Reference no: EM132625141

Your company is considering investing in its own transport fleet. The present position is that carriage is contracted to an outside organization. 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 organization for its carriage needs is $ 250,000 for this year. This cost, it is projected, will rise 10 per cent 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:

Other costs include depreciation. It is projected that the fleet would be sold for RM150 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 per cent 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 = three years

Accounting rate of return = 30 per cent

Net present value = RM140 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:

Question i. Do a table showing the net cash savings to be made by the firm over the life of the transport fleet project.

Question ii. Compute the payback period, accounting rate of return and net present value for the transport fleet project

Question iii. Do 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.