You are working in the finance department of Innotech Ltd (INT). The Company has spent $5 million in research and development over the past 12 months developing cutting-edge battery technology
which will be incorporated into the electric vehicle market. INT now need to choose between the
following three options for bringing the product to market. These options are:
Option 1: Manufacturing the product “in-house” and selling directly to the market
Option 2: Licensing another company to manufacture and sell the product in return for a royalty
Option 3: Sell the patent rights outright to the company mentioned in option 2
Your task
Your manager, INT’s CFO, Mr Barry Smith, has asked you to evaluate the three different options and
draft a memo to the Board of Directors providing recommendations on the alternatives, along with
supporting analyses.
Mr Smith has outlined the following three (3) areas you need to cover in your memo:
a) Analyse base case figures for the three options and using NPV as the investment decision
rule;
b) Provide recommendations based on the base-case analyses;
c) Provide recommendations on further analyses and discuss 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).
Further details for the various options are as follows:
Option 1: Manufacturing the product “in-house” and selling directly to the market
Three months ago, INT paid an external consultant $1.5 million for a production plan and demand
analysis. The consultant recommended producing and selling the product for five years only as
technological innovation will likely render the market too competitive to be profitable enough after
that time. Sales of the product are estimated as follows:
In the first year, it is estimated that the product will be sold for $45,000 per unit. However, the price
will drop in the following three years to $40,000 per unit and fall again to $36,000 per unit in the
final year of the project, reflecting the effects of anticipated competition and improving technology
Year Estimated sales volume
(units)
1 5,200
2 4,600
3 4,200
4 3,800
5 3,600
In the first year, it is estimated that the product will be sold for $45,000 per unit. However, the price
will drop in the following three years to $40,000 per unit and fall again to $36,000 per unit in the
final year of the project, reflecting the effects of anticipated competition and improving technology
in the market. Variable production costs are estimated to be $29,000 per unit for the entire life of the
project.
Fixed production costs (excluding depreciation) are predicted to be $3 million per year and marketing
costs will be $1.6 million per year.
Production will take place in factory space the company owns and currently rents to another business for $2.5 million per year. Equipment costing $87 million will have to be purchased. This
equipment will be depreciated for tax purposes using the prime cost method at a rate of 10% per
annum. At the end of the project, the company expects to be able to sell the equipment for $37
million.
Investment in net working capital will also be required. It is estimated that accounts receivable will
be 30% of sales, while inventory and accounts payable will each be 25% of variable and fixed
production costs (excluding depreciation). This investment is required from the beginning of the
project because credit sales, inventory stocks and purchases on trade credit will begin building up
immediately. All accounts receivable will be collected, suppliers paid and inventories sold by the end
of the project, thus the investment in net working capital will be returned at that point. (Refer to
spreadsheet example provided in Assessment Details).
Option 2: Licensing another company to manufacture and sell the product in return for a royalty
Lion Batteries Ltd (LIB), a multinational corporation, has expressed an interest in manufacturing and
marketing the pro
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