Question $125$ Marks

Genius Innovators Company $($GIC$)$ has just designed a new product manufacturing system. GIC Management must now choose from the following three alternative options:

Sell the design outright to another company with $2$ years payment, or

License the design to another manufacturer for a period of five years, or

Manufacture and market the system.

Your consulting company has assigned you to advise GIC on the following:

$1\mathrm{.}1.$ The cost of capital that GIC should use in evaluating the options. $(5)$

$1\mathrm{.}2.$ Calculating the net present value $($NPV$)$ of each alternative and rank them accordingly.

$(10)$

$1\mathrm{.}3.$ Use of comparative methods of replacement chain and equivalent annuity approach to rank the unequal lives alternatives. $(8)$

$1\mathrm{.}4.$ Recommending an alternative, if any. $(2)$

You have been provided with the following additional information:

Cash Flows $($ignore taxes and depreciation$)$

Alternative

Sell

License

Manufacture

Initial Investment

R$2000000$

R$2000000$

R$4500000$

Period

$1$

R$2000000$

R$2500000$

R$2000000$

$2$

R$2500000$

R$1000000$

R$2500000$

$3$

R$800000$

R$2000000$

$4$

R$600000$

R$2000000$

$5$

R$800000$

R$2000000$

$6$

R$2000000$

$$ GIC preferred equity and debt projects financing are in a ratio of $3$:$1.$

$$ Company Tax rate $=30\%$

$$ Beta $=0\mathrm{.}75$

$$ South Africa Treasury Bond estimated at $6\mathrm{.}5\%.$

$$ The market rate of return is estimated at $10\%.$

$$ GIC can borrow at $8\%.$