Reference no: EM132600214

Question - The board of education for the Malayo School District is considering the acquisition of several minibuses 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 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, 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 school district are part-time employees whose compensation costs the school district P18,000 per year for each driver. In addition to the drivers' compensation, the annual costs of operating and maintaining a full-size bus amount to P50,000. In contrast, the board projects that a minibus will cost only P20,000 annually to operate and maintain. A minibus driver earns the same wages as a full-size bus driver. The school district controller has estimated that it will cost the district P15,250, initially, to redesign its bus routes, inform the public, install caution signs in certain hazardous locations, and retrain its drivers.

A minibus costs P27,000, whereas a full-size bus costs P90,000. The school district uses straight-line depreciation for all of its long-lived assets. The board has two options regarding the five full-size buses. First, the buses could be sold now for P15,000 each. Second, the buses could be kept in reserve to use for field trips and out-of-town athletic events and to use as backup 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 P30,000. The school district controller has estimated that this cost could be cut to P5,000 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 projected to be five years also.

Malayo School District uses a hurdle rate of 12 percent on all capital projects.

What is the internal rate of return on the proposed minibus acquisition?