MBA 720: Group Case Study Apple iCar

| July 2, 2019

MBA 720: Group Case StudyApple iCarApple designs, manufactures, & markets mobile communication & media devices, personalcomputers, & portable digital music players, & sells a variety of related software, services,accessories, networking solutions, & third-party digital content. The company has had avery good run, both in terms of earnings and stock prices, over past decade. Based largelyon the success of the iPhone, Mac and the iPad, the company has reported double digitgrowth in revenues and earnings over the last few years and its stock price has reflectedthis success. It is currently the most valuable company in the world though Google is fastclosing in. It has a substantial cash balance and a good balance sheet. However, Tim Cook,CEO of Apple, is concerned that though iPhone 6 series has been an unprecedented success,Apple is too much dependent on iPhone revenues. Hence, it wants to diversify its productline to come up with something very different.The ProposalApple has been working on an ambitious project called TITAN for the past few years.If the initial prototypes are successful it will consider entering the automobile market withan innovatively designed electric car, called the iCar, aimed at the premium end of the1automobile market. You have been asked to collect the data to make the assessment andhave come back with the following information:1. R&D Expenses: Apple has already spent (and expensed) $ 8 billion on research on theautomotive technology and development of the commercial design of the electric car.None of that money can be recouped at this stage, if Apple decides not to go ahead withthe iCar.2. Introductory Costs; If Apple decides to go ahead with the iCar investment, it will haveto spend $18 billion up front (in 2016) and $2 billion in installation costs to create anew production facility, lock in suppliers, distributors and retailers and to invest ininfrastructure. The cost is depreciable over the next 10 years, down to a book value of$ 4 billion. Apple expects the salvage value to be equal to the book value. Apple expectsto use straight-line depreciation.3. Market Potential and Share: In the premium auto market (including all cars priced at orabove $60,000) there were 5 million automobiles sold globally in the most recent yearand the market is expected to grow approximately 5% a year for the next decade. Appleexpects to gain a 2% market share next year (ie.,2017) if the iCar is introduced andincrease that market share by 2% a year (4% in the second year, 6% in the third yearand so on) to reach a target market share of 10% of the overall market by the fifth year.It expects to maintain that market share beyond year 6.4. Pricing and Unit Costs: Apple expects to price its cars at $ 70,000 a unit next year (or2017) and the price will keep pace with inflation after that. Based upon the costs of thematerials used in the iCar currently, Apple expects the Gross margin on the iCar to be39% and that rate is expected to be steady for the next 10 years5. Marketing Options and Costs: Apple plans to use two different retailing options. In thefirst, it will sell the iCar through auto retailers and pay the retailers a commission of15% of the price per unit sold (The retailers will have to follow Apple’s fixed priceschedule – no discounting allowed). In the second, it will sell the iCar through the AppleAuto Stores around the country. To do the latter, Apple will have to spend $5 billionright now in creating those stores; this expense will be depreciated straight line overthe next 10 years to a salvage value of zero. It will also pay its sales people a2commission of 10% of the price per unit for every car sold at an Apple Auto store.Apple expects to generate 80% of its revenues from specialty retailers and 20% fromApple Auto Store sales each year for the next 10 years.6. Production Facilities and Costs: Apple will be building a manufacturing facility inTaiwan to produce the iCar. The facility will allow Apple to produce 650,000 cars eachyear. It is expected that Apple will operate below capacity in the initial years but if thecapacity limit is reached, Apple will have to invest a substantial amount to create a newfacility of equivalent capacity. The current estimate (for 2016) of the cost of building anew facility is $ 8 billion, but this cost will grow at the inflation rate.7. Advertising Expenses: Apple spent $ 2 billion on advertising in the most recent year.If Apple does not invest in iCar, it expects this cost to increase 15% a year for the next10 years. If the iCar is introduced, the total advertising expenses each year, from years1 to 10, are expected to be 20% higher than they would have been without the iCardivision.8. Working Capital: The iCar will create working capital investments that are to be madeat the beginning of each year, which you have estimated as follows:•The sale of iCars to retailers will create accounts receivable amounting to 8%of revenues each year.•Inventory (of both the input material and finished iCars) will be approximately10% of the variable production cost (which does not include depreciation, oradvertising expenses).•Accounts payable will be 9% of the variable production cost (not includingdepreciation, marketing costs, or advertising expenses).9. Risk Measures: The beta for Apple is 1.477, calculated using monthly returns over thelast 3 years and against the S&P 500 Index. But management believes that theappropriate beta should be the average beta for the car industry which is 1.95. Thecurrent stock price for the firm is $ 100 and there are 5,753.42 million sharesoutstanding.10. Bonds: Apple expects to finance the iCar division using the same mix of debt andequity (in market value terms) as it is using currently in the rest of its business. Apple’s3currently has $62.99 billion in market value of interest bearing debt. Apple is ratedA1/A+. This rating currently has a default spread on a 10 year US Treasury bond of0.9%.11. Taxes: Apple’s effective tax rate is 26.4%.12. Macro data: The current long-term nominal US Treasury bond rate is 2%, and theexpected inflation rate is 2 %. The expected Market Risk Premium is 5.75%.Questions on the Project1. Cash Flow Analysis•Estimate the after-tax incremental cash flows from the proposed iCarinvestment to Apple over the next 10 years.•If the project is terminated at the end of the 10th year, and both working capitaland investment in other assets can be sold for book value at the end of thatyear, estimate the net present value of this project to Apple.2. Sensitivity Analysis• Estimate the sensitivity of your numbers to changes in at least two of the keyassumptions underlying the analysis.Based upon your analysis, and any other considerations you might have, tell me whetheryou would accept this project or reject it. Highlight any assumptions you make.Submit an Excel report by June 19th. Name your Excel file with the last name of one ofyour group members. On the first sheet, it should show the names of your Groupmembers, the NPV, IRR and the Accept/Reject Decision for the Base case scenario4

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