This project represents a capstone on your learning in the course as it brings together several of the courses primary learning outcomes. You will analyze a capital investment opportunity under consideration by a multinational manufacturing firm (MNC). The project involves the following steps: (1) gather relevant data from the case; (2) develop an APV model that integrates the data; (3) determine an appropriate course of action; (4) conduct a sensitivity analysis of your model results; (5) write an executive summary explaining your findings; (6) develop a short presentation to present your findings and recommendations.

Background Michelin, founded in 1889, is the worlds second-largest tire producer. Michelins international headquarters are located in Clermont-Ferrand, France. Though Michelin sells tires globally under various brands, the United States represents its fastest-growing market for its Michelin brand passenger and light-truck tires. Marketing indicates that the company needs additional capacity to meet current and future demand in the United States. Senior management has assigned you to evaluate the following proposed project and make recommendations on whether to move forward based on the total financial picture.

The Proposed Project Due to its limited production capacity to meet US demand through its North American (MNA) division, Groupe Michelin leverages its European (MNE) division to export 220,000 tires (with 0% annual growth) to the American market each year. However, since the American market is larger than the combination of its current MNA capacity and European exports, Michelin is considering the construction of a new passenger and light-tire facility in Spartanburg, South Carolina, to boost MNAs total production capacity. The proposed facility would add 400,000 tires of additional capacity to MNAs current portfolio. American demand is such that this capacity could be immediately and fully used. Furthermore, Michelin operations personnel can scale this capacity to meet a projected increase in demand of 7% year-on-year. The new facility will cost USD150M. To benchmark against other projects in its portfolio, Michelin assumes a project lifespan of 8 years when conducting APV analysis. Funding Considerations Michelin plans to finance the Spartanburg project by a combination of equity and debt. The plant will increase the firms borrowing capacity by EUR50M. In addition, Spartanburg County will provide USD20M of concessionary loan financing for 7 years at 3.5%. (Michelin would repay the concessionary loan principal in equal installments over the life of the loan). At this point, to finance in a manner consistent with its optimal debt ratio, Michelin is uncertain whether to raise the remaining debt through a Yankee (USD-denominated) bond issue or a domestic (EURdenominated) bond issue.

Regardless of the country of issue, coupon payments will be constant each year for the term of the bond (7 years). Michelin believes it can borrow EUR at 6% and USD at 7%. Michelin would like to consider the swap market to lower its borrowing costs. There is a US firm that could borrow USD at 6% and EUR at 8%. Michelin would prefer to issue USD-denominated debt since the project costs are denominated in USD. The swap bank is quoting 0.2% (0.1%) on the notional principal denominated in USD (EUR). Operational Considerations Michelin presently realizes a contribution margin of EUR49.50 on its exports to the US. Once the new US manufacturing facility is online, Michelin forecasts a unit cost of USD118 against a unit price of price of USD188, both of which are expected to increase in a manner consistent with US inflation. Michelins economic consultant forecasts US inflation at 5% annually over the life of the project, as compared with 2% in the eurozone. The current spot exchange rate is S(EUR/USD) = 0.8808. Michelin uses PPP to forecast future exchange rates. 2 To minimize the costs of sales cannibalization, Michelins existing exports to the US would need to be re-directed to a new market. It can begin to channel its current US exports to the UK over the next three years. (That is, Michelin assumes it can rechannel 1/3 in year 1, another 1/3 in year 2, and another 1/3 in year 3 such that the cannibalization effect is nullified in year 3).

Tax Considerations The IRS will allow Michelin to fully depreciate the new facility over the life of the project using a straight-line depreciation technique. On the books, the facility will be worth USD0 at the end of the project. However, Michelin anticipates being able to resell the project PPE for USD80M at the end of the project. The capital gain tax rate in the US is 25%. Assume the corporate income tax rate is 35% in France and 40% in the US. Assume that transfer pricing strategies are ruled out. Michelins all-equity cost of capital is calculated at 10%.

Base Case Questions 1. What action does your analysis suggest Michelin should take regarding the proposed project? Does the base case suggest doing the project or not? 2. Is your answer the same if the terminal value of the equipment is included in the analysis? Why or why not?

Sensitivity Analysis Questions Note: In each of the following, assume your base case includes terminal value of PPE. Then run each scenario, one at a time, making sure to return to the base case before processing the next scenario. 1. Ceteris paribus, what price per unit achieves an APV of EUR1? Interpret the result. 2. Ceteris paribus, what COGS per unit achieves an APV of EUR1? Interpret the result. 3. Ceteris paribus, what project cost achieves an APV of EUR1? Interpret the result. 4. Ceteris paribus, what PPE resale value achieves an APV of EUR1? Interpret the result.