Details of this Paper

Peter Franklin is the CEO of Nature Cola company located in Bridgeport

Description

solution


Question

Peter Franklin is the CEO of Nature Cola company located in Bridgeport (an imaginary;country). He is pondering about whether his company should introduce a new cola;drink which has no calories and can be considered as a healthy drink. He has a number;of options and is pondering over which of these options are the best.;Cola Market in Bridgeport;Bridgeport is a small country with a population of about 25 million. It has a mix of both;rich and middle class people. Nature Cola was started by James Franklin, father of;Peter in 1999. Because of the size of the country, multinationals such as Coco Cola and;Pepsi Cola did not consider Bridgeport as a viable market and there was no cola market;in Bridgeport until Nature Cola was formed. In the initial stages, it was difficult to;market the product, but by 2001, the market had picked up. The target market for;Nature Cola was the large middle class and Nature Cola was priced at $1 per bottle. A;bottling plant was commissioned which could produce 50000 litres of Cola every;month. With bottle size of 250 ml, it amounted to 200,000 bottles per month. The;demand for Nature Cola is currently at 200,000 bottles per month which is being met;by the existing bottling plant.;In 2005, Pepsi saw an opportunity to enter the market. However, it could not compete;directly in the market against Nature Cola as the price of Nature Cola was very low.;Pepsi positioned its cola drink as a gourmet drink and started selling the same through;restaurants and hotels as opposed to Nature cola being sold in shops and supermarkets.;In 2011, 3 years back, another company Low C Cola, was started by a local;entrepreneur, Benjamin. Benjamin lacked the financial clout of Pepsi or Nature Cola;and was not experienced in marketing aspects of cola. Though people liked the taste of;Low C Cola, its price was $2 per 250 ml and this company was struggling to market the;cola. It also had a bottling plant that has a capacity of 200,000 bottles per month but;sales have been stagnating at about 50,000 bottles per month.;Introducing a new drink called Zero Cola was mooted by Peter after he visited other;Western countries where he saw companies like Coco Cola and Pepsi Cola had;introduced zero calorie Cola with health benefits. This gave him the idea of introducing;this Zero Cola in Bridgeport. In order to induce the people to form healthy habits, he;studied the obesity rate in Bridgeport and found that it ranked very high in both;overweight category and obesity category. Thus, Peter felt that with proper education;of the population towards healthy habits, he can find a market for Zero Cola.;His research team developed a cola that had zero calorie and used that in test;marketing. A market research team was engaged at a cost of $200,000 to estimate the;possible demand for this Zero Cola. The market research team found that there is likely;to be good demand for the same which encouraged Peter to think carefully about the;introduction.;He formed a team consisting of CFO Joshua, Finance Manager Christian and;Production Manager Rasool to look into the feasibility of introducing this product.;FIN351e Copyright 2014 SIM University;CASE: NATURE COLA July Semester 2014;Page 2 of 17;Joshua, Christian and Rasool worked on the project and formulated the following cost;and sales estimates;Cost;Since the current bottling plant is running at full capacity, introduction of a new drink;would require a new bottling plant. This plant would require a large area as well as a;set of machinery. Currently the company already owns a large warehouse which cannot;be rented out to others. The team felt that this area can be used for locating the new;plant.;The search for machinery showed there are machineries available with different;capacities and different prices. The details of the machinery is shown in Table 1.;The cost includes the cost of machinery as well as installation costs. This machine can;be depreciated using straight line depreciation over a period of 5 years towards zero;salvage value. The resale value of these machines if sold at the end of the year over the;next 5 years is also shown in Table 1.;Table 1 Details of Machinery Available;Capacity (bottles per month);Cost;Resale value at end of year 1;Resale value at end of year 2;Resale value at end of year 3;Resale value at end of year 4;Resale value at end of year 5;Machine 1;200,000;6,000,000;5,000,000;4,000,000;3,000,000;2,000,000;1,000,000;Machine 2;500,000;12,000,000;10,000,000;8,000,000;6,000,000;4,000,000;2,000,000;Machine 3;800,000;20,000,000;16,000,000;12,000,000;9,000,000;6,000,000;4,000,000;Next, the team analysed the possible demand for the new cola. Since this is a new cola;with no calories, they were not sure whether the demand will be high or low. They;contacted the market research team that conducted the original research and formulated;the following demand for the new cola. The cola can be priced at $2.00 per bottle. The;demand estimates for the next 5 years are shown in Table 2.;Table 2 Demand Estimates;Demand (bottles per month);100,000;200,000;500,000;800,000;Probability;0.15;0.2;0.5;0.15;Based on this estimate, the expected demand is calculated as 425,000 bottles per;month.;FIN351e Copyright 2014 SIM University;CASE: NATURE COLA July Semester 2014;Page 3 of 17;Costs;Various costs associated with Zero Cola are;Raw material cost;Labour costs;Overhead costs;Fixed;Variable;$0.20 per bottle;$0.10 per bottle;$0.30 per bottle with Machine 1;$0.25 per bottle with Machine 2;$0.20 per bottle with Machine 3;$0.15 per bottle irrespective of machine used;Marketing costs;General and administrative expenses;$200,000 per year;$200,000 per year;The retailer would charge a sales commission of $0.1 per bottle irrespective of the;machine used.;It is also expected that introduction of zero calorie cola will result in a reduction in after;tax cash flow from Nature Cola to the tune of $500,000 a year.;Working capital needed;Raw material inventory will be maintained at one month production needs;Collection period for receivables will be 30 days;Accounts payable will be paid in 36 days;For calculation purposes, 360 days in a year will be used;The tax rate for the company is 30%;Cost of capital;Nature Cola has a capital structure of 30% debt and 70% equity. The beta of nature;Cola is estimated as 0.75. The risk-free rate is based on short-term government bond;rate which stands at 4% currently. The market risk premium has varied between 4%;and 8% in the past and the team believes that an estimate of 6% can be used. The debt;is from a bank which charges interest at 8% per annum. The tax rate for Nature Cola is;30%.;Purchase of machinery through bank loan;Nature Cola has sufficient cash in hand that can be used to purchase the machinery.;However, Joshua feels that Bank of Bridgeport with whom Nature Cola has a very;good relationship will be able to provide a loan towards the purchase of machinery. The;bank will provide a loan to the value of 80% of the purchase price at an interest rate of;8% per annum. This loan will have no prepayment penalty.;FIN351e Copyright 2014 SIM University;CASE: NATURE COLA July Semester 2014;Page 4 of 17;Leasing the machinery;Another option that Joshua has identified is that Nature Coal can enter into a sale and;leaseback arrangement with Bridgeport Leasing company. The leasing company is;willing to enter into such sale and leaseback arrangement with the following terms;Lease period: 5 years irrespective of the capacity of machinery;Lease payments will be calculated based on the following financing rates;Machine with capacity of 200,000 bottles: 7%;Machine with capacity of 500,000 bottles: 8%;Machine with capacity of 800,000 bottles: 9%;The lease also will come with a cancellation option. If lease is cancelled by nature Cola;at any time, Nature Cola will need to pay a penalty of 1% of the remaining value of;lease.;Based on the assumptions of demand and cost and assuming that the company will use;existing cash to purchase the machinery, the team worked out the net present value for;various demands. They decided to use the machinery with capacity of 200,000 bottles;to calculate the NPV for demand of 100,000 bottles and 200,000 bottles. For a demand;of 500,000 (800,000) bottles, they assumed that machinery with a capacity of 500,000;(800,000) bottles will be bought. The calculations are shown in Exhibits 1 to 4.;Exhibit 5 shows the calculation of NPV if the actual demand is the expected demand of;425,000 bottles per month.;Exhibit 6 shows the expected NPV using the probabilities of demand estimated.;New offer to purchase Low C Cola;As Peter is pondering about whether to introduce the Zero Cola, he received a phone;call from Benjamin. Benjamin, the owner of Low C Cola would like to get out of this;business and invest in something else. The valuation of Low C Cola is provided in;Exhibit 7. The valuation is based on the current cash flow being in perpetuity and;discounted at the cost of equity of Nature Cola. If Peter is interested, Benjamin is;willing to sell Low C Cola to Peter for a consideration of $7,000,000.;Peter and his team believe that if Nature Cola purchases Low C Cola, it can use the;existing marketing personnel to promote Low C Cola to increase its sale from the;current 50,000 bottles to 100,000 bottles per month. It can also reduce administrative;and general costs from $200,000 to $50,000. The marketing costs will be reduced from;$100,000 to $50,000. Further, because of the economies of scale, the raw material cost;can be brought down from 0.25 to 0.2 per bottle. In order to promote the sale of Low C;cola, the price would be reduced from $2 to $1.50. Since Low C Cola has lower;calories than Nature Cola, promoting Low C Cola will also help in promoting the zero;cola in the future. Since Low C Cola has a capacity of 200,000 bottles per month and;the production of Low C Cola will be only 100,000 bottles per month, remaining;capacity can be used to produce 100,000 bottles of Zero Cola. If the demand for Zero;FIN351e Copyright 2014 SIM University;CASE: NATURE COLA July Semester 2014;Page 5 of 17;Cola turns out to be high after 1 year, the company can plan to divest Low C Cola and;continue only with Zero Cola. If demand for Zero Cola remains at 100,000 bottles only;even after a year, company can continue to produce 100,000 bottles of Low C Cola and;100,000 bottles of Zero Cola.;Even though acquisition provides additional options, Peter is not sure whether the;consideration demanded by Benjamin is appropriate.;Thus, Peter and Team have a number of options;Should zero coal be introduced at all?;If it is introduced, what capacity machinery should be introduced at the current;time?;Should the machinery be bought with cash or with borrowed funds?;Should the company buy the machinery with cash or enter into a sale and;leaseback arrangement?;Should the company buy Low C Cola?;FIN351e Copyright 2014 SIM University;CASE: NATURE COLA July Semester 2014;Page 6 of 17;Exhibit 1 NPV for demand 100,000 bottles per month;0;monthly sales;(units);Price per unit;Annual sales;Costs;Raw material costs;per bottle;labour costs;overhead costs;Commission on;sales;Total variable costs;per unit;Fixed overhead;costs;Total costs per unit;Total costs per;year;Marketing costs;General and;Administrative;costs;Total costs;Cost of machine;life;resale value at end;of 5 years;Amount of;depreciation;Depreciation per;year;Additional;working capital;Raw material;inventory;Receivables;Payables;Total working;capital investment;Sales;Costs;Depreciation;Pretax income;Tax rate;1;2;3;4;5;100,000;2;2,400,000;100,000;2;2,400,000;100,000;2;2,400,000;100,000;2;2,400,000;100,000;2;2,400,000;0.2;0.1;0.15;0.2;0.1;0.15;0.2;0.1;0.15;0.2;0.1;0.15;0.2;0.1;0.15;0.1;0.1;0.1;0.1;0.1;0.55;0.55;0.55;0.55;0.55;0.3;0.85;0.3;0.85;0.3;0.85;0.3;0.85;0.3;0.85;1,020,000;200,000;1,020,000;200,000;1,020,000;200,000;1,020,000;200,000;1,020,000;200,000;200,000;1,420,000;200,000;1,420,000;200,000;1,420,000;200,000;1,420,000;200,000;1,420,000;1,000,000;1,000,000;1,000,000;1,000,000;1,000,000;2,400,000;1,420,000;1,000,000;-20,000;30%;2,400,000;1,420,000;1,000,000;-20,000;30%;2,400,000;1,420,000;1,000,000;-20,000;30%;2,400,000;1,420,000;1,000,000;-20,000;30%;2,400,000;1,420,000;1,000,000;-20,000;30%;6,000,000;5;1,000,000

 

Paper#25902 | Written in 18-Jul-2015

Price : $27
SiteLock