Question

Given the soaring price of gasoline, Ford is considering introducing a new production line of gas-electric hybrid sedans. The expected annual unit sales of the hybrid cars is 30,000; the price is $22,000 per car. Variable costs of production are $10,000 per car. The current fixed overhead including salary of top executives is $80 million per year, the new production line is expected to add $10 million to this. However, the introduction of the hybrid sedan will decrease Ford’s sales of regular sedans by 10,000 cars per year; the regular sedans have a unit price of $20,000, a unit variable cost of $12,000, and fixed costs of $250,000 per year. Depreciation costs of the new production line are $50 million per year. The marginal tax rate is 40 percent. What is the incremental annual cash flow from operations? If this new production line had an upfront cost of $500 million and a 10-year useful life, depreciated using a straight-line method (accounted for by the previously mentioned $50M per year of depreciation), the impact to sales and costs were consistent for the 10-year life (i.e. incremental cash flows are the same for each of the 10 years) and your firms uses a WACC for this project of 15%, what are the NPV, IRR and payback of the new production line.

Answer 1

Part I of the Question:

a) Computation of Revenue:

Annual unit sales of Hybrid cars 30,0000

Price per car $22,000

There, Revenue (30,0000*$22,000) $660 million

b) Computation of Variable Cost of Production:

Variable cost of production per car $10,000

Annual unit sale of cars 30,0000

Therefore, Total Variable cost of production $300 million

(30,000*$10,000)

c) Given Fixed Overheads:

Current fixed overhead including salary $80 million

Note: These fixed overheads would not be taken into consideration as this cost would exist irrespective

of the new line of production

Incremental Fixed overhead expected to be

added as a result of new line of production $10 million

Note: This is to be taken into consideration in computation of net incremental cashflows as this is the

additional cost which would be incurred as a result of new line of production

d) Computation of lost revenue due to new line of production:

Decrease in Ford's sales of regular sedans 10,000 units

Unit Price of regular sedans $20,000

Variable cost per unit of regular sedans $12000

Therefore, Lost net revenue from regular $80 million

sedans ($20,000-$12000)*10,000

e) Annual Depreciation cost of new production line $50 million

f)           

Computation of Total Operating Expenses:	Amount $ in million
Variable cost of production ( Refer sub part (b))	300
Incremental Fixed overhead (Refer sub part (c))	10
Lost net revenue from regular sedans (Refer sub part (d))	80
Total Operating Expenses	390

g) Computation of Net Incremental Cashflows:

Particulars	Amount $ in million
Net Revenue from New Production Line	660
Total operating expenses (Refer subpart (f))	390
Earnings before interest, tax, depreciation and amortization (EBITDA)	270
Less: Depreciation (Given in the question)	50
Earning before interest and tax (EBIT)	220
Less: Tax @ 40% ( as given in the Question)	88
Net Operating Profit after tax (NOPAT)	132
Add: Depreciation	50
Net Cashflow from Operations	182

Therefore, incremental annual cashflow from operations is $182 million.

Part II of the Question:

a) Computation of NPV:

NPV = ( Todays value of expected future cashflows) - (Todays value of invested cash)

= {$182 million * PVIAF(15%, 10years) - {$500+ $50}million

= ( $182*5.019)million - $550million

= ($913.458 - $550) million

= $363.458 million