Reference no: EM132010240

Your company has been asked to build a new bike path and you want to create a capital budget to evaluate the alternatives. You will build and operate it for 5 years.

Using old technologies, the path will cost $3,000,000 of capital spending right now (Year 0). At the end of the contract the salvage value of the capital asset will be equal to the value of the asset’s undepreciated capital cost (UCC).

To maintain the path when in operation (Year 1 and onwards) there will be an annual fixed cost of $500,000 and a variable costs of $0.35 per rider.

The initial networking capital will be $700,000 and total net capital per year will be equal to 10% of revenues. The net working capital will be recovered at the end of the contract.

In researching the project you became aware of a new technology called a “smart” road.

There is a cost of $6,000,000 initially (Year 0) for the equipment and materials. At the end of the five year contract you will be able to sell the remaining capital assets for their undepreciated capital cost (UCC).

You will also need an initial working capital of $1,000,000 that will be recovered at the end of the project’s life. No further networking capital will be needed.

When up and running (Year 1 and onwards) you estimate there will be $300,000 fixed costs annually and a variable cost of $0.21 per cyclist to keep it in proper shape.

It is estimated that every rider to use the path will travel an average of 1.4 kms. For every kilometer a rider travels it is estimated 0.005 kilowatts hours of electricity will be created. You estimate that the price of a kilowatt hour of electricity will be $0.10.

The CRD will pay $0.95 for every cyclist that uses the new bike path. You have estimated the path will have 5,000 users a day during the work week and 10,000 users a day on the weekend in the first year. Usage is expected to increase every year by 10%. For your calculations you have assume that there are 52 weeks in a year.

While you feel though your usage estimates are sound, you are hopeful the new path could attract 10% more cyclists than you anticipated to start and see annual usage increase by 15% from one year to the next. You are also aware that if cyclists don’t like the path the initial usage estimate may be 20% less than the base case estimate, with usage decreasing (rather than increasing) by 13% from one year to the next.

For both alternatives Revenue Canada has assigned a 20% rate to your capital cost allowance (CCA) and you are expecting a tax rate of 35%. The relevant discount rate is 9%. The appropriate amount of time to analyze payback periods is 3.2 years.

1. In the space below show a table for each project alternative summarizing the OCF, change in networking capital, capital spending, total project cash flow, cumulative project cashflow and discounted cash flow for each year.

2. In the space below show a table comparing the NPV, IRR, payback period, discounted payback period and profitability index for each project alternative. Include space in the table for identifying whether or not the different criteria would suggest accepting or rejecting the particular alternative.

Then, in a few sentences, discuss whether the criteria for each project alternative give a consistent recommendation or if they conflict (i.e. does the NPV suggest you should accept the project alternative but the IRR suggest it should be rejected?)

3. In the space below show a table comparing how sensitive each project alternatives’ NPV is to the variability in usage. In one to two sentences discuss which project alternatives’ NPV is most sensitive to a change in usage.