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.

Deliverable:

Write a report providing the CFO with your recommendation whether Zeta should set up the plant to produce the Spenza?s and support your recommendation by in-depth analysis in Excel. In your report, explain the results of each portion of your analysis (represented by the tabs on the Excel template). Submit all the completed Excel worksheets with the completed responses to the questions posed to support your report and recommendation. Provide a one-page Executive Summary summarizing the results of your analysis and recommendation.

Steps to Completion:

Capital Investment Data

To assess the suitability of the project you begin by listing the various cash flows. A consultant has been paid $50,000 to do a market survey. She reports back that Zeta can sell 7,000 Spenza?s for $80,000 each in years 1 and 2, and 4,000 Spenza?s for $80,000 each in years 3 and 4. The consultant also estimates that the increased sales of the Spenza will cannibalize the sale of an existing model, the Zeta Monza, resulting in 1,000 fewer units of the Monza sold in each of the 4 years. Monza?s are priced at $65,000.

After 4 years it is expected the Spenza will be phased out, and the plant will be put to other uses generating $15 M annually. However, this decision can be reevaluated at the end of year 3, based on new information which will become at that time. Your consultant has prepared her estimates of what this new information might be. These estimates are given in the attached Excel spreadsheet.

The cost of setting up the plant is to be $250 M with annual manufacturing capacity of 10,000 cars. In addition, at the beginning of each year the plant will require the Net Working Capital outlay equal to 4.75% of direct manufacturing costs (excluding labor and overheads) in the coming year. The NWC outlay will be recovered after 4 years.

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. 80% of the carbon cost is the cost of energy and the estimated carbon cost body per car of $14,000 is based on electricity cost of 7 cents /per kWh, which is the current cost of electricity in Michigan, where the plant will be located. This cost is 70% of the average nationwide retail electricity price. EIA electricity cost projections are provided in the Excel sheet.
• Battery Pack cost for Spenza is $15,000 per car.
• Cost of materials for engine and other parts will be identical to Monza?s.
• Labor cost of $4,000 per car is based on annual production of 10,000 Spenza?s. Labor is unionized; number of workers and wages do not depend on the number of units produced.
• Overheads at 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 over 4 years for 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 the Excel sheet attached)

If you recommend setting up the plant, you should also consider that the plant will require land which the firm can put to other uses. These alternative uses will earn the firm $15 M annually.

Modeling Financial Metrics and Cash FlowsDepreciation

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 of 7%.

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 is 40%.

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

Net Income

• What will be the incremental 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! At this point we are still assuming that the project will last only for four years.

• 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 as one of the major factors affecting your variable costs and would like to perform some additional analysis to check the project?s sensitivity to electricity costs. As was mentioned EIA 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.

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

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.

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. Deliverable: Write a report providing the CFO with your recommendation whether Zeta should set up the plant to produce the Spenza's and support your recommendation by in-depth analysis in Excel. In your report, explain the results of each portion of your analysis (represented by the tabs on the Excel template). Submit all the completed Excel worksheets with the completed responses to the questions posed to support your report and recommendation. Provide a one-page Executive Summary summarizing the results of your analysis and recommendation. Steps to Completion: Capital Investment Data To assess the suitability of the project you begin by listing the various cash flows. A consultant has been paid $50,000 to do a market survey. She reports back that Zeta can sell 7,000 Spenza's for $80,000 each in years 1 and 2, and 4,000 Spenza's for $80,000 each in years 3 and 4. The consultant also estimates that the increased sales of the Spenza will cannibalize the sale of an existing model, the Zeta Monza, resulting in 1,000 fewer units of the Monza sold in each of the 4 years. Monza's are priced at $65,000. After 4 years it is expected the Spenza will be phased out, and the plant will be put to other uses generating $15 M annually. However, this decision can be reevaluated at the end of year 3, based on new information which will become at that time. Your consultant has prepared her estimates of what this new information might be. These estimates are given in the attached Excel spreadsheet. The cost of setting up the plant is to be $250 M with annual manufacturing capacity of 10,000 cars. In addition, at the beginning of each year the plant will require the Net Working Capital outlay equal to 4.75% of direct manufacturing costs (excluding labor and overheads) in the coming year. The NWC outlay will be recovered after 4 years. 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. 80% of the carbon cost is the cost of energy and the estimated carbon cost body per car of $14,000 is based on electricity cost of 7 cents /per kWh, which is the current cost of electricity in Michigan, where the plant will be located. This cost is 70% of the average nationwide retail electricity price. EIA electricity cost projections are provided in the Excel sheet. Battery Pack cost for Spenza is $15,000 per car. Cost of materials for engine and other parts will be identical to Monza's. Labor cost of $4,000 per car is based on annual production of 10,000 Spenza's. Labor is unionized; number of workers and wages do not depend on the number of units produced. Overheads at 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 over 4 years for 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 the Excel sheet attached) If you recommend setting up the plant, you should also consider that the plant will require land which the firm can put to other uses. These alternative uses will earn the firm $15 M annually. 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 of 7%. 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 is 40%. What incremental taxes Zeta will pay if the Spenza plant is set up? Net Income What will be the incremental 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! At this point we are still assuming that the project will last only for four years. 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 as one of the major factors affecting your variable costs and would like to perform some additional analysis to check the project's sensitivity to electricity costs. As was mentioned EIA 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. 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 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 in 2015 10,000 Monza's price $65,000 Monza Cost structure per car Body materials $11,000 Engine $4,000 Drivetrain $6,000 Battery Pack $20,000 Electronics $5,000 Labor (allocated) $4,000 Overhead (allocated) $2,000 Consulting Fees Spenza Price $50,000 $80,000 Spenza Sales projections Year 1 7,000 Sales Volume Plant Investment Alternative Land Use Plant Capacity Project life Percentage of Debt Financing Interest Rate Tax rate 4.75% 1,000 cars $0.07 per kWh 70% of national average $14,000 80% Electricity used per car Other Spenza direct costs Body materials (other than electricity) Engine Drivetrain Battery Pack Electronics Year 2 7,000 $250 Mil $15 Mil 10,000 cars 4 years 50% 7% 40% NWC as % of direct manufacturing Monza Sales Cannibalization Electricity cost Carbon Body Cost per Car Percentage of electricity MACRS Schedule year 1 year 2 year 3 year 4 $4,000 $6,000 $15,000 $5,000 Year 3 4,000 Solution Choosing Depreciation Year 1 Year 2 Year 3 Projected Net Income Year 1 7,000 $0.0707 Year 2 7,000 $0.0721 Year 3 4,000 $0.0724 Straight-Line depreciation MACRS Depreciation Your recommendation Sales Volume Projected electricity cost (per kWh) Revenues Direct Body Costs materials (electricity only) Body materials (other than electricity) Engine Drivetrain Battery Pack Electronics Total Direct Costs Fixed Costs Labor Overheads Depreciation EBIT Interest EBT Taxes Net Income Projected FCF Monzas Lost Profit Volume Price Direct Costs (per car) Lost Profit (After-Tax) OCF CapEx Investment in NWC Opportunity Costs Alternative Land Use 1,000 cars $65,000 Lost Profit from Cannibalized Sales FCF WACC (From WACC Tab) NPV IRR Six Scenarios Reference High Oil Price Low Oil Price High Oil and Gas Resource Availability High Economic Growth Low Economic Growth 2015 $0.0707 $0.0715 $0.0705 2016 $0.0721 $0.0721 $0.0722 2017 $0.0724 $0.0726 $0.0725 $0.0699 $0.0710 $0.0715 $0.0705 $0.0710 $0.0721 $0.0720 $0.0719 $0.0715 MACRS Schedule 33% 45% 15% 7% Year 4 4,000 Solution Legend Value given in problem Formula/Calculation/Analysis required Assumptions, Qualitative analysis or Short answer required Goal Seek, Scenario or Data Table cell Crystal Ball Input Crystal Ball Output Year 4 Year 4 4,000 $0.0718 2018 $0.0718 $0.0724 $0.0721 $0.0706 $0.0717 $0.0704 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 Your assumptions Author: Please replace stabs below by real peers names. The number of peers does not have to be five Company Comparable Companies Unlevered Beta Levered Beta Market Value Market Value Debt/ Equity of Debt of Equity Peer Company A Peer Company B Peer Company C Peer Company D Peer Company E Median Mean Relevered Beta Mean Unlevered Beta Zeta WACC Calculation Target Target Debt/ Marginal Tax Relevered Beta Equity Rate Equity/ Marginal Total Tax Rate Assets Company's Capital Structure Debt to Total Capitalization Equity to Total Capitalization Debt to Equity Ratio Cost of Equity Risk-free rate Market risk Premium Levered Beta Cost of Equity Cost of Debt Cost of Debt Taxes After Tax Cost of Debt WACC Value given in problem Formula/Calculation/Analysis required Qualitative analysis or Short answer required Beta Unlevered Beta Electricity breakeven Annual Growth 0.50% Year 1 electricity cost for Breakeven Year 0 Electricity Price EBIT Interest EBT Taxes Net Income OCF CapEx Investment in NWC Opportunity Costs Alternative Land Use Lost Profit from Cannibalized Sales FCF WACC (From WACC Tab) NPV IRR Year 1 Year 2 Year 3 Year 4 0.0709723 0.0719649 0.071477 0.0704424 Solution Legend Value given in problem Formula/Calculation/Analysis required Assumptions, Qualitative analysis or Short answer required Goal Seek, Scenario or Data Table cell Crystal Ball Input Crystal Ball Output Zeta Spenza Project Given Monza's sales in 2015 Monza's price Body materials Engine Drivetrain Battery Pack Electronics Labor (allocated) Overhead (allocated) 10,000 $65,000 Monza Cost structure per car $11,000 $4,000 $6,000 $20,000 $5,000 $4,000 $2,000 Consulting Fees Spenza Price $50,000 $80,000 Spenza Sales projections Year 1 7,000 Sales Volume Year 2 7,000 Plant Investment Plant Capacity Project life Percentage of Debt Financing Interest Rate Tax rate $250 Mil Uniform distribution from 125 to 375 Mil 10,000 cars 4 years 50% Uniform distribution from 25 to 75 % 7.00% Uniform distribution from 4 to 10 % 40% NWC as % of sales Monza Sales Cannibalization 4.75% Uniform distribution from 4% to 5.5 % 1,000 cars Uniform distribution from 500 to 1,500 Electricity cost Carbon Body Cost per Car Percentage of electricity $0.07 per kWh 70% of national average $14,000 80% Electricity used per car Other Spenza direct costs Body materials (other than electricity) Engine Drivetrain Battery Pack Electronics $4,000 $6,000 $15,000 Uniform distribution from $ 10 to 20 K $5,000 Solution Projected Net Income Year 1 Year 2 7,000 7,000 $0.0707 $0.0721 Triangular distribution with min and max - 10% away f Sales Volume Projected electricity cost (per kWh) Distribution assumption Revenues Direct Body Costs materials (electricity only) Body materials (other than electricity) Engine Drivetrain Battery Pack Electronics Total Direct Costs Fixed Costs Labor Overheads Depreciation EBIT Interest EBT Taxes Net Income Projected FCF Monzas Lost Profit Volume Price Direct Costs (per car) Lost Profit (After-Tax) 1,000 cars $65,000 Year 0 OCF CapEx Investment in NWC Opportunity Costs Alternative Land Use Lost Profit from Cannibalized Sales FCF WACC (From WACC Tab) NPV Year 1 Year 2 IRR MACRS Schedule year 1 33% year 2 45% year 3 15% year 4 7% Year 3 4,000 m 125 to 375 Mil m 25 to 75 % m 4 to 10 % m 4% to 5.5 % m 500 to 1,500 m $ 10 to 20 K Year 4 4,000 Solution Legend Value given in problem Formula/Calculation/Analysis required Assumptions, Qualitative analysis or Short answer required Goal Seek, Scenario or Data Table cell Crystal Ball Input Crystal Ball Output Year 3 Year 4 4,000 4,000 $0.0724 $0.0718 th min and max - 10% away from the mean, correlation 0.7 Year 3 Year 4 wer required Energy prices Figure 9. Average retail electricity prices in six cases, 2013-40 (2013 cents per kilowatthour, kWh) Source: AEO2015 National Energy Modeling System, runs REF2015. D021915A, LOWPRICE.D021915A, HIGHP http://www.eia.gov/forecasts/aeo/section_prices.cfm#elec Year Reference High Oil Price Low Oil Price 2015 2016 2017 2018 2019 2020 2021 2022 2023 2024 2025 2026 2027 2028 2029 2030 2031 2032 2033 2034 2035 2036 2037 2038 2039 2040 10.10 10.30 10.34 10.25 10.33 10.51 10.68 10.75 10.83 10.84 10.96 11.00 11.05 11.08 11.04 11.05 11.07 11.14 11.21 11.26 11.32 11.36 11.43 11.55 11.69 11.83 10.22 10.30 10.37 10.35 10.41 10.53 10.75 10.96 11.23 11.47 11.63 11.69 11.66 11.70 11.70 11.78 11.90 12.02 12.07 12.12 12.19 12.24 12.36 12.52 12.72 12.87 10.06 10.32 10.35 10.30 10.31 10.36 10.42 10.48 10.56 10.62 10.69 10.82 10.90 10.96 11.01 10.97 10.97 10.98 11.02 11.05 11.07 11.11 11.16 11.26 11.42 11.55 13.00 lowatthour, kWh) 5A, LOWPRICE.D021915A, HIGHPRICE.D021915A, LOWMACRO.D021915A,12.50 HIGHMACRO.D021915A, and HIGHRESO High Oil and Gas Resource High Economic Availability Growth 9.98 10.14 10.22 10.09 9.99 9.97 9.99 9.98 9.97 9.93 9.95 10.03 10.01 10.01 10.01 10.01 10.01 10.11 10.05 10.04 10.17 10.19 10.22 10.23 10.23 10.26 10.08 10.29 10.27 10.24 10.35 10.57 10.75 10.83 10.96 11.06 11.10 11.12 11.15 11.14 11.12 11.15 11.23 11.31 11.40 11.48 11.58 11.68 11.80 11.91 12.10 12.28 Low Economic Growth 10.14 10.28 10.21 10.06 10.16 10.28 10.36 10.44 10.51 10.55 10.67 10.76 10.77 10.74 10.68 10.72 10.79 10.84 10.85 10.92 10.94 10.98 11.07 11.15 11.28 11.39 12.00 11.50 11.00 10.50 10.00 9.50 9.00 8.50 8.00 2015 2020 2025 2030 2 21915A, and HIGHRESOURCE.D021915B. Reference High Oil Price Low Oil Price High Oil and Gas Resource Availability High Economic Growth Low Economic Growth 2025 2030 2035 2040