Reference no: EM133491779

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.

Introduction:

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.

Deliverables:

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. Report should include a one-page Executive Summary summarizing the results of your analysis and recommendation.

Project Data

To assess the suitability of the project you begin by listing the various cash flows. A consultant has been paid $150,000 to do a market survey. She reports back that Zeta can price Spenzas at $80,000 per car and sell 5,000 cars next year (in year 1), then sales will peak at 7,000 in year 2 and after that they will start declining with 6,000 Spenzas sold in year 3, 4,000 in year 4, and 3,000 in year 5. After that the sales decline will not make manufacturing of Spenzas profitable. The consultant also estimates that introduction of Spenza model 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 5 years. Monza's are priced at $65,000.

After 5 years it is expected the Spenza will be phased out, and the plant will be put to other uses generating after-tax cash flow of $15 M annually.

The cost of setting up the plant is to be $250 M with annual manufacturing capacity of 10,000 cars. It is a one-time capital investment made at the very beginning of the project. In addition, at the beginning of each year the plant will require an outlay of Net Working Capital equal to 7.5% of direct manufacturing costs (excluding labor and overheads) in the coming year. The NWC outlay will be recovered at the end of the project in year 5.

The CFO provided you with historical information about Monza's cost structure (Excel sheet attached) and noticed that Spenza will have the following differences:

Spenza's body will be made from reinforced carbon, which makes the car lighter, thus significantly improving mileage range per battery charge. About 80% of the carbon cost is the cost of energy and the estimated carbon cost body per car of $14,000 is based on electricity cost of 7 cents /per kWh, which is the current cost of electricity in Michigan, where the plant will be located. This cost is 100% of the average nationwide retail electricity price. EIA nationwide electricity cost projections for future years are provided in the Excel sheet.
Battery Pack cost for Spenza is $15,000 per car.
Cost of materials for engine and other parts will be identical to Monza's.
Labor cost of $5,000 per car is based on annual production of 10,000 Spenza's. Labor is unionized; number of workers and wages do not depend on the number of units produced.
Overheads at the new plant will be identical to total overheads at the existing Monza plant.
IRS allows you to straight line depreciate the cost of the plant over 4 years for tax purposes (equal depreciation in all years and not an accelerated schedule of depreciation). You have a choice to use 3 year MACRS depreciation schedule (see the Excel sheet attached)

If you recommend setting up the plant, you should also consider that the plant will occupy a piece of land which the firm could put to other uses. These alternative uses would earn the firm $15 M after-tax annually.

Modeling Financial Metrics and Cash Flows

Depreciation

You have to decide whether Zeta should set up the plant to produce the Spenza's by answering the following series of questions. After having enumerated the various cash flows you are now ready to analyze the project using capital budgeting techniques and project analysis methods.

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 6%.

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 after the tax reform is 21%.

What incremental taxes Zeta will pay if the Spenza plant is set up?
Net Income

What will be the 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!

What will be the FCF (Free Cash Flow) each year?