Question
Pembroke-Hawk Limousine Pembroke-Hawk Limousine is deciding if they should invest in a charter company to run trips to various educational and cultural sites throughout the
Pembroke-Hawk Limousine
Pembroke-Hawk Limousine is deciding if they should invest in a charter company to run trips to various educational and cultural sites throughout the southeast of the. To make the vehicles more cost-effective and the trips more popular, each of eight new buses will be equipped with a kitchenette and a video screen for movies and sports telecasts.
Each bus costs $250,000 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 $600,000 and will be paid for immediately. Other start-up costs total $75,000.
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), and increase at a rate of 10% each year for the life of the project. Operating costs are 35% of total revenues. Personnel expenses, including driver salaries, are $650,000 in year 1 and will increase by 15% in year 2 and each year for the life of the three-year project.
The company expects to discontinue operation of its video bus tours after the third year. Each bus will be sold to a university for $75,000 ($60,000 for the bus itself and $15,000 for the equipment). The finance department has determined that the beta of this project is 1.50, while the market return is expected to be 15%. Treasury bills pay a nice safe 1 percent. Hawk Transport can finance the entire project with a bank loan from their local First Guaranty Bank at 10%.
The firm wants to maintain their target debt to equity ratio of 1:1.
Should the company proceed with this project? Demonstrate your decision by answering the following questions (build a cash flow estimate, and in it show):
o What are the cash flows for the initial investment period (CF0)?
o What is the MACRS depreciation schedule for the of the project for all of the buses and the equipment? Include this in your Income Statement (*and Cash Flow) They fall into the MACRS 5 year class. See below
o What are the after-tax cash flows for the years that the bus tours will be in operation if their combined state and local tax rate is 30%?
o What are the termination cash flows in the final year?
o If NPV analysis is used, should the buses be purchased?
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