Question

FreeAuto is an American retailer located in Vancouver, WA. The company president is Vincent Miller, who inherited the company. When the company was founded over 30 years ago, it originally focuses on producing high-end batteries, for automobile manufacturers. Over the years, the company still maintains its main business, which accounts for about 50 percent of its total revenue. Faced with stiff competition, the company also expanded into the business of manufacturing its own fully electric cars. You and your team, the Carson College of Business graduates, are hired by the company's finance department to evaluate a new project for the company.

As of now FreeAuto's only electronic car model is a compact car called the C3, and sales have been excellent. FreeAuto's main competitor in the electric car market is Tesla, Inc (TSLA). FreeAuto's C3 is similar to the Tesla Model 3 but have a longer driving range per charge. However, FreeAuto wants to incorporate a new luxury vehicle, the CX into their lineup. FreeAuto spent $13,500,000 to develop new features such as quicker acceleration, even greater driving range, a new more aerodynamic design and a nicer interior, which was incorporated in the new CX and make it more high-end than the existing C3. The company has spent a further $255,000 for a marketing study to determine the expected sales figures for the new car.

FreeAuto can manufacture the new car for $47,800 per vehicle in variable costs. Fixed costs for the operation are estimated to run $38 million per year. The estimated sales volume is 5,750, 6,537, 5,044, 3,825 and 2,630 cars per year for the next five years, respectively. The unit price of the new car will be $79,800. The necessary equipment can be purchased for $460 million and will be depreciated on a seven-year MACRS schedule. It is believed the value of the equipment in five years will be $325 million.

As previously stated, FreeAuto currently manufactures the C3. Production of the existing product is expecting to be terminated in three years. If FreeAuto does not introduce the new luxury CX product, sales of the existing product will be 13,000, 10,050 and 8,500 cars per year for the next three years, respectively. The price of the existing car is $34,900 per car, with variable costs of $19,900 each and fixed costs of $27 million per year. If FreeAuto does introduce the new car, sales of the existing one will fall by 1,000 cars per year, and the price of the existing cars will have to be lowered to $32,500 each car. Net working capital for the project will be 20 percent of sales and will occur with the timing of the cash flows for the year; for example, there is no initial outlay for NWC, but changes in NWC will first occur in Year 1 with the first year's sales. FreeAuto has a 25 percent corporate tax rate. The company has a target debt to equity ratio of 0.5 and is currently B+ rated (according to S&P 500 ratings). The overall cost of capital of the company is 16 percent.

The finance department of the company has asked your team to make a report to Vincent, the company's CEO, and the report should answer the following questions.

2. The company's CEO, Vincent, wants to understand the risk of the e-car industry better. Since FreeAuto's main competitor, Tesla (TSLA), is a leading company in this industry, Vincent ask you to perform the following analysis on TSLA.

a. Using the past N years of data (ending at 2019) to estimate your own beta and alpha of TSLA based on a regression analysis. Document data sources used. Also explain how long a time period (from which year to which year) that you decide to use to perform your estimation, and explain why?

B.Provide your beta and alpha estimates, as well as the statistical significance (e.g. t ratio, p-value). Comment briefly.

C. Plot the security characteristic line for this company. Clearly show alpha and beta on the diagram. Is the company correctly priced, overpriced or underpriced?

D. From the above analysis, can you explain to Vincent the risk characteristics of TSLA and the e-car industry using the beta you estimated? Do you think your estimated beta makes sense given the nature of the company and the industry?