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Mini Case Study Questions on Aus Car Exes: Group Assignment Answer

Group Assignment

You are to form a group of 3-4 students and work in teams. Using the mini case study below, answer the series of questions that are asked. This group assignment carries a total 20 marks for this unit. The deadline for submission is 14 April 2019, Midnight. Any assignments received after this date will not be considered for evaluation. The assignment is to be submitted through Moodle. Only one group member per group to submit the assignment. A hard copy to be submitted in class in Week 12, 15 April 2019. Any plagiarism will be dealt strictly, attracting penalty marks

Mini Case Study:

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.

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 $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:

  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 cannibilisation 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?

Answer

Group Assignment

Mini Case Study: Aus Car Exes (ACE)


a) What is the initial cash flow (fixed asset expenditure) for this discount used rental car project?

The initial cash outflow for this project is $1,050,000

Initial investment = cost of the car + the Cost of Lojack system 

Initial investment   = $9,500*100 + $1000*100 = $950,000+$100,000 =$1,050,000

b) Is the cost of installing the LoJack system relevant to this analysis?

Yes. It is relevant for the Project as installation of the system would certainly increase productivity and also prevent loss on account of theft of car. 

c) Are the maintenance costs relevant?

Maintenance  cost of the plot where the cars would be stored is not relevant for the company’s new car project as the same would have to be incurred even if the project is not undertaken. Its cost which is not solely being incurred because of the new Discounted car project. 

d) Should you consider the change in net working capital?

if this project is undertaken, net working capital will increase by $50000. This means the commissioning  of the new used car project would require the firm to spend an additional $50,000 on working  capital and hence the same would be considered as an outflow in the beginning and also the same would be expected to be recovered as and when the project is completed. Thus the amount of the working capital would be considered as an outflow in the beginning year( 0 year) and as a inflow in the last year of the project. 

e) Estimate the depreciation costs incurred for each of the next six years

It has been mentioned that the  the useful life of the cars is determined to be five years, and they will be depreciated using the diminishing Value method. Thus the depreciation on a per year basis is expected to be :

Depreciation per ( for each of the 5 years) = $1,050,000/ 5 = $210,000.

This means each year the total depreciation would be charged as $210,000 and after the end of the life term of 5years, the book value of the cars used under this project would be reduced to zero. 

f) Estimate the net cash flow for each of the next six years.

The net cash flow of the company in the next 6 years is estimated as follows and presented in the following table:


012345
Initial Investment -1,050,000




Working capital -50,000











Revenue per car /year
4,8004,8004,8004,8004,800
Operating costs per car/year
1,0001,0001,0001,0001,000
no of car 
100100100100100
Total Operating Revenue 
480,000480,000480,000480,000480,000
Total operating expenses 
100,000100,000100,000100,000100,000
Annual Depreciation
210,000210,000210,000210,000210,000
less: loss of revenue 
25,00025,00025,00025,00025,000
less: Opportunity cost of leasing 
80,00080,00080,00080,00080,000
Profit Before taxes 
65,00065,00065,00065,00065,000
less Taxes @ 32%
20,80020,80020,80020,80020,800
PAT 
44,20044,20044,20044,20044,200
add: Depreciation 
210,000210,000210,000210,000210,000
Working capital recovered 




50,000
CFAT -1,100,000254,200254,200254,200254,200304,200

As can be seen from the above the cash flow after taxes form the project is uniform across years and the company would be expected generate an annual cash flow of $254,200 each year for the next 4 years. However in the last year the cash flow would be $304,200 as the project is expected to recover an investment of $50,000 in the working capital. The initial cash outflow has been estimated as $1,100,000 and the working capital has bene assumed to be recoverable at the end of the year 5. 

g) How are possible cannibilisation costs considered in this analysis?

As it has clearly established that the new discounted car rental business would have a negative impact on the usual full service car rental business of the company, the same has been included in the evaluation of new projects effective cash flow by including the same. The loss of revenue ( a minimal impact) is still considered an impact and has bene accounted for in the above estimation of the cash flows. The loss of revenue in the existing business has bene deducted form the revenue stream of the new project. It cant be ignored as the new project has a clear impact on the business of the existing business even if the same is considered to minimal. 

h) How does the opportunity to lease the lot affect this analysis?

As the lot which would be sued for the new project can be considered for other projects and can be given on a lease for $80,000 per annum the same is an opportunity cost and the same must be included and expected to be recovered for the new project to be given a go ahead. This is why the lease rent income of $80,000 is included in the operating costs of the project and subtracted from the revenue  to reach the project before taxes. 

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)

The terminal value of the project is $304,200 which is usual cash flows of the project plus the working capital which is assumed to be recoverable at the end of the year 5. the cash flow after taxes form the project is uniform across years and the company would be expected generate an annual cash flow of $254,200 each year for the next 4 years. However in the last year the cash flow would be $304,200 as the project is expected to recover an investment of $50,000 in the working capital. The working capital has bene assumed to be recoverable at the end of the year 5. However there is no terminal cash flow on account of sale of the cars as they don’t have any realizable value at the end of the year 5 and fully depreciated with book value of zero. 

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?

The Net present value of the Project can be defined as the excess of the present value of the used car projects cash inflows over that of the initial investments. If the net present value is estimated to be positive ( the present value of the used car projects cash inflows > initial investments) then the project can be recommended to be invested as the same would mean the project would add market value to the company which is evaluating the project. The net present value of the project is evaluated as follows using the standard discount rate of 12% and the same has been shown as follows:


012345
Initial Investment -1,050,000




Working capital -50,000











Revenue per car /year
4,8004,8004,8004,8004,800
Operating costs per car/year
1,0001,0001,0001,0001,000
no of car 
100100100100100
Total Operating Revenue 
480,000480,000480,000480,000480,000
Total operating expenses 
100,000100,000100,000100,000100,000
Annual Depreciation
210,000210,000210,000210,000210,000
less: loss of revenue 
25,00025,00025,00025,00025,000
less: Opportunity cost of leasing 
80,00080,00080,00080,00080,000
Profit Before taxes 
65,00065,00065,00065,00065,000
less Taxes @ 32%
20,80020,80020,80020,80020,800
PAT 
44,20044,20044,20044,20044,200
add: Depreciation 
210,000210,000210,000210,000210,000
Working capital recovered 




50,000
CFAT -1,100,000254,200254,200254,200254,200304,200
PVF @ 12%10.8928570.7971940.711780.6355180.567427
Present Values -1,100,000226,964202,647180,935161,549172,611
NPV-155,295





NPV of the Project @ 12% rate of discounting is assessed to be -$155,295 and it is recommended to reject the proposal at its present form. 

If the project is evaluated suing a higher rate of discounting the NPV would higher negative as shown below:


012345
Initial Investment -1,050,000




Working capital -50,000











Revenue per car /year
4,8004,8004,8004,8004,800
Operating costs per car/year
1,0001,0001,0001,0001,000
no of car 
100100100100100
Total Operating Revenue 
480,000480,000480,000480,000480,000
Total operating expenses 
100,000100,000100,000100,000100,000
Annual Depreciation
210,000210,000210,000210,000210,000
less: loss of revenue 
25,00025,00025,00025,00025,000
less: Opportunity cost of leasing 
80,00080,00080,00080,00080,000
Profit Before taxes 
65,00065,00065,00065,00065,000
less Taxes @ 32%
20,80020,80020,80020,80020,800
PAT 
44,20044,20044,20044,20044,200
add: Depreciation 
210,000210,000210,000210,000210,000
Working capital recovered 




50,000
CFAT -1,100,000254,200254,200254,200254,200304,200
PVF @ 14%1.0000.8770.7690.6750.5920.519
Present Values -1,100,000222,982195,599171,578150,507157,992
NPV-201,342




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