Citilinkhas a business line currently owns and runs 350 sightseeing buses and has a turnover of $10 million per annum.The current system for allocating jobs to drivers is very inefficient. Citilink is considering the implementation of a new computerised tracking system called "DigiLink". This will make the allocation of jobs far more efficient.
You are the financial analyst of the business line. You have been asked to perform somecalculations to help the Finance Director to decide whether DigiLink should be implemented. The project is being appraised over 5 years.
The costs and benefits of the new system are set out below.
i. The central tracking system costs $2,100,000 to implement. This amount will be payable in three equalinstalments: one immediately, the second in one year's time, and the third in two years' time.
ii. Depreciation on the new system will be provided at $420,000 per annum.
iii. Staff will need to be trained how to use the new system. This will cost $425,000 in the first year.
iv. If DigiLink is implemented, revenues will rise to an estimated $11 million this year, thereafter increasing by 5%per annum (i.e. compounded). Even if DigiLink is not implemented, revenues will increase by an estimated$200,000 per annum, from their current level of $10 million per annum.
v. Despite increased revenues, DigiLink will still make overall savings in terms of vehicle running costs. These costsavings are estimated at 1% of the post DigiLink revenues each year (i.e. the $11 million revenue, rising by 5%thereafter, as referred to in note iv).
vi. 6 new operators will be recruited to manage the DigiLink system. Their salaries will cost the business line $120,000 per annum in the first year, $200,000 in the second year, thereafter increasing by 5% per annum(i.e. compounded).
vii. The business line will have to take out a maintenance contract for the DigiLink system. This will cost $75,000 per annum.
viii. Interest on money borrowed to finance the project will cost $150,000 per annum.
ix. The business line's cost of capital is 10% per annum and the maximum allowable payback period is 2.5 years.
x. Ignore taxation.
(a) Assess the viability of the DigiLink project using payback period, accounting rate of return, net present value, and internal rate of return.
(b) Evaluate appropriate sources of finance for the DigiLink project in terms of suitability and their respective advantages and disadvantages.