ACC00716 Finance - Business Case Studies Assignment Solution

Memorandum

To: CEO

From: Finance manager 

Subject: Produce recycled sachet plastic or license use of patented method

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.

Financial analysis (see spreadsheet in appendix) reveals that the option of producing recycled sachet plastic is more feasible than licensing use of patented method. 

Net present value method has been used to conduct the financial analysis. This method has its own plus points as well as limitations. 

Option 1:

It seems like that with option one there is has an initial investment outlay of $20,000,000 with an $2,000,000 of depreciation expense every year on it. At the same time there are few issues associated with it, to mention few: 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 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. 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. An additional $2 million annually in selling, administrative and general expenses directly related to the project (excluding depreciation) will be incurred. Depreciation (non-cash expense) is added back to compute net cash flow.