Net Present Value (NPV) - Research Proposal

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Therefore, Clink should only utilize the lease option is the lease is valued at less than £230,000 per year.

Some of the factors that might influence this decision would be the estimated life span of the machinery and the estimated resale value. The longer the estimated life span of the machinery and the greater the estimated resale value, the less likely the lease is to be a viable option. However, there is always a price at which the lease could be more effective.

However, Clink would want to consider the taxation effects of the two options before coming to a decision. Another consideration should be the robustness of the sales assumptions. The lease creates an obligation and that leverage increases the riskiness of the venture. This could affect the discount rate, but if we assume that we will leave the discount rate the same, we must understand that Clink will need to earn enough in each year of the project to cover that obligation.

3. It could potentially be advisable to lower the price after year 3 in order to spur sales. The lease creates a fixed obligation and Clink needs to make enough money to cover that obligation. The present value of year 4 cash flows is just over £20,000, which does not give Clink must breathing room. In year 5, the clig product is a money-loser under the lease scenario. It must be said, however, that lowering the price to boost sales will not necessarily yield the desired results.

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Sales do not alone cover costs, contribution does. Contribution equals sales multiplied by sales price, less variable costs. Clink will need to examine the demand curve to see if lowering the price will in fact spur enough of an increase in sales to increase the contribution margin of the clig product. If so, they should lower the price. If not, they may even find that increasing the price gives them greater contribution. It all depends on the elasticity of demand for the clig product at that stage of its life cycle.

That said, it is clear that the product's profitability declines from year 3 onward under the current assumptions. Therefore, management will need to consider its strategy with regards to the clig product in the later stages of life carefully. This is important under the lease option, but it is also important if they purchase because the depreciation tax shield may be lost if the product is already unprofitable at that point. Thus, all of the potential cash flow implications of a change in price should be taken into account when weighing the two different decisions.

Clink NPV calculations

Initial Investment

Incremental Revenue

Labour cost

Materials cost

Resale value

Net Cash Flow

Present Value

Net Present Value discount rate selling price

Sales in units raw material cost increase….....

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