Ecsy$-$Cola$23$

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 $2019.$ This would involve a capital outlay of $$20$ million in

$2018$ 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 $2018$ onward. This would

be sufficient to make and sell $200$ million liters 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 costs of production and distribution would be $12$ cents per liter. 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 liter.

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 the 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 $124$ rule works in most new markets. Sales typically double

in the second year, 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 $12\mathrm{.}5$ million

liters in $2020,$ ramping up to $50$ million in $2022$ and onward.

Ms$.$ Flannery also worried whether it would be better to wait a year. The soft drink market was

developing rapidly in neighboring countries, and in a year$$s time she should 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 liters, 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

were interested in the Inglistan market. Would that favor delay or immediate action?

Maybe Ecsy$-$Cola should announce its plans before Sparky$-$Cola had a chance to develop its

own proposals. It seemed that the Inglistan project was becoming more complicated by the day. QUESTIONS

$1.$ Calculate the NPV of the proposed investment, using the inputs suggested in this case. How

sensitive is this NPV to future sales volume?

$2.$ What are the pros and cons of waiting for a year before deciding whether to invest? $($Hint:

What happens if demand turns out high and Sparky$-$Cola also invests? What if Ecsy$-$Cola

invests right away and gains a one$-$year head start on Sparky$-$Cola?$)$