Capital Budgeting Problem

Caitlin is an accounting major at Boise State University. Caitlin has realized that there are numerous students attending BSU that live in communities within 120 miles of BSU who would like to go home on weekends but don’t have cars. Caitlin, an entrepreneur at heart, believes a weekend commuting service could be organized and run profitably. She has gathered the following information:

A. Six used vans can be purchased for a total of $90,000. Each van has a four-year useful life with a salvage value of $1,500 at the end of the fourth year. Caitlin plans on using straight-line depreciation.

B. Caitlin would hire 10 drivers. Payroll expense is estimated at $48,000 annually.

C. Other annual operating expenses associated with running the commuter van service include:

Gasoline: $ 16,000

Maintenance: $ 3,300

Repairs: $ 4,000

Insurance: $ 5,000

Advertising: $ 1,200

D. Caitlin has talked to local banks and has been able to negotiate an operating loan at 14%. Use this rate for your cost of capital (the discount rate).

E. After surveying students on campus Caitlin has determined each van would make 10 round trips weekly and carry an average of five students on each trip. The vans would operate 30 weeks each year. Each student would pay $12 per round-trip ticket.

Required: Compete the following in Excel. Do your own work! If any solutions even appear to be the same, zero points will be earned for this assignment.

1) Calculate annual net income. Remember the formula for straight-line depreciation is (cost – salvage value)/useful life.

2) Calculate net annual cash flows for the service.

3) Calculate the net present value of the commuter service.

4) Based on the net present value of the service and the potential income, should Caitlin start this service?

5) What if she could not get financing for less than 20%? Should she still make the investment?