1.

CASE STUDY

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 cars at the average price of $18,000. In order to reduce their insurance costs, AME will have a LoJack Stolen Vehicle Recovery System installed in each car at a cost of

$1,500 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 abandoned lot and building where it could store its vehicles. If AME does not undertake the project, the lots can be leased to an auto-repair company for $90,000 per year (total amount for both lots). The $25,000 annual maintenance cost (total for both lots) will be paid by AME whether the lots are leased or used for this project. This discount rental car business is expected to have minimum impact on AMEs regular car rental business in Tasmania, where the net cash flow is expected to fall by only

$20,000 per year.

For taxation purposes, the useful life of the cars is determined to be five years and they will be depreciated using the most advantageous depreciation method set out by the Income Tax Assessment Act. It is assumed that the cars will first be used at the beginning of the next financial year: 1 July 2018.

Before starting this new operation, AME will need to redevelop and renovate the buildings at each airport location. This is expected to cost $220,000 for both locations. AME has also budgeted

$80,000 in marketing costs that will be spent prior the start of operation and during the first two years of operation. In addition, if the project is undertaken, a total new injection of $150,000 in net working capital will be required.

Maeve, the company CFO would like you help her examine the viability of the project for the next five years taking into account the projections of sales and operating costs prepared by AMEs accountants. Given the risk associated with the project, she believes it is reasonable to use a cost of capital of 12% for the evaluation of this project. Further financial data relating to the project can be found in the appendix.

1. Discuss which costs are relevant for the evaluation of this project and which costs are not. Your discussion should be justified by a valid argument and supported by references to appropriate sources.