1. Calculate the NPV of the proposed investment? How sensitive is this NPV to future sales volume? Also, what are the pros and cons of waiting for a year before deciding whether to invest?

Case Study 1 Libby Flannery, the regional manager of Ecsy-Cola, the international soft drinks empire, was reviewing her investment plans for Central Asia. She had contemplated launching Ecsy-Cola in the ex-Soviet republic of Inglistan in 2007. This would involve a capital outlay of $20 million in 2006 to build a bottling plant and set up a distribution system there. Fixed costs (for manufacturing, distribution and marketing) would then be $3 million per year from 2006 onward. This would be sufficient to make and sell 200 million litres per year - enough for every man, woman and child in Inglistan to drink four bottles per week! But there would be few savings from building a smaller plant, and import tariffs and transport costs in the region would keep all production within national borders. The variable cost of production and distribution would be 12 cents per litre. Company policy requires a rate of return of 25% in nominal dollar terms, after local taxes but before deducting any costs of financing. The sales revenue is forecasted to be 35 cents per litre. Bottling plants last almost forever, and all unit costs and revenues were expected to remain constant in nominal terms. Tax would be payable at a rate of 30%, and under Inglistan corporate tax code, capital expenditures can be written off on a straight line basis over four years. All these inputs were reasonably clear. But Ms. Flannery racked her brain trying to forecast sales. Ecsy-Cola found that the \"1-2-4\" rule works in most new markets. Sales typically double in the second years, double again in the third year, and after that remain roughly constant. Libby's best guess was that, if she went ahead immediately, initial sales in Inglistan would be 12.5 million litres in 2008, ramping up to 50 million in 2010 and onward. Ms. Flannery was also worried whether it would be better to wait a year. The soft drink market was developing rapidly in neighbouring countries, and in a year's time she would have a much better idea whether Ecsy-Cola would be likely to catch on in Inglistan. If it didn't catch on and sales stalled below 20 million litres, a large investment probably would not be justified. Ms. Flannery had assumed that Ecsy-Cola's keen rival, Sparky-Cola, would not also enter the market. But last week she received a shock when in the lobby of the Kapitaliste Hotel she bumped into her opposite number at Sparky-Cola. Sparky-Cola would face costs similar to Ecsy-Cola. How would Sparky-Cola respond if Ecsy-Cola entered the market? Would it decide to enter also? If so, how would that affect the profitability of Ecsy-Cola's project? Ms. Flannery thought again about postponing investment for a year. Suppose Sparky-Cola was interested in the Inglistan market. Would that favour delay or immediate action? Maybe Ecsy-Cola should announce its plans before Sparky-Cola had a chance to develop its own proposals. It seemed the Inglistan project was becoming more complicated by the day. Case Study 1 Libby Flannery, the regional manager of Ecsy-Cola, the international soft drinks empire, was reviewing her investment plans for Central Asia. She had contemplated launching Ecsy-Cola in the ex-Soviet republic of Inglistan in 2007. This would involve a capital outlay of $20 million in 2006 to build a bottling plant and set up a distribution system there. Fixed costs (for manufacturing, distribution and marketing) would then be $3 million per year from 2006 onward. This would be sufficient to make and sell 200 million litres per year - enough for every man, woman and child in Inglistan to drink four bottles per week! But there would be few savings from building a smaller plant, and import tariffs and transport costs in the region would keep all production within national borders. The variable cost of production and distribution would be 12 cents per litre. Company policy requires a rate of return of 25% in nominal dollar terms, after local taxes but before deducting any costs of financing. The sales revenue is forecasted to be 35 cents per litre. Bottling plants last almost forever, and all unit costs and revenues were expected to remain constant in nominal terms. Tax would be payable at a rate of 30%, and under Inglistan corporate tax code, capital expenditures can be written off on a straight line basis over four years. All these inputs were reasonably clear. But Ms. Flannery racked her brain trying to forecast sales. Ecsy-Cola found that the \"1-2-4\" rule works in most new markets. Sales typically double in the second years, double again in the third year, and after that remain roughly constant. Libby's best guess was that, if she went ahead immediately, initial sales in Inglistan would be 12.5 million litres in 2008, ramping up to 50 million in 2010 and onward. Ms. Flannery was also worried whether it would be better to wait a year. The soft drink market was developing rapidly in neighbouring countries, and in a year's time she would have a much better idea whether Ecsy-Cola would be likely to catch on in Inglistan. If it didn't catch on and sales stalled below 20 million litres, a large investment probably would not be justified. Ms. Flannery had assumed that Ecsy-Cola's keen rival, Sparky-Cola, would not also enter the market. But last week she received a shock when in the lobby of the Kapitaliste Hotel she bumped into her opposite number at Sparky-Cola. Sparky-Cola would face costs similar to Ecsy-Cola. How would Sparky-Cola respond if Ecsy-Cola entered the market? Would it decide to enter also? If so, how would that affect the profitability of Ecsy-Cola's project? Ms. Flannery thought again about postponing investment for a year. Suppose Sparky-Cola was interested in the Inglistan market. Would that favour delay or immediate action? Maybe Ecsy-Cola should announce its plans before Sparky-Cola had a chance to develop its own proposals. It seemed the Inglistan project was becoming more complicated by the day