Capital budgeting evaluation

MEMO

Date: 18^th May 2019

To: DuoLever’s CEO

From:

Subject: Capital Budgeting Analysis of Alternative Options

Dear Sir,

I am hereby presenting the findings about the analysis done for evaluating alternative options available for running the business in environmentally and socially responsible way. After reviewing the case study, it appears that Duo Limited is trying to determine whether to add production of recycled sachet plastic to company’s portfolio of business or license the use of its patented method to partner company Clean World Ltd. The following is the expected net profit of the company if none of the option is selected:

The assumptions associated with above analysis are:

1. The sales for first year are expected to be $200 million with a growth rate of 4% every year.
2. The variable packaging cost is $22 million with a growth rate of 3% every year.
3. The selling, administration and general cost are expected to be $1 million.

OPTION 1:

It appears that the option 1 has an initial investment outlay of $20,000,000 with $2,000,000 depreciation expense every year. The following incremental benefits and costs are expected to flow to Duo Ltd. if the option 1 is selected:

The above analysis is done based on following assumptions:

1. Additional sales benefits will flow to Duo Ltd. at 2%.
2. The variable cost will reduce by 15%.
3. Due to avoiding supplier margin, the variable cost will further decrease by 10% however a new partner payment of 10% will offset this benefit.
4. The additional selling, administration and general expenses associated to option 1 is expected to be $2 million annually.
5. The whole project is funded through loan at interest payment of $1.40 million annually.
6. The machinery used for producing recycled plastic will depreciate at 20% straight line method for 5 years with cost of $20 million. So, depreciation expense of $4 million is expected annually.
7. The tax rate is given to be 25%.

Option 2:

Option 2 will allow Duo Ltd. to allow Clean World Ltd. for using the patented recycling method researched and developed by Dup. Ltd. If this option is followed, no initial investment has to be made and the supply cost will remain fixed for next five years. This method will also allow Duo to enjoy additional sales revenue as calculated under option 1 with no extra selling and administration expenses. So, no additional cost is expected to arise in this option however additional benefits are as follows:

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