Pepsico Ghanghun Joint Venture: Capital Expenditure Analysis

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