10: Cash Flow and Capital Budgetingmini caseCASH FLOW AND CAPITAL BUDGETING
Aus Car Execs (ACE) is set up as a sole trader and is
analysing whether to enter the discount used rental car
market. This project would involve the purchase of 100
used, late-model, mid-sized cars at the price of $9,500
each. In order to reduce their insurance costs, ACE will
have a LoJack Stolen Vehicle Recovery System installed
in each car, at a cost of $1,000 per vehicle. ACE will also
utilise one of its abandoned lots to store the vehicles. If
ACE does not undertake this project, it could lease this
lot to an auto-repair company for $80,000 per year. The
$20,000 annual maintenance cost on this lot will be paid
by ACE whether the lot is leased or used for this project.
In addition, if this project is undertaken, net working
capital will increase by $50,000.
For taxation purposes, the useful life of the cars is
determined to be five years, and they will be depreciated
using the diminishing value method. Each car is expected
to generate $4,800 a year in revenue and have operating
costs of $1,000 per year. Starting six years from now, one-
quarter of the fleet is expected to be replaced every year
with a similar fleet of used cars. This is expected to result
in a net cash flow (including acquisition costs) of $100,000
per year continuing indefinitely. This discount rental car
business is expected to have a minimum impact on ACE’s
regular rental car business, where the net cash flow is
expected to fall by only $25,000 per year. ACE expects to
have a marginal tax rate of 32%.
Based on this information, answer the following
questions.ASSIGNMENT
1 What is the initial cash flow (fixed asset expenditure)
for this discount used rental car project?
2 Is the cost of installing the LoJack System relevant to
this analysis?
3 Are the maintenance costs relevant?
4 Should you consider the change in net working
capital?5 Estimate the depreciation costs incurred for each of
the next six years.
6 Estimate the net cash flow for each of the next six
years.
7 How are possible cannibalisation costs considered in
this analysis?
8 How does the opportunity to lease the lot affect this
analysis?9 What do you estimate as the terminal value of this
project at the end of year 6? (Use a 12% discount rate
for this calculation.)
10 Applying the standard discount rate of 12% that ACE
uses for capital budgeting, what is the NPV of this
project? If ACE adjusts the discount rate to 14% to
reflect higher project risk, what is the NPV?ONLINE STUDY TOOLS
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