DuoLever Limited: Investment Decision using NPV & Uncertainty Analysis

This assignment presents a case study involving DuoLever Limited, focusing on NPV computation and uncertainty analysis for two investment options. The first option involves capital investment and internal production, while the second involves outsourcing production. The analysis includes calculating sales increases, cost savings, depreciation, and profit after tax for each option. Uncertainty analysis is performed using scenario analysis (optimistic and pessimistic scenarios) and sensitivity analysis (varying discount rates) to assess the robustness of the NPV results. The assignment concludes by highlighting the sensitivity of each option to changes in the discount rate and providing insights into making informed investment decisions. Desklib provides a platform to access similar solved assignments and past papers.

NPV computation (Option 1)
 The sales increase owing to introduction of new packaging is expected to be 2% on the
current future forecast. Hence for year 1 = $ 200 million *2% = $ 4 million. Since a
growth of 4% is expected in the future sales forecast hence, the increased sales every year
on account of new packaging can be obtained by multiplying 4 by 1.04.
 The second benefit is savings in variable cost which has been computed at 15% of the
expected variable cost for the project life. Hence for year 1=$ 22 million *15% = $ 3.3
million. As a growth of 3% in packaging cost is expected, hence the increasing packaging
related savings amount to a multiplication factor of 1.03 for each year.
 The additional cost would be incurred in the form of additional selling, general and
administrative expenses to the tune of $ 2 million each year. Also, depreciation expenses
have been considered on the capital investment of $ 20 million which has been
depreciated @ (20/5) = $ 4million
 Rise in Profit Before Tax = Sales increase + savings in variable costs – additional SG&A
expenses – Depreciation
 Further, tax has been deducted at the rate provided of 25% to arrive at higher profit after
tax.
 Depreciation has been added back since it is a non-cash item and was deducted initially
so as to reflect the tax benefit on account of depreciation.
NPV computation (Option 2)
 Here, since the production is outsourced, hence no capital investment is undertaken and
as a result depreciation is not charged.
 The sales increase owing to introduction of new packaging is expected to be 2% on the
current future forecast. Hence for year 1 = $ 200 million *2% = $ 4 million. Since a
growth of 4% is expected in the future sales forecast hence, the increased sales every year
on account of new packaging can be obtained by multiplying 4 by 1.04.
 The savings in variable cost will be reaped by the contract manufacturer and hence not
available to the company.
 The additional cost would be incurred in the form of additional selling, general and
administrative expenses to the tune of $ 1 million each year.
 Rise in Profit Before Tax = Sales increase– additional SG&A expenses
 Further, tax has been deducted at the rate provided of 25% to arrive at higher profit after
tax.
Uncertainty Analysis
The first tool used here is Scenario analysis where two scenarios are defined besides the base
case already available. The assumptions for optimistic scenario are as follows.

 Sales growth (without new sachets) – Increase of 100 bps (From 4% to 5%)
 Sales growth to existing forecasts – Increase of 100 bps (From 2% to 3%)
 Higher increase of packaging cost – Increase of 100 bps (From 15% to 16%)
 Higher increase in variable costs on account of higher sale projections –Increase
of 50bps (From 3% to 3.5%)
The assumptions for pessimistic scenario are as follows.
 Sales growth (without new sachets) – Decrease of 100 bps (From 4% to 3%)
 Sales growth to existing forecasts – Decrease of 100 bps (From 2% to 1%)
 Lower decrease of packaging cost – Decrease of 100 bps (From 15% to 14%)
 Lower increase in variable costs on account of higher sale projections –Decrease
of 50bps (From 3% to 2.5%)
The weighted average NPV for both options has been computed using an equal probability of 0.3
for optimistic and pessimistic scenario while the remaining probability of 0.4 associated with the
base case.
The second tool for uncertainty analysis is sensitivity analysis. The key factor considered here is
the discount rate as NPV is quite sensitive to changes in discount rate. By changing the value of
discount rate, the NPV has been computed for the two options. This clearly highlights that option
2 NPV is less sensitive to discount rate in comparison to option 1.