Analysis and Recommendation for Bringing Driverless Sports Car to the Market

This memo provides an analysis and recommendation on options available for bringing a driverless sports car to the market. The recommended option is to license the right to manufacture and sell to InoTech Ltd. The analysis is based on the Net Present Value (NPV) of the alternatives.

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) $71,40,00,00
0
$54,90,00,00
0
$49,80,00,00
0
$42,30,00,00
0
$29,00,00,00
0
Less: Expenses
Variable Cost $27,200 per unit $55,48,80,00
0
$49,77,60,00
0
$45,15,20,00
0
$38,35,20,00
0
$31,55,20,00
0
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 $14,60,60,00
0 $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 $10,22,42,00
0 $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
)
$10,95,02,00
0 $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 ($6,38,15,41
2)
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.

Estimated Cash Flows – option B:
Option B: Licensing InoTech Ltd. to manufacture and sell
Year 1 2 3 4 5
Estimated Sales Volume - By MNT 20,400 18,300 16,600 14,100 11,600
Estimated Sales Volume - By InoTech (+2%)
(A) 20,808 18,666 16,932 14,382 11,832
Royalty Fee per unit (B) $180 $180 $180 $180 $180
Total Royalty received (A*B) $37,45,440 $33,59,880 $30,47,760 $25,88,760 $21,29,760
Tax on Patents Rights (30%) $11,23,632 $10,07,964 $9,14,328 $7,76,628 $6,38,928
Net Cash received after tax $26,21,808 $23,51,916 $21,33,432 $18,12,132 $14,90,832
Discounting Factor @15% 0.8696 0.7561 0.6575 0.5718 0.4972
Present value of cash received $22,79,833 $17,78,386 $14,02,766 $10,36,092 $7,41,207
NPV of Licensing to InoTech Ltd $72,38,285
Estimated Cash Flows – option C:
Option C: Selling Patent Rights to InoTech Ltd.
Year 0 1 2 3
Amount for Patent Rights $25,00,000 $25,00,000 $25,00,000 $25,00,000
Tax on Patents Rights (30%) $7,50,000 $7,50,000 $7,50,000 $7,50,000
Net Cash received after tax $17,50,000 $17,50,000 $17,50,000 $17,50,000
Discounting Factor @15% 1.0000 0.8696 0.7561 0.6575
Present value of cash received $17,50,000 $15,21,739 $13,23,251 $11,50,653
NPV of Selling Patents $57,45,644

Supplementary Analysis:
Since, the R&D team suggested that the technology up gradation in the
future will lead to this product becoming obsolete in next 5 years, the
efforts of investing and building up a factory does not seem wise. This is
also evident from the negative NPV of the option A.
The decision to licensing the right to manufacture and sell or selling the
patent has been considered and as evident from the higher NPV, we
should be licensing the right to manufacture and sell to InoTech
Ltd.
The project should be executed as we have already spent $2.7 million for
over 18 months now on the R&D of the project and the same is a sunk
cost. In order to capitalize on the same, we should license the right to
manufacture and sell to InoTech and earn NPV of $72,38,285 for the
company.
Regards.