The Capital Regional District wants to build a new bike path from the Toronto to downtown Toronto.Your company has been asked to build the path and you want to create a capital budget to evaluate the alternatives. You will build and operate it for 5 years.
Using old technologies, the path will cost $3,000,000 of capital spending right now (Year 0). At the end of the contract the salvage value of the capital asset will be equal to the value of the asset's undepreciated capital cost (UCC).
To maintain the path when in operation (Year 1 and onwards) there will be an annual fixed cost of $500,000 and a variable costs of $0.35 per rider.
The initial networking capital will be $700,000 and total net capital per year will be equal to 10% of revenues.The net working capital will be recovered at the end of the contract.
In researching the project you became aware of a new technology called a "smart" road. The technology incorporates a special type of receptor lying underneath the roadway payment. It can convert road vibration and sunlight into electric energy. Theelectricity is then used to provide power to the surrounding traffic lights, parking meters and illuminated road lines.
There is a cost of $6,000,000 initially (Year 0) for the equipment and materials. At the end of the five year contract you will be able to sell the remaining capital assets for their undepreciated capital cost (UCC).
You will also need an initial working capital of $1,000,000 that will be recovered at the end of the project's life. No further networking capital will be needed.
When up and running (Year 1 and onwards) you estimate there will be $300,000 fixed costsannually and a variable cost of $0.21 per cyclist to keep it in proper shape.
As an added bonus, the electricity can be sold to the power grid. It is estimated that every rider to use the path will travel an average of 1.4 kms. For every kilometer a rider travels it is estimated 0.005 kilowatts hours of electricity will be created. You estimate that the price of a kilowatt hour of electricity will be $0.10.
The CRD will pay $0.95 for every cyclist that uses the new bike path. You have estimated the path will have 5,000 users a day during the work week and 10,000 users a day on the weekend in the first year. Usage is expected to increase every year by 10%. For your calculations you have assume that there are 52 weeks in a year.
While you feel though your usage estimates are sound, you are hopeful the new path could attract 10% more cyclists than you anticipated to start and see annual usage increase by 15% from one year to the next. You are also aware that if cyclists don't like the path the initial usage estimate may be 20% less than the base case estimate, with usage decreasing (rather than increasing) by 13% from one year to the next.
For both alternatives Revenue Canada has assigned a 20% rate to your capital cost allowance (CCA) and you are expecting a tax rate of 35%. The relevant discount rate is 9%. The appropriate amount of time to analyze payback periods is 3.2 years.
The Analysis
You now must decide whether or not to proceed and whether or not to use old technologies or the"smart road" is better.To do this you will use a Microsoft Excel to create a capital budgeting model. Your model will be used to answer the "Project Questions"posed below
Your Excel model must be dynamic and your calculations should not be "hard coded". In otherwords, your calculations (NPV, IRR, comprehensive income, etcetera) should change with changes in the inputs (initial investment, tax rate, discount rate etcetera).
The "Project Questions" are designed to guide you through the process of creating your model and conducting your capital budgeting analysis.
Project Set Up and Completion
To get started answering the "Project Questions and creating your models it will be useful to create labels and space for the following inputs in your Excel spreadsheet:
• Tax rate
• CCA rate
• Fixed cost(s)
• Variable cost(s) per unit
• Initial Investment
• Discount Rate
• Appropriate Payback Period
• Initial riders during a work week day
• Initial riders during a weekend day
• Kilometres travelled
From there, create a document answering each of the "Project Questions". The answers for each question in the "Project Questions" will help guide you in building your capital budgeting models. Be aware that you may need to bring in other elements to create a proper capital budgeting model and decide which project (if any) you should proceed with.
Term Project : Project Questions
Student Number:
1. In the space below, show a table for the annual the depreciation of the capital asset for each project alternative.
(Hint: For each year include beginning undepreciated capital cost (UCC),CCA, End UCC)
2. In the space below, show a table for each projectalternatvie with the annual comprehensive income and operating cash flow. Include one to two sentences for each project alternative describing how the comprehensive income changes from year to year.
(Hint: for an example see Table 10.7 on page 349 of your textbook)
3. In the space below show a table for each project alternativewith the total networking capital and the change in net working capital for each year. Include one to two sentences for each project alternative describing how the net working capital changes from year to year.
(Hint: Don't forget to include the net working capital recovered at the end of the project)
4. In the space below, show a table for each project alternative depicting capital spending and salvage amounts for each year.
5. In the space below show a table for each project alternative summarizing the OCF, change in networking capital, capital spending, total project cash flow, cumulative project cashflow and discounted cash flow for each year.
(Hint: For an example, see Table 10.10 on page 351 of your textbook)
6. In the space below show a table comparing the NPV, IRR ,payback period, discounted payback period and profitability index for each project alternative. Include space in the table for identifyingwhether or not the different criteria would suggest accepting or rejecting the particular alternative.
Then, ina few sentences, discuss whether thecriteria for each project alternativegive a consistent recommendation or if they conflict (i.e. does the NPV suggest you should accept the project alternative but the IRR suggest it should be rejected?)
7. In the space below show a table comparing how sensitive each project alternatives' NPV is to the variability in usage. In one to two sentences discuss which project alternatives' NPVis most sensitive to a change in usage.
(Hint: Compare the percentage change in usage to the percentage change in NPV)
8. Using your answers and analysis in the questions above, write one to two paragraphs discussing which project alternative, if any, should be chosen.
(Hint: Remember to justify your answerswith data and discuss why some criteria might have greater weight than others when making this capital budgeting decision.)