Lon Timur is an accounting major at a midwestern state university located approx
ID: 2450330 • Letter: L
Question
Lon Timur is an accounting major at a midwestern state university located approximately 60 miles from a major city. Many of the students attending the university are from the metropolitan area and visit their homes regularly on the weekends. Lon, an entrepreneur at heart, realizes that few good commuting alternatives are available for students doing weekend travel. He believes that a weekend commuting service could be organized and run profitably from several suburban and downtown shopping mall locations. Lon has gathered the following investment information. 1. Five used vans would cost a total of $75,000 to purchase and would have a 3-year useful life with negligible salvage value. Lon plans to use straight-line depreciation. 2. Ten drivers would have to be employed at a total payroll expense of $47,998. 3. Other annual out-of-pocket expenses associated with running the commuter service would include Gasoline $15,995, Maintenance $3,303, Repairs $4,008, Insurance $4,204, Advertising $2,491. 4. Lon has visited several financial institutions to discuss funding. The best interest rate he has been able to negotiate is 15%. Use this rate for cost of capital. 5. Lon expects each van to make ten round trips weekly and carry an average of six students each trip. The service is expected to operate 30 weeks each year, and each student will be charged $11.97 for a round-trip ticket.
Determine the annual (1) net income and (2) net annual cash flows for the commuter service. (Round answers to 0 decimal places, e.g. 125.)Net income $ Net annual cash flows $
Explanation / Answer
1)
Initial Investment = 75000
Useful life = 3 year
Salvage Value = 0
Annual Depreciation = (VAN cost - Salvage Value)/useful life
Annual Depreciation = (75000-0)/3
Annual Depreciation = 25000
Driver Cost = 47988
Gasoline = 15995
Mainenance = 3303
Repair = 4008
Insurance = 4204
Advertising = 2491
Total Annual Expenses = 25000 + 47988 + 15995 + 3303 + 4008 + 4204 + 2491
Total Annual Expenses = 102989
Revenue = 5*10*30*6* 11.97
Revenue = $ 107730
Net Income or (Loss) = Revenue - Total Annual Expenses
Net Income or (Loss) = 107730 - 102989
Net Income or (Loss) = 4741
Net annual cash flows = Net Income or (Loss) + Annual Depreciation
Net annual cash flows = 4741+ 25000
Net annual cash flows = $ 29,741
2)
Cash payback period = Initial Investment/Annual Cash flow
Cash payback period = 75000/29741
Cash payback period = 2.52 Years
Annual rate of return = Net Income or (Loss)/Average Investment
Net Income or (Loss) = 4741
Average Investment = (75000+0)/2 = 37500
Annual rate of return = 4741/37500
Annual rate of return = 12.64%
3)
NPV = -Initial Investment + Annual Cash flow/(1+r) + Annual Cash flow/(1+r)^2 + Annual Cash flow/(1+r)^3
NPV = -75000 + 29741/1.15 + 29741/1.15^2 + 29741/1.15^3
NPV = $ - 7095
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