Reference no: EM132756972

Question: Case: Decision problem with alternatives; NPV; IRR; ethics: school

The board of management for the Charters Towers School is considering the acquisition of several minibuses to transport students to school. Five of the school bus routes are underpopulated, so the full-size buses on those routes are not fully utilised. After a careful study, the board has decided that it is not feasible to consolidate these routes into fewer routes served by full-size buses. The area in which the students live is too large for that approach, and the bus ride to school for some students would exceed 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 that covered by a full-size bus. The bus drivers are part-time employees whose salaries cost $18 000 per year for each driver. In addition to the driver's salary, the annual costs of operating and maintaining a full-size bus amount to $50 000. In contrast, the board projects that a minibus will cost only $20 000 annually to operate and maintain. A minibus driver earns the same wages as those earned by the driver of a full-size bus. The school accountant has estimated that it will cost the school a further $15 250, initially, to redesign its bus routes, pay for the installation of caution signs in certain hazardous locations, and retrain its drivers.

A minibus costs $54 000, whereas a full-size bus costs $180 000. The school uses straight-line depreciation for all its non-current assets. The board has two options regarding the five full-size buses. First, the buses could be sold now for $30 000 each. Second, the buses could be kept in reserve to use for field trips and sports events and to use as back-up vehicles when buses break down. Currently, the board charters buses from a private company for these purposes. The annual cost of chartering buses amounts to $60 000. The accountant has estimated that this cost could be cut to $10 000 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 new minibus is also projected to be five years.

Charters Towers School uses a required rate of return of 12 per cent to evaluate all capital expenditure projects. Ignore income taxes.

Suppose that the board of management chooses to buy the minibuses. Prepare net present value analysis of the two options for the five full-size buses. Should the buses be sold now or kept in reserve? Explain your decision.