Each bus costs $200,000 and requires customized equipment that costs an addition
ID: 2634482 • Letter: E
Question
Each bus costs $200,000 and requires customized equipment that costs an additional $100,000 per bus. All the buses and the equipment have a recovery period (MACRS life) of 5 years. An advertising campaign, which will start immediately, costs $750,000 and will be paid for immediately. Other start-up costs total $30,000.
The sports trips are scheduled for 3-10 days and will generate revenues of $100 per day per seat. For the eight video buses, total revenues are expected to be $3,168,000 for the first year and $3,484800 for the second year (a 10% increase). Operating costs are 30% of total revenues. Personnel expenses, including driver salaries, are $650,000 in year 1 and will increase by 5% in year 2.
The company expects to discontinue operation of its video bus tours after the second year. Each bus will be sold to a university for $35,000 ($30,000 for the bus itself and $5,000 for the equipment). The finance department has determined that the beta of this project is 1.5, while the market return is expected to be 14%. Treasury bills pay a nice safe 4 percent.
Should the company proceed with this project? Demonstrate your decision by answering the following questions:
Explanation / Answer
Number of new buses = 8
Cost of each bus = $200,000
Additional cost = $100,000
Total cost per Bus = $300,000
Recovery period = 5 years
Advertisement cost = $750,000
Start up cost = $30,000
Revenue in 1st year = $3,168,000
Revenue in 2nd year = $3,484,800
Operation cost in 1st year = 30% of revenue
= 0.3*3,168,000 = $950400
Personal expense in 1st year = $650,000
Net Operating Income in 1st year = $3,168,000 - $950400 - $650,000
= $1567600
Operating cost in 2nd year = 30% of $3, 484800
= 0.3*3484800 = $1045400
Personal expenses in 2nd yr = 1.05*650,000 = $682500
Net Operating income in 2nd year = $3168000 - $1045400
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