The Managing Director, Roads Infrastructure, has to decide whether to continue operating the in-house gravel road maintenance services or close it down and contract in an external service provider. Determine the best option for the next five years, accepting that the roads to be serviced will remain functional and grading and maintenance are done per annum. Road Infrastructure will receive R20m in revenue in the first year of operations, and this amount will increase by 8% per year. Use a discount rate of 10%, and a tax rate of 27%. Option 1: In-house service: This option requires covering maintenance costs of the facilities and the budget in year one for this item is R1 500 000, an amount which will escalate by 5% per annum until the end of the five-year period. It however also requires immediate acquisition of urgently required new equipment at a cost of R15 750 000, with training cost of R250 000, and installation cost of R1 250 000. The book value of the equipment will be R200 000 at the end of the five-year period. Staff salaries and materials will amount to R11 095 000 in year one and will escalate by 8% per annum. Inventory of R200 000 will be required at the start of the project. Option 2: Service Provider Contract: This option requires entering into a contract whereby a service provider is paid a base amount of R860 000 per month (R10,32 million per annum) starting in year one. This amount escalates by 7% per annum. Provision is made for material in the contract at R6 050 000 in year one, with escalation of 10% per annum. Determine both the NPV and the IRR (Use layout provided at end of test paper)
The Managing Director, Roads Infrastructure, has to decide whether to continue operating the in-house gravel road maintenance services or close it down and contract in an external service provider. Determine the best option for the next five years, accepting that the roads to be serviced will remain functional and grading and maintenance are done per annum. Road Infrastructure will receive R20m in revenue in the first year of operations, and this amount will increase by 8% per year. Use a discount rate of 10%, and a tax rate of 27%. Option 1: In-house service: This option requires covering maintenance costs of the facilities and the budget in year one for this item is R1 500 000, an amount which will escalate by 5% per annum until the end of the five-year period. It however also requires immediate acquisition of urgently required new equipment at a cost of R15 750 000, with training cost of R250 000, and installation cost of R1 250 000. The book value of the equipment will be R200 000 at the end of the five-year period. Staff salaries and materials will amount to R11 095 000 in year one and will escalate by 8% per annum. Inventory of R200 000 will be required at the start of the project. Option 2: Service Provider Contract: This option requires entering into a contract whereby a service provider is paid a base amount of R860 000 per month (R10,32 million per annum) starting in year one. This amount escalates by 7% per annum. Provision is made for material in the contract at R6 050 000 in year one, with escalation of 10% per annum. Determine both the NPV and the IRR (Use layout provided at end of test paper)
Cornerstones of Cost Management (Cornerstones Series)
4th Edition
ISBN:9781305970663
Author:Don R. Hansen, Maryanne M. Mowen
Publisher:Don R. Hansen, Maryanne M. Mowen
Chapter19: Capital Investment
Section: Chapter Questions
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Transcribed Image Text:The Managing Director, Roads Infrastructure, has to decide whether to continue operating the in-house
gravel road maintenance services or close it down and contract in an external service provider.
Determine the best option for the next five years, accepting that the roads to be serviced will remain
functional and grading and maintenance are done per annum. Road Infrastructure will receive R20m in
revenue in the first year of operations, and this amount will increase by 8% per year. Use a discount rate
of 10%, and a tax rate of 27%.
Option 1: In-house service: This option requires covering maintenance costs of the facilities and the
budget in year one for this item is R1 500 000, an amount which will escalate by 5% per annum until the
end of the five-year period. It however also requires immediate acquisition of urgently required new
equipment at a cost of R15 750 000, with training cost of R250 000, and installation cost of R1 250 000.
The book value of the equipment will be R200 000 at the end of the five-year period. Staff salaries and
materials will amount to R11 095 000 in year one and will escalate by 8% per annum. Inventory of R200
000 will be required at the start of the project.
Option 2: Service Provider Contract: This option requires entering into a contract whereby a service
provider is paid a base amount of R860 000 per month (R10,32 million per annum) starting in year one.
This amount escalates by 7% per annum. Provision is made for material in the contract at R6 050 000 in
year one, with escalation of 10% per annum.
Determine both the NPV and the IRR (Use layout provided at end of test paper)
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