Case Study #1 (Middle River Automotive, LLC)

This case will be graded as your next assignment.

You may work on this case study independently or in small groups of up to 5 students.  If you work on this case as part of a group, please make ONLY ONE submission with the names of all students who contributed to the case study listed in the appropriate space on the first tab of  the Excel workbook.  The case study will be graded and grades will be assigned to the listed    students as appropriate.

•   You will complete your work in the provided Excel workbook titled, “Pegasus Case Study TEMPLATE.xlsx” which has been provided in Blackboard.

•   Several tabs have been created that may aid in your calculations, along with several       blank tabs at the end if you need to perform additional work.  The only tab that you are REQUIRED to complete is the first, labelled “FCF Forecast” .

•   You MUST provide your answers to the case study questions on the first workbook tab which is labelled “FCF Forecast” .  PLEASE DO NOT MAKE ANY CHANGES TO THE              FORMATTING OF THIS TAB.  You MUST provide a completed FCF forecast in the             template provided according to the assumptions outlined in this document.  You must also provide a value in any cell that is highlighted in yellow.  You may make use of

and/or modify any additional tabs/cells as you see fit to support your work.

•   When you have completed your work on the case study, please save your workbook and create a PDF of the first tab, “FCF FORECAST” .  Instructions for creating a PDF from           Microsoft Excel are provided in Blackboard.  Name your PDF using the following                convention: SPRING23_CS1_NETID.  In place of “NETID” please include the UIC NetID       (not the UIN) of the student making the case study submission.  For example, my NetID  is “thealy4” .  Therefore, if I were making a submission, it would be titled:

SPRING23_CS1_THEALY4

•   Make sure all students who participated in the completion of the case study are indicated on the first workbook tab in the provided table.

•   Submit your completed workbook according to the instructions provided in Blackboard. Please do not email your submission.

•   All submissions must be made by 11:59PM CT on Thursday, March 30.

Company Background

Middle River Automotive, LLC (MRA) is a company that was established in 2017 with the goal of designing, developing, manufacturing, and selling both hybrid and fully electric cars and light     trucks.  The company’s corporate and design headquarters are in Baltimore, MD.  In 2018, the   company acquired several decommissioned assembly plants in nearby Middle River, MD,            previously owned by Martin Marietta, Corp., an aerospace manufacturing company later            acquired by Lockheed Martin.  MRA has spent the past 18 months renovating and updating        these facilities in anticipation of using them to manufacture electric vehicles.  The cost of these renovations thus far has been approximately $1 billion.

Scenario

It is 2023 and MRA management is currently evaluating a proposal to move forward with plans to manufacture its first light pickup truck, the fully electric Pegasus EVX.  The company has        already conducted extensive research into both the manufacturing and marketing of this new  vehicle and has developed the following estimates:

•   The company expects that, upon the commencement of production, this new project will have an 8-year life.

•   If the project moves forward, a further $250 million investment in Property, Plant, & Equipment will be required immediately.  This capital expenditure will be fully            depreciated using the straight-line method over an 8-year depreciable life.

•   If given the green light, it will take one year to finish preparing the manufacturing            facility, install the new equipment, and hire and train employees.  Production and            deliveries will commence during year 2 and run for 8 total years.  Though operations will not have commenced in Year 1, the company will begin to recognize any depreciation     expense in Year 1.

•   The company expects to deliver 50,000 vehicles in the first year of production.  The  company expects the number of units delivered to increase by 25% in Year 2, 15% in year 3, with sales growth to fall by 5% each year thereafter for the remainder of the project’s life.

•   The company has estimated that the average selling price for the Pegasus will be              $40,000 in its first year of availability.  The company estimates that after this, the             average selling price will fall by 2% per year as competition increases and consumers are presented with increasing options in the electric vehicle market.

•   The company expects gross margin to be 5% in the first year of production, 10% in Year 2, and 20% every year thereafter.  Gross margin can be calculated as:

Gross Margin =

•   A summary of these baseline forecasts is provided below:

Some further assumptions:

•  The company expects operating expenses (SG&A) of $100 million per year, beginning in Year 1, and continuing for the life of the project.

•  In addition, the company expects an additional $100 million investment in Research &        Development in Year 1 in order to finalize the design of the vehicle and its groundbreaking battery technology.  After Year 1, the company expects R&D expenses of $25 million per    year for the remainder of the project.

•  Furthermore, the company anticipates having to spend $40 million on marketing in Year 1, in advance of the launch of the Pegasus.  Marketing expenses are expected to fall by 10%  per year after Year 1.

•  Final assembly of the Pegasus will take place in the Pershing Assembly Building.  MRA    currently leases a portion of this building to a third party for $25 million annually.  If the Pegasus project moves forward, this third party will need to relocate its operations         immediately and will no longer lease the space from Year 1 onward.

•  Though the company is fully depreciating its equipment over 8 years, it has also estimated that it will likely be able to sell some of this equipment at the end of the project’s life.  You

anticipate that the equipment could be sold for $60 million at the end of the project’s life.

•  The company expects that the vast majority of its sales will be to new customers making the transition from traditional, gas-powered vehicles.  However, they also expect that some sales of the Pegasus will be to customers who may have been planning on purchasing other MRA vehicles, such as their hybrid SUV launched last year.  The company has               determined that 10% of its annual Pegasus sales will fall into this category.  Other vehicles  manufactured by MRA have an average selling price of $35,000 and are produced at an        average gross margin of 20%.

•  For accounting purposes, except for any investment in CapEx, which will be recognized     immediately (T=0), all revenues, expenses, and cash flows will be recognized at the end of the year during which they take place.

•  An additional investment in inventory will need to be made in Year 1 in the amount of $50 million.  This inventory will be maintained for the duration of the project’s life and will be  drawn down to $0 upon the termination of the project.

Deliverable

You are to prepare an incremental earnings and free cash flow forecast based on these      assumptions.  Middle River Automotive uses a cost of capital of 13% when evaluating new projects.  Its marginal corporate tax rate is 21%.

When completing your incremental FCF forecast and answering the following questions,     please provide all dollar amounts in thousands of $USD.  Meaning, for example, that if a     certain raw value of $100 million, it would be represented in your spreadsheet as $100,000 (in effect, 100,000 thousand dollars).

In addition to providing a complete incremental free cash flow forecast, please answer the following questions:

1. What is the NPV of this project using the base-case assumptions presented above?

2. Based on input from the marketing department, MRA has concerns about the uncertainty   surrounding the first year’s sales figures.  Holding all other assumptions constant, including YoY sales growth estimates, what is the NPV of the Pegasus project if first year sales are      10% greater than anticipated?  What is the NPV if first year sales fall 10% short of our base- case estimates?  What is the NPV break-even level of first year sales?

3. In order to meet sales growth targets, MRA is aware that it may need to lower the price of the Pegasus in order to incentivize customers to choose their product over a competitor’s. Management is fairly confident that it will be able to achieve the $40,000 average selling    price forecast for year 1 of operations.  However, they would like you to take a look at how the project’s value is impacted if they need to be more aggressive in pricing the Pegasus     beyond Year 1.  What is the NPV of the Pegasus project if, after Year 1, the average selling  price falls by 4% per year, instead of the 2% per year drop incorporated into our base-case assumptions.  What is the NPV break-even level of YoY drop in average selling price beyond Year 1.  Again, hold all other assumptions constant.