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 Spenzas 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 Spenzas for $80,000 each in years 1 and 2, and 4,000 Spenzas 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. Monzas 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 Monzas cost structure (Excel sheet attached) and noticed that Spenza will have the following differences:

Spenzas body will be made from reinforced carbon, which makes the car lighter, thus significantly improving mileage range per battery charge. of the carbon cost is the cost of energy and the estimated carbon cost body per car of is based on electricity cost of /per kWh, which is the current cost of electricity in Michigan, where the plant will be located. This cost is of the average nationwide retail electricity price. EIA electricity cost projections are provided in the .

Battery Pack cost for Spenza is $15,000 per car.

Cost of materials for engine and other parts will be identical to Monzas.

Labor cost of $4,000 per car is based on annual production of 10,000 Spenzas. Labor is unionized; number of workers and wages do not depend on the number of units produced.

< > at the new plant will be identical to total overheads at the existing Monza plant.

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 industrys beta, market risk premium and the risk free rate.

Estimate the WACC using the earlier assumption about the projects 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 projects 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			MACRS Schedule
Monza's price	$65,000			year 1	33%
Monza Cost structure per car				year 2	45%
Body materials	$11,000			year 3	15%
Engine	$4,000			year 4	7%
Drivetrain	$6,000
Battery Pack	$20,000
Electronics	$5,000
Labor (allocated)	$4,000
Overhead (allocated)	$2,000
Consulting Fees	$50,000
Spenza Price	$80,000
Spenza Sales projections
		Year 1	Year 2	Year 3	Year 4
Sales Volume		7,000	7,000	4,000	4,000
Plant Investment	$250 Mil
Alternative Land Use	$15 Mil
Plant Capacity	10,000 cars
Project life	4 years
Percentage of Debt Financing	50%
Interest Rate	7%
Tax rate	40%
NWC as % of direct manufacturing costs	4.75%
Monza Sales Cannibalization	1,000 cars
Electricity cost	$0.07 per kWh	70% of national average
Carbon Body Cost per Car	$14,000
Percentage of electricity	80%
Electricity used per car
Other Spenza direct costs
Body materials (other than electricity)
Engine	$4,000
Drivetrain	$6,000
Battery Pack	$15,000
Electronics	$5,000
Solution
Choosing Depreciation
		Year 1	Year 2	Year 3	Year 4
Straight-Line depreciation
MACRS Depreciation
Your recommendation
Projected Net Income
		Year 1	Year 2	Year 3	Year 4
Sales Volume		7,000	7,000	4,000	4,000
Projected electricity cost (per kWh)
Revenues
Direct Costs
Body 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	1,000 cars
Price	$65,000
Direct Costs (per car)
Lost Profit (After-Tax)
OCF
CapEx
Investment in NWC
Opportunity Costs
Alternative Land Use
Lost Profit from Cannibalized Sales
FCF
WACC (From WACC Tab)
NPV
IRR
Six Scenarios
		2015	2016	2017	2018
Reference		$0.0707	$0.0721	$0.0724	$0.0718
High Oil Price		$0.0715	$0.0721	$0.0726	$0.0724
Low Oil Price		$0.0705	$0.0722	$0.0725	$0.0721
High Oil and Gas Resource Availability		$0.0699	$0.0710	$0.0715	$0.0706
High Economic Growth		$0.0705	$0.0721	$0.0719	$0.0717
Low Economic Growth		$0.0710	$0.0720	$0.0715	$0.0704