Present Value Analysis; Sensitivity Analysis; Spreadsheet Application Because of increased consumer demand for fuel-efficient, alternative-energy automobiles, Global Auto Company is considering investing in a new hybrid crossover vehicle. Development costs each year for a two-year period for this new vehicle are estimated as $750 million. Tooling and other setup costs in year 2 are estimated at $1 billion. Actual production and sales are estimated to begin in year 3. It is anticipated that the plant being envisioned could produce vehicles for six years. Each vehicle sold is estimated to provide $3,500 of net cash flow (pretax). The estimated salvage value of the manufacturing plant after six years of operation is thought to be $250 million. Assume that all cash flows take place at year-end and that the pretax WACC for Global Auto is 15%. Income tax effects can be ignored in this problem.
Required
1. What minimum volume of car sales (per year, in the six-year life of the plant) is needed to make this proposed investment acceptable using NPV as decision criterion? (Note: For calculating present values of after-tax cash flows, use the following formula rather than the factors presented in Appendix C: PVi = 1 ÷ (1 + r)i, where r = discount rate (WACC) and i = year, 1–8. Also, use the Goal Seek function in Excel to answer this question.)
2. How does your answer in (1) change if the company’s pretax WACC is 14%? 16%? Do you think the estimated NPV of this project is sensitive to the estimate of the company’s discount rate?
3. What strategic considerations, including those related to risk management, would likely bear on this decision?
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