cash flows that would result from an investment in this project using your base case assumptions

You will complete your work in the provided Excel workbook titled, “Pegasus Case StudyTEMPLATE.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: FALL23_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:

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 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:
����� ������ = ������� − ����
�������
• 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
Year of
Operations
Vehicle
Deliveries
YoY
Delivery
Growth
Average
Selling Price
YoY Price
Change
Average
Gross
Margin
1 50,000 $ 40,000 5%
2 62,500 25% $ 39,200 -2% 10%
3 71,875 15% $ 38,416 -2% 20%
4 79,063 10% $ 37,648 -2% 20%
5 83,016 5% $ 36,895 -2% 20%
6 83,016 0% $ 36,157 -2% 20%
7 78,865 -5% $ 35,434 -2% 20%
8 70,979 -10% $ 34,725 -2% 20%
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 basecase 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.
4. MRA anticipates gross margin to increase from 5% in Year 1 of production to 20% by Year 3
of production due to efficiency gains in production processes as well as lower production
costs. However, there is some concern that these estimates are too optimistic. Holding
our gross margin estimates constant in the first 2 years of operations, what is the NPV
break-even level of gross margin that must be achieved by Year 3 of operations and
maintained for the remainder of the project’s life.
5. In order to incentivize investment in “green” industry, the government has made additions
to the corporate tax code that it hopes will encourage investment in these types of
companies. Recently-passed legislation allows investments in electric vehicle production
to utilize and benefit from an accelerated depreciation schedule. This legislation allows
50% of the cost of any capex investment to be depreciated in its first year (Year 1). The
remaining 50% will be depreciated evenly over the remaining originally assumed
depreciable life. What is the NPV of the Pegasus project using these updated depreciation
assumptions? Despite this recently passed tax legislation, MRA still plans on using straightline depreciation for all of the company’s accounting. Which depreciation method should
you utilize in your FCF and NPV analysis?
6. What is the IRR of this project? Provide your answer to 1 decimal place (0.1%). 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:
����� ������ = ������� − ����
�������
• 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
Year of
Operations
Vehicle
Deliveries
YoY
Delivery
Growth
Average
Selling Price
YoY Price
Change
Average
Gross
Margin
1 50,000 $ 40,000 5%
2 62,500 25% $ 39,200 -2% 10%
3 71,875 15% $ 38,416 -2% 20%
4 79,063 10% $ 37,648 -2% 20%
5 83,016 5% $ 36,895 -2% 20%
6 83,016 0% $ 36,157 -2% 20%
7 78,865 -5% $ 35,434 -2% 20%
8 70,979 -10% $ 34,725 -2% 20%
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 basecase 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.
4. MRA anticipates gross margin to increase from 5% in Year 1 of production to 20% by Year 3
of production due to efficiency gains in production processes as well as lower production
costs. However, there is some concern that these estimates are too optimistic. Holding
our gross margin estimates constant in the first 2 years of operations, what is the NPV
break-even level of gross margin that must be achieved by Year 3 of operations and
maintained for the remainder of the project’s life.
5. In order to incentivize investment in “green” industry, the government has made additions
to the corporate tax code that it hopes will encourage investment in these types of
companies. Recently-passed legislation allows investments in electric vehicle production
to utilize and benefit from an accelerated depreciation schedule. This legislation allows
50% of the cost of any capex investment to be depreciated in its first year (Year 1). The
remaining 50% will be depreciated evenly over the remaining originally assumed
depreciable life. What is the NPV of the Pegasus project using these updated depreciation
assumptions? Despite this recently passed tax legislation, MRA still plans on using straightline depreciation for all of the company’s accounting. Which depreciation method should
you utilize in your FCF and NPV analysis?
6. What is the IRR of this project? Provide your answer to 1 decimal place (0.1%).