Evaluation and Selection of Financial Alternatives for MicroNet Technologies Ltd

MEMO
Date: May 21, 2019
To: The Board of Directors, MicroNet Technologies Ltd (MNT).
From: Person ABC
Subject: Evaluation and Selection among various Financial Alternatives
proposed by the Company.
MNT Ltd., through the endeavor of its Research & Development team over the past 18
months has successfully developed a break-through technology which can be incorporated
into driverless sports car. The company is now faced with three alternatives to choose from
to give its concept a practical shape. Below are the three options available to the company
that needs to be evaluated and discussed prior to final selection.
The options are as follows:-
A) Manufacturing the product “in-house “and selling directly to the market.
B) Licensing another company to manufacture and sell the product in return for a royalty.
C) Sell the patent rights outright to the company mentioned in Option B.
All the options are empirically analyzed in regards to the Net Present Value method (NPV)
and the Profitability Index basis the data that have been provided. A brief report is provided
based on the outcome of the analysis for each option and finally a recommendation to the
board for the final selection of the best one.
Option-A: Manufacturing the product “in-house “and selling directly to the
market.
Step-wise explanation of the empirical analysis
Sl.
No.
Steps /
Particulars
Explanation
1
Sales Volume Yearly Forecasted units of sale are given as per the production plan &
demand analysis.
Sale Price Estimated per unit price for different years given as per the production
plan & demand analysis.
Total Sales Total turnover or sales arrived by multiplying the sales volume of
different years with respect to their price per unit.
2
Variable Cost The Variable Cost is calculated by multiplying the Variable Cost per unit
with the estimated sale units per year as per the data provided.
Contribution Subtracting the Variable Cost from the Total Sales gives the contribution.
Thus, the formula is as such Contribution= Sales – Variable Cost.
3 Factory Rent Since, for exercising Option A, the company needs to use the factory
space the company owns. Hence, though not actually an expense, i.e.,
imputed, it needs to be deducted as an expense from the contribution for
taxation purpose.
Fixed Cost It is an expense and hence needs to be deducted from contribution to
arrive at profit before tax.

Marketing
Cost
Same as Fixed Cost.
Salvage Value It is the scrap value that the equipment/asset possesses at the end of its
life and hence, sale of such asset is an income and is added with the
contribution.
Profit It is arrived as follows: Profit= Contribution – Factory Rent – Fixed
Cost – Marketing Cost
+ Salvage Value
3
Depreciation It is the decrease in the value of the asset every year due to its usage
and wear and tear. Depreciation has been calculated at 11% on prime
cost method. Calculation shown on Working- 1 below.
Earnings
before
interest and
Tax (EBIT)
It is the amount calculated after deducting the Depreciation from the
Profit. The formula is as follows: EBIT= Profit or EBIDT (Earnings
before Interest, Depreciation and Tax) –
Depreciation
Please note: Since there is no interest, therefore, EBIT & EBT are
both the same.
4
Tax Now the Tax is calculated as per the rate given (30%).
Earnings after
Tax / Net
Income
After the tax is deducted from EBIT, the company is left with its own
residual income and thus the name net income.
5
Net Cash
Flow
Since, after the tax is deducted and net income is generated, we now
add back the depreciation and the factory rent to arrive at the Net Cash
Inflow as depreciation is something calculated and deducted on books
but not on reality. Hence the actual amount of depreciation remains
intact which is the reason for its addition. Similarly, Factory rent is
imputed, i.e., not actually paid and is thus added back.
6
Discount Rate It is the rate by which the value of a $1 depreciates in the upcoming
years. Given 15% as the Discount rate, the values of $1 in different years
are calculated in the table.
Present Value The Present Value is derived by multiplying the Net Cash Flow with the
Discount rate.
Present Value
of all Cash
Flows
All the discounted yearly cash flows are now added to get the net return
from the investment.
Calculation of NPV for Option- A and its Profitability Index
Variable Cost (Fixed for all years) $27,200.00
Year 1 2 3 4 5
Sales Vol (Units) 20400 18300 16600 14100 11600
Sales/Unit $35,000.00 $30,000.00 $30,000.00 $30,000.00 $25,000.00
Total Sales $7140,00,000.
00
$5490,00,000.
00
$4980,00,000.
00
$4230,00,000.
00
$2900,00,000.0
0
Less: Variable Cost
-
$5548,80,000.
00
-
$4977,60,000.
00
-
$4515,20,000.
00
-
$3835,20,000.
00
-
$3155,20,000.0
0
Contribution $1591,20,000. $512,40,000.0 $464,80,000.0 $394,80,000.0 -$255,20,000.00

00 0 0 0
Less: Factory Rent
(Imputed)
-
$15,00,000.00
-
$15,00,000.00
-
$15,00,000.00
-
$15,00,000.00 -$15,00,000.00
Less: Fixed Cost -
$29,00,000.00
-
$29,00,000.00
-
$29,00,000.00
-
$29,00,000.00 -$29,00,000.00
Less : Marketing
Cost
-
$14,00,000.00
-
$14,00,000.00
-
$14,00,000.00
-
$14,00,000.00 -$14,00,000.00
Add: Salvage Value
of Equipment - - - - $140,00,000.00
Profit $1533,20,000.
00
$454,40,000.0
0
$406,80,000.0
0
$336,80,000.0
0 -$173,20,000.00
Less : Depriciation -
$72,60,000.00
-
$72,60,000.00
-
$72,60,000.00
-
$72,60,000.00 -$72,60,000.00
EBIT/ EBT $1460,60,000.
00
$381,80,000.0
0
$334,20,000.0
0
$264,20,000.0
0 -$245,80,000.00
Less: Tax (30%)
-
$438,18,000.0
0
-
$114,54,000.0
0
-
$100,26,000.0
0
-
$79,26,000.00 $73,74,000.00
EAT/ Net Income $1022,42,000.
00
$267,26,000.0
0
$233,94,000.0
0
$184,94,000.0
0 -$172,06,000.00
Add: Depriciation $72,60,000.00 $72,60,000.00 $72,60,000.00 $72,60,000.00 $72,60,000.00
Add: Factory Rent $15,00,000.00 $15,00,000.00 $15,00,000.00 $15,00,000.00 $15,00,000.00
Net Cash Flow $1110,02,000.
00
$354,86,000.0
0
$321,54,000.0
0
$272,54,000.0
0 -$84,46,000.00
Discount Rate / Cost
of Capital (15%) 0.87 0.76 0.66 0.57 0.50
Present Value of
Cash Flows
$965,23,478.2
6
$268,32,514.1
8
$211,41,776.9
4
$155,82,562.9
6 -$41,99,154.71
Present Value of
All Cash Flows $1558,81,177.63
Initial Cost
$1531,00,000.
00
Net Present Value and Profitability Index is calculated as follows:-
NPV =Present Valueof all Cash Flows – Initial Cost
Profitability Index= Present Value of all Cash Flows
Initial Cost
Net Present Value $27,81,177.63
Profitability Index 1.02
Workings -1:
Depreciation
Asset Cost
$800,00,000.
00
Depreciation is calculated as follows:-
Depreciation= Given rate of depreciation
100 X (Asset Cost−Salvage Value)Salvage Value
$140,00,000.
00
Depreciation/annum
$72,60,000.0
0
Workings -2: Initial Cost of
Investment