Question

Bluemart Limited ("BL") provides online grocery shopping and delivery in Singapore. The company has been gaining market share with its fresh produce, friendly user-interface and on-time delivery services.

Delivery service is currently outsourced to an external provider, and is expected to cost $250,000 for the coming year. BL wants to have better control over delivery operations, and hence, is considering investing in its own fleet of delivery vehicles. The useful life of the vehicle fleet is expected to be five years, after which the fleet will be disposed.

The cost of the external provider is expected to rise 10 per cent per annum over the useful life of the vehicle fleet. The initial cost of the fleet is $750,000. Additional costs are estimated to be incurred over the next five years:

Included in "Other Costs" is depreciation expense. Depreciation is charged on a straight-line basis. BL expects that the vehicle fleet to be sold for $150,000 at the end of year 5.

BL has obtained a long-term loan to finance the project. Interest on the loan is at a fixed rate of 12 per cent per annum.

If the loan is not used for the acquisition of the vehicle fleet, there is a competing project where the loan can be used for. The projected results for the competing project is as follows:

Payback = 3 years

Average accounting rate of return = 30%

Net present value = $140,000

As funds are limited, investment can only be made in one project.

Note: You can assume that the vehicle fleet will be purchased at the beginning of the project, and all other expenditures will be incurred at the end of each relevant year.

(a) Construct a table showing the net cash savings (or losses) that BL can expect over the useful life of investment in the vehicle fleet.

(b) Compute the following for the vehicle fleet investment:

(i) Payback period.

(ii) Average accounting rate of return.

(iii) Net present value.

(Note: PV factors for 12% are as follows: Year 1 = 0.893; Year 2 = 0.797; Year 3 = 0.712; Year 4 = 0.636; Year 5 = 0.567; the PV annuity factor for 12%, 5 years = 3.605)

(c) Discuss in a short report to the investment manager of BL whether the funds from the loan should be invested in the vehicle fleet or the competing project.

Answer 1