General Motors Trax Case Study
Case Background
The following presents a hypothetical set of facts created solely for this exercise.
It is January of 2014 and GM has just completed the successful launch of 13 new models into their current vehicle portfolio. This is a huge step in fulfilling their promise to renew over 75% of their portfolio within a 2 and a half year period. The market has responded very well to the new products and in certain vehicle segments, sales results have surpassed GM's expectations. Now that they head into 2014, GM leadership is considering some strategic initiatives to capitalize on some of this unpredicted success.
In the past, GM's success has been largely based around their truck and SUV lineup. However, during the past 4 years Chevrolet has launched 6 small-vehicles which have caused the brand's share of the small-, compact- and mini-car segments to more than triple - up over 200%. Chevrolet isn't the only GM brand benefiting from strong products in this space. Buick Encore sales continue to beat expectations. This small SUV has seen its monthly sales numbers more than double since its launch a year ago. Chevrolet is currently forecasting global small SUV sales to jump 80% by 2016.
Due to the Buick Encore's success in the U.S., GM is considering introducing a Chevrolet version of the same vehicle at a lower price point to appeal to both young buyers and Baby Boomers who want to downsize but still enjoy the functionality of an SUV. Up to this point, GM has been slightly reluctant to enter a new vehicle into this space because of the success of the larger Chevrolet Equinox and the smaller Chevrolet sub-compact sedan, Sonic. They are concerned that if they release a vehicle in the space between the Equinox and Sonic, it could cannibalize sales from both successful vehicles. The good news is they already produce a Chevrolet vehicle that fits perfectly in the small SUV space, but is currently not sold in the U.S.
The Chevrolet Trax is a global mini-SUV that is built off the same platform as the Chevrolet Sonic. It is currentlysold in Canada and Mexico with another version of it, the Tracker, sold in Russia, South America and other global markets. Despite potential sales cannibalization and manufacturing capacity constraints, GM leadership feels that it is time to seriously consider launching the Trax in the U.S. GM will need to act quickly because new competitors
like the Jeep Renegade, set to launch early next year, are quickly entering this growing segment. If GM makes this strategic move, they will want to launch by the first quarter of 2015.
As an analyst, make a recommendation on whether or not to launch the Trax in the U.S. using quantitative and qualitative analyses to support your position.
Financial Details (Assume that all cash flows occur at year end)
A. Resources: Due to GM currently producing the non-U.S. Chevrolet Trax/Tracker in both Mexico and Korea, they will be able to minimize the start-up costs for a U.S. version of the vehicle. $40M of capital and $5M of engineering (cash outflows) were the initial estimates needed for the implementation of all incremental changes required for the U.S. version. All engineering and capital costs will be incurred one year prior to launch.
B. Sales: The table below shows 2013 vehicle sales for the Chevrolet Sonic, Equinox, and Buick Encore. The current number of units sold in the U.S. small SUV segment is 250,000. This segment is expected to grow by 30% over the next 2 years. The planning team has forecasted the initial year sales volume for the Trax in the U.S. at 60,000 units. For most programs, sales grow at an annual rate of 5% for the first 3 years (i.e., through the end of 2018) and then decrease at 2% for the remaining lifecycle years. The U.S. Trax is expected to have a 5-year lifecycle, in line with the current industry lifecycle average.
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Vehicle
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U.S. Sales Volume
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Average MSRP
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Profit Margin % of MSRP
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Buick Encore
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50,000
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$24,000
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12%
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Chevrolet Sonic
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100,000
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$15,000
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8%
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Chevrolet Equinox
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250,000
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$25,000
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10%
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The marketing group is suggesting an advertising campaign that would cost $100M, 40% of which would be spent in the year before launch and the remaining would be spent evenly over the life of the program. However, they mentioned that if GM spent 50% less on the marketing campaign, the forecasted volumes would drop by only 10%. In your memo, recommend which plan GM should implement and substantiate your recommendation.
The manufacturer suggested retail price (MSRP) of the Trax is expected to be $18,000 in the U.S. Manufacturers must pay a commission on each sale to dealers as well as an average incentive to maintain forecasted sales volumes. The "Net Sale" of each vehicle after commissions and incentives is 88% of MSRP (equivalently, the "Profit Margin" of each vehicle after the commissions and incentives is 12% of MSRP).
C. Cannibalization: After an in-depth market study, the planning group has confirmed that if GM launches the Trax in the U.S. they will lose sales from the other three vehicles sold in competing segments. They project that Buick Encore sales will decline by 10%, Chevy Sonic by 6%, and Chevy Equinox by 12%. In order to calculate this cost to the company you can assume constant volumes for these vehicles during the U.S. Trax lifecycle.
D. Costs: The current global Trax contribution costs per vehicle, including material & freight cost, is 75% of Net Sale. In addition, the U.S. version of the vehicle will launch with some upgraded standard content that drive additional cost. These features include 4G LTE wireless hot-spot capability, XM satellite radio, and push-button start and increase vehicle cost $500. This project will have a 3% (of annual net Trax sales) working capital requirement each year that will be fully unwound in the final year of the project. 1 Assume no depreciation and/or amortization.
The working capital requirement impacts the NPV calculation since Change in Working Capital each year must be subtracted from Net Income on route to obtaining Cash Flow. Change in Working Capital is simply the current year's working capital, less the previous year's working capital. Assume that Working Capital in the final year of the project is zero. In previous years, Working Capital is calculated as 3% x net sale price per unit x number of units.
E. Capacity: Trax volume for Mexico and Canada markets is built in San Luis Potosi, Mexico, which has a capacity of 150K units and is currently producing at 80% of capacity - this is where GM will initially support U.S. Trax volume. Any additional capacity required to support the U.S. Trax volume will be built at the South Korean plant. Any South Korean production requires an additional customs fee that equates to 1% of Net Sale.
F. Cost of Capital: GM has $7B in debt (D), and a market cap of $60B (E). The return on GM's debt: rd = 5%, and GM has a beta of 1.4. Use this information to estimate GM's Weighted Average Cost of Capital (WACC). A reminder that the formula for WACC is:
WACC = E/(D+E) re + D/(D+E) (1 - tax rate) rd
where re is GM's cost of equity, which you can estimate using CAPM, assuming that the riskless rate is 2% and the market risk premium is 7%. Assume a corporate tax rate of 35%.2
GM's typical discount rate is 12%. In your written memo, discuss which discount rate to use in the model. Should it be 12%, your calculated WACC, or some other rate?
INSTRUCTIONS
Step 1
Using the case materials above, complete the NPV model using the template spreadsheet provided. Note that cells shaded in blue represent input assumptions (i.e., hardcoded numbers) while cells shaded in yellow should contain calculations based on the assumptions (so that if you change any of the assumptions in the blue cells, these changes feed through into the calculations in the yellow cells).
Step 2
Based on your projections from the model, make a recommendation on whether to proceed with the launch of the Trax into the US market, using qualitative and quantitative arguments to support your position. In formulating your recommendation, consider employing additional analysis or calculations in addition to the base case NPV. To do this, test alternative assumptions about key inputs to the model (e.g., discount rate, market share, other inputs that are uncertain, and that you think are pivotal to the success of the project), and see what impact these changes have to your NPV estimate. (Bear in mind that identifying worst case scenarios is at least as important as best case scenarios.) Your written response must be no longer than 2 pages, not including exhibits. Good analysis is important; and clear, succinct writing and well formatted data tables/charts will also play a role in determining your grade for this assignment.
Please submit the following:
• A printout of the Excel model of your base case NPV calculations. I have already set the "print_area" on the spreadsheet to print from cell A1 ± K44 as a single page. You might wish to submit multiple versions of this same print area, to reflect the model output under alternative scenarios that you have considered in your analysis.
• A written memo (in Word) no longer than 2 pages 1.5 spacing, and any additional exhibits. Your written memo should focus on your analysis and recommendations.