Context for Assignment: Your company is an established manufacturer of tradition

Question

Context for Assignment: Your company is an established manufacturer of traditional (i.e., gas-fueled) cars, but you are considering a substantial investment project where you would produce and sell electric cars for the first time. It is estimated that this expansion would require an initial investment of $3 billion. (Assume all monetary amounts in this assignment are in U.S. dollars) All subsequent cash flows (after the initial investment) would be allocated at the end of each year (during the year they occur) for the next 5 years, after which production would stop (since an even newer car model would be ordered at that time). You can ignore both shutdown and replacement costs at t-5. Also, assume straight line depreciation of the initial investment amount The table below gives the numerical levels of the 'best estimate' assumptions for all variables in your model, which is first used to calculate net cash flow for each year, and then used to calculate the NPV of the project (using all 5 years of projected cash flows) The table also gives 'pessimistic' and 'optimistic' assumptions for each model variable Assume that all variable levels remain constant for years 1-5 (except for initial investment which is at t 0 only, and market size growth which changes market size; e.g., if market size growth-10%, market size in year 3-(1.1)2"market size in year 1) Note: It will be helpful to reproduce this table in Excel for cell referencing purposes Model Variable Total Market Size Co.'s Market Share | 6% Sale Price per Unit $36,000 Var. Cost per Unit $33,000 Total Fixed Cost Initial Investment $3.5 billion Project's Lifetime 4 years Corporate Tax Rate | 40% Market Size Growth | -10% per year Cost of Capital Pessimistic Case 4 million cars Best Estimate Case Optimistic Case 5 million cars 8% $40.000 $30,000 $2.6 billion $3.0 billion 5 years 35% 0% per year 12% 6 million cars 10% $44,000 $27,000 $2.2 billion $2.5 billion 6 years 30% +10% per year 10% $3.0 billion 14%

Explanation / Answer

Soln : A) Please refer here the excel table we have used formula for best estimate thing and calculated for NPV

We can change the values in excel in this table to get the desired NPV every time we would change one variable here, please note when PBT comes 0 , please make taxes 0 in that year to get the desired result:

B) Pessimistic view:

Lets change the initial investment only we get:

NPV = 0.57

Change in Market size, NPV = -0.84

Change in Market share NPV = -1.56

In a similar manner , we need to change each variable for pessimistic and optimistic view to get the sensitivity analysis of NPV

Change in sales price per unit

NPV = -3.72

Change in variable cost

NPV = -2.28

Change in fixed cost

NPV = 0.10

Change in Tax rate = 40%, NPV = 0.89

Change in project years , t = 4 years , we get NPV = 0.56

Change in growth rate to -10%, NPV = -12.08

Change in cost of capital, = 14% , NPV = 0.85

Now similarly we can get 10 more NPVs by changing the each variable for optimistic view.

Best Estimate case Total market size (in mn) 5.00 Year 0 1 2 3 4 5 Initial investment size 3.00 Revenue = 8% pf market share 16.00 16.00 16.00 16.00 16.00 Var.cost 12.00 12.00 12.00 12.00 12.00 Fixed cost 2.60 2.60 2.60 2.60 2.60 Operating profit 1.40 1.40 1.40 1.40 1.40 Dep. 0.60 0.60 0.60 0.60 0.60 PBT 0.80 0.80 0.80 0.80 0.80 Taxes 0.28 0.28 0.28 0.28 0.28 PAT 0.52 0.52 0.52 0.52 0.52 Net cash flows,C = PAT + dep. 1.12 1.12 1.12 1.12 1.12 discount factor,d= 1/(1+r)^t 1 0.8929 0.7972 0.7118 0.6355 0.5674 PV = C*d -3.00 1.00 0.89 0.80 0.71 0.64 NPV 1.04

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