CASE STUDY Tasmanian Motor Rental (TMR) is set up as a proprietary company in car rental industry 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 $13,500. In order to reduce their insurance costs, TMR will have a LoJack Stolen Vehicle Recovery System installed in each car at a cost of $1,200 per vehicle. The rental car operation projected by TMR will have two locations: one near Hobart airport and the other near Launceston airport. At each location, TMR owns an abandoned lot and building where it could store its vehicles. If TMR does not undertake the project, the lots can be leased to an auto-repair company for $80,000 per year (Total amount for both lots). The $25,000 annual maintenance cost (total for both lots) will be paid by TMR whether the lots are leased or used for this project. This discount rental car business is expected to result in a fall in its regular car rental business by $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 straight-line depreciation method over 5 years with no residual values at the end. It is assumed that the cars will first be used at the beginning of the next financial year: 1 July 2020. Before starting this new operation, TMR will need to redevelop and renovate the buildings at each airport locations. This is expected to cost $250,000 for both locations. Assume that TMR is not able to claim any annual tax deduction for the capital expenditure to the renovation of the building until the business is sold. TMR has also budgeted marketing costs what will be spent immediately to promote the new business and during the first two years of operation to boost the sales. The estimated costs are $30,000 per year. These costs are fully tax deductible in the year they are incurred. In addition, if the project is undertaken, a total new injection of $250,000 in net working capital will be required. There will be no additional working capital required from the commencement of the operation until the end of the project. The initial networking capital will be recovered in full by the end of year 5. Revenue projections from the car rental for the next five years are as follows: Year 1 Year 2 Year 3 Year 4 Year 5 Beginning 1/7/2020 1/7/2021 1/7/2022 1/7/2023 1/7/2024 Ending 30/6/2021 30/6/2022 30/6/2023 30/6/2024 30/6/2025 Revenue ($ 000) 1,092 1,150 1,350 1,500 1,550 Operating variable costs associated with the new business represent 8% of revenue. Annual operating fixed costs (excluding depreciation) are $520 per vehicle. Existing administrative costs are $400,000 per annum. As a result of the new operation, these administrative costs will increase by 15%. The company is subject to a tax rate of 27.5% on its profits. Catherine, the company CFO would like you to help her examine the viability of the project for the next five years, taking into consideration the projections of sales and operations costs prepared by companys accountants. Given the risk associated with the project, she believes it is reasonable to use the cost of equity for the evaluation of this project. TMRs equity beta is estimated to be 1.1, the Treasury bond yield is 2% and the market risk premium is 10%. Your tasks: Based on the information in the case study, Catherine has asked you to write a report to TMRs management advising them as to the best course of action regarding this project. Your report should address the following specific questions asked by TMRs management: 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 2. How are possible cannibalization and opportunity costs considered in this analysis? 6. Using sensitivity analysis, recalculate NPV using the scenario of a decrease in project sales by 10% annually. Briefly comment on your results.