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ACC00152 Business Finance - Free Samples to Students

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Savanah has outlined the following three areas you need to cover in your memo:

1. Analyse base case figures for the three options and using NPV as the investment decision rule;

2. Provide recommendations based on the base-case analyses;
3. Provide recommendations on further analyses and factors that should be considered prior to making a final decision on the three options (Note. You do NOT have to undertake any further financial analyses).

Answer:

Introduction:

Analysis of available three projects has been done by considering method net present value. this methods considers the fundamental concept that the money in future is less worthy than the money in hand today, by considering this the discount on cash flows are done by other time of capital costs. The method also depicts that if or if not to create value for investment, and in what quantity. Further, the NPV measure considers the capital cost and the inborn risk while making proposed plan for future. This will help in creating less impact in the NPV than more expected cash flows taking place in past times.

Decision matrix

 

Statement showing Evaluation of the 3 alternatives

 

 

Particulars

Amount

A

NPV as Per Option I

Production

 $58.66 million

B

NPV as Per Option II

Product licensing

$72.43 million

C

NPV as Per Option III

Patent rights

$72.80 million

Decision

By considering the analysis of all three options, managerial authorities are recommended to selection option C where instead of production is to be done by company, managers can Patent rights provide to Aero Jett Ltd company. However, by giving patent right to Aero Jett Ltd company will create competitor for themselves which can affect their future profitability. 

NPV of Option: A: producing and selling the product by SSF

     

(In$)

Particulars

1

2

3

4

5

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 (275-55)*20%

 $44.00

 $ 44.00

 $ 44.00

 $ 44.00


 $ 44.00

Opportunity Cost (Rent that can be earned)

 $ 7.50

 $ 7.50

 $ 7.50

 $ 7.50

 $ 7.50

Salvage value

 $ 55.00

Cash Flows before tax

 $ 227.50

 $ 50.00

 $ 120.00

 $ 32.50

 $ 5.00

Tax @ 30%

 $68.25

 $ 15.00

 $ 36.00

 $ 9.75

 $ 1.50

Profit after tax

 $ 159.25

 $ 35.00

 $ 84.00

 $ 22.75

 $ 3.50

Add: Depreciation For the Year

 $44.00

 $ 44.00

 $ 44.00

 $ 44.00

 $ 44.00

Add: Recovery of working capital

 $ 79.70

After tax cash flows

 $ 203.25

 $ 79.00

 $ 128.00

 $ 66.75

 $ 127.20

Discounting Factor @ 16%

0.8621

0.7432

0.6407

0.5523

0.4761

Present Value of Cash Flows

 $ 175.22

 $ 58.71

 $82.00

 $ 36.87

 $ 60.56

Total present value of cash inflows

 $ 413.36

Less: Initial investment (Cost of equipment + working capital investment)

 $ 354.70

Net present value

 $ 58.66

Working note 1: Calculation of contribution

     

(In$)

Particulars

1

2

3

4

5

Sales Price per unit

110000.00

70000.00

70000.00

70000.00

50000.00

(-)Variable Cost per unit

35000.00

35000.00

35000.00

35000.00

35000.00

Contribution/ Unit of the Product

75000.00

35000.00

35000.00

35000.00

15000.00

Total Production during the years (in 000 Units)

4000.00

3500.00

5500.00

3000.00

1500.00

Total Contribution

300000000.00

122500000.00

192500000.00

105000000.00

22500000.00

Working note 2: Computation of Net Working Capital

Particulars

 

Sales

Amount

Amount In Million

Account Receivable

(25% of Sales)

440000000

110000000

$110

Account Payable

(20% of Production Overhead and Variable Cost)

151500000

30300000

$30.3

 Working Capital

(Account Receivable- Account Payable)

$79.7

Assumptions

  • $950,000 paid for a production plan and demand analysis is irrelevant as it is already occurred and has not impact on cash flows in future
  • Working capital is computed by reducing current liabilities from current assets

Net present value of Option B where license is to be given to Aero Jett Ltd

Particulars

1

2

3

4

5

Sales units

4200.00

3675.00

5775.00

3150.00

1575.00

Royalty per product

 $ 8,250.00

 $8,250.00

 $ 8,250.00

 $ 8,250.00

 $8,250.00

Total Royalty

 $ 34,650,000.00

 $ 30,318,750.00

 $ 47,643,750.00

 $ 25,987,500.00

 $ 12,993,750.00

Total Royalty (In Millions)

 $ 34.65

 $ 30.32

 $ 47.64

 $ 25.99

 $ 12.99

Tax @ 30%

 $ 10.40

 $ 9.10

 $ 14.29

 $ 7.80

 $ 3.90

After tax cash flows

 $ 24.26

 $ 21.22

 $ 33.35

 $ 18.19

 $ 9.10

Discounting Factor @ 16%

 $ 0.86

 $ 0.74

 $ 0.64

 $ 0.55

 $ 0.48

Present Value of Royalty

 $ 20.91

 $ 15.77

 $ 21.37

 $ 10.05

 $ 4.33

Net present value

 $ 72.43

Net present value of Option C in which patent right is sold to Aero Jett Ltd

Statement showing Cash Inflows if Patent Rights are sold to Aero Jett Inc.

    

Particulars

0

1

2

Patent Fees

 $ 40.00

 $ 40.00

 $ 40.00

Tax @ 30%

 $ 12.00

 $ 12.00

 $ 12.00

Patent Fees after tax

 $ 28.00

 $ 28.00

 $ 28.00

Discounting Factor @16%

 $ 1.00

 $ 0.86

 $ 0.74

Present Value of Patent Fees

 $ 28.00

 $ 24.08

 $ 20.72

Net present value

 $ 72.80


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