if the discount rate adjusted to 14

Australian Motor Execs (AME) is set up as a proprietary company and is considering whether to enter the discount rental car market in Tasmania . This project would involve the purchase of 100 used, late model, mid – sized car at the average price of $12,500. In order to reduce their ins urance c osts, AM E will have a Lo Ja ck Stolen Vehicle Recovery System installed in each car at a cost of $1,000 per vehicle . The rental car operation projected by AME will have two locations : one near Hobart airport and the other near Launceston airport. At each location, AME owns an abandone d lot where it could store its vehicles. If AME does not undertake the project, the lots can be leased to an auto – repair company for $110,000 per year ( Total amount for both lots). The $20,000 annual maintenance cost (total for both lots ) will be paid by A ME whether the lots are leased or used for this project. In addition , if the project is undertaken, net working capital will increase by $70,000. For taxation purposes, the useful life of the cars is determined to be five years and they will be depreciated using the diminishing value method set out by the Income Tax Assessment Act. It is assumed that the car will first be used at the beginning of the next financial year: 1 July 2016. Each car is expected to generate $5,800 a year in revenue and have operati ng costs of $1,000 per year. Starting at the beginning of year 6 , one quarter of the fleet is expected to be replaced each year with a similar fleet of used cars. This is expected to result in a net ca sh outflow ( including acquisition costs of the replacem ent car and installation of a new vehicle recovery system on each car ) of $120,000 per year continuing indefinitely. This discount rental car business is expected to have minimum impact on AME’s regular car rental business in Tasmania, where the net cash f low is expected to fall by only $25,000 per year. AME’s tax rate is 30%. Based on this information, you are required to write a report to AME’s executive managers advising them as to the best course of action regarding this project. Your report should addr ess the following specific questions asked by AME’s management: 1. What is the initial cash flow for this discount used rental car project? 2. Which costs are relevant to the project evaluation? Which cost s are not? The managers ask you to justify your answer with an appropriate argument . 3. How are possible cannibalization and opportunity costs considered in this analysis? 4. Estimate the depreciation costs incurred for the next six years. 5. Estimate the net cash flow for each of the next six years . 6. Estimate the terminal value of this project at the end of year 6 (30 June 2022) in the event where AME was to sell the discount rental car business at that date ? We assume that the car fleet would be disposed at book value. 7. Usi ng the standard discount rate of 9% ( which represents AME’ s cost of capital), what is the Net Present Value (NPV) of this project assuming the business is sold at the end of year 6 ? 8. Considering the higher risk associated with this project, AME would like to know what the NPV would be if the discount rate was adjusted to 14% .