Pepsico Changchun Joint Venture: Capital Expenditure Analysis

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Background
PepsiCo is currently involved in 7 Joint ventures in People’s Republic of China (PRC) and is in the proposal process of investing into an equity joint venture in the city of Changchun.This proposal would be one of the first two green field equity joint venture with PepsiCo having control over both the board and day-today managmenet. PepsiCo uses capital budgeting tools such as NPV and IRR to systematically evaluate their investment project. Using this evaluation method Mr Hawaux, vice president of Finance for PepsiCo East Asia, was wondering whether this project would be profitable and if PepsiCo should proceed with the Changchun Joint Venture. The Central Government of PRC had made it difficult for foreign compaies to enter the PRC market. The only acceptable method of entry was through a joint venture with a local chinese firm. To attract foreign investors, the equity joint venture was established. This meant that the foreign company would invest a maximum of 60% ownership share into the entity, while the remaining 40% would be invested by the local chinese company. PepsiCo’s equity joint venture is proposed to be with two local chinese companies. PepsiCo would hold 57.5% interest in the joint venture, while 37.5% by Second Food Factory and the remaining 5% by Beijing Chong Yin Industrial & Trading Company. Mr. Hawaux needs to determine the attractiveness of the project’s risk and return prospects.

Assumptions:
As expected, the city implements an additional 3% tax rate in 2001.

NPV and IRR calculations:
The NPV and IRR were calculated both with and without NOBPT. Furthermore the replicated NPV was incorrect and as such was corrected using a revised NPV function. The Excel NPV function does not correspond to the finance use of the term NPV. To correct this NPV should be calculated as the present value of future cash flows minus the initial payment, the initial payment is later added outside the parenthesis of the function.

Example:
=NPV (0.16, Q5:Q16) +Q3 (Correct use)
=NPV (0.16, Q4:Q16) (Incorrect use)

With NOBPT
Year| NPV (Replicated)| NPV (Corrected)|
| | |  |
1994| (6,726)| (6,726)|  |
1995| (3,631)| (3,631)|  |
1996| (4,628)| (4,628)|  |
1997| 767 | 767 |  |
1998| 3,619 | 3,619 |  |
1999| 2,182 | 2,182 |  |
2000| 1,268 | 1,268 |  |
2001| 4,315 | 4,315 |  |
2002| 4,544 | 4,544 |  |
2003| 5,066 | 5,066 |  |
2004| 6,339 | 6,339 |  |
2005| 7,370 | 7,370 |  |
2006| 81,886 | 81,886 |  |
NPV| $10,060.12| 11,669.74 |  |
| | |  |
IRR| 24.55%| 24.55%|  |

Without NOPBT
Year| NPV (Replicated)| NPV (Corrected)|
| | |  |
1994| (6,726)| (6,726)|  |
1995| (3,631)| (3,631)|  |
1996| (4,628)| (4,628)|  |
1997| 767 | 767 |  |
1998| 3,619 | 3,619 |  |
1999| 2,417 | 2,417 |  |
2000| 1,541 | 1,541 |  |
2001| 4,579 | 4,579 |  |
2002| 5,942 | 5,942 |  |
2003| 6,788 | 6,788 |  |
2004| 8,652 | 8,652 |  |
2005| 10,536 | 10,536 |  |
2006| 86,209 | 86,209 |  |
NPV| $12,704.55| 14,737.28 |  |
| | |  |
IRR| 26.24%| 26.24%|  |

Sensitivity Analysis:
Our sensitivity analysis calculates NPV with varying discount rates between 10 and 30 percent. Our NPV with NOPBT has a negative correlation, as the discount rate increases the NPV value decreases significantly. Suggesting that the NPV is very sensitive to changes in the discount rate. Head Office...
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