Flight Central wishes to form an affiliation with a nationally based sales firm to provide business travel packages for its employees.
This client is concerned with the lack of availability of hire cars for his employees and has indicated to Flight Central it would like this risk resolved.
Hence Flight Central has considered trialing a new fleet of hire vehicles in one area in an effort to provide added value to business clients.
This client generates a substantial portion of the business to Flight Central and will bring all their travel requirements to them, provided this risk is mitigated. Therefore, Flight Central has investigated the purchase of 10 cars at a cost of $50,000 each.
Each car will have a useful life of 5 years and generate extra income of $600,000 in the first year and increase by 15% pa each year after.
These vehicles will be depreciated on a straight-line basis over the five-year life of the project and are expected to have a 20% salvage value.
The trial will also require an initial investment of $50,000 in working capital to set up the new business processes. This will be returned at the end of the project.
The project’s variable costs are $27,000 for each car and fixed costs are $208,000 per year.
Flight Central currently has a policy of only investing in a project if the return is 10% p.a. or more.
(a) Set out all relevant data in an appropriate table format.
(b) Calculate NPV and estimate IRR.
(c) Would you recommend investing in the project? Justify your choice.
(d) Just before the meeting to discuss the final decision for this project, you realize the analysis has ignored tax rates. The corporate tax rate is 30%. How would you modify your NPV calculations to take into account the tax rate?