Road King Trucks Case

Abstract

This paper is an analysis of Road King Trucks’ new project which is introducing a new product into its product line. I will decide whether run the project or not. Six issues will be discussed as follows 1) importance of energy cost; 2) project’s cash flows; 3) cost of capital; 4) choose an engine 5) evaluation 6) accept or reject.

We should accept the project because of the positive NPV and high IRR. We will gain $532 million in wealth which is a big money on the scale like this. The company has a bond rating of AA that makes the risk relatively low. So we should definitely say yes.

Issues

Importance of Energy Cost

Road King Trucks, Inc. is a truck manufacturing company. The new CEO Michael Livingston arranged a meeting with the firm’s top managers and engineers considering introducing a large, public transit bus into its current product line. As the oil prices keep going high and have no sign of decreasing. Mr. Livingston thought it would lead people more likely to use public transportation.

The price of gas has gone up for the 30th day in a row, and with it tempers are rising. Increased demand for public transportation is expected to continue into the spring [1]. The impact of high oil prices makes people more willingly to use public transportation and there will be an increase of riders. The company should adapt itself to the changes of market. Now it is a fashion to be “Green”. People show great environmental consciousness to the world. It is wise to attract people with public transportation and fulfill their demands.

Project’s Cash Flows (see table 1)

We expect inflows are greater than outflows, so to cover the cost occurred in the progress. But to determine whether we should run the project or not, we need to calculate the NPV. I will discuss it later.

The total life of the project is 22 years. The production and selling of buses start in year 3. I add inflation on sales and costs in year 4, the year after production and sales begin (Idea comes from Mr. Hasse). Straight line depreciation was used in calculation and depreciation won’t be affected by inflation.

The land was accounted for opportunity cost. If we don’t run the project, we can sell it and earn $6 million right now.

Cost of Capital (see table 2)

I used WACC as the discount factor, we expect the rate of return to be higher than it, the same at least. The WACC reflects the average risk and overall capital structure of the entire firm [2]. It’s the required return and it presents how much the company pays for the capital it finances. In this case, the cost of equity is 10.33%, the cost of debt is 6.50%. I calculated WACC using those numbers and got a result of 8.49%.

Choose