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SCHOOL OF GLOBAL MANAGEMENT TB0343;«©

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HOLA-KOI.A IhE CAPITAL BUDGETING.DECISION

I'he consumptiori ofsugar-sweetened be\?erageshas been [irtked to ricks .for obesity. diabetes, ana
peart disease; thereÍore. a compelling cme can be made .for lhe )leed.for reduced Comumption oÚ
!bese beverages
Health Pollcy Report, The Are14'
Eng/andlozrrna/ o#/t4ed7c/ne,
October 15, 2009.
. ;.#h,
Mexico leads world in soda consut7tption.World Health OrgaM=ation planning tonight it.
Carolyn Crist, Obesity Initiative, October25, 2012.

In December 2012, Antonio Ortega, the owner of Bebida So:l, had just"ñnished reading a report done by his
general manager, Pedro Cortez, about the possible investmenlí in a new product line, Hola-Kola. The idea of
Hola-Kola came about three months earlier when Antonio attended a seminar on youth obesity organized by a
local high school that his two children attended. Even.though he lvad often heard of the rising obesity problem
in Mexico, Antonio was still very disturbed by the stalistici indicatíng how the obesity rat€ in Mexico had tripled
since 1980, and that 69.5% ofthe people 15 yean~andomer Wereestherobeseor overweight.
&:.
Even more shocking to Antonio, basedoñ tab statistic, Mexico now had rhe highest overweight fate in the
world, surpassing the United Stakes.' 11' ' %,% '"i:;Ú%

After the seminar, Antonio discussed the idea afHola-Kola, a low-price, zero-calorie carbonated soft drink,
with Pedro Cortez. Pedro was excited about the idea, and liked the opportuniq' [o launch something new, espe-
cially given that the company had not introduced a new product in the last ñve years. However, Pedro thought
a market study should be done tó gaugethe.potencial demand before the farm underrook rhe investment.

Company Background
Bebida Sol is a small, privately owned carbonated soft drink company based in Puebla, Mexico. A rerired ex-
ecutive from a popul'u fast-food restaurant chain, Roberto Ortega, woundedit in 1998. During his carter as
a restaurant exectltivé, Roberto learned that Mexicana, regardlessof social statlls, loved their soda pop. Many
would drink soda tb:quench.dleir thirst on a regular basis,due [o the lock ofhygienic, drinkable water.With
the inHux of intclnationd brandi of sodapop, Mexico now had the highestconsumptionof carbonatedsoft
drinks per capito in :theworld.: The averageper capito consumption was40% higher than the United Stakes,at
163 1iters(43 gallons) per yeah,while the United Stakesconsumed 1 18 litera (3 1 gallons), according to statistics
piesent¿dby the international organizacionOxfam and the Mexican NGO Consumir's Power. Due to the high
obesity problem, health and consumir groups in Mexico had demanded that the government impase a 20% tax
on soft drinks, cjaíming chaeit would not only reduce consumption, but the [ax revenue could algo be used to
right health problema that soft drinks generated.:

l TThe World is Fat" by Catherine Rampe11,9/23/20 10. -

/ÉKín.fas.usda.aov/Recent%20GAIN%20Publications/The%20Mexicall%20Mat
exico%20ATO Mexico 8 20-2009.pdñ Global Agricultura Inñormation Network (GAIN) report MX9326
3 I'Mexico. Leader in Soft Drink Consumption". July 10. 20 12 hup://www.mexicanbusinessweb.mx/eng/20 12/
tmexico-leader-in-soft-drink-consumption/

:opJright © 2013 ThunderbirdSchooLofGhbaLManagement. All lights reserued.This cmewas prepatedbJProfessorLena Cbt4a

Booth far tbe purpose ofclmsroom cliscttssiononly, atü not to indicate eitber e$ectiue or ine$ectiue management.
 Exhibit 1. Rates ofOverweight and Obesity Persona by Country (2010)
Overwre$ght
C)besÉty
2 Japan(2008]
3
31 Korea (2008)
Switzerland(2007]
'i"""""
l
46 Italy(2008) l:ü
hJorway(2008] 1:0
44

:45
Sweden(2007]
France(2008)
penmark (2Q05)
m@'?,
:: @ ll
47 Netherlands[2009] lmK::$=:1:gW
12
48 AustriaC200S)
43 Roland[2004]
lsrael(2008]
47 Belgium[2008]
Turkey (2008]
52 Portugal [2006)
49 Finland(2008)
OECD
GermanaC2009)
Slovenia(2007)
52 Slovak Republic (2008)
52 Czech Republic (2008)
Spam[2009)
Greene(2008)
3 Hungara(2003)
Luxembourg(2007)
Iceland(2007]
60 Chile(2005]
61 líeland(2007)
Canada(2008)i.
61 United Kingdom (2008]
61 Australia(2007)
NewZ Bland[2007]:
Mexico[2006)
United8tóte [2a08]

leda 2005)
Indonesia(2005]
China[2ü05]
Brazil (2005)
IRü$#íün
Federatioñ(2005)
Estonia(2008}
SotjthAhibó (2ü05)
8'0 4:a 2a 0 Q IQ 20 30 4D
% af adult population % of adult population

Source:"World Obesity Stars--201 0 and Beyond" Douglas Robo Sept. 27, 2010, //e.z/rñ Akmí.

The market leaders6or carbonated soft drinks in h4exico were Coca-Cola, Pepsi-Cola, Dr. Pepper Snapple,
and Grupo Penañel.Together, they accountcd for a combined market sharo of more than 90%, with Coca Cola
boing the major player.The Mexican Bott drink market (producto include bottled water, carbonates, RTD tea/
coffee, functional drinks, fruit/vegetable jueces,and other soft drinks) had total revenuesof$39.2bn in 2011,
representing a compound annttal growth rafe (CAGR) of6.3% between 2007 and 201 1. 1\marketconsiimption
volumenincreasedwith a CAGRof4.5% between 2007 and 2011, reachinga total of49.3 bullion litera in 2011 .'

Roberta thought thesepopular international btands commanded prices that might be out of reachñar
[he poorer segmenrof the population. To capture this market, he started the company to offer primate-labeled
carbonatedsoft drinks with similar gastes,
but at about hair the price. His producesconsistedof regularcola
carbonates and non.cola carbonates, such as lemon/lime or orange carbonares.

Bebida Sol's producto were said only in small, independent grocery stonesand convenience stonesin Mexico.S
I'he ñrm avolded the supermarkers and hypermarkets becaiise it could not sustain the desired margen in these
large stones.Moreover, mast of the consumers, especially the middle-to-low income ones, shopped at small,
independent grocery stones.To crearé awareness,the owners of these independent store$were viven incentives
[o personally promete the produces. Salesincreaseddramatically, from 80 million pesosin 1998 [o about 900
million pesosin 2011

+I'Soft Drinks in Mexico," Market ResearchReport, March 29, 20 13.hrtp://wwwmarketresearch.com/MarketLine-v3883/

Soft-Drinks Mexico-7679076/.
5There were about half a million small, independent grocery shores,and more than 8,000 convenienceshoresthrough\out
Mexico.

2 TB0343
 In 2007, Antonio Ortega, Ro.berto'sonly son: toole over the businesswhen Roberto unexpectedly passed
away. Antonio started working on the salesside of the business two years before his father's death. He had gath-
ered a few valuable tips on how to run the business from his cather,'whicll had made him a rather conservntive
businessman.A !ea! arte: Antonio took over the business,the global financial crisis hit. The economia downnli n
in l\mexicoactually benefitted che low-price soda business.Demand increaseddramatically a$ many consumeis
became price conscious and switched from international brandi to primate labels. Bebida St I's'sale!;incíeased
by 60% from 2008 to 2009, and continued [o increasewithout the farm changing any of its busiü¿ssstiategy
or practices.The company's return on sales(net profit margen) dso had been incfeasing in rhe last ñewyears.
Exhibit 2. Bebida Sol's Sales and

5.00%
W
>

4.00%
8
'=

3.(D%
Q-

$200,000
$100,000
$o

M Saies : !u Return oñ Sales

The Proposal
Reading once again the executive summary ofthe report, Antonio recalled what his father told slim several times
during the two yearshe was working with hime "Don't grow the company hor the sakeofgrowing. Inx est o nly when
you areconfident there is stifhcient demand far a new produce, an(i dso when you have the financial resolirces.
As Earas financial resources,Antonio ñlt the timing could not be better. Due to strong salesand profitability
in the last 6ewyflars,Bebida Sol had accumulateda sizableamount ofcash. With solid financial performance
and .steadycash flows, his banker had agreedto extend him a five-yeah,16% anniial entere.sttet m toad [o launch
Hola-Kola. In the proposal. Pedro Cortez estimated that with 20% of the needed capital borran,ed, rhe 20/80
debe-equitystructuic would.{esult in ai} 18.2% weighted averagecoseof capital for this project

The bigget questionlingering in Antonio's mind waswhether Elaere

would be sufñcient demand fot this
new, zero-calorie pioduct line. Even though rhe demand for low calorie sodas had increased in Mexico, they
seemedto be consumedmainly by the middle-to-tipperincomesegmentof the poplílation. The majority of
Ehelower-income people sti]] consumed on]y the regular, high-sugared carbonated soft drinks. ]t warn't cleai-
whether this was becausethe low income group lacked the awarenessof the obesity problem, or becausethere
were not too nnuly low-priced, low-calorie soda options available.' if it were the ñormer, the otitlook for low-
price, low-calorie carbonated soft drinks might not be too promising at this rime. If it were the larter, it might
be the perfect timing ñor Bebida Sol to introduce Hola-Kola.

Pedrohired a consultant to do a market study right after Antonio discussedthe ideaofHola-Kola with hlm
The consultant estimated chaethe company could sdl a total of 600,000 1iters of these zero-calorie carbonates
a mouth, at a projected price of ñve pesos a miter.This volume ofsales wa.sexpected for a pernod of five years at

6 in an efñort to right the obcsity problem, the Mexican governmcnt had been launching media campaigns ro cncouragc lhc
public ro participate in weighr loss programé in regent years. Drasric measureswere dso taken to ban high-Eat, high-sugar
food and drinks in schools,and to add more physical educacionin the school curriculum

TB0343 3
 the samep'ice. The market study took about two monEhsto complete and cast the company five million pesos
whichPedrohadpaidshorrlyafteritscompletion. ' ' ' =;. '

Since the existing bottling p.lanewas running at 100% capacity producing regular sodas,the proposal called
for a Reetofnew,.semi-automated bottling and kegging machines designed for long, high-quality runs. The total
coseofthese machines:including insrallation,wasestimatedto l)e 50 million pesos.This amount could be tully
depreciared.on a straight-line basicover a pernod of five years. Pedro believed that the purchase af these machines
would enable Bebida Sol to reduce its coit oflabor and therefore the price to the customers, putting the film ii)
a more competitivo posicion. W'ith proper maintenance, these machinescould produce at least600,000 lirers of
carbonated drinks per month. Pedro dso estimated that these machines would have a resalevalue ofGour million
peso.s.in
ñve years..time,ifthe companywere to either shut down the production of Hola-Kola, or repJacethese
machines with tully automared ones at that lime.

The new machines would be housed in an unoccupied annex by the mal n production Encility ofBeblda Sol.
The ann.exwas dso .large enough to store the finished produces behoie tílcy Were shlpped out [o' grocery shores.
Antonio's father bunt the annex yearsago when he planned to venture into tale mineral ware, business.He died
before he could ejecute his plan. The annex had been vacant ever since, even though Antonio recenrly received
an offer to teaseout the spacefor 60,000 pesosa yeah.

Pedrodetermined that additional working capital was ileeded [o ensuresmooth production and salesof
new produce line. He proposed keeping raw materials inventory at a level equal to one monté of pi'oduc-
tion. To encouragethe independent grocery shoresto carry.the new produce line, he proposed ofíering a longer
collection period, letting the grocerypay in 45 days,:insteadof the normal 30 days. As Earas accounts payable,
he would follow the company's normal policyl and settle the .accouritgin 36 days.

The proposal dso outlined the various estiMates of production and overhead coses, and serling expensas.
Raw materials neededto produce the sodaswere estiinated to be 1.8 pesosper lider, while labor cosesand'energy
cosesper nlonth were estimatedto be 180,000 pesosand 50,000 pesos,respectively.The incremental general
administrative and wellingexpensaswere quite inodesE,estimated to be 300,000 a yeah,as the new produce could
be said by Bebida Sol's current si3lesflorceand via existing distribution channels. The accounring deparrment
typica[[y charged ] % of sa]esasoverhead cosesfior any new projecto.

Glancing back at his notes, Ahtnnio started pondering. The market study seemed[o indicate sufficient
demand for the new produce line. What he really feared was that the new zero-calorie carbonates might erode the
gajesof his existing producto--the regular sodas.The market study suggestedthat potencial erosion could coit
Ehefarm as much as 800,000 p6cns ofafter-tax cash flows per year. At lhe new [ax race of30% for both income
and capital goins, could he add value to the film by taking on this project?

TB0343
 Appendix 1. Bebida Sol--lncome Statements for the Yaar Ending December 3t
(thousands ofpesos)

tem 2010
Sales
642,400Í:íé1
0G.0% 8S2,S4ijii}
ioo.o%
COGS
Groso marlin

Marketing & welling Expenses

GeneralAdm nistratíve Expenses
349*8w©54:5%
292,5i6;:.45,5%
120,359í;i
li8:7%
6S.S4Q i ¿Q:2%
456,401
375,932,
w'
i50,S221:1i 118*1bHn
88 ,ó22i$111i110:6%
EBITDA l06,817 E 16.6% 136,988iilr1
.,]6.5%
Depreciation
EBIT
.046
61,77i 9,6%
M'm
77,S4411 1i17%;3% 80,975 9.0%

23,] 20 9,340
38,651g 6.0% 71,635 8.a%

11 21.491
}8:
Dividendo 20,000 20,000 20,000
Retained Earnings 7,056. 2.4,4] 9 30,145

Appendix 2. Bebida Sol--Balance Skeet as of December 31

(thousands of pesos)
Assets 2010 2011
Cash ] 2;0239ii$;;1 3::;1% 36,090ii:i É8.9% 53,020:$i: 14.0%
Accoünts R¿ceil¿ble úl,óoo:: 1:15;7% 75,253111 11811
8.6% 78,9131;11 20. 8%
Inventory 32.592mg$
8.3% 45.0161ilÍilÍI 1 1;1% 60,044ilf:i5.8W
h aid;,,Exeenses l l :z92i; i:lli 3.Q%: 2Q:66Q lili;:i S:Jj 15:] !71 í; :!ii 4*Q%
Current,Assets4@g.
@: 118,007:!$30.i% 177,019:!!i:: 43.8% 207,093:f& 54. 5%

Grass lixed assets 439,230.Í:12,aW 452,020 é ÍÍ:Í :7% 463,122{122:0%

Accum deoredáúi)¿il i6s .04ó :iljÉ2;11% 224:49Q ':.: s5.5% 290,475 :1 76,5%
Net fixed ass&jÉ 227,530:i : á6,2% iz2 ,ú47 11:Í!áS*5%
h..
Talal AÉ$#Q 392.191 100.0% 404,549 100.0% 3Z9:Z4Q: ;ioo.o%

Lübiliú 2011
Á&qüñts Fiabie 34,Sop$g1 8.8% 43,7ÓSí$j! }0:8% 48,035111?12. 6%
Accluüd expensas 15,0831;1ili11
3:8% i9,087il:iil:i 4:7% z0,4pS$1il:::lS.4s
Short?téjMdebe 70,520: ],8;Qg 63,4a ;!! :!S:Z% 22,900 kFj 6.Q%
Current Eíábilities 120,1 12:.' 30.6% 126,281llilli131,2o%ü pt,428;iíi24.1%

ilDng-team debe 4s,023¿g,1

! .5% 26,793 ., ?:f6.6% 6,693 . : 1.8%
Equity 22Z:Q56 SZ:9% 251,475: : 62.2% 281.óipli1:24:22

[i .biiiy e$&Net Worth 11122:!P] IGG*o% 404,549 i;$Í00.Q% !Zl?:740 100.0%

TB0343