Reference no: EM132822085

Question - Laws and Morris Ltd. (LML) is a small executive transportation company operating in the Vancouver area. LML is considering replacing its fleet of 10 luxury gas-powered cars with luxury electric cars. Senior management has asked the finance manager to evaluate whether LML should buy 10 electric cars to replace its current fleet of cars, which are coming to the end of their useful lives.

The electric-car manufacturer has quoted a price of $150,000 each for the electric cars plus delivery costs of an additional $5,000 per car. The electric cars are expected to have a useful life of 10 years with an estimated salvage value of $15,000 per car. The current gas-powered fleet has a salvage value of $100,000.

The electric cars are expected to increase revenue by $110,000 per car per year, as the electric cars require less maintenance and therefore have over 10% more revenue-producing hours per year than the current gas-powered cars. The electric cars will require LML to install five new charging stations at its office facility, which will cost $5,000 each and are expected to have a useful life of 10 years with NO salvage value.

Operating expenses for the electric cars are 65% of sales. Parts inventory is expected to increase by $100,000, accounts receivable is expected to increase by $50,000, and accounts payable is expected to increase by $37,500. The working capital accounts are expected to remain at this level after the end of the new cars' useful lives.

LML's effective tax rate is 35%. The cars are Class 10 (30%) and are eligible for the accelerated investment incentive rules (ACII) for capital cost allowance (CCA). The same CCA class already has assets in it, and the pool is expected to continue to have assets in it after the useful lives of the cars. The charging stations are Class 43 with a CCA rate of 30%, and are also eligible for the ACII rules. The same CCA class already has assets in it, and the pool is expected to continue to have assets in it after the useful lives of the charging stations.

LML has $5.5 million in bank loans outstanding at an interest rate of 6.5%. LML's capital structure is 55% debt and 45% equity. LML's weighted average cost of capital is 13.5%.

a) Using the net present value method, should LML purchase the 10 electric cars?