Analysis and Recommendation for Bringing Driverless Sports Car to the Market

From:
To, The Board of Members, MNT
17th May, 2019
Sub: Analysis and Recommendation on options available for bringing
driverless sports car to the market.
Dear Sir,
The objective of the memo is to bring to your knowledge important financial
information related to the decision of introducing driverless sports car to the
market. We have already spent $2.7 million for over 18 months now on the
R&D of the project and this innovation in the car industry will give us a
competitive edge and we will be able to improve the profitability of the
company with the launch of the product.
For bringing the car to the market, we have 3 alternatives as below:
a. Produce the car “In-House” and sell directly
b. License the right to manufacture and sell to InoTech Ltd and earn
royalty on each unit that they sell.
c. Sell the complete patent right to InoTech Ltd and earn patent income
in 4 equal instalments.
Method Followed: The viable option among all would be the one that would
maximize our profit and create wealth for us. The concept of Net Present
Value has been used to analyse the options as it is the most logical, robust
and an accurate method of evaluating future projects.
Key Findings: The analysis reveals that the opportunity will be prosperous
for the initial 5 years only after which new technologies will emerge leading
to obsolescence of the product. This is also one of the other factors which
must be considered when setting up factory as the same needs to be
disposed after 5 years.
Recommendation: Based on the NPV of the 3 available alternatives, it is
advised to license the right to manufacture and sell to InoTech Ltd and earn
royalty on each unit that they sell as the NPV of the option is the highest
indicating that it would create maximum wealth for the shareholders.
Key Financial Analysis: The key financial analysis point for the 3 options
was evaluating the project based on NPV. The computation of the same is
attached as below for your ready reference and easy decision making.

Estimated Cash Flows – option A:
Option A: Producing the Product "In-House"
Year 0 1 2 3 4 5
Estimated Sales Volume (A) 20,400 18,300 16,600 14,100 11,600
Estimated Sales Price per unit (B) $35,000 $30,000 $30,000 $30,000 $25,000
Total Sales Revenue (A*B) $71,40,00,000 $54,90,00,000 $49,80,00,000 $42,30,00,000 $29,00,00,000
Less: Expenses
Variable Cost $27,200 per unit $55,48,80,000 $49,77,60,000 $45,15,20,000 $38,35,20,000 $31,55,20,000
Fixed production Cost (excl Dep) $29,00,000 $29,00,000 $29,00,000 $29,00,000 $29,00,000
Marketing Cost $14,00,000 $14,00,000 $14,00,000 $14,00,000 $14,00,000
Opportunity Cost (Factory Space) $15,00,000 $15,00,000 $15,00,000 $15,00,000 $15,00,000
Depreciation for tax purpose (11%) $72,60,000 $72,60,000 $72,60,000 $72,60,000 $72,60,000
Income Before Tax $14,60,60,000 $3,81,80,000 $3,34,20,000 $2,64,20,000 ($3,85,80,000)
Tax on Income (30%) $4,38,18,000 $1,14,54,000 $1,00,26,000 $79,26,000 ($1,15,74,000)
Net Income $10,22,42,000 $2,67,26,000 $2,33,94,000 $1,84,94,000 ($2,70,06,000)
Add: Depreciation (Non-Cash Expenses) $72,60,000 $72,60,000 $72,60,000 $72,60,000 $72,60,000
Less: Equipment Cost ($8,00,00,000)
Add: Salvage Value of Equipment $1,40,00,000
Changes in NWC (Refer WN -1) ($17,13,60,000) $6,96,00,000
Net Cash Flow ($25,13,60,000) $10,95,02,000 $3,39,86,000 $3,06,54,000 $2,57,54,000 $6,38,54,000
Discounting Factor @15% 1.0000 0.8696 0.7561 0.6575 0.5718 0.4972
Present value of cash received ($25,13,60,000) $9,52,19,130 $2,56,98,299 $2,01,55,503 $1,47,24,933 $3,17,46,723
NPV of Producing In House ($6,38,15,412)
Notes: The depreciation on the equipment is computed as 11% of the remaining value ($80 million - $14 million).
Since, depreciation is a tax-deductible but non-cash expense; it is deducted to arrive at the net income after tax and
then added to the net income to compute the free cash flow.