Finance Case Study
Assessment 3: Business Case Studies 2 ACC00716 S1 2019
ACC00716 Finance Session 1, 2019
Assessment 3: Business Case Studies 2
Due date: 19 May 2019, 11PM
This assignment has a 25% weighting in your overall mark for this unit and focuses on content from Weeks 6, 7 and 8. The assignment will be marked out of 25 and marks will be allocated as indicated in the rubric on page 4. Your total assignment submission will consist of a word document and a spreadsheet.
The assignment is based on the case information below. While the company and financial data in the case are fictitious1, the context is not. Many companies face similar investment decisions as well as challenges and opportunities to run more environmentally and socially responsible businesses.
DuoLever Limited operates in the personal care (e.g. skin and hair care products) industry. All its products are sold in plastic packaging and a significant proportion in multi-layer sachets (or pouches)2.
Managers at DuoLever are acutely aware of the increase in world production of plastic and the environmental impact of plastic waste ending up in landfills, rivers and oceans. For example, it is estimated that 8 million metric tons entered the ocean in 2010 and this annual amount is predicted to more than double by 2025, accumulating as show in the following graph3:
To help develop a closed-loop system related to the company’s products, DuoLever has invested around $50 million in soft plastic recycling research, development and pilot testing. The outcome is a new and efficient method for recycling sachet waste. In fact, their recycling method is more energy efficient than producing virgin sachet plastic, reducing energy usage by 83%. The output plastic is of
1 UniLever and its research and development in the area of multi-layer sachet recycling provides the inspiration for this case but all facts related to the financial analysis are fictitious.
2 While not necessary for attempting this case study, you will better understand the plastic packaging in this case context if you go to https://www.plasticpackagingfacts.org/blog/multi-layer-pouch-packaging-a-sustainable-story-animated/ and watch the video on multilayer plastic pouches. Although many improvements to this packaging have been made, as pointed out in the video, there remains much to do in reducing the impacts of waste pouches on the environment.
3 Estimates from Jambeck, J.R., Andrady, A., Geyer, R., Narayan, R., Perryman, M., Siegler, T., Wilcox, C., Lavender Law, K. (2015) Plastic waste inputs from land into the ocean, Science, 347, p. 768-771 and graph reproduced from p. 770. If you are interested, see see https://jambeck.engr.uga.edu/landplasticinput for further details and an infographic.
Assessment 3: Business Case Studies 2 ACC00716 S1 2019
such high quality it can be used in food grade packaging applications. Currently, no other recycling method in the market can achieve this.
The company now faces a decision: should it (1) add production of recycled sachet plastic to the company’s portfolio of businesses or (2) license use of the patented method? The CEO has asked you to undertake a financial analysis of the options and present your recommendations in a short memo.
The recycling production option requires an upfront investment in plant and equipment of $20 million, which will be depreciated to a zero book value on a straight-line basis over 5 years. The plant will provide sufficient capacity to meet the company’s forecast plastic packaging needs over the period of its life. After this, it is expected that the plant will have no salvage value and will be updated using new and better technology. Financing for the plant and equipment will be via a new 5 year debt issue, resulting in interest costs of $1.4 million payable at the end of each year.
Producing recycled plastic has several financial benefits for the company. First, sales revenue of the company’s existing products, which will be packaged in the recycled plastic, is predicted to increase due to consumer demand for environmentally responsible products. Excluding this benefit, the company’s forecast sales revenue for the coming year is $200 million and this is expected to grow by 4% each year after that. The benefit of recycled packaging is expected to increase these sales forecasts 2% during the 5 year life of the project.
The second benefit is that the cost of plastic packaging for the company’s existing products will decrease. The recycled plastic will be cheaper than buying virgin plastic due to lower energy costs and avoiding a supplier margin. The reduced energy costs will shave 15% off total variable packaging costs, currently (without recycling) estimated at $22 million for the coming year and expected to grow by 3% per year after that. Avoiding a supplier margin will reduce total variable packaging costs by 10%. However, the benefits of avoiding the current supplier margin will be offset by the need to pay a new partner, Clean World Ltd, who will set up a plastic waste collection system to supply sufficient raw material for the recycling plant. Apart from these changes, it is expected that variable costs and net working capital will be equivalent to existing forecasts. However, an additional $2 million annually in selling, administrative and general expenses directly related to the project (excluding depreciation) will be incurred.
Option 2 involves licensing use of the patented recycling method to another company, Clean World Ltd, which has shown interest in taking on the entire project, not just supply of raw material. Initial negotiations between DuoLever and Clean World have reached some agreement on what the terms of the arrangement would involve. Clean World would produce recycled plastic using DuoLever’s method for the next 5 years and all output during that time would be supplied exclusively to DuoLever for the same cost as DuoLever’s existing virgin plastic supply forecasts. This means that Clean World would capture the energy savings associated with the new recycling method, along with a supplier margin. The benefits for DuoLever would be no initial outlay for plant and equipment and locked in packaging materials supply costs for the next 5 years. DuoLever would also retain the ability to market the environmentally responsible characteristics of its recycled packaging and so retain the expected
Assessment 3: Business Case Studies 2 ACC00716 S1 2019
additional sales revenue benefits of Option 1. Annual selling, administrative and general expenses would be just $1 million annually under Option 2, as no additional production administration would be required.
DuoLever has an 8% weighted average cost of capital and is subject to a 25% tax rate on its income.
Prepare (1) a spreadsheet financial analysis of the proposed options and (2) a memo to DuoLever’s CEO that briefly explains and justifies your chosen methods, inputs and any assumptions made, summarises your findings, and presents your recommendations on the proposed options. Ensure you not only address base case cash flows but also analyse potential uncertainty. Recommendations should address the decision to be made, along with any further follow up or other matters the company should consider prior to making a final decision.
Submit your spreadsheet separately in the provided spreadsheet link in the BCS2 section of the unit site. By submitting the spreadsheet, you are confirming that it is entirely your own work. Save the spreadsheet with your details in the file name using the following format (failure to do so could result in your spreadsheet not being considered in marking):
For example: 13579246_Jennifer_Harrison_ACC00716A3
The memo will be submitted as a word document via a Turnitin assignment link in the BCS2 section of the unit site and include your name, student ID, unit code (ACC00716), assessment number (A3) and word count at the beginning of the document. The remainder of the document should be set up as a formal memo and include an appendix with a screen shot(s) of your base case figures from the spreadsheet. Within the memo body, you may provide tables and figures that are discussed in the text and assist decision makers understand your methods, findings and their implications for decision making. The word document submission must not exceed 1,000 words (excluding the screen shot appendix and reference list).
This is an individual assessment exercise. The unit teaching team is very experienced at marking such assessments and recognising the differences between individual and “group” work, as well as data, facts, statements and ideas of others that have not been appropriately acknowledged. To avoid any potential for academic misconduct investigation, ensure that every aspect of your work is your own and that you acknowledge all sources you have directly drawn upon in your submitted work. Quotations should be shown as such. We are not fussy about referencing style, just that you reference when needed.
Assessment 3: Business Case Studies 2 ACC00716 S1 2019
Accurate estimation of relevant base case cash flows and decision criteria (12 marks)
All relevant base case cash flows have been accurately incorporated into the analysis and net cash flows and decision criteria are correct. (12 marks)
Nearly all relevant base case cash flows have been accurately incorporated into the analysis and decision criteria are correct based on your net cash flows (10 marks)
Most relevant base case cash flows have been accurately incorporated into the analysis and decision criteria are mostly correct based on your net cash flows. (8 marks)
About half the relevant base case cash flows have been accurately incorporated into the analysis and decision criteria are mostly correct based on your net cash flows. (6 marks)
Less than half the relevant base case cash flows have been accurately incorporated into the analysis and decision criteria may be mostly incorrect based on your net cash flows. (0 to 4 marks)
Accurate and appropriate analysis of uncertainty (5 marks)
You have accurately analysed project uncertainty using appropriate techniques. You have shown insight by judicious input choices that are well-articulated and linked to case facts. The analysis is easy to follow. (5 marks)
You have accurately analysed project uncertainty using appropriate techniques and judicious input choices that are mostly well-articulated and linked to case facts. The analysis is easy to follow. (4 marks)
You have analysed project uncertainty using appropriate techniques and mostly judicious input choices that are mostly well-articulated and linked to case facts. The analysis is easy to follow. (3.5 marks)
You have analysed project uncertainty using at least one appropriate technique. Input choices lack justification, are unreasonable or the analysis is not easy to follow. (2.5 marks)
You have not analysed project uncertainty using appropriate techniques or have attempted to use at least one appropriate technique but with no demonstrated consideration of input choices in a hard to follow analysis or there are major inaccuracies. (0 to 2 marks)
Appropriate interpretation and recommendations based on the project analysis (8 marks)
You have accurately interpreted the results of your financial analysis and made appropriate and insightful recommendations with the basis of those recommendations clearly and concisely explained. Recommendations go further than simply accepting or rejecting the project by recognising the subtleties of project decision making and needed additional analysis or considerations. Use of language makes meaning consistently clear; no or very few grammar, syntax and spelling errors. (8 marks)
You have accurately interpreted the results of your financial analysis and made appropriate recommendations. Recommendations go further than simply accepting or rejecting the project by recognising some subtleties of project decision making and/or needed additional analysis or considerations. Use of language mostly makes meaning clear; no or very few grammar, syntax and spelling errors. (6.5 marks)
You have accurately interpreted most of the results of your financial analysis and made some appropriate recommendations. Subtleties of project analysis and decision making have generally not been recognised. Use of language mostly makes meaning clear; several grammar, syntax and spelling errors. (5.5 marks)
You have accurately interpreted some of the results of your financial analysis and made at least one appropriate recommendation. Use of language mostly makes meaning clear; several grammar, syntax and spelling errors. (4 marks)
You have not correctly interpreted most results from your financial analysis or no recommendations have been made or recommendations do not follow from the results or interpretation. Use of language mostly makes meaning unclear; many grammar, syntax and spelling errors. (0 to 3 marks)
TO: CEO DUOLEVER LIMITED
FROM: INVESTMENT TEAM
DATE: May 5, 2019
SUBJECT: APPRAISING TWO PROJECTS
This is to report to you the analysis and evaluation of the two development projects for the recycling methods. The first project involves the purchase of new machinery and equipment to facilitate the recycling method. The second project option involves the use of a patented licensing method of Clean World Ltd. The report shows the decision criteria and the project that is most viable for the company.
The two projects are expected to run for a useful life of 5 years, during which they are expected to generate cash flows for the company. The first project option has an initial outlay of $2,000,000 and is depreciated on a straight line basis since it has no salvage value (Farell, 2016, pg.1). The second investment option has no initial capital outlay. Thus no depreciation was carried out. The base case was estimated on the current level of the company’s revenues and costs, which were expected to remain constant within the five years. Investment option one variable costs are assumed to grow at 3% annually while revenues increase by 4% every year. In investment option two, the costs and revenue increase as in option one, but there are no energy cost savings made. The weighted average cost of capital and the income tax rate of the company was 8% and 25% respectively.
The two projects are evaluated using the net present value method. Net present value is used since the projects are mutually exclusive, and the company is required to invest in one that generates a higher return (El-Halwagi, 2017, pg.611). Also, cash flows of each investment option are compared against the base case to estimate cash flow changes that influence investment in either of the projects for the company (Nekrasova, Leventsov, and Axionova, 2016, pg.741).
Base Case Analysis
The estimation for cash flows is done by using the current sales volume of the company. Also the current variables costs and selling, general and administrative expenses are used. The annual tax rate is 25% and the weighted average cost of capital is 8%. The results of the base case analysis are as follows.
Metric Base case value Investment rating Explanation
Net present value $527,037,724.89 Accept The net present value is positive hence this will increase the value of the firm
Payback period 0 Accept There is no initial outlay
Discounted payback period 0 Accept The firm does not need to incur initial costs
Profitability Index –
Figure 1: Base case analysis
The sensitivity analysis was done on the net sales, variable costs as well as the selling, general and administrative expenses of the firm. The variables were estimated against net present value for the both pessimistic and optimistic. In all cases the company will generate a higher net present value as shown in the table below.
Npv Pessimistic Npv current Npv optimistic
Net sales $467,147,074.34 $527,037,724.89 $586,928,375.45
Variable costs $520,449,753.33 $527,037,724.89 $ 533,625,696.46
Selling and distribution $526,438,818.39 $527,037,724.89 $ 527,636,631.40
Figure 2: Sensitivity analysis of the base case
The changes in net present value were plotted to obtain the graph below which shows how net present value is sensitive to changes in net sales, variable costs and selling, general and administrative expenses (Iamsiraroj, 2016, pg.116).
Figure 3: Sensitivity analysis of base case
Figure 4: Sensitivity analysis of option 2
The base case, investment option 1, and investment option 2 have a positive net present value. However, the second investment option has a higher net present value. The base case has a net present value of $527,037,724.89, the first option $598,212,797.32 while the option 2 results in a net present value of $603,998,017.94. The second option projects result in a higher net present value since there is no initial investment costs incurred in the project as well as the sales, general and administrative expenses of the company reduced from $2,000,000 to $,1000,000 which enables the company to benefit from cost savings from operations.
Option Net present value
Base case $527,037,724.89
Option 1 $598,212,797.32
Option 2 $603,998,017.94
Figure 3: Net present value for base case, option 1 and option 2
Conclusion and Recommendations
The company needs to adopt investment option 1. The project, despite having a lower net present value the company will benefit from high net cash flows returns during the project life for the next five years (Lee and Shin, 2018, pg.35). Moreover, the company will save on costs since the investment in new machinery would result in 10% energy costs savings as well as reducing the supplier margin for raw materials. Consequently, investing in option 1 will help the company to achieve its sustainability by reducing energy costs. The projects were evaluated on the ability to generate future cash flows for the company rather than increase in the future value since if the project were to extend for five years, the net present value would increase.
Therefore, we recommend for approval of the investment in new equipment and machinery. The investment will facilitate cost savings and is likely to generate more cash flows for the company. Also, the company needs to invest in projects that aim at reducing environmental costs. These projects are likely to improve sustainability within the company as well with the members of the public (Tukker and Tischiner, 2017, pg.1).
El-Halwagi, M.M., 2017. A return on investment metric for incorporating sustainability in process integration and improvement projects. Clean Technologies and Environmental Policy, 19(2), pp.611-617.
Farrell, B., 2016. Depreciation and the Time Value of Money. arXiv preprint arXiv:1605.00080.
Iamsiraroj, S., 2016. The foreign direct investment–economic growth nexus. International Review of Economics & Finance, 42, pp.116-133.
Lee, I. and Shin, Y.J., 2018. Fintech: Ecosystem, business models, investment decisions, and challenges. Business Horizons, 61(1), pp.35-46.
Nekrasova, T., Leventsov, V., and Axionova, E., 2016. Evaluating the efficiency of investments in mobile telecommunication systems development. In the Internet of Things, Smart Spaces, and Next Generation Networks and Systems (pp. 741-751). Springer, Cham.
Tukker, A. and Tischner, U. eds., 2017. New business for old Europe: product-service development, competitiveness, and sustainability. Routledge.
1. Base case
2. Option 1
3. Option 2
4. Option 2 sensitivity analysis
5. Base case sensitivity Analysis