Financial Analysis of manufacturing vs licensing options

FINANCE
STUDENT ID:
[Pick the date]

MEMORANDUM
To: CEO (DuoLever Company)
From: STUDENT NAME
Date: 19th May, 2019
Subject: Financial Analysis of manufacturing vs licensing options
Respected Sir
The key objective of this memo is to present a summary of the financial analysis which has been
carried out in wake of the two options that the company is currently contemplating for the
recycled plastic sachet project. In this regards, the focus is on identification of incremental
cashflows associated with each of the two options after which the NPV has been determined
using the respective cost of capital. Further, uncertainty in financial projections has also been
considered so as to outline the impact of adverse movements in critical inputs on the project
feasibility.
NPV Computation
Option 1:
For the given analysis, focus is only on incremental cash flows which would be derived based on
the decision to go ahead with the project or abandon the same. This would imply that sunk costs
such as the $ 50 million investment made by the company to develop the environment friendly
plastic technology would not be considered in the financial analysis. Another key factor is the
funding of project and resultant cost of capital. The project is 100% debt funded with an interest
rate of 7% which becomes the relevant discount rate (Ross et. al.,2015).
Going ahead with the option under consideration would bring about the following incremental
cash inflows for DuoLever company.
 The current sales forecast for the next five year would undergo upward revision to the
extent of 2% as customers would prefer environmental friendly product against the
alternatives which lack this feature.

 The company would reap savings in variable cost associated with packaging to the extent
of 15% as the new process is significantly energy efficient.
Going ahead with the option under consideration would bring about the following incremental
cash outflows for DuoLever company.
 The company would have to arrange for a debt of $ 20 million for purchase of plant and
machinery for the manufacturing of the recycled sachets. A flip side to this investment is
that depreciation would be available which would facilitate lowering of tax outflow for
the company on account of project.
 The expenses in regards to selling, administration and general support activities would be
incurred amounting to $ 2 million per annum.
Considering the above cashflow information provided along with the relevant information
offered in the case, the NPV based on incremental cashflows is estimated as follows.
Option 2:
This option would involve a licensing arrangement by the company whereby patented
technology would be licensed to a contract manufacturer that in turn would supply the sachets to
the company at the existing price only. The profit margins for this manufacturer would be
derived through the lower manufacturing cost on account of energy efficiency. For the company,
licensing would mean that the manufacturing setup would not be required and thereby it would
not have to assume extra debt of $ 20 million. Additionally, the company would save on
administration costs to the extent of $ 1 million per annum. Considering the above cashflow