Aus Car Exes (ACE) is set up as a sole trader and is analyzing 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 $9500 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 $1000 per vehicle. ACE will also utilize 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 $80000 per year. The $20000 annual maintenance cost on this lot will be paid by ACE whether the lost is leased or used for this project. In addition, if this project is undertaken, net working capital will increase by $50000.
The percentage of this equipment’s basis that is depreciable each year is 20.00 per cent in year 1, 32.00 per cent in year 2, 19.20 per cent in year 3, 11.52 per cent in year 4, 11.52 per cent in year 5 and 5.76 per cent in year 6. Each car is expected to generate $4800 a year in revenue and have operating costs of $1000 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 $100000 per year continuing indefinitely. This discount rental car business is expected to have a minimum impact on ACE’s regular car rental business, where the net cash flow is expected to fall only by $25000 per year. ACE expects to have a marginal tax rate of 32%.
Based on this, answer the following questions:
a. What is the initial cash flow (fixed asset expenditure) for this discount used rental car project?
b. Is the cost of installing the LoJack system relevant to this analysis?
c. Are the maintenance costs relevant?
d. Should you consider the change in net working capital?
e. Estimate the depreciation costs incurred for each of the next six years
f. Estimate the net cash flow for each of the next six years
g. How are possible cannibilisation costs considered in this analysis?
h. How does the opportunity to lease the lot affect this analysis?
i. 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)
j. 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?
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