Assignment: Analysis and Memo to Management
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- by (Name)
- The Name of the Class (Course)
- Professor (Tutor)
- The Name of the School (University)
- The City and State where it is located
- The Date
- Innotech Ltd (INT) Business Memorandum
- DATE: 11th May 2021
- TO: Board of Directors, Innotech Ltd (INT)
- FROM: Name
RE: Cutting-Edge Battery Technology NPV Marketing Strategy Memo Analysis and Recommendations
I appreciate the opportunity to share my thoughts on the company’s NPV Marketing Strategy Memo for the cutting-edge development of electric vehicles over the next year. As requested, I evaluated the three options for taking the product into the market between manufacturing the product and selling it to the market, licensing Lion Batteries Ltd (LIB) to manufacture the product, sell it for royalties, and sell the patent rights to LIB. The investment decision-making rule used in this analysis is the Present Net Value (NPV). The following is a summary of the method used to analyze the three alternatives.
NPV Marketing Strategy Memo: Strategy 1
This option involves the manufacture and sale of the product for five years, with the expected sales being 5,200, 4,600, 4,200, 3,800, and 3,600 for the first consecutive five years. Given the estimated sales units, the estimated value of sales was calculated based on the expected prices per unit to determine the expected cash inflows, which were discounted based on the 15 percent cost of capital. It would be important to note that the calculation for NPV involved depreciation cash flow because it is not a cash expense. The fixed and variable costs were subtracted per year in the calculation of net cash flows.
| OPTION 1 | ||||||||
|---|---|---|---|---|---|---|---|---|
| Year | Estimated Sale Volume | Estimated Sale Price | Total Annual Sales | Variable Cost | Fixed & Marketing Cost | Option 1 Cash Inflow | Discount Factor | Discounted Cash Flows |
| 1 | 5,200 | $45,000 | $234,000,000 | $150,800,000 | $4,600,000 | $78,600,000 | 1.15 | $68,347,826.09 |
| 2 | 4,600 | $40,000 | $184,000,000 | $133,400,000 | $4,600,000 | $46,000,000 | 1.32 | $34,782,608.70 |
| 3 | 4,200 | $40,000 | $168,000,000 | $121,800,000 | $4,600,000 | $41,600,000 | 1.52 | $27,352,675.27 |
| 4 | 3,800 | $40,000 | $152,000,000 | $110,200,000 | $4,600,000 | $37,200,000 | 1.75 | $21,269,220.74 |
| 5 | 3,600 | $36,000 | $129,600,000 | $104,400,000 | $4,600,000 | $20,600,000 | 2.01 | $10,241,840.75 |
| NPV | $161,994,171.53 |
NPV Marketing Strategy Memo: Strategy 2
This option involves licensing Lion Batteries Ltd (LIB) to manufacture and sell the product relating to cutting-edge battery technology. The calculation of total royalty in this option involved the increase of the estimated volume of sales by ten percent. These annual royalties were then discounted at a 10 percent cost of capital.
| OPTION 2 | |||||
|---|---|---|---|---|---|
| Year | Estimated Sale Volume | LIB Sales | Total Royalty | Discount Factor | Discounted Cash Flows |
| 1 | 5,200 | 5720 | $11,440,000 | 1.15 | $9,947,826.09 |
| 2 | 4,600 | 5060 | $10,120,000 | 1.32 | $7,652,173.91 |
| 3 | 4,200 | 4620 | $9,240,000 | 1.52 | $6,075,449.99 |
| 4 | 3,800 | 4180 | $8,360,000 | 1.75 | $4,779,857.13 |
| 5 | 3,600 | 3960 | $7,920,000 | 2.01 | $3,937,639.74 |
| NPV | $32,392,946.86 |
NPV Marketing Strategy Memo: Strategy 3
This option involves the sale of patent rights to Lion Batteries Ltd (LIB) outright, whereby they would pay four equal annual installments of $10.5 million. These installments were also discounted at a 15 percent cost of capital.
| OPTION 3 | |||
|---|---|---|---|
| Year | Net Cashflow | Discount Factor | Discounted Cash Flows |
| 1 | $10,500,000 | 1.15 | $9,130,435 |
| 2 | $10,500,000 | 1.32 | $7,939,509 |
| 3 | $10,500,000 | 1.52 | $6,903,920 |
| 4 | $10,500,000 | 1.75 | $6,003,409 |
| NPV | $29,977,273 |
The decision on the most desirable of the alternatives was based on net present value, which involves calculating the present value of future cash flows. This is an intrinsic valuation that determines the value of a project. Based on this decision rule, the alternative with the highest net present value is the most preferable.
It was found that option one leads to a net discounted cash inflow of $162 million. Option 2 required that I multiply the sales for option one by 110 percent. This value was multiplied by $2,000, which was discounted at a fifteen percent cost of capital, the discounted cash inflows $32 million. The third option involved the discounting of the future cash inflows of $29 million.
Therefore option 1 is the most preferable of the three alternatives as it has the most positive net present value (Mellichamp, 2019). It is also essential for me to inform the board that the NPV is a decision-making rule. This is because it considers the time value of money on the streams of income.
However, this decision-making rule does not consider the hidden costs, such as depreciation, involving the discounted net present value of cash inflows (Capela et al., 2019). However, the internal rate of return would be necessary if any two or more projects would have equal NPV. In addition, the payback period would be necessary if the initial outlay for the projects was bigger than the first cash inflow (Gorshkov et al., 2018).
I, therefore, recommend that the board adopts option one and disregard options two and three. This will allow that company to account for the expected cash inflows.
NPV Marketing Strategy Memo: Strategy 3 References
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- Mellichamp, D.A., 2019. Profitability, risk, and investment in conceptual plant design: Optimizing key financial parameters rigorously using NPV%. Computers & Chemical Engineering, 128, pp.450-467.
- Gorshkov, A.S., Vatin, N.I., Rymkevich, P.P. and Kydrevich, O.O., 2018. Payback period of investments in energy saving. Magazine of Civil Engineering, (2).
- Capela Moraes, C.A. and Shaiek, S., 2019, April. Subsea Separation: The Way to Go for Increasing Water Production and NPV Optimization. In Offshore Technology Conference. Offshore Tec
