Road King Essay

1697 words - 7 pages

BUS 500D

Road King Trucks was established by the Smith brothers in 1880 as the California Wagon Company and it has been manufacturing trucks for almost a century. The company has been looking to evaluate the opportunity of manufacturing “The Transit Bus”. The management has realized that the private vehicles have become very costly and people are becoming more and more aware about environmental impact of using private vehicles. Therefore, the management sees the business opportunity in the manufacture of “The Transit Bus”. Recently hired CEO Michael Livingston has a reputation for successfully ...view middle of the document...

The use of public transport system has continuously declined in the last 5 decades due to the ease of availability for private vehicle ownership. The environment has been badly affected because of wide use of fuels in the private transport vehicles. Moreover, the supply of energy is limited with us. As we use more and more of energy, our future energy gets reduced. The use of public transportation system will help reduce the energy consumption and consequently its cost. Therefore, public transportation system should be used to save the energy.

2. Project’s Cash Flows for the next 20 years are as follows:
Year Project’s Cash Flows
If Detroit Engine is used If Marcus Engine is used
0 -$642,000,000 -$642,000,000
1 -$323,859,746 -$324,947,019
2 $22,711,826 $21,586,498
3 $128,949,056 $127,784,342
4 $195,404,588 $194,199,109
5 $202,086,065 $200,838,394
6 $209,001,393 $207,710,054
7 $216,158,757 $214,822,221
8 $223,566,630 $222,183,315
9 $231,233,778 $229,802,047
10 $239,169,276 $237,687,434
11 $247,382,516 $245,848,810
12 $255,883,220 $254,295,834
13 $264,681,448 $263,038,504
14 $273,787,615 $272,087,168
15 $283,212,497 $281,452,534
16 $292,967,250 $291,145,689
17 $303,063,420 $301,178,104
18 $313,512,955 $311,561,653
19 $324,328,225 $322,308,627
20 $824,250,933 $822,160,649

Notes TO Q2:
A. Negative amounts indicates cash outflow.
B. Historic cost of land and sales realization of this land at the end of 20 years is not relevant in this case as it is not linked with this project.
C. It has been assumed that NWC required for the year will be invested at the end of previous year.
D. It has been assumed that the company will not recover any amount for building at the end of the project life.
E. It has been assumed that the warranty cost will be incurred at the end of the year.

3. The company’s weighted average cost of capital of the company is 7.76% (round off). The weighted average cost of capital of the company has been taken as weighted average of cost of capital of equity and debt. The cost of capital of equity has been derived from the “Capital Asset Pricing Model”. As per the Capital Asset Pricing Model, Risk factor is added to the risk free rate of return to derive the cost of capital of the equity. Generally, risk free rate of return is the rate of return on government treasury. Risk factor is calculated by way of multiplying beta of the company with market premium. In the given case, risk free rate is 4%, market premium is 5.5% and beta of the company is 1.15. Therefore, cost of capital of equity as per Capital Asset Pricing Model is 10.325%. Cost of Debt has been taken as after tax as tax shield is available against interest expense. Interest paid to debt holders is deductible from profit for tax purpose. Therefore, it is appropriate to take after tax cost of debt for the purpose of calculating cost of capital of the company. The cost of debt, which has been assumed to be equal to current year to maturity...

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