Problem:
You work for an automobile company that is considering developing a new car. The product development cost for this new car will be $500 million per year for 3 years. During the third year of product development, the company will incur $1 billion for manufacturing set up costs. Three years after the start of product development, the company will begin making and selling cars. Production and sales will last 7 years, and each car sold will generate incremental profit of $2,500. After 7 years, the salvage value associated with the manufacturing facilities will be $200 million. The company's cost of capital is 12%. Assume all cash flows occur at the end of the year.
Q1. What is the minimum number of cars the company must sell during each of the 7 years of the product's life to make this investment desirable under the net present value criterion?
Q2. What will the minimum number of vehicles be if the company's cost of capital is 15%?