Problem 2. Ford Smart Cars
The management of Ford Motor Company is considering building a factory to manufacture a vehicle which would compete with Daimler AG's Smart cars. Management is analyzing the project over a 4-year horizon. Management has spent $100m developing the Ford Smart car. Management uses a discount rate of 15% for projects of this type. Fords marginal tax rate is 40%.
If it accepts the project, management would spend immediately (year 0) $40m to construct a new plant and $100m for robotic equipment to go in the new plant. The new plant would be depreciated to zero over 10 years using straight-line depreciation and would have an estimated market value at the end of the projects life of $30m. Robotic equipment falls into the 5-year MACRS life class and would be depreciated using the following (rounded) depreciation percentages: year 1, 20%; year 2, 30%; year 3, 20%; years 4 - 6, 10%. Robotic equipment would have a market value of zero at the end of year 4.
If it accepts the project, management would immediately (year 0) transfer to the new plant non-robotic equipment from a plant Ford is closing. At present this equipment has a book value of $400m; management will depreciate the asset to zero over the next four years using straight-line depreciation. Management believes it could sell the non-robotic equipment today for $450m. Management estimates that the equipment will have a market value of $150m at the end of year 4 if it uses the equipment in the new project.
Numbers of Ford Smart cars sold, unit prices, and variable costs are shown in the worksheet. Initially, sales of Ford Smart cars would have little impact on sales of other Ford cars; but eventually, car buyers are expected to switch from other Ford models to the Ford Smart car, reducing revenues from those products, but also saving on production costs. Numbers are also shown in the worksheet.
For Ford Smart cars and for other Ford models, net working capital equal to 12.5% of coming-year sales must be held. The initial investment in net working capital must be made in project year 0; this investment is recaptured at the end of the projects life. Note that holdings of net working capital are reduced when sales of Ford Smart cars cut into sales of other Ford models.
If management accepts the project Ford will borrow immediately $250m by selling 20-year, 8% corporate bonds, representing an annual interest expense of $20m. Once built, the factory will be overseen by Ford's VP of American operations. Ford's controller has suggested allocating 5% of the VP's $1.5m annual salary to the project, although closings of other Ford plants means the VP will likely not be spending any more hours at her desk.
Should Fords management accept the project? Compute the after-tax free cash flow stream for the project and then use it to compute the project's NPV, IRR and PI.
Year	0	1	2	3	4
Data
millions of Ford Smart cars sold		0.08	0.15	0.30	0.45
$ price per Ford Smart car		$12,000	$15,000	$18,000	$20,000
$ of var. op. cost per Ford Smart car		$7,000	$9,000	$11,000	$12,000
millions of other Ford cars not sold					0.10
$ price per other Ford car					$30,000
$ of var. op. cost per other Ford car					$15,000
MACRS %, robotic equipment
Year	0	1	2	3	4
Pro Forma Income Statement ($ mil)
Sales
Ford Smart cars
Other Ford cars
Total
Costs (excl. Depreciation)
Ford Smart cars
Other Ford cars
Total
Depreciation
Plant
Robotic equipment
Non-robotic equipment
Total Depreciation
Development Costs
Allocated Costs
=EBIT
Interest
Tax (40%)
= Net Income
Year	0	1	2	3	4
Pro Forma Balance Sheet -- Asset side ($ mil)
Net Working Capital
Ford Smart cars
Other Ford cars
Total
Net Fixed Assets
Plant
Robotic equipment
Non-robotic equipment
Memo: After-tax Cash Flow = MV (MV BV)T
	Year	MV	BV	T	ATCF
Non-robotic equipment
Plant
Robotic equipment
Non-robotic equipment
				Total
Year	0	1	2	3	4
Project Free Cash Flow Worksheet ($ mil)
= Project Free Cash Flow
NPV @ 15% :		Accept/ Reject because ...
IRR :		Accept/ Reject because ...
PI @ 15% :		Accept/ Reject because ...