Thiel Corporation is a globally diversified industrial manufacturer with businesses in fluid power systems, electrical power quality, distribution and control, automotive engine air management and fuel economy, and intelligent truck systems. It is considering an expansion into the hydrogen fuel cell business. It has been researching its move into the fuel cell industry over the past few years. To date it has spent $270 million in research and development on fuel cell technology and an additional $96 million in marketing and feasibility studies and hopes to recover these costs with the successful move into the industry.

You have been asked to collect the data to make an assessment and have come back with the following information:

• You estimate that it will cost Thiel $6,000 million to establish a presence in this business. Of this amount, $1,500 million will have to be spent right now (t = 0) acquiring the capital assets needed for the business. There will be an additional $2,000 million investment one year from now (t = 1) and a final investment of $2,500 million in two years (t = 2). The business will be operational at the start of the third year. The entire $6,000 million investment is depreciable starting in the third year and will be depreciated using the MACRS schedule for a 5-year asset (20.00%, 32.00%, 19.20%, 11.52%, 11.52%, and 5.76%).

• The total market for fuel cell technology products is currently estimated to be $40,000 million, but is expected to grow 15% per year for the next 6 years with the growth rate leveling off by 3% per year until it reaches 3% per year in the 10th year and beyond (i.e., the growth rate will be 15% per year through year 6, 12% in year 7, 9% in year 8, 6% in year 9, and 3% per year in year 9 and beyond). Thiel is expected to attain a 5% global market share in the first year in which it enters the market (which is three years from now), a 6% market share in year 4, a 7% market share in year 5, an 8% market share in year 6, a 9% market share in year 7, and a 10% market share in year 8 and beyond.

• Thiel expects that its cost of sales will be 60% of its total fuel cell revenues in the first year of operations (t = 3). Production efficiencies will reduce this amount by 2 percentage points per year until the cost of sales levels off at 50% of total revenues in the 8th year and beyond (i.e., the cost rate will be 58% in year 4, 56% in year 5, etc.).

• Thiel will allocate 10% of its existing general and administrative costs to the new division. These costs now total $800 million for the entire firm and are expected to grow at 3% per year over the long term. In addition, it is expected that Thiel will have an increase of $200 million in general and administrative costs in year 3 when the new fuel cell operations begin generating revenues, and that this amount will grow at the same rate as the firms total fuel cell revenues after that. The growth rate in revenues per year can be calculated as Revenuest Revenuest-1 1.

• Thiel currently spends $400 million firm-wide in research and development and expects these expenditures to grow at 3% per year indefinitely. However, if the fuel cell division is added to the company, the expected growth rate in Thiels total R&D expenses is expected to increase to 20% per year beginning next year (year 1) through year 8. After year 8, the expected growth rate in total R&D expenses if the fuel cell division is added to the company is expected to be 10% per year.

• While the new business will need distributional support, it is anticipated that Thiel can use excess capacity in its existing distribution network. Its existing businesses are currently using 70% of the firms distribution capacity with an expected growth of 5% per year (i.e., it will use 73.5% (70% 1.05) of the distribution network next year, 77.2% the year after, and so on). Adding the fuel cell business would use an additional 10% of the total capacity in year 3 (which is the first year of revenue generation) and its increased use would track revenue growth in the fuel cell business beyond that point. When Thiel runs out of distribution capacity, it will have to pay for an expansion of the distribution network in the year prior to exceeding its capacity. The current estimated cost of expansion is $500 million, but this cost is growing at 3 percent per year. Note that the distribution system would also be a depreciable asset with depreciation expenses occurring in the year following implementation.

• The fuel cell division will create working capital needs, as estimated below:
  • The sale of fuel cells on credit to wholesalers and various industrial firms will create accounts receivable amounting to 25% of total revenues each year.
  • The purchase of inventory (of both raw material and finished goods) will be approximately 20% of the total cost of sales (not including depreciation, general and administration expenses, or R&D expenses).
  • The credit (i.e., accounts payable) offered by suppliers of inventory will be 18% of the total cost of sales (not including depreciation, general and administrative expenses, or R&D expenses).

Any new investment in net working capital will be made at the beginning of each year in which the goods are sold. Thus, the working capital investment for the third year will have to be made at the beginning of the third year (i.e., end of the second year) and so on.

• The company faces a 24% tax rate and uses a weighted average cost of capital of 11.5% when analyzing other similar projects.

1. Estimate the after-tax incremental cash flows from the proposed fuel cell investment to Thiel. Although the project is not expected to have a fixed termination date, for purposes of project valuation, cash flows associated with the project are expected to grow indefinitely at 1.5 percent per year after Year 10. That is, after determining the after-tax cash flows for year 10, calculate the terminal value of the project at that point in time using the 1.5% perpetual growth rate for all cash flows generated beyond year 10. Calculate the net present value and internal rate of return for the project.

1. Rather than analyzing the project with a terminal value based on perpetual cash flows occurring after year 10, assume instead that the company plans to operate the project for only 8 years. The after-tax salvage value for the project at the end of year 8 will be the sum of the total net working capital invested in the project since its inception and one-third of the initial capital investment made (i.e., $2,000). Calculate the net present value and internal rate of return for the project.

Based on your analysis and any other considerations you might have, describe whether you would recommend accepting or rejecting this project under either or both scenarios and briefly explain/defend your recommendation.