I just need help with the electricity used per car and body materials line items:

Introduction:

You have recently been hired as a Financial Analyst in the Finance Department of Zeta Auto Corporation which is seeking to expand production. The CFO asks you to help decide whether the firm should set up a new plant to manufacture the roadster model, the Zeta Spenza.

Deliverables:

Project Data

To assess the suitability of the project you begin by listing the various cash flows. A consultant has been paid$150,000 for a market survey.She reports back that Zeta can price Spenzas at$80,000per car and sell5,000cars next year (in year 1), then sales will peak at7,000in year 2 and after that they will start declining with6,000Spenzas sold in year 3,4,000in year 4, and3,000in year 5.After that the sales decline will not make manufacturing of Spenzas profitable. The consultant also estimates that introduction of Spenza model will cannibalize the sale of an existing model, the Zeta Monza, resulting in1,000fewer units of the Monza sold in each of the5 years. Monza's are priced at$65,000.

After 5 years it is expected the Spenza will be phased out, and the plant will be put to other uses generating cash flow of$15 M annually.

The cost of setting up the plant is to be$250 Mwith annual manufacturing capacity of 10,000 cars. It is a one-time capital investment made at the very beginning of the project. In addition, at the beginning of each year the plant will require an outlay of Net Working Capital equal to7.5%of direct manufacturing costs (excluding labor and overheads) in the coming year. The NWC outlay will be recovered at the end of the project inyear 5.

The CFO provided you with historical information about Monza's cost structure (Excel sheet attached) and noticed that Spenza will have the following differences:

Spenza's body will be made from reinforced carbon, which makes the car lighter, thus significantly improving mileage range per battery charge. About80%of the carbon cost is the cost of energy and the estimated carbon cost body per car of$14,000is based on electricity cost of7 cents/per kWh, which is the current cost of electricity in Michigan, where the plant will be located. This cost is70%of the average nationwide retail electricity price. EIA nationwide electricity cost projections for future years are provided in theExcel sheet.

Battery Pack cost for Spenza is$15,000per car.

Cost of materials for engine and other parts will be identical to Monza's.

Labor cost of $5,000per car is based on annual production of10,000Spenza's. Labor is unionized; number of workers and wages do not depend on the number of units produced.

Overheadsat the new plant will be identical to total overheads at the existing Monza plant.

IRS allows you to straight line depreciate the cost of the plant over4 yearsfor tax purposes (equal depreciation in all years and not an accelerated schedule of depreciation). You have a choice to use 3 year MACRS depreciation schedule (see theExcel sheet attached)

If you recommend setting up the plant, you should also consider that the plant will occupy a piece of land which the firm could put to other uses. These alternative uses would earn the firm$15 Mannually.

Modeling Financial Metrics and Cash Flows

Depreciation

You have to decide whether Zeta should set up the plant to produce the Spenza's by answering the following series of questions. After having enumerated the various cash flows you are now ready to analyze the project using capital budgeting techniques and project analysis methods.

What will be the depreciation for tax purposes from the investment in the Spenza plant using the straight line method? What will be the depreciation using MACRS? Which schedule would you recommend to use?

EBIT

What will be the costs and revenues for the first four years? What will be the incremental EBIT (Earnings before Interest and Taxes) each year?

Interest and Taxes

You now have to need to determine interest costs and taxes. Assume that the cost of setting up the plant will be 50% financed by debt with an interest rate of6%.

At this point you are getting closer to the cash flows the project will produce, and need to determine the tax rate. You research tax rates and determine that the appropriate tax rate after the tax reform is21%.

What incremental taxes Zeta will pay if the Spenza plant is set up?

Net Income

What will be the Net Income for Zeta from the project each year?

Incremental OCF

Now you can calculate the net increase in cash flows from the project.

What will be the incremental OCF (Operating Cash Flow) each year?

Free Cash Flow

The next step will be calculating FCF taking into account OCF and other incremental cash flows, including opportunity costs!

What will be the FCF (Free Cash Flow) each year?

WACC and CAPM

The next step will be estimating WACC. Using Yahoo Finance! or other financial sources available on the course website find auto-making industry's beta, market risk premium and the risk free rate.

Estimate the WACC using the earlier assumption about the project's financing and the CAPM equation for the cost of equity.

Decision Criteria - NPV and IRR

Now you are ready to calculate the first criterion that is used to assess projects.

What will be the Net Present Value of the project?

You should also calculate another widely used criterion.

What will be the IRR of the project?

Analyzing Risk using Scenario Analysis

You consider the electricity cost and projected sales volume as two major factors affecting your variable costs and revenues. Therefore, you would like to perform some additional analysis to check the project's sensitivity to electricity costs and to sales volumes. You want to analyze these two factors separately, one at a time.

As was mentionedEIA has several electricity cost projections (Excel sheet, tab Energy Prices Forecast). First you decide to see how your recommendations might change under different cost scenarios.

Perform scenario analysis on the electricity cost and present the summary of results.

Given uncertainty of sales volume forecast, you would like to look at optimistic and pessimistic scenarios for sales. Optimistic scenario assumes sales volume to be500cars more than predicted (i.e.,5,500cars in year 1,7,500in year 2 etc.). Pessimistic scenario assumes sales volume to be500cars less than predicted (i.e.,4,500cars in year 1,6,500in year 2 etc.).

Run scenario analysis on the sales volume and present the summary of results.

Break-even Analysis

Next, you would like to find the maximum electricity cost in year 1 at which the project would still be advisable. For simplicity assume 0.5% annual growth of electricity costs.

Find the break-even value for the electricity cost in year 1.

Monte Carlo Simulation (extra credit 5%) - ATTENTION, THIS PART IS OPTIONAL

Finally, you would like to perform a Monte Carlo simulation. Possible distribution assumptions are provided in Excel Spreadsheet tab "Crystal Ball Simulation," but you are welcome to make (and explicitly state) your own and use Random Numbers generator in Data Analysis Pack.

Based on your analysis, what is the probability that the project will be profitable?

[Crystal Ball]You also want to estimate the sensitivity of your project to different factors.

Using Crystal Ball, please create a Tornado Diagram and discuss its results.

Zeta Spenza Project Given Monza's sales 10,000 MACRS Schedule Solution Legend Monza's price $65,000 year 1 33% Value given in problem Monza Cost structure per car year 2 45% Formula/Calculation/Analysis required Body materials $11,000 year 3 15% Assumptions, Qualitative analysis or Short answer required 9 Engine $4,000 year 4 7% Goal Seek, Scenario or Data Table cell 10 Drivetrain $6,000 Crystal Ball Input 11 Battery Pack $20,000 Crystal Ball Output 12 Electronics $5,000 13 Labor (allocated) $4,000 14 Overhead (allocated) $2,000 454 x-463 15 16 Consulting Fees $150,000 17 Spenza Price $80,000 18 19 Spenza Sales projections (number of cars) 20 Year 1 Year 2 Year 3 Year 4 Year 5 21 Base Case Scenario 5,000 7,000 6,000 4,000 3,000 22 Optimistic Scenario 5,500 7,500 6,500 4,500 3,500 23 Pessimistic Scenario 4,500 6,500 5,500 3,500 2,500 24 25 Plant Investment $250 Mil 26 Alternative Land Use $15 Mil 27 Plant Capacity 10,000 cars 28 Depreciation period 4 years 29 Percentage of Debt Financing 50% 30 Interest Rate 6% 31 Tax rate 21% 32 3328 Depreciation period 4 years 29 Percentage of Debt Financing 50% 30 Interest Rate 6% 31 Tax rate 21% 32 33 34 NWC as % of direct manufacturing co 7.50% 35 Monza Sales Cannibalization 1,000 cars 36 37 Historical Electricity Cost mmmmmmmmm### 70%% of national average 38 Carbon Body Cost per Car $14,000 39 Percentage of electricity 80% 40 41 Electricity used per car 42 43 Other Spenza direct costs Body materials 44 (other than electricity) 45 Engine $4,000 46 Drivetrain $6,000 47 Battery Pack $15,000 48 Electronics $5,000 49 50 Solution 51 Choosing Depreciation 52 Year 1 Year 2 Year 3 Year 4 53 Straight-Line depreciation 54 MACRS Depreciation 55 56 Your recommendation 57