To answer the next three questions, refer to the following example. In early 1998, General Motors announced plans to launch the Cadillac Escalade, its first truck under the Cadillac brand name and its first luxury sport-utility vehicle (SUV). GM's decision was primarily a reaction to the runaway success of such new luxury SUVs as Ford's Lincoln Navigator and Mercedes-Benz's new M-class. These vehicles were exceptionally profitable; for example, each of the 18,500 Lincoln Navigators that sold in the four months after their introduction in June 1997 generated well over $10,000 in profit for Ford. GM had previously been unwilling to build a luxury SUV, but these profit margins were too large to ignore.

GM planned to introduce the truck as a revised version of the new GMC De-nali, which was introduced in February 1998. However, some analysts questioned GM's decision, suggesting that GM was too late entering the market; concerns were also expressed about whether GM would just end up taking sales from its other SUV lines.

Erosion In evaluating the Escalade, under what circumstances might GM have concluded that erosion of the Denali line was irrelevant? Capital Budgeting GM was not the only manufacturer looking at the big sport-utility category. Chrysler, however, initially decided not to go ahead with an entry (Chrysler later reversed course on this issue). Why might one company decide to proceed when another would not?

Capital Budgeting In evaluating the Escalade, what do you think GM needs to assume regarding the enormous profit margins that exist in this market? Is it likely they will be maintained when GM and others enter this market?

Ross et al.: Fundamentals of Corporate Finance, Sixth Edition, Alternate Edition

IV. Capital Budgeting

10. Making Capital Investment Decisions

© The McGraw-Hill Companies, 2002

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