Tasmania car rental company (TMR), a proprietary company, isconsidering whether to enter Tasmania's discount rental car market.The program will involve buying 100 used cars, midsize cars, andmidsize cars at an average price of $15,000. To reduce theirinsurance costs, TMR will install a LoJack recovery system on eachvehicle, which costs $1,500. TMR expects the rental service to havetwo locations: one near Hobart airport and one near Launcestonairport. At each location, TMR has an abandoned lot and buildingwhere vehicles can be stored. If TMR does not take on the project,the lot can be leased to a car repair company for $90,000 a year(two lots in total). Whether leased or used for the project, TMRwill pay an annual maintenance cost of $25,000 (two batches total).The discount car rental business is expected to reduce its regularcar rental business by $20,000 a year.

For tax purposes, the life of the car is set at five years andwill be depreciated over five years using the straight-line method,with no residual value. Assume the car will be in use at thebeginning of the next fiscal year: July 1, 2019.

Before starting the new business, TMR will need to redevelop andrenovate the buildings at each airport. The estimated cost for bothlocations is $215,000. Suppose that TMR is unable to claim anyannual tax relief on capital expenditure on building refurbishmentbefore selling the business. TMR also budgeted for marketing costs,which will be used when the project is launched and for the firsttwo years of operation. The estimated cost is $30,000 per annum.These expenses are fully tax-deductible in the year they areincurred. In addition, the project would require a full injectionof $150,000 in net working capital. No additional working capitalis required from start to finish. The initial network capital willbe fully recovered at the end of year 5.

The income forecast of car rental in the next five years is asfollows:

Revenue projections from car rental for the next five years areas follows

	Year 1	Year 2	Year 3	Year 4	Year 5
Beginning	1/7/2019	1/7/2020	1/7/2021	1/7/2022	1/7/2023
Ending	30/6/2020	30/6/2021	30/6/2022	30/6/2023	30/6/2024
Revenue ($’000)	900	1,100	1,200	1,250	1,250

Operating costs

Operating variable costs associated with new business are 10% ofrevenue. Annual operating fixed costs (excluding depreciation) are$1,800 per vehicle.

Existing administrative costs are $550,000 per annum. As aresult of the new operation. These administrative costs willincrease by 20%. The company is subject to a tax rate of 27.5% onits profit.

Catherine, the chief financial officer of the company would likeyou to help her examine the feasibility of the project in the nextfive years, taking into account the sales and operating costprojections prepared by the company's accountants. Given the risksassociated with the project, she thinks it is reasonable to use a12% cost of capital to evaluate the project.

Your Tasks:

Based on the information in the case study, Catherine asked youto write a report to TMR's management about the best course ofaction for the project. Your report shall address the followingspecific issues raised by TMR's management:

1. Discuss which costs are relevant to the evaluation of theproject and which are not. Your discussion should be supported byvalid arguments and references to appropriate sources.

2. How are the possible internecine and opportunity costs takeninto account in this analysis?

3. Determine the initial investment cash flow.

4. Estimate all cash flows related to the project over 5 years.Assume that, in the relevant case, capital expenditures andmarketing costs are consumed throughout the year, while cash flowsrelated to revenue and operating costs occur at the end of theyear. You need to broadly describe the methods used to determinethese cash flows.

5. Calculate the payback period of the project. Suppose thebusiness could be sold for millions of dollars at the end of fiveyears. This figure includes the value of car fleets, homes andcapital gains for businesses. Ignore any tax consequences that mayarise from the sale of the business and ignore the time value ofthis particular currency calculation. Briefly comment on yourresults.

6. Estimate the net present value (NPV) of the project, assumingthat the initial investment can be sold for $1 million at the endof five years. This figure includes the value of car fleets, homesand capital gains for businesses. Ignore any possible tax sequencefor the sale of the business.

Briefly comment on your results and, if necessary, makeappropriate comments on the assumptions of these calculations.

7. Using sensitivity analysis, the NPV was recalculated using ascenario that reduced project sales by 10% per year. Brieflycomment on your results.

8. In view of your answers to points 5 to 7 above, please informTMR management whether to proceed with the investment project. Inyour recommendations, you may wish to suggest possible improvementsfor this project.