Business feasibility study for the national 'Out and About' Recycling and Litter Initiative

1. Executive summary

2. Introduction

3. Background to the Initiative

4. Market and competitive environment

5. Financial drivers

6. Business case options

7. Financial assessment

8. Facility needs analysis

9. Management and governance

10. Environmental analysis

11. Risk analysis

12. Bin design requirements

Appendix I: Cranleigh's terms of reference

Appendix II: New Zealand and international advertising bins

7. Financial assessment

7.1 Methodology

A detailed financial model has been prepared by Cranleigh to assess the financial implications of the Initiative. This model has the ability to assess profitability and cash flows, and project investment returns and various other financial ratios against a wide range of variables.

The two rollout scenarios discussed above in Section 6 have been modelled. The associated spreadsheet files including profit and loss accounts, balance sheets, cash flows, investment returns and charts have been sent separately with this report.

Set out in the table below is a summary of the results of the modelling which compares base, optimistic and pessimistic scenarios during a ten-year period.

7.2 Key assumptions and constraints

7.2.1 Scenario A: limited coverage

The key assumptions adopted in the financial model are as follows:

• capital costs per bin of $2000
• the bins have been depreciated over five years
• advertising revenue per bin per month of $500
• average advertising occupancy rate of 75%
• advertising commissions are 25% of advertising revenue
• site rentals are 5% of advertising revenue
• the required investment is financed equally between equity and debt
• a total of 1,000 bins are installed over a period of two years.

7.2.2 Scenario B: national basis

The key assumptions adopted in the financial model are as follows:

• the first seven assumptions adopted in Scenario A above also apply to Scenario B
• a total of 2,000 bins are installed over a period of three years
• management costs are increased by $150,000 per annum in year 3 onwards, to meet additional operational needs.

7.3 Summary of financial analysis

7.3.1 Scenario A: Limited coverage

View Scenario A: limited coverage (large table)

7.3.2 Scenario B: National basis

View Scenario B: national basis (large table)

7.4 Results

7.4.1 Scenario A: limited coverage

Based on the assumptions outlined above, this scenario shows strong growth in sales and profitability in the first two years levelling out once all bins are in place. Once established, strong positive cash flows are exhibited except in years where capital expenditure on replacement bins is required.

This generates a project Internal Rate of Return (IRR) of 32%. Given the risk of a new venture many investors would consider this inadequate to proceed with on a commercial basis.

An addition, sensitivity analysis shows that returns are highly sensitive to changes to the advertising revenue per bin and the advertising occupancy rate (the average time that bins have sold advertising on them). A 10% fall in advertising revenue or the occupancy rate reduces the project IRR to only 21% while a 10% drop in both together reduces the IRR to 10%.

As overheads will be similar to the national basis scenario, the full benefits of economies of scale will not be realised leading to greater sensitivity in returns.

A total investment of $2.5 million is required to establish the business.

7.4.2 Scenario B: national basis

With twice as many bins, revenues are twice as high once all bins are in place. However, due to greater economies of scale Net Cash Flow before Tax and Dividends is 140%, or $7.8 million higher over the 10-year forecast period compared to limited coverage scenario.

The resulting project IRR is 63%. While returns are not as highly sensitive to changes to the advertising revenue per bin and the advertising occupancy rate as in the limited coverage scenario, the variability is still significant. A 10% fall in advertising revenue or the occupancy rate reduces the project IRR to 48% while a 10% drop in both together reduces IRR to 32%.

It can be seen that the economies of scale of the larger project increases profitability and reduces the volatility in returns. The total investment required increases to $4.0 million.

7.5 Conclusions

Average revenue per bin and the advertising occupancy rate are the key variables for this project. The price and quantity of recycled materials has little financial impact. Provided the advertising demand is there, Scenario B, involving a roll out of the Initiative on a national basis, has much more attractive investment characteristics that the limited coverage scenario.