Your company is considering investing in its own transport fleet. The present posi-
tion is that carriage is contracted to an outside organization. The life of the trans-
port 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 organization 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 next five years:
Drivers’ Costs Repairs & Maintenance Other Costs
(£) (£) (£)
Year 1 33 000 8 000 130 000
Year 2 35 000 13 000 135 000
Year 3 36 000 15 000 140 000
Year 4 38 000 16 000 136 000
Year 5 40 000 18 000 142 000
Other costs include depreciation. It is projected that the fleet would be sold for
£150 000 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 rate 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 a table showing the net cash savings to be made by the firm over the
life of the transport fleet project. (5 marks)
(b) Calculate the following for the transport fleet project:
(i) Payback period
(ii) Accounting rate of return
(iii) Net present value (13 marks)
(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. Clearly state the reasons for your decision.
(7 marks