ACC00716 S1 2019: Duolever Recycling Packaging Options Analysis Report

This report analyzes two plastic recycling options for Duolever Limited, a personal care product company: investing in a new recycling production plant and licensing its patented method to Clean World Ltd. The analysis utilizes Net Present Value (NPV) to evaluate the financial viability of each option, considering factors such as revenue growth, variable costs, selling and administrative expenses, and income tax rates. The findings reveal that both options yield positive NPVs, indicating profitability. However, the licensing option demonstrates a higher NPV, leading to the recommendation that Duolever should license its method. The report also emphasizes the importance of considering qualitative factors like environmental regulations and competitor actions, and provides detailed financial projections, including revenue, cost, and cash flow analyses, along with an appendix containing supporting data and calculations. The report concludes with a profitability index and IRR calculation for the investment option.

Memo
To: Duolever CEO
From: Student Name
Date: May 11, 2019
Subject: An analysis of Duolever Recycling Plastic Packaging Options
Introduction
Duolever currently sells most of its products in plastic packaging and sachets. Due to the
increased world awareness of production of plastics, the company is now considering going into
plastic recycling to assist them to reduce their environmental impact of plastic waste (Tipaldo,
2017).
Following recent research, Duolever has been presented with two options. Option 1 involves
investing in a new recycling production plants for their packaging solutions. Option 2 involves
the licensing of Duolever’s patented method to Clean World Ltd, who will then supply Duolever
with the packaging material exclusively for 5 years.
Data and Methodology
Quantitative methods like Net Present Values, Profitability Index, IRR or Payback period can be
used by companies when making decisions to choose between two projects such as building a
new plant or outsourcing the process (Özsöylev, 2015).
The most common method is the net present value (NPV). A positive NPV suggests that the
project is feasible, whereas a negative NPV suggests a project is not feasible (Ehrhardt &
Brigham, 2003).
An NPV analysis of the two options is presented in the next section.
1. Option 1: Investing in Recycling Production
Under this option, Duolever will require an upfront investment in plant and equipment valued at
$20 million. This equipment will have a useful life of 5 years.
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General Assumptions
Revenue year 1 (without recycling) $200,000,000
Revenue year 1 (with recycling) $204,000,000
Growth in revenue 4.0%
Variable costs year 1 (without recycling) $22,000,000
Variable costs year 1 (with recycling) $16,830,000
Growth in variable cost 3.0%
Selling and admin expenses $2,000,000
Income tax rate 25%
Discount rate 8%
Duolever producing their own recycled plastic has several financial benefits for the company:
a. An increase in forecasts sales by 2% during the 5 year life of the project
Firstly, there will be an increase in sales as their products will be packaged in the
recycled plastic. The table below shows the projected revenues arising from the new
production facility.
Time 1 2 3 4 5
_Revenues 4,000,000 4,160,000 4,326,400 4,499,456 4,679,434
Revenues Before 200,000,000 208,000,000 216,320,000 224,972,800 233,971,712
Revenues After 204,000,000 212,160,000 220,646,400 229,472,256 238,651,146
b. An Increase in cost savings arising from 15% reduction in energy cost and 10%
reduction in supplier margin
Secondly, variable cost of the company will decrease. This is because the recycled plastic
will be less costly than buying the previous plastic due to avoiding a supplier margin and
low energy costs.
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The table below shows the projected cost arising from the new production facility.
However, these will be offset by Selling and Admin expenses of $2 million per year.
Time 1 2 3 4 5
– Variable costs savings (5,170,000) (5,325,100) (5,484,853) (5,649,399) (5,818,881)
cost before recycling (22,000,000) (22,660,000) (23,339,800) (24,039,994) (24,761,194)
cost after recycling (16,830,000) (17,334,900) (17,854,947) (18,390,595) (18,942,313)
– Selling and Admin expenses 2,000,000 2,000,000 2,000,000 2,000,000 2,000,000
2. Option 2- License use of the patented method
Under this option, Duolever will license the use of the patented method to Clean World Ltd.
Clean World will then reproduce recycled plastic using DuoLever’s method while supplying the
packaging to DuoLever exclusively for 5 years.
The financial benefit of this option is that there is no initial investment and Duolever will still
retain the benefits of the original expected additional sales revenue benefits. Furthermore, selling
and admin costs will reduce to $1 million per year.
General Assumptions
Revenue year 1 (without recycling) $200,000,000
Revenue year 1 (with recycling) $204,000,000
Growth in revenue 4.0%
Selling and admin expenses $1,000,000
Income tax rate 25%
Discount rate 8%
Findings
1. NPV Analysis- Investment in Recycling Production
The table below summarizes the after tax cash flows for Duolever over 5 years should they
invest in the new plant.
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Annual Net Cash Flow
Estimates
0 1 2 3 4 5
Investment in Plant (20,000,000
)
Net income 2,377,500 2,613,825 2,858,440 3,111,641 3,373,736
Add back depreciation 4,000,000 4,000,000 4,000,000 4,000,000 4,000,000
Net cash flows during
forecast period
(20,000,000
)
6,377,500 6,613,825 6,858,440 7,111,641 7,373,736
Net Present Value
(NPV)
7,265,541
The NPV is calculated as $ 7,265,541.
2. NPV Analysis- License use of the patented method to Clean World Ltd
The table below summarizes the after tax cash flows for Duolever over 5 years should they
license production to Clean world Ltd.
Net income 0 1 2 3 4 5
_Revenues 4,000,000 4,160,000 4,326,400 4,499,456 4,679,434
– Selling and Admin
expenses
1,000,000 1,000,000 1,000,000 1,000,000 1,000,000
Taxable income 3,000,000 3,160,000 3,326,400 3,499,456 3,679,434
– Taxes 750,000 790,000 831,600 874,864 919,859
After-tax income 2,250,000 2,370,000 2,494,800 2,624,592 2,759,576
Annual Net Cash Flow
Estimates
0 1 2 3 4 5
Net cash flows during
forecast period
0 2,250,000 2,370,000 2,494,800 2,624,592 2,759,576
Net Present Value
(NPV)
9,902,95
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The NPV is calculated as $9,902,953
The table below summarizes the Net Present Value findings under both options.
Option 1 Option 2
Net Present Value $ 7,265,541 $ 9,902,953
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Recommendations
From the table we observe that both the NPV under the investing option and licensing option are
positive. These suggest that the recycling project is profitable and Duolever should proceed with
using recycled plastic sachets (EduPristine , 2018). Furthermore, the NPV value calculated under
the licensing option to Clean World Ltd is larger than the NPV calculated under the investing
option. Hence, the licensing option is the most profitable option to the company. Consequently,
we recommend that Duolever should license their patented method to Clean World Ltd.
Other Important Considerations
It is important to note that Net Present Value should not be used in isolation. Duolever should
also give consideration to other qualitative techniques like the effects of environmental
regulation, effects of competitor actions, effects of financing costs etc. This is because these
factors will be important when making key assumptions on the forecasts, hence reducing any
uncertainty in projections (EFINANCE, 2019). Otherwise, if there are errors in projections, then
the company may end up selecting projects that were otherwise not profitable in the first place or
may not be able to select projects that are otherwise profitable in the long run.
References
EduPristine , 2018. Capital Budgeting: Techniques & Importance. [Online]
Available at: https://www.edupristine.com/blog/capital-budgeting-techniques
EFINANCE, 2019. Factors Affecting Cost of Capital. [Online]
Available at: https://efinancemanagement.com/investment-decisions/factors-affecting-cost-of-capital
Ehrhardt, M. & Brigham, E., 2003. Corporate Finance: A Focused Approach. s.l.:Thomson/South-Western.
Özsöylev, H., 2015. Mechanics of Capital Budgeting. Instanbul: s.n.
Tipaldo, E., 2017. Multi-material Pouch Packaging: A Sustainable Story Animated. [Online]
Available at: https://www.plasticpackagingfacts.org
Tucker, J., 2009. How to set the hurdle rate for capital investments. [Online]
Available at: https://www.eprints.uwe.ac.uk/11334/1/Tucker_2009_QFinance_book_chapter.doc
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Appendix
Investing OPTION
General assumptions
plant and equipment
Depreciation expense
Revenue year 1
Growth in revenue
Additional revenue from recycling
Variable costs year 1
Growth in variable costs
Additional cost savings
Supplier margin savings
selling and admin expenses
Income tax rate
Discount rate
Net income 0 1 2 3 4 5
_Revenues 4,000,000 4,160,000 4,326,400 4,499,456 4,679,434
Revenues Before 200,000,000 208,000,000 216,320,000 224,972,800 233,971,712
Revenues After 204,000,000 212,160,000 220,646,400 229,472,256 238,651,146
– Variable costs savings (5,170,000) (5,325,100) (5,484,853) (5,649,399) (5,818,881)
cost before recycling (22,000,000) (22,660,000) (23,339,800) (24,039,994) (24,761,194)
cost after recycling (16,830,000) (17,334,900) (17,854,947) (18,390,595) (18,942,313)
– Selling and Admin expenses 2,000,000 2,000,000 2,000,000 2,000,000 2,000,000
– Depreciation expense 4,000,000 4,000,000 4,000,000 4,000,000 4,000,000
Taxable income 3,170,000 3,485,100 3,811,253 4,148,855 4,498,315
– Taxes 792,500 871,275 952,813 1,037,214 1,124,579
After-tax income 2,377,500 2,613,825 2,858,440 3,111,641 3,373,736
Annual Net Cash Flow Estimates 0 1 2 3 4 5
Investment in fixed assets (20,000,000)
Net income 2,377,500 2,613,825 2,858,440 3,111,641 3,373,736
Add back depreciation (non-cash expense) 4,000,000 4,000,000 4,000,000 4,000,000 4,000,000
Net cash flows during forecast period (20,000,000) 6,377,500 6,613,825 6,858,440 7,111,641 7,373,736
Net Present Value (NPV) 7,265,541
Cumulative cash flows (20,000,000) (13,622,500) (7,008,675) (150,235) 6,961,406 14,335,142
Discounted cash flow (PV) (20,000,000) 5,905,093 5,670,289 5,444,451 5,227,268 5,018,441
Profitability index 1.36
IRR 20.60%
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Licensing OPTION
General assumptions
Revenue year 1 $200,000,000
Growth in revenue 4.0%
Additional revenue from recycling 2.0%
selling and admin expenses $1,000,000
Income tax rate 25%
Discount rate 8.000%
Net income 0 1 2 3 4 5
_Revenues 4,000,000 4,160,000 4,326,400 4,499,456 4,679,434
Revenues Before 200,000,000 208,000,000 216,320,000 224,972,800 233,971,712
Revenues After 204,000,000 212,160,000 220,646,400 229,472,256 238,651,146
– Selling and Admin expenses 1,000,000 1,000,000 1,000,000 1,000,000 1,000,000
Taxable income 3,000,000 3,160,000 3,326,400 3,499,456 3,679,434
– Taxes 750,000 790,000 831,600 874,864 919,859
After-tax income 2,250,000 2,370,000 2,494,800 2,624,592 2,759,576
Annual Net Cash Flow Estimates 0 1 2 3 4 5
Net cash flows during forecast period 0 2,250,000 2,370,000 2,494,800 2,624,592 2,759,576
Net Present Value (NPV) 9,902,953
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