Case 1:
A high-tech company, Robotic Vehicles Ltd., has hired you as a financial specialist to determine the financial consequences associated with investing in developing an autonomous car (self-driving) solution for traffic in the central areas of New York. One alternative is to sell the electric autonomous cars to the city "government" and provide electricity swapping stations as well as electricity fill up at full cost (=zero net present value). The other alternative is to deliver the autonomous electric cars as well as electricity swapping stations at full cost and charge each passenger an electricity consumption mileage fee for car usage. Robotic Vehicles ltd. has provided you the following information:
General:
- The full cost of producing a car in nominal terms is estimated to $10 000. The New York City government wants to order 2000 cars in total. They want 200 cars per year to be delivered to them for the next 10 years, starting this year. The cars will be paid upon delivery the 1st of January each year. Each car has an expected lifetime of 10 years with zero scrap value.
- The New York City government also demands in total three swapping stations installed at different central city locations. They require that the three swapping stations are up and running when the first 200 cars are delivered. The full cost of each swapping station is estimated to $1 000 000 at full cost. The swapping stations are supposed to last forever.
- The corporate tax rate is expected to remain at the current level 28%
- Yearly inflation rate is estimated to 2%
- Robotic Vehicles Ltd. has a D/E ratio equal to 2 and the cost of debt is expected to be constant at 7% and the cost of equity is estimated to be constant at 10% forever.
- Today is the 1st of January 2015.
The autonomous car sales alternative:
- The price per car for the first 1000 cars delivered is estimated to $20000 in real terms.
- The price per car for the remaining 1000 cars delivered is estimated to $15000 in real terms
- Electricity fill-up is provided at full-cost (zero net present value)
- Robotic Vehicles Ltd also in this investment alternative sells a maintenance service of the cars to the New York city Government. The service is provided at the end of each year for each car. Robotic Vehicles ltd's current profit per car and year for providing this service is estimated to be $100 in nominal terms. This profit-level is expected to grow yearly at a 10% rate
- The investment will be financed according to Robotic Vehicles Ltd's current overall proportion of debt and equity (assume zero additional cost for issuing new debt or equity).
The electricity charging alternative:
- The yearly use of each car is estimated to 10 000 miles.
- The current fee charged per mile each electric autonomous car is driven is currently estimated to $0.50 in nominal terms. The fee is expected to grow at a 5% rate yearly.
- Robotic Vehicles ltd is currently charged for electricity use of each car by a utility company. The electricity cost per mile the car is driven is estimated to $0.20 in nominal terms. By the end of each year there is a 20% chance that the electricity cost per mile and car decreases by $0.01 in nominal terms and an 80% chance that the price increases by $0.02 in nominal terms.
- The investment will be financed solely by equity capital.
Your task:
Your task is to create a spreadsheet model (using Microsoft Excel) showing your friend which alternative is to prefer from a financial point of view. In particular your friend wants you to show her the following in the spreadsheet model:
a) Show by calculation the net present value for the two options (selling cars, mileage fees). Also, according to NPV suggest which alternative you advise your friend to choose
b) Show by calculation (creating a formula) the discount rate for the mileage alternative at which (assuming all else the same as in the instructions above) Robotic Vehicles Ltd is indifferent between the two investment alternatives.
c) Robotic Vehicles Ltd is a bit uncertain about whether the cost of debt will remain constant at 7% over time. Therefore they want you to show by calculation how the company's cost of capital is influenced by a 1% increase and decrease respectively in cost of debt (i.e. by the cost of debt being 6%, 7%, or 8% forever starting today). Also, they want you show by calculation how Re (return on equity, hint WACC) is influenced by the increase and decrease in cost of debt.+
Finally, since Robotic Vehicles Ltd. wants to be able to use this spreadsheet in the future as well you need to use cell references in the formulas (for a, b and c above).
Case 2:
A friend of yours is the CEO of a company called CSR delivering corporate social responsibility solutions. The company has grown quickly and it is since the 1st of January 2015 noted on the Stockholm Stock Exchange. Your friend knows you are a finance specialist and therefore consults you to analyze whether or not the company shall pay yearly dividends or not to its shareholders.
General
- The company has until now made yearly earnings before interest and taxes (EBIT) of $1.5million.
- Growth in EBIT is expected to be 4% annually.
- The corporate tax rate is expected to be 25% per year forever.
- The Company's current re, cost of equity capital, is 12%.
- The company expects to make profits for the next 10 years and then make zero profits forever.
- Today is the 1st of January 2015.
Dividends and shares
- The total number of shares outstanding is 1 000 and the number is expected to remain fixed forever.
- The company considers paying no dividends at all, paying dividends of $100 per share and year or paying dividends of $200 per share and year.
Cost of dividends
- The transaction cost for issuing dividends amounts to $5 per share and dividend.
- There are no legal costs associated with dividends.
Your task
Your task is to create a spreadsheet model (using Microsoft Excel) showing your friend which alternative is to prefer. In particular your friend wants you to show her the following in the spreadsheet model:
d) Show by calculation what would be the price per share today for each of the three dividend alternatives (no dividend, $100 dividend, $200 dividend). Also, given the information above, explain which of the three alternatives the company (CSR) should choose in order to
maximize company value.
e) Now assume that instead of paying dividends for years 2015 and 2016 the company can choose to invest today the amount equivalent to those two dividend payouts. The investment opportunity implies putting money into a financial security that will yield a 12% return per year for the next 10 years. Should the company make the investment or not in order to maximize company value? Show by computation!
f) Now assume a perfect capital market (according to Modigliani & Miller). The company considers repurchasing 100 shares today, January 1st 2015, instead of using that amount of money to pay dividends. Should the company repurchase shares or pay out dividends in order to maximize company value? Show by computation.
Finally, since your friend wants to be able to use this spreadsheet in the future as well you need to use cell references in the formulas (for a, b and c above).