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cost benefit analysis 13

  1. The President of Tesla was really impressed by your analysis on market reactions and wants more (of course, he’ll pay you more!). He recently told his management team to do some research and find a fix for the autopilot system and analyze any option for a minimum five-year period.

The management team has found a company that can provide an improved computer. With this improvement, the management team believes the company’s revenues will increase in the first year by $25 million, by $7 million in the second year, then by $2 million per year in years three, four and five. The charge for the improved capability will cost Tesla $100 million (including license fee) in the first year, with a flat license and maintenance fee of $10 million in years two through five. The team accounted for inflation in their figures and is very confident of the estimated costs and revenue.

The President wants you to look at these figures and advise him on a decision. Assume that Tesla’s CFO can borrow money at a rate of 5% per year, and that rate holds over the life of this project. All costs come at the end of the year.

A. Based on the data above, make a recommendation for the President of Tesla. Should he make this investment under the conditions described?

B. Does your advice change if interest rates triple to 15% because the capital markets consider Tesla very risky? If your recommendation changed, briefly describe why it changed.

C. Are there any other costs the President should consider? You don’t have to estimate these, just comment. Did the team consider everything, or could there be more? (Not looking for numbers looking for our thinking) Look at ch 1 implicit costs.

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