This paper is an analysis of Road King Trucks’ new task which is presenting a new product into its line of product. I will decide whether run the task or not. Six problems will be talked about as follows 1) value of energy expense; 2) job’s capital; 3) cost of capital; 4) pick an engine 5) evaluation 6) accept or turn down.
We should accept the job since of the positive NPV and high IRR. We will gain $532 million in wealth which is a big money on the scale like this.
The business has a bond rating of AA that makes the danger relatively low. So we should definitely say yes.
Roadway King Trucks, Inc. is a truck producing company. The new CEO Michael Livingston arranged a conference with the firm’s top managers and engineers considering presenting a big, public transit bus into its present line of product. As the oil costs keep going high and have no sign of reducing.
Mr. Livingston thought it would lead individuals more most likely to use public transport. The price of gas has gone up for the 30th day in a row, and with it moods are rising. Increased need for mass transit is expected to continue into the spring [1] The impact of high oil rates makes individuals more voluntarily to use public transport and there will be an increase of riders. The business ought to adjust itself to the modifications of market. Now it is a fashion to be “Green”. People show excellent environmental awareness to the world.
It is smart to attract people with public transport and meet their needs.
We expect inflows are higher than outflows, so to cover the expense happened in the development. However to identify whether we should run the task or not, we need to compute the NPV. I will discuss it later on. The total life of the job is 22 years. The production and selling of buses start in year 3. I add inflation on sales and costs in year 4, the year after production and sales begin (Idea comes from Mr. Hasse). Straight line depreciation was used in estimation and devaluation won’t be affected by inflation. The land was represented opportunity cost. If we do not run the job, we can sell it and make $6 million right now.
I used WACC as the discount factor, we expect the rate of return to be higher than it, the same at least. The WACC reflects the average risk and overall capital structure of the entire firm [2]. It’s the required return and it presents how much the company pays for the capital it finances. In this case, the cost of equity is 10.33%, the cost of debt is 6.50%. I calculated WACC using those numbers and got a result of 8.49%.
There are two options for engines will be installed on buses. And so are the warranties. The decision should be made according to engines’ quality, effectiveness, etc. But to investors, cost is the main factor. In this case, Detroit engine has an installation cost of $20,000 and a warranty of $1,000 each year for 5 years; the cost of installation of Marcus engine is $2,000 less but the warranty is $1,500 per year. To figure out the cost I calculated the NPVs of each year for 20 years. The NPVs of the warranties for each bus are same at the year it been produced. For example, the warranty of a Detroit engine has a NPV of $4,276 in the year it been produced. (This method is coming from Mr. Hasse. I used to combine the warranty for each year and use those numbers in calculation.) The NPV of installation cost and warranty of Detroit engine is $252,154, which is smaller than the number of Marcus engine, $253,589. So Detroit engine should be used in the bus.
The capital budgeting techniques are used in evaluating the project. The most important two factors are NPV and IRR. NPV determines whether a company can get profit running project through time. The project’s cash flows are discounted by WACC. The difference between the investment in year 0 and the total PV sum of future cash flows is NPV. If it is positive, we should accept the project. In this project it is $532 million. IRR is the rate that makes the NPV zero at the end of project life time. Which means if it’s higher than WACC, the project will be viable. I got an IRR of 12.41% greater than WACC, 8.49%. It fits the situation. Also we can find PI and payback. But they can’t present the whole situation as well as NPV and IRR do. The company has a bond rating of AA. That will be a good thing if we run the project. Investors will bare a relatively low risk. And a overall beta of 1.15 also says the same.
If we run the project it will increase the company’s value by $ 532 million. We should accept the project because of the positive NPV and high IRR. Except the numbers, we should consider more than that. The government policies, environmental factors and future economy ought to be added in decision making.
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