Tesla Incorporated (Tesla Inc.)

Today is July 2nd 2017. You are the product development manager for Tesla Motors Limited (Australia). Tesla Inc., headquartered in Palo Alto, California, is a manufacturing company that has innovation at its core. Their commitment to research and development has been growing significantly. For example, in 2016, Tesla spent in excess of $834m on research and development (R&D) (source: www.statista.com). The company is considering new investment into research products that address the challenges of logistics and transportation[1]. You have been asked to make recommendations of new investment to the Board, specifically in reference to two new vehicles recently developed within the company’s Research Department.

The first development is a new electric semi-truck, called the Tesla Semi, which has the ability to synchronise with other similar trucks and may lead to driverless “freight trains” of trucks of particular interest to the mining companies operating in the arid northern territories of both Australia and Canada. The first sales of this truck are expected in July 2019. Upon your request, the project leader provides some standard cost estimates if the product is approved and launched later this year.

Development costs                25 million

Testing costs:                         12 million

Initial Marketing costs:         18 million

Initial outlay                          55 million

The new truck is expected to generate $54 million in sales in the first year. The sales revenue generated from this product alone is expected to grow at a solid rate of 14% pa in the first three years and stay in line with inflation thereafter until its patent expires in 10 years.

The second recommendation is to expand production of the Model 3 compact sedan, the first “mass market” vehicle produced by Tesla Motors which has traditionally targeted more exclusive markets. This product has passed the testing phase and is expected to start generating sales in July 2017. The initial marketing cost is around $23 million. Its sales revenue is expected to start off from $23.7 million in the first year and continue to grow steadily at 9% over the next 10 years.

The manufacturing of either product would be done in an unused plant already owned by the company that would otherwise be leased out for $200,000 per year after tax. Required equipment costing $12 million is expected to have a sale value of $300,000 after 10 years, by which time its book value will be zero. For both vehicles, fixed production costs are estimated to be $2.5 million per year while variable production costs are expected to be equal to 25% of sales revenues for each project. To get the project underway, additional inventory of $1,200,000 would be required. The company would also need to increase its account payable by $1,000,000 and its account receivable by $500,000. It is anticipated that the net working capital committed to each production line would be maintained at 20% of its sales each year thereafter. Investment in working capital can be recovered at the end of year 10.

The nominal weighted average cost of capital was calculated to be 14% p.a., which is applicable for both projects. The current inflation of 2.5% pa is expected to remain constant over the next 20 years, as is the company’s tax rate of 30%.

Requirements:

Please answer the following two questions in the form of a business report:

  1. You have been asked to advise the manager which one of these proposals should be adopted using NPV and IRR analysis. Based on the base-case estimates, propose which project/s Tesla should invest in.
  2. In addition, you have been asked to provide some break-even analysis and sensitivity analysis. The Board has indicated that it is not that concerned with the numbers for Model 3, but the main concern is that the forecasts of sales growth for Tesla Semis may be overly optimistic. Further analysis leads you to believe there is a 20% chance that sales growth of Tesla Semis in the first three years will be 25% higher and a 40% chance of being 25% lower. In addition, there is a 25% chance that the variable costs account for 35% of total sales, and a 25% chance that the variable costs account for 22% of total sales. The initial marketing cost may also be 25% lower (10% chance) or 25% higher (40% chance). Based on these analyses, comment on the viability of Tesla Semis.

[1] While some of the material regarding Tesla Motors presented in this assessment task is factually correct, much is not. This information is merely used as an indication of the types of decisions that might be expected in a company like Tesla Motors, for the purpose of assessing your ability to apply the material taught in GSBS6130.