ACC00152: Manufacture and Sell the Product - Investment Decision Rule - Accounting Assignment Help

Assignment Task :

You are working in the finance department of Innotech Ltd (INT). The Company has spent $3.4 million in research and development over the past 12 months developing battery technology which  will be incorporated into the Australian luxury car 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 $1.2 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: 

final year of the project, reflecting the effects of anticipated competition and improving technology  in the market. Variable production costs are estimated to be $27,300 per unit for the entire life of the  project.  

Fixed production costs (excluding depreciation) are predicted to be $3.1 million per year and  marketing costs will be $1.5 million per year.  

Production will take place in factory space the company owns and currently rents to another  business for $2 million per year. Equipment costing $90 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 $40 million.  

Investment in net working capital will also be required. It is estimated that accounts receivable will  be 25% of sales, while inventory and accounts payable will each be 20% 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  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 product under license for 5 years. For each unit sold, LIB will pay $1,000 royalty fees  per unit to INT as part of its licensing agreement. Due to LIB’s international reach and strong  distribution networks, it is estimated that they can sell 5% more units each year than INT.  

Option 3: Sell the patent rights outright to the company mentioned in option 2 

As an alternative to a licensing arrangement, LIB has offered to buy the patent rights to the product  design from INT for $15 million. This amount would be paid in 4 (four) equal annual instalments, with  the first payable immediately.  

General Information Relevant to the Analysis  

INT’s cost of capital is 12% and the company is subject to a 30% tax rate. Assume that royalties and  patent right payments are treated as assessable income for tax purposes and that tax is paid at the  end of the year in which the income is received. The company is not eligible for any research and  development tax deductions. During the project analysis period(s), INT is expected to have other  sources of taxable income.  

Marking Criteria  

Your manager at INT has asked that you structure your memo to begin with a (maximum) one-page summary of your method, key findings and recommendations, supported by no more than three  additional pages showing input assumptions, estimated cash flows and supplementary analysis detail  and discussion.  

Table format for presenting numerical analyses is preferable. Ensure that readers will be able to  easily follow what you have done. You may wish to use footnotes under tables that clarify  calculations, details and/or assumptions where this is not clear from the table itself. 

This assignment has a 30% weighting in your overall mark for this unit. It will be marked out of 30.  Marks will be allocated as per rubric on following page based on:  

• Accurate analysis of base case figures  
•  Sound recommendations on the alternatives founded on base case analyses  
• Insightful recommendations for further considerations prior to final decision 
• Memo format and professionalism of communication

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