Evaluation of Investment Options using Net Present Value Tool

This memo evaluates three investment options using Net Present Value tool and recommends the most suitable option. Supporting analysis is also provided.

ACC00152 Business finance
Assignment 1: Memo to management

MEMO
To
Savanah Harley
Chief financial officer
Space Sky Flight Ltd (SSF)
Subject: Evaluation of three investment options by considering Net present value investment
appraisal tool to recommend suitable option.
Net present value
For the present analysis NPV is selected because this tool shows computation that makes
comparison of the invested amount to the present value of receipts of future cash flows from
the investment. The amount that is invested is contrasted with the amounts of future cash
after the deduction of discount by a given rate. It is an evaluation of profit computed by
deducting the present value of cash outflows inclusive of initial costs from the cash inflows
of prevents value over the time. Decision rule:
NPV must be positive and comparatively higher than available options
Decision table1
Investment option Net present value of project Option to be selected
Option A $59.89 million Option C should be selected
as it has highest NPV.Option B $72.43 million
Option C $79.7 million
Option C is also beneficial because merely patent rights are sold to other Aero Jett Ltd in
future if company believes that they can produced at lower cost and to earn higher benefits
then they can relinquish the rights.
From
Finance department
Space Sky Flight Ltd (SSF) Date 11-May-2018
1 Above described recommendations has been provided by considering supporting analysis.

SUPPORTING ANALYSIS
NPV of option 1
Statement showing Cash Inflows if product is manufactured in house and sold
directly to the market
(In$)
Particulars Year 1 Year 2 Year 3 Year 4 Year 5
Sales Price/ Unit of the
Product 110000 70000 70000 70000 50000.00
(-)Variable Cost/ Unit of
the Product 35000 35000 35000 35000 35000.00
A
Contribution/ Unit of the
Product 75000 35000 35000 35000 15000.00
Total Production during
the years (Units) 4000 3500 5500 3000 1500.00
Total Contribution 300000000 122500000 192500000 105000000 22500000
B
Total Contribution (in
Millions) 300.00 122.50 192.50 105.00 22.50
Fixed Production Cost 11.50 11.50 11.50 11.50 11.50
Fixed Marketing Cost 9.50 9.50 9.50 9.50 9.50
Depreciation (Working
Note 1) 44.00 44.00 44.00 44.00 44.00
Opportunity Cost of Rent
foregone 7.50 7.50 7.50 7.50 7.50
C Cash Flows before tax 227.50 50.00 120.00 32.50 -50.00
D Tax @ 30% 68.25 15.00 36.00 9.75 0.00
E Cash Flows After Tax 159.25 35.00 84.00 22.75 -50.00
Add: Depreciation For
the Year 44.00 44.00 44.00 44.00 44.00
F
Net Cash Inflows for the
Years 203.25 79.00 128.00 66.75 -6.00
G
Discounting Factor @
16% 0.86 0.74 0.64 0.55 0.48
H Present Value of Cash
Flows 175.22 58.71 82.00 36.87 -2.86
Statement showing Total Cash Inflows during the entire life of the Project

Particulars Amount (In Million)
A Total Present Value of Cash Inflows 349.94
B
Salvage Value of Equipment at the end of the
Project 55.00
C Investment in Net working Capital 79.70
D Discounting Factor at the end of 5th Year 0.48
E
Present Value of Salvage Value and Investment in
Net Working Capital at the end of the Project 64.66
F Total Present Value of Cash Inflows 414.59
Statement Showing Initial Outlay of the Project if product is manufactured in
house and sold directly into the market
Particulars
Amount (In
Million $)
A Cost of the Equipment 275
B Investment in Working Capital (Working Note 2) 79.7
C Total Initial Outlay of the Project 354.7
Statement showing NPV of the Project
Amount (In
Million$ )
A Present Value of Cash Inflows over the Period of Project 414.59
B Initial Outlay of the Project 354.7
C Net Present Value 59.89
Notes Cost of plan and demand analysis is sunk cost in option A.
NPV of option 2
Statement showing Cash Inflows if product is manufactured by Aero Jett Inc.
(In$)
Particulars Year 1 Year 2 Year 3 Year 4 Year 5
A Sales Volume (In Units) 4200 3675 5775 3150 1575
B Royalty/ Product 8250 8250 8250 8250 8250
C Total Royalty 34650000 30318750 47643750 25987500 12993750
D Total Royalty (In Millions) 34.65 30.32 47.64 25.99 12.99
E Tax @ 30% 10.40 9.10 14.29 7.80 3.90

F Cash Flows after tax 24.26 21.22 33.35 18.19 9.10
G Discounting Factor @ 16% 0.86 0.74 0.64 0.55 0.48
H
E Present Value of Royalty 20.91 15.77 21.37 10.05 4.33
F
Total Net Present Value
of Royalty 72.43
NPV of option 3
Statement showing Cash Inflows if Patent Rights are sold to Aero Jett Inc.
Particulars Year 0 Year 1 Year 2
A Patent Fees 40 40 40
B Tax @ 30% 12 12 12
C Patent Fees after tax 28 28 28
D Discounting Factor @16% 1 0.86 0.74
E Present Value of Patent Fees 28 24.08 20.72
F Total Net Present Value If Patent Rights are sold 72.8
Working note
Working Note 1
Computation of Depreciation
(In Millions)
Particulars Amount
Cost of the Equipment 275
Salvage Value at the end of the Project 55
Net Cost of the Equipment 220
Rate of Depreciation 20%
Depreciation/ Annum 44
Working Note 2
Computation of Net Working Capital
Particulars Sales Amount
Amount In
Million
Account Receivable (25% of Sales) 440000000 110000000 110
Less: Account Payable (20% of
Production Overhead and Variable Cost) 151500000 30300000 30.3
Net Investment in Working Capital 79.7