Reference no: EM131371200

Case - Decision Problem with Suboptions; NPV; IRR; Ethics (Section 1)

Present value of incremental annual cash flows: $129,780.

Acquisition cost of minibuses: $(216,000)

Initial cost if the minibuses are purchased: $(231,250)

The board of education for the Central Catskill School District is considering the acquisition of severalminibuses for use in transporting students to school. Five of the school district's bus routes are under populated,with the result that the full-size buses on those routes are not fully utilized. After a carefulstudy, the board has decided that it is not feasible to consolidate these routes into fewer routes served byfull-size buses. The area in which the students live is too large for that approach, since some students'bus ride to school would exceed the state maximum of 45 minutes.The plan under consideration by the board is to replace five full-size buses with eight minibuses,each of which would cover a much shorter route than a full-size bus.

The bus drivers in this rural schooldistrict are part-time employees whose compensation costs the school district $18,000 per year for eachdriver. In addition to the drivers' compensation, the annual costs of operating and maintaining a full-sizebus amount to $50,000. In contrast, the board projects that a minibus will cost only $20,000 annually tooperate and maintain. A minibus driver earns the same wages as a full-size bus driver. The school districtcontroller has estimated that it will cost the district $15,250, initially, to redesign its bus routes, informthe public, install caution signs in certain hazardous locations, and retrain its drivers.A minibus costs $27,000, whereas a full-size bus costs $90,000.

The school district uses straight-line depreciation for all of its long-lived assets. The board has two options regarding the five full-sizebuses. First, the buses could be sold now for $15,000 each. Second, the buses could be kept in reserveto use for field trips and out-of-town athletic events and to use as backup vehicles when buses breakdown. Currently, the board charters buses from a private company for these purposes.

The annual costof chartering buses amounts to $30,000. The school district controller has estimated that this cost couldbe cut to $5,000 per year if the five buses were kept in reserve. The five full-size buses have five years of useful life remaining, either as regularly scheduled buses or as reserve buses. The useful life of a newminibus is projected to be five years also.Central Catskill School District uses a hurdle rate of 12 percent on all capital projects.

Required:

1. Think about the decision problem faced by the board of education. What are the board's two mainalternatives?

2. One of these main alternatives has two options embedded within it. What are those two options?

3. Before proceeding, check the hint given at the end of the chapter, which explains and diagrams theschool board's alternatives. Suppose the board of education chooses to buy the minibuses. Preparea net-present-value analysis of the two options for the five full-size buses. Should these buses besold now or kept in reserve?

4. From your answer to requirement (3), you know the best option for the board to choose regardingthe full-size buses if the minibuses are purchased. Now you can ignore the other option. Preparea net-present-value analysis of the school board's two main alternatives: (a) continue to use thefull-size buses on regular routes or (b) purchase the minibuses. Should the minibuses be purchased?

5. Compute the internal rate of return on the proposed minibus acquisition.

6. What information given in this case was irrelevant to the school board's decision problem? Explainwhy the information was irrelevant.

7. Independent of requirements (1) through (6), suppose the NPV analysis favors keeping the full-sizebuses. Michael Jeffries, the business manager for the Central Catskill School District, was preparedto recommend that the board not purchase the minibuses. Before doing so, however, Jeffries raninto a long-time friend at the racquet club. Peter Reynolds was the vice president for sales at a localautomobile dealership from which the minibuses would have been purchased. Jeffries broke the badnews about his impending recommendation about the minibuses to his friend. The two talked forsome time about the pros and cons of the minibus alternative. Finally, Reynolds said, "Michael, youand I go back a long time. I know you're not paid all that well at the school district. Our top financialperson is retiring next year. How would you like to come to work for the dealership?""That's pretty tempting, Peter. Let me think it over," was Jeffries' response."Sure, Michael, take all the time you want. In the meantime, how about rethinking that minibusdecision? It's no big deal to you, and I could sure use the business.""But Peter, I told you what the figures say about that," responded Jeffries."Come on, Michael. What are friends for?"Discuss the ethical issues in this situation. What should Michael Jeffries do?

Hint for Case 16-59

The school board's two main alternatives are as follows: (1) continue to use the five full-size buses on regular routes or (2) purchase eight minibuses to cover the regular bus routes. Under alternative (2), the board has two options. The full-size buses could be (a) sold now or (b) kept in reserve.

Thus, the board's decision problem can be diagrammed as follows:

Main Alternatives Secondary Options
(1) Full-size buses on regular routes
(a) Sell full-size buses

(2) Minibuses on regular routes

(b) Keep full-size buses in reserve

Instruction: APA format is not required, but solid academic writing is expected. Submit in a Word document with each item numbered. Excel spreadsheets with relevant calculations should be embedded within the document.
Rubrics :

Content

Introduction to the case
The background on the case is presented, and the explanation demonstrates a superior understanding of the case materials.

Choice of analyses

A strong understanding of the decision to be made is demonstrated. A logical approach to the decision is presented and supported through the use of outside references. A valid conclusion is made and well-supported by computations that are presented in an accepted format.

Presentation of Data

Data presented to support the decision is accurate, persuasive and presents more information than required by the assignment.

Conclusions drawn are valid, clearly stated and supported, and demonstrate the high-level analysis of the issues.