CASE STUDY

DEVELOPING AND SELLING AN INNOVATIVE IDEA

Background

Three engineers who worked for Mitchell Engineering, a company specializing in public

housing development, went to lunch together several times a week. Over time they decided to

work on solar energy production ideas. After a lot of weekend time over several years, they

had designed and developed a prototype of a low-cost, scalable solar energy plant for use in

multifamily dwellings on the low end and medium-sized manufacturing facilities on the upper

end. For residential applications, the collector could be mounted along side a TV dish and be

programmed to track the sun. The generator and additional equipment are installed in a closet sized area in an apartment or on a floor for multiple-apartment supply. The system serves as a

supplement to the electricity provided by the local power company. After some 6 months of

testing, it was agreed that the system was ready to market and reliably state that an electricity

bill in high-rises could be reduced by approximately 40% per month. This was great news for

low-income dwellers on government subsidy that are required to pay their own utility bills.

Information

With a hefty bank loan and $200,000 of their own capital, they were able to install

demonstration sites in three cities in the sunbelt. Net cash flow after all expenses, loan

repayment, and taxes for the first 4 years was acceptable; $55,000 at the end of the first year,

increasing by 5% each year thereafter. A business acquaintance introduced them to a potential

buyer of the patent rights and current subscriber base with an estimated $500,000 net cash out

after only these 4 years of ownership. However, after serious discussion replaced the initial

excitement of the sales offer, the trio decided to not sell at this time. They wanted to stay in the

business for a while longer to develop some enhancement ideas and to see how much revenue

may increase over the next few years. During the next year, the fifth year of the partnership,

the engineer who had received the patents upon which the collector and generator designs were

based became very displeased with the partnering arrangements and left the trio to go into

partnership with an international firm in the energy business. With new research and

development funds and the patent rights, a competing design was soon on the market and took

much of the business away from the original two developers. Net cash flow dropped to $40,000

in year 5 and continued to decrease by $5000 per year. Another offer to sell in year 8 was

presented, but it was only for $100,000 net cash. This was considered too much of a loss, so

the two owners did not accept. Instead, they decided to put $200,000 more of their own savings

into the company to develop additional applications in the housing market. It is now 12 years

since the system was publicly launched. With increased advertising and development, net cash

flow has been positive the last 4 years, starting at $5000 in year 9 and increasing by $5000 each

year until now.

Case Study Exercises

It is now 12 years after the products were developed, and the engineers invested most of their

savings in an innovative idea. However, the question of When do we sell? is always present

in these situations. To help with the analysis, determine the following:

1. The rate of return at the end of year 4 for two situations: ( a ) The business is sold for the

net cash amount of $500,000 and ( b ) no sale.

2. The rate of return at the end of year 8 for two situations: ( a ) The business is sold for the

net cash amount of $100,000 and ( b ) no sale.

3. The rate of return now at the end of year 12. Hint: Use Excel spreadsheet.

4. Consider the cash flow series over the 12 years. Is there any indication that multiple rates

of return may be present?

5. Assume you are an investor with a large amount of ready cash, looking for an innovative

solar energy product. What amount would you be willing to offer for the business at this

point (end of year 12) if you require a 12% per year return on all your investments and, if

purchased, you plan to own the business for 12 additional years? To help make the decision,

assume the current NCF series continues increasing at $5000 per year for the years you

would own it.

Not: Please solve the case study. Prepare the xls file for the cash flows. Answer the above questions as well.

Use MS Excel by putting the net cash flows for each year according to each situation.

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I need an answer of the following Question

1. The rate of return at the end of year 4 for two situations: ( a ) The business is sold for the

net cash amount of $500,000 and ( b ) no sale.

2. The rate of return at the end of year 8 for two situations: ( a ) The business is sold for the

net cash amount of $100,000 and ( b ) no sale.

3. The rate of return now at the end of year 12. Hint: Use Excel spreadsheet.

4. Consider the cash flow series over the 12 years. Is there any indication that multiple rates

of return may be present?

5. Assume you are an investor with a large amount of ready cash, looking for an innovative

solar energy product. What amount would you be willing to offer for the business at this

point (end of year 12) if you require a 12% per year return on all your investments and, if

purchased, you plan to own the business for 12 additional years?