Some Background

Ten years ago, the world entered an industrial development phase known as the Electric Revolution. With greenhouse gases becoming an increasingly concerning global issue, many industries opted to electrify their operations to lower their environmental footprint and stay relevant to current customers trends, who demanded greener corporate initiatives.

The automobile industry was one of the first major sector to begin electrification. At the time, the was high demand for bigger boxy cars called ''sport utility vehicles or SUVs'' and automakers made great efforts to make electric SUVs in all possible size and colors.

Freshly graduated from MIT in automobile engineering, you wanted to ride electric, but the current offering did not fit your taste for sporty, compact cars. Hence, with the help of your best friend and funding from his dad Melon Dusk, a venture investor, you founded ST Performance Designs Inc. with the intent to create the most fun and fastest electric sports car to ever hit the roads.

Today

ST Performance vehicles were an instant hit, and the company went from just you two, to over 2000 employees with a large manufacturing facility in Saguenay, Qubec. Customers are lining up to buy cars, yet production is limited by your single factory.

You have recently called a meeting with all top managers, to discuss where should ST Performance Designs head next. Two main courses of action were discussed:

1- The company could build a second factory and increase production volume, since there is enough demand to support it, bolstering profits.

2- The company could return to its innovative roots and invest heavily in research and development, with the intent to create a high-performance battery that would increase the usability of the current vehicle offering and could potentially revolutionize the electric mobility market.

During the meeting, arguments for both sides were presented, along with the following information:

1) Expanding production will require:

a. Purchasing additional land to accommodate a 400 000 sq. ft factory. Such land could be purchased in a nearby industrial plot for 50 000 000 $.

b. Construction, engineering, and architectural fees of 125 000 000$. The total construction cost will be split evenly over 4 payments, with the first one being due before construction work begin at year 0

c. Construction will be completed in 3 years, and the new factory will be operational at the beginning of year 4

d. Purchasing and installing new equipment for 55 000 000 during the final year of construction

e. Hiring 2000 employees with an average hourly rate (including fringe benefits, vacations, etc) of 50 $/hr with 40 hours/week on average, with annual raises equivalent to inflation (3%)

f. Marketing experts estimates that there is enough demand to immediately fill 70 % of the new factory for the first year of operations, and 95 % thereafter.

g. The current factory is working at 100 % capacity, producing 10 000 cars per year, sold for an average price of 70 000 $ each.

2) Investing in R&D to develop a battery will require:

a. Hiring additional researchers to focus on battery development, with salaries averaging 10 000 000 $ for all personnel hired, subject to the same indexation as regular factory workers (3% per year).

b. The R&D department will also need a yearly budget of 50 000 000 $ to build and test prototypes

c. R&D expenditures are considered tax deductible

d. This project is highly risky, there is no certainty that a revolutionary battery will be created or that it will before a competitor does.

e. The R&D lead managers estimates that we have 10 years to develop and bring to market a battery before competition catches up

f. Once developed, the battery technology would be patented and licensed to other electric automakers but could also be adapted for different applications. Revenues generated from licensing would be estimated at 1 000 000 000 per year in perpetuity.

g. In the best-case scenario, these incremental revenues would begin at the 11 years mark, since patenting and licensing will take time.

3) Other information:

a. The rate of return for projects approvals is 12 %

b. Corporate taxation rates is 26 %

c. The project analysis horizon is 11 years

Required

1) Determine whether the company should invest in a new factory, or in R&D, based on the NPV (only use the NPV method)

2) Present arguments supporting your conclusion in 1)

3) Present arguments against your conclusion in 1) (ex: why would the company not choose the highest NPV project)

4) Present the limitations of your mathematical analysis in 1)