Working capital requirements is expected to be RM250,000 at the beginning of the project and this will be recovered at the end of the project.
EVALUATION OF CAPITAL BUDGETING PROJECT
Luxury Resort Cruisers Bhd. is considering a proposal to launch a new holiday leisure cruise, taking passengers to an exotic location. The proposal has been coded "Project Love Boat" and is to be discussed at the next Finance Committee meeting.
For this proposal the company will charge RM3,000 per passenger per year and it is expected that 2,500 passengers will be attracted to the new cruise. However, following the recent global downturn, a market research campaign has been conducted at a cost of RM300,000 to re-evaluate the expected demand for the cruise. This has produced a revised estimate which suggests that only 1,500 passengers per annum will be attracted to the new cruise.
The proposal will involve investing in a new cruiser at a cost of RM15,000,000 and this will be payable immediately. This cruiser is expected to have a useful life of 10 years after which it is expected to be sold for RM1,000,000. Straight-line depreciation applies for tax purposes and the tax rate is 25%.
Food and beverage cost relating to the proposal have been estimated at RM1,000,000 per annum.
Maintenance of the new cruiser is to be provided by the company's own engineering staff. The maintenance team currently earn RM80,000 each per annum. However, the department is currently overstaffed and it is expected that two persons will be retrenched during the next year, with each receiving retrenchment benefits of RM130,000. Approval of the project would require the continuing employment of one of these engineers.
Maintenance materials are expected to cost RM120,000 per annum.
The total crew salaries including the maintenance engineer's salary is expected to be RM750,000 per annum.
Overheads relating to the proposal are expected to amount to RM200,000 per annum with half of this amount reflecting an allocation of existing company fixed costs.
Working capital requirements is expected to be RM250,000 at the beginning of the project and this will be recovered at the end of the project.
Unless otherwise stated all costs and revenues have been estimated using year 1 prices. All continuing costs and revenues are subject to inflation at a forecast rate of 5% per annum.
The company's cost of capital is 12%.
REOUIRED
Text Box: (1)Text Box: You are required to prepare the necessary calculations with explanations on the viability of this project.
Since there are several techniques that can be used to evaluate the project, you are also required to provide a critical evaluation of the relevant techniques and recommend an appropriate technique(s) to be applied.
Prepare a report to submit to the Finance Committee at its next meeting. The report should include an "Executive Summary" at the start of the report which is a brief statement (one page or less) outlining the investment under consideration and the recommendation together with the reasons why the recommendation was made.