Question

Braves Bus Tours wants to provide excursions to several national and international sports events that will be taking place throughout the country during the next few years. To make the buses more comfortable and the trips more popular, each of eight new buses will be equipped with a kitchen and a large video screen for movies and sports telecasts.

Each bus costs $200,000 and requires customized equipment that costs an additional $100,000 per bus. All the buses and the equipment have a recovery period (MACRS life) of 5 years. An advertising campaign, which will start immediately, costs $750,000 and will be paid for immediately. Other start-up costs total $30,000.

The sports trips are scheduled for 3-10 days and will generate revenues of $100 per day per seat. For the eight video buses, total revenues are expected to be $3,168,000 for the first year and $3,484800 for the second year (a 10% increase). Operating costs are 30% of total revenues. Personnel expenses, including driver salaries, are $650,000 in year 1 and will increase by 5% in year 2.

The company expects to discontinue the operation of its video bus tours after the second year. Each bus will be sold to a university for $160,000 ($150,000 for the bus itself and $10,000 for the equipment). The finance department has determined that the beta of this project is 1.5, while the market return is expected to be 14%. Treasury bills pay a nice safe 4 percent.

Should the company proceed with this project? Demonstrate your decision by answering the following questions (build a cash flow estimate, and in it show):

1. What are the cash flows for the initial investment period (CF₀)?

2. What is the MACRS depreciation schedule for the first two years for all of the buses and the equipment? The fall into the MACRS 5 year class. See Table 9.7 (page 284 of the text).

3. What are the after-tax cash flows for the 2 years that the bus tours will be in operation if their tax rate is 24%?

4. What are the termination cash flows in year 2?

5. If NPV analysis is used, should the buses be purchased?

** This question has been answered before on Chegg but didn't complete the requirements or have the right numbers. Please do your best to make everything easy to understand so I can learn it. thanks

Answer 1

1. Initial cost of the project is for 8 buses with a cost of $300,000($200000 bus cost +$100000 additional cost) for each each bus.

Cost of 8 buses=$2,400,000

additional advertisement expenses and other start-up costs=$780,000 ($750,000+$30,000)

Total initial cost= $3,180,000 ($2,400,000+$780,000)

2. First we have to find the depreciation for 2 year using MACRS method. US tax department accepts either 150% or 200% depreciation declining method. I have taken 200% for the calculation

Formula for depreciation= (total cost)*(1/asset life)*200%

Total cost= We should take only depreciable assets. should take 8 buses cost, not to include advertisement expenses and other start-up costs=$2,400,000

asset life=5 years (given in the question)

Year 1 depreciation=($2,400,000)*(1/5)*200%=$960,000

Year 2 depreciation=(Total cost-Year 1 depreciation)*(1/5)*200%=($2400000-960000)*(1/5)*200%=$576,000

3. After tax cash flows for Year 1 and Year 2 & Termination cash flow in Year 2

4. NPV can be calculated as

NPV=(Present value of Year 1 and Year cashinflows)-(initial total cost)

rate of return=risk free rate of return+beta (market expected return-risk free rate of return)

rate of return=4.0%+1.5(14%-4%)

Rate of return=19%

NPV=(1421776/1.19)+(1595054/(1.19)^2)-$3180000

NPV=(1194770)+(1126371)-3180000

NPV=-$858,860

NPV is negative and hence we should not buy the buses (reject this project)