ACC00716 S1 2019: Financial Analysis of DuoLever Packaging Options

This report presents a financial analysis of DuoLever's options for introducing new, environmentally friendly sachet packaging. The analysis compares two strategies: establishing an in-house manufacturing unit versus outsourcing production to an external vendor, Clean World. The report utilizes incremental cost-benefit analysis and net present value (NPV) calculations to evaluate the financial viability of each option, considering factors such as variable cost reductions, increased sales due to the eco-friendly nature of the plastic, and capital investments. Sensitivity analysis is conducted to assess the impact of potential changes in key variables on the project's profitability. The analysis concludes that outsourcing is the optimal choice, primarily due to a higher NPV, reduced risk, and avoidance of additional debt. The report also acknowledges the importance of qualitative factors in the final decision-making process, given the company's prior investment in developing the new plastic.

FINANCE
STUDENT ID:
[Pick the date]

MEMORANDUM
Date: May 17, 2019
To: DuoLever CEO
From: STUDENT NAME
Subject: Financial analysis of options pertaining to introduction of new sachet packaging
Dear Sir
The company has already developed this environmental friendly plastic which can be recycled. It
now needs to determine the best strategy to take this product to the market. There are two options
on the table in this regards. This memo aims to provide a financial analysis for each of these
options based on the incremental cost benefit analysis. Further, a recommendation has been
offered considering the financial analysis of the two options.
Financial Analysis – Own manufacturing unit
Before proceeding further, a key point needs to be made regarding $ 50 million investment in
development of the new plastic. This expense has already been incurred by the company and
thereby it has no relevance for the decision at hand. For the purposes of this analysis, it would be
treated as a sunk cost. The estimated benefits expected to arise form the given proposal are
summarized below.
 The recycled plastic is highly energy efficient and requires lower raw material which
would culminate in 15% variables cost decrease.
 Also, the environment friendly nature of the recycled plastic is expected to result in
higher sales from the consumers to the tune of 2%.
However, for manufacturing the sachets, it would be imperative that plant and equipment are
purchased which would require an expenditure of $ 20 million. During the project life,
depreciation would be available using straight line method till the book value becomes zero. This
would enable some relief in tax outflow. Further, additional costs to the tune of $ 2 million
annually would be incurred on account of selling, general and administrative expenses which

would hike on account of this project. Using the information provided along with cost of capital
(8%), the NPV calculations have been performed in the attached spreadsheet (Ehrhardt and
Brigham, 2016).
NPV for setting up own manufacturing facility has come out $1.35 million.
Sensitivity Analysis
The NPV above is not very high and considering that future estimates may deviate, sensitivity
analysis is pivotal to identify crucial factors. This is a useful tool which needs to be considered
especially since the actual figures for the given proposal may show an unfavorable deviation
from the expected value. The two key factors have been identified as the benefits which the
project is expected to provide. The table below indicates the adverse impact of changes in these
factors on the NPV computed above.

It is evident from the above results that the project NPV and feasibility is quite sensitive to
changes in the two benefits identified. Hence, if the management does decide to proceed with
this project, it is essential that any adverse movements in the estimates must be kept under check
(Beck et. al., 2016).
Financial Analysis -Outsourcing
As per the details provided, the company would partner with Clean World, an external vendor
which already has manufacturing setup in place. In this option, the risk exposure for the
company is significantly declined since the company need not make the $ 20 million investment
which would assist in balance sheet deleveraging. Additionally, the expenses related to selling,
general and administrative activities would also dip by $ 1 million annually. However, as part of
the arrangement, the company would not benefit from the local material and manufacturing cost
as it would be kept as profit margin by the external partner. But the benefit pertaining to higher
sales on account of environmental friendly plastic would still be accrued. Using the information
provided along with cost of capital (8%), the NPV calculations have been performed in the
attached spreadsheet.
..

NPV for outsourcing manufacturing to an external partner has come out $9.90 million.
Considering that the NPV from this option is significantly high, thus the margin of safety from
adverse movements in various inputs is quite high. As a result, a separate sensitivity analysis has
not been performed in this case. Further, this option also reduces the overall risk since benefit
only from incremental sales is considered in this model. The reduced variable cost whether
realized to the same extent as envisaged or not would not have any impact on feasibility in the
given proposal (Gitman, Juchaou and Flanagan, 2015).
Recommendation
The requisite capital budgeting technique which has been deployed to decide between the two
mutually exclusive choices is NPV. The NPV is higher in case of outsourcing when compared
with producing the packaging through in house facility setup for the same. Further there are other
key factors which hint at outsourcing of production being the optimal choice. It enables the
company to ensure that incremental debt is not taken and thereby present higher leverage which
would indicate higher business risk. Further, any risks related to variable cost savings not being
realized would pose major downside risk for in-house manufacturing. This risk is automatically
mitigated in outsourcing option. However, the above analysis considers only quantitative
parameters and hence the final decision must also consider qualitative factors. These would be
vital for the given choice as the company has spent $ 50 million in developing the new type of
plastic and thereby would want to leverage the same for creating wealth for shareholders
(Brigham and Houston, 2014).

Yours truly
STUDENT NAME

References
Brigham, E. F. and Houston, J. F., (2014). .Fundamentals of Financial Management (14th ed.).
Boston: Cengage Learning, pp. 143
Berk, J., DeMarzo, P., Harford, J., Ford, G., Mollica, V. and Finch, N. (2016) Fundamentals of
corporate finance. (3rd ed.) London: Pearson Higher Education, pp. 165
Ehrhardt, M. C. and Brigham, E. F. (2016).Corporate Finance: A Focused Approach (6thed.).
London: South- Western College Publisher, pp. 189
Gitman, L.J., Juchaou, R., and Flanagan, J. (2015).Principles of Managerial Finance (6thed.). NSW:
Pearson Australia, pp. 211

Appendix
In-house Manufacturing (NPV)
Outsourcing Production (NPV)