Need help with capital budgeting analysis and going public analysis

Capital Investment Analysis

The Tuxedo Corporation have also asked that your team evaluate two production alternatives submitted by the production department for the new Tuxedo Electric vehicles. The proposed capital project calls for developing that plant for producing the Tuxedo Electric Vehicles. Two alternatives plant models are proposed. Alternative A is a Semi-automated system that has initial equipment and software development costs projected at $194,000,000. Alternative B is a fully automated system that is estimated with an initial equipment and software cost estimated to be $336,000,000. For each alternative, the initial equipment and software costs would be capitalized and qualify for a capital cost allowance (CCA) rate of 30 percent. You will use the cost of capital obtained through the pure play approach for evaluating the two alternatives. As an environmental friendly product, the Tuxedo Corporation pay corporate tax at the rate of 35 percent for investments in its EV manufacturing project.

The market research conducted by a marketing consultant indicated three possible economic condition for the next five years. The market research indicated that the economy can be normal, booming or there can be a recession. The consultants provided the probability of each state of the economy. They also estimated sales for next year and the expected increase in sales for the subsequent years under each possible economic condition. The expected sales data provided by the market research consultant for the Tuxedo Electric Vehicle is presented in the table below:

Table 3

Expected Economic Condition, Estimated Sales Units and Projected Annual Increase in Sales for the Tuxedo Electric Vehicle.

State of the Economy

Probability

Sales Units

Yearly Expected Increase in Sales Units

2021

2022

2023

2024

2025

Recession

20%

150,000

5%

5.50%

6.05%

6.66%

Normal

50%

200,000

7%

7.70%

8.47%

9.32%

Boom

30%

250,000

10%

11.00%

12.10%

13.31%

Although the initial cost of building the semi-automatic production plant for the Electric Vehicle is cheaper than the option to build a fully automated system, the operating cost of the semi-automatic system is higher. Electric car produced from either of the two alternative plant are the same. The main difference is the approach adopted in the production process. Each of the Tuxedo Electric car is expected to command a price of $45,000. The estimated unit variable cost of producing each Tuxedo EV is as shown in the table below

Table 4

Per Unit Production Cost for the Tuxedo Electric Vehicle - Semi-Automatic and Fully-Automatic Production System

Year

Alternative A

Semi-Automatic

System

Alternative B

Fully-Automatic

System

2,021

$28,000

$22,000

2,022

29,400

23,100

2,023

30,870

24,255

2,024

32,414

25,468

2,025

34,034

26,741

The Tuxedo Corporation expect to invest $8,000,000 as initial working capital. The working capital will increase by 10 percent of the annual increase in sales revenue of the following year. The equipment purchased for each alternative production process will last for five years at the end of which the working capital is irrecoverable. The company also has an annual fixed cost of $2 billion

For Intellectual property security reasons, it is company policy not to rent excess production capacity to outside users. Your team is required to address the following in your report to the Tuxedo Corporation executives:

1. capital budgeting analysis with as many tools as possible to evaluate each of the alternatives production system. Both the semi-automatic and the fully-automatic production system have 5-year useful life.
2. Jack and Mark suspect that there is a high risk that new technology will render the production equipment in the Semi-Automatic production system useless at the end of three years and may need to be replaced to continue production if this alternative is chosen. The fully-automatic production system on the other will last 5 years before needing complete replacement. Jack and Mark want you to recommend the alternative that the company should adopt if it chooses not to replace. They also will like you to make a recommendation regarding the system to adopt if they choose to replace after the suspected useful life of each alternative.

The Tuxedo Corporation could salvage the equipment in the Semi-Automated production system for 30 percent of its original cost at the end of the third year and for 15 percent by the end of the fifth year. The realizable salvage value for the fully-automated system is 10 percent of its original cost by the end of year 5.

Going Public

Jack and Mark have been discussing the future of TA. The company has been experiencing fast growth, and the two see only clear skies in the company's future. However, they are worried that the expected growth may no longer be funded by internal sources, so Jack and Mark have decided the time is right to take the company public. To this end, they have entered into discussions with the investment bank of Crowe & Mallard. The company has a working relationship with Zoe Harper, the underwriter who assisted with the company's previous bond offering. Crowe & Mallard have assisted numerous small companies in the IPO process, so Jack and Mark feel confident with this choice.

Jack and Mark begins by telling your team about the process. Although Crowe & Mallard charged an underwriter fee of 4 percent on the bond offering, the underwriter fee is 7 percent on all initial stock offerings of the size of Tuxedo Air's offering. The company can expect to pay about $1,800,000 in legal fees and expenses, $12,000 in Ontario Securities Commission (OSC) registration fees, and $15,000 in other filing fees. Additionally, to be listed on the Toronto Stock Exchange the company must pay $100,000. There are also transfer agent fees of $6,500 and engraving expenses of $520,000. The company should also expect to pay $110,000 for other expenses associated with the IPO.

Finally, Jack told your team that to file with the OSC, the company must provide three years' audited financial statements. The company provides audited financial statements as part of the bond covenant, and the company pays $300,000 per year for the outside auditor.

1.At the end of the discussion, Mark asks your team about the Dutch auction IPO process. What are the differences in the expenses to Tuxedo Air if it uses a Dutch auction IPO versus a traditional IPO? Should the company go public through a Dutch auction or use a traditional underwritten offering?

2.During the discussion of the potential IPO and Tuxedo Air's future, Mark states that he feels the company should raise $750 million. However, Jack points out that if the company needs more cash in the near future, a secondary offering close to the IPO would be problematic. Instead he suggests that the company should raise $900 million in the IPO. How can we calculate the optimal size of the IPO? What are the advantages and disadvantages of increasing the size of the IPO to $900 million?

3.After deliberation, Jack and Mark have decided that the company should use a firm commitment offering with Crowe & Mallard as the lead underwriter. The IPO will be for $750 million. Ignoring underpricing, how much will the IPO cost the company as a percentage of the funds received?

4.Many employees of Tuxedo Air have shares of stock in the company because of an existing employee stock purchase plan. To sell the stock, the employees can tender their shares to be sold in the IPO at the offering price, or the employees can retain their stock and sell it in the secondary market after Regina Air goes public. Jack asks your team to include an advice for the employees about which option is best.