Your company is considering investing in its own transport fleet. The present position is that carriage is contracted to an outside organization. The life of the transport fleet would be five years, after which time the vehicles would have to be disposed of. The cost to your company of using the outside organization for its carriage needs is £250 000 for this year. This cost, it is projected, will rise 10% per annum over the life of the project. The initial cost of the transport fleet would be £750 000 and it is estimated that the following costs would be incurred over the following five years:
Drivers' Costs Repairs and Other costs
Maintenance
£ £ £
Year 1 33 000 8 000 130 000
Year 2 35 000 13 000 135 000
Year 3 36 000 15 000 140 000
Year 4 38 000 16 000 136 000
Year 5 40 000 18 000 142 000
Other costs include depreciation. It is projected that the fleet would be sold for £150000 at the end of Year 5. It has been agreed to depreciate the fleet on a straight line basis. To raise funds for the project your company is proposing to raise a long-term loan at 12% interest per annum.
You are told that there is an alternative project that could be invested in, using the funds raised, which has the following projected results:
Payback = 3 years
Accounting rate of return = 30%
Net present value = £140 000
As funds are limited, investment can only be made in one project. Note: The transport fleet would be purchased at the beginning of the project and all other expenditure would be incurred at the end of each relevant year.
Required:
(a) Prepare a table showing the net cash savings to be made by the firm over the life of the transport fleet project.
(b) Calculate the following for the transport fleet project.
(i) payback period;
(ii) accounting rate of return; and
(iii) net present value.
The discount factors for 12% are as follows:
Year 1 0.893
Year 2 0.797
Year 3 0.712
Year 4 0.636
Year 5 0.567
(c) Write a short report to the Investment Manager in your company outlining whether investment should be committed to the transport fleet or the alternative project outlined. State clearly the reasons for your decision.