Suppose Elon Musk has an existing business making electric bicycles. Sales are s

Question

Suppose Elon Musk has an existing business making electric bicycles. Sales are so strong that he is considering selling his existing factory and replacing it with a new factory.   Assuming the following, what is the NPV of the project and is it financially worthwhile? (12 points available; 9                                                    points gets full credit toward final score)

a. The current factory can be sold for $200mm; it has a tax value of $100mm. The current factory produces annual after tax cash flow of $50mm.   Elon believe that after six years from now, the existing factory would have a resale value of $10mm which would also be its tax value.

b. A new bicycle factory can be built for $500mm and equipment will cost $400mm plus installation costs of $100mm. Assume the plant and equipment can be built and operational on day one.

c. Expect incremental working capital needs (starting on day one) of $50mm of Accounts Receivable and $75mm of Inventory; expect an incremental $25mm of Accounts Payable.

d. He initially projects after-tax cash flows of $275mm per year for eight years occurring on the last day of each year, starting at the end of year one and finishing after eight years of operations. This cash flow is for the new project alone (remember you are no longer going to have the cash flow from the current factory if you do the new project)

e. Now assume that after six years, Elon gets bored and liquidates the business. Assume the working capital is liquidated and the PP&E is sold for $200mm (assume it had been depreciated to $150mm.

f. Assume a tax rate of 30% and a cost of capital is 17%.

g. For an optional extra 2 points (potentially 14 total points for this problem 12), what is the IRR of the project?

Explanation / Answer

NPV of the project is posiyive so it is financially worthwhile.

To calculate IRR, we calculate NPV @ 19% DCF

IRR = Cost of Capital with higher NPV +((Higher NPV*Difference between 2 cost of capitals at which NPVs are calculated)/(Higher NPV-Lower NPV) )

Year 0 Year 1 Year 2 Year 3 Year 4 Year 5 Year 6 Proceeds from sale of factory 100 New bicycle factory -500 Equipment and instllation cost -400 Incremental Working Capital -125 25 25 25 25 25 25 revenue 225 225 225 225 225 225 Working Capital Liquidated 25 Proceeds from sale of PP&E 140 Opprtunity Cost on sale of old factory -10 Net Cashflow -925 250 250 250 250 250 405 DCF @ 17% 1           0.85           0.73           0.62           0.53           0.46           0.39 Disscounted Cashflow -    925.00      213.68      182.63      156.09      133.41      114.03      157.88 NPV         32.72

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