You are one of the four co-founders of FastCharge, an equity-financed company based in California selling batteries
Question:
You are one of the four co-founders of FastCharge, an equity-financed company based in California selling batteries for electric cars. Last year (t=-1) you paid $200,000 to a marketing firm to advertise your new fast-charging battery. You just came back to San Francisco from Austin with a good news for your co-founders. A large electric car manufacturer from Austin is interested in your product and willing to sign a contract to buy a large amount of your new fast-charging batteries for the next for the next ten years (t=0 to t=10). In case FastCharge decides to accept, the projections are as follows: • The buyer is willing to buy 20,000 batteries immediately (at t=0). Then the buyer expects an increase in the demand for electric cars (assume each car needs one of the new battery) by 5% per year for the first five years (t=1 to t=5) and by 2% thereafter (t=6 to t=10).
• The average annual revenues per battery for years 0 to 10 are expected to be $200, while average operating expenses to produce them are expected to be $160.
• Increasing production in future years require an initial investment of $5 million at t=0 in a new establishment. This investment will be depreciated over the next 10 years assuming no salvage value (i.e., to zero). The establishment is expected to be sold at the end of year 10 for $1 million.
• Additionally, the increase in production of the new battery in future years requires training of personnel. This will increase labor costs by $500,000 in the years 1 and 2. • The project requires working capital of $1 million from the end of year 1 until the end of year 5. Working capital is reduced to $500,000 at the end of year 5 and to 0 at the end of year 10.
• The company faces a corporate tax rate of 21%, and the after-tax cost of capital (discount rate) is 5%.
(a) What are the company's free cash flows from accepting the offer? Should FastCharge accept the offer if it is the only option available? (b) What is the IRR of the project? What is the modified IRR assuming a reinvestment rate equal to the discount rate?
Cost Management Measuring Monitoring And Motivating Performance
ISBN: 9781118168875
2nd Canadian Edition
Authors: Leslie G. Eldenburg, Susan Wolcott, Liang Hsuan Chen, Gail Cook