Assignment CASE STudy 16-57 blue ridge school district

jakarta OCTOBER 7, 2011

Background INFO
Organization Name Blue Ridge School District

Case 16-57
BlueRidge School District

Major Services

Student transportation

Board of education is considering the acquisition of several minibuses for student transportation to school.

Key topics

Existing full sized bus (5 buses in total) is under utilized. It is considered not feasible to consolidate bus routes since the student living area is too large and bus ride to school would exceed the limit of 45 minutes.

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PROBLEM identification
Blue Ridge School District

Case 16-57
BlueRidge School District

The plan is to replace 5 full-sized buses with 8 minibuses; each minibus would cover much shorter route. Bus drivers are part-time employee with $18,000 annual compensation for each. This value is the same if minibus is acquired. Annual cost of operation and maintenance for a full-sized bus is $50,000. Annual cost of operation and maintenance for a mini bus is $20,000. Initial setup if minibus is acquired is $15,250. Acquisition cost: Full-sized bus: $90,000 each; Minibus: $27,000 each if existing buses are sold, the price would be $15,000 each.

Currently Bus charter cost (for field-trips, out-of town event): $30,000 per year if existing bus are kept, the cost for field trips or out-of-town event can be reduced to $5,000 per year
Hurdle rate: 12%

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TASK
Required
1. Determine the 2 main alternatives for problem decision

Case 16-57
BlueRidge School District

2. Determine the 2 sub-options embedded in one of the main alternatives 3. Supposedly the school board decides to buy the minibuses, prepare NPV (Net Present Value) analysis for each of the 2 sub-options in question no.2 above 4. Prepare NPV analysis for the 2 main alternatives, should the minibuses be purchased? 5. Compute the IRR (Internal Rate of Return) on the proposed minibus acquisition 6. Identify which information is irrelevant to the problem decision 7. Michael Jeffries, business manager of Blue Ridge School was approached by his old-friend, Peter Reynold, who was the vice president of local automobile dealership. Reynolds offered a job in the dealership to Jeffries and asked him to recommend the acquisition of the minibuses. What should Michael Jeffries do?
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ANALYSIS
No. 1 and 2, Decision Tree
1. Keep using Fullsize Bus

Case 16-57
BlueRidge School District

2a. Sell the 5 Fullsize Bus

2. Purchase new Minibus

2b. Keep the 5 Fullsize Bus

Above figure shows the decision tree that needs to calculate both using NPV or IRR methods for each 2 options.

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ANALYSIS
3. NPV Analysis for the 2 sub-options
2a. Sell the 5 Fullsize Buses Bus Selling price Bus charter cost per year Total cash flow x Discount factor Present Value NPV $ Y0 75,000.00 75,000.00 1.00 75,000.00 Y1 Total Cost Approach Y2 (30,000.00) (30,000.00) 0.80 (23,915.82) (33,143.29) Y3 (30,000.00) (30,000.00) 0.71 (21,353.41) Y4 (30,000.00) (30,000.00) 0.64 (19,065.54)

Case 16-57
BlueRidge School District

Y5 (30,000.00) (30,000.00) 0.57 (17,022.81)

Total

(30,000.00) (30,000.00) 0.89 (26,785.71)

2b. Keep the 5 Fullsize Buses Field trip cost per year Total cash flow x Discount factor Present Value NPV

Y0 1.00 $

Y1 (5,000.00) (5,000.00) 0.89 (4,464.29)

Y2 (5,000.00) (5,000.00) 0.80 (3,985.97) (18,023.88)

Y3 (5,000.00) (5,000.00) 0.71 (3,558.90)

Y4 (5,000.00) (5,000.00) 0.64 (3,177.59)

Y5 (5,000.00) (5,000.00) 0.57 (2,837.13)

Total

Based on the above calculation we can conclude that keeping the 5 Fullsize Bus will be more favorable due to lower NPV costs $(18,023.88) compared with Selling the 5 Full-size Bus.

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ANALYSIS
4. NPV Analysis for the 2 main alternatives
Y0 1. Keep Using Fullsize Bus Driver Annual compensation costs Annual Operation and maintainance costs Total Cash Flow x Discount factor Present Value NPV 1.00 Y1 (90,000) (250,000) (340,000.00) 0.89 (303,571.43) $ Y2 (90,000) (250,000) (340,000.00) 0.80 (271,045.92) (1,225,623.91) Y3 (90,000) (250,000) (340,000.00) 0.71 (242,005.28) Y4 (90,000) (250,000) (340,000.00) 0.64 (216,076.15)

Case 16-57
BlueRidge School District

Y5 (90,000) (250,000) (340,000.00) 0.57 (192,925.13)

NPV @12%

Y0 2. Purchase new Minibus Acquisition of minibuses Driver Annual compensation costs Annual Operation and maintainance costs Initial setup if minibus acquired Selling the 5 Fullsize Buses Total Cash Flow x Discount factor Present Value NPV Difference in NPV Favors Keep using Fullsize Bus $ (216,000) (15,250) 75,000 (156,250) 1.00 (156,250)

Y1 (144,000) (160,000) (304,000.00) 0.89 (271,428.57) $ $

Y2 (144,000) (160,000) (304,000.00) 0.80 (242,346.94) (1,252,101.97) 26,478.06

Y3 (144,000) (160,000) (304,000.00) 0.71 (216,381.20)

Y4 (144,000) (160,000) (304,000.00) 0.64 (193,197.50)

Y5 (144,000) (160,000) (304,000.00) 0.57 (172,497.76)

NPV @12%

$ $

Based on the above calculation we can conclude that keep using Full-size bus is more favorable due to lower NPV costs $ (1,225,623.91) compared with purchasing new Minibus
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ANALYSIS
5. Calculate the IRR
Incremental Cost of Purchase New Minibus over Keep Using Fullsize Bus Y0 Y1 Y2 2. Purchase new Minibus Acquisition of minibuses Driver Annual compensation costs Annual Operation and maintainance costs Initial setup if minibus acquired Selling the 5 Fullsize Buses Total Cash Flow x Discount factor Present Value NPV $ (216,000.00) (15,250) 75,000 (156,250.00) 1.00 (156,250.00) (54,000.00) 90,000.00 36,000.00 0.89 32,142.86 $ (54,000.00) 90,000.00 36,000.00 0.80 28,698.98 (26,478.06) Y3 (54,000.00) 90,000.00 36,000.00 0.71 25,624.09

Case 16-57
BlueRidge School District

Y4 (54,000.00) 90,000.00 36,000.00 0.64 22,878.65

Y5 (54,000.00) 90,000.00 36,000.00 0.57 20,427.37

$ $

To compute the Internal Rate of Return (IRR), we will need to modify the Total-Cost Approach into Incremental-Cost Approach, which will only include the difference of cost between two options, as shown in above calculation
Y0 (156,250.00) Y1 36,000.00 Y2 36,000.00 Y3 36,000.00 Y4 36,000.00 Y5 36,000.00

Incremental Cost & Revenue

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ANALYSIS
5. cont..

Case 16-57
BlueRidge School District

Since the annual cash inflow is constant, we can calculate IRR using formula:
Annuity Discount Factor = Initial Cash Outflow / Annual Cash Inflow = $ (156,250.00) / (36,000.00) = 4.34 And the IRR value is obtained using PV Table below, so we will get 4.91%, since the resulting IRR is less than the schools hurdle rate (12%), then the board should not proceed with acquisition of minibuses.

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ANALYSIS
6. Which one is irrelevant for decision making

Case 16-57
BlueRidge School District

The irrelevant information in this case is: Acquisition price of full-sized bus & Method of Depreciation since the decision is more related to cash problem.

7. Ethical Action or Not?

Assuming that the NPV analysis favors keeping the Full-size buses, Ethically, Michael Jeffries should not change the school boards recommendation because of his long-time friend Reynolds request. If Jeffries changed his recommendation, he would be acting in the best interest of himself, and not of the school.

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Conclusion
Conclusion

Case 16-57
BlueRidge School District

From the case analysis above, we can conclude that in determining the decision to investment proposal, both the Net Present Value (NPV) method and Internal Rate of Return (IRR) method are based on important assumptions. The NPV method is somewhat easier to apply; it also has the advantage of allowing the decision maker to adjust the discount rate upward for highly uncertain cash flows

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Thank You