620000 9620000 9620000 30% 30% 30% 30% 30% 6734000 6734000 6734000 6734000 6734000 15934000 15934000 15934000 15934000 15934000 22668000 22668000 22668000 22668000 22668000 4240110 0 -5,00,00,000 -50,00,000 4000000 -55000000 26908110 22668000 22668000 22668000 26668000