Your company is considering investing in its own transport fleet. The present position is that carriage is contracted to an outside organisation. The life of the transport fleet would be five years, after which time the vehicles would have to be disposed of. The cost to your company of using the outside organisation for its carriage needs is 250 000 for this year. This cost, it is projected, will rise 10% per annum over the life of the project. The initial cost of the transport fleet would be 750 000 and it is estimated that the following costs would be incurred over the following five years:

Drivers' CostsRepairs andOther costs

Maintenance

Year 133 000 8 000130 000

Year 235 00013 000135 000

Year 336 00015 000140 000

Year 438 00016 000136 000

Year 540 00018 000142 000

Other costs include depreciation. It is projected that the fleet would be sold for 150000 at the end of Year 5. It has been agreed to depreciate the fleet on a straight line basis.

To raise funds for the project your company is proposing to raise a long-term loan at 12% interest per annum.

You are told that there is an alternative project that could be invested in, using the funds raised, which has the following projected results:

Payback = 3 years

Accounting rate of return = 30%

Net present value = 140 000

As funds are limited, investment can only be made in one project. Note: The transport fleet would be purchased at the beginning of the project and all other expenditure would be incurred at the end of each relevant year.

Required:

(a) Prepare the following table showing the net cash savings to be made by the firm over the life of the transport fleet project.

Year 1 Year 2 Year 3 Year 4 Year 5

Saving in fleet costs

Driver's costs (-)

Repairs and maintenance (-)

Other costs (-)

Net savings

(b) Calculate the following for the transport fleet project.

(i) payback period;

(ii) accounting rate of return; and

(iii) net present value.

The discount factors for 12% are as follows:

Year 1 0.893

Year 2 0.797

Year 3 0.712

Year 4 0.636

Year 5 0.567

(c) Write a short report to the Investment Manager in your company outlining whether investment should be committed to the transport fleet or the alternative project outlined. State clearly the reasons for your decision.