Cynthia Lu the production planning manager of Tesla Motors, is considering introducing Model 3. Model 3 is a successor to Model S, which is selected as the North American Car of the year in 2013. Cynthia had already paid $2 million for a feasibility study made by Boston Consulting group, which estimated that the number of Model 3 models that would be sold could be as high as 500,000 per year for the next 5 years, however expected number of units sold is 100,000. The model 3 is expected to be obsolete after 5 years (a convenient assumption to allow us ignore cash flows after year 5). The average price per car would be $30,000. The variable cost of production is estimated to be $25,000 per unit.
The initial capital investment on assembly equipment is $50 million. There is also need for a battery assembly line however the battery assembly line built for model S and X has idle capacity that can do the work for model 3 and is not expected to be utilized in the next five years. Regardless, production manager of model S, Mark Huston, insisted that 50% of the original investment made in the line should be allocated to model 3, which is about $20 million.
Investment in new machinery and equipment will be depreciated using straight line depreciation in 5 years. Idle equipment is fully depreciated. The initial capital requirement (at time zero) is equal to 10% of sales, which would be fully recovered at the end of 5 years. Tesla already employs several support staff in its headquarters such as secretaries, which costs $3 million per year and production manager of Model S argued that 50% of the salaries of the support personnel should be allocated to Model 3 project going forward.
There is ample factory space that will not be used for anything in the next five years but again Mr Ciabotti (manager for model X) insists that model 3 should allocated at least $10 mill for factory space because someone has to pay for it. Tax rate is 30%.
Write down the cash flows for years 0, 1,and 5 that are relevant in evaluating the project Model 3 in the space provided in the next page. (do not calculate NPV)