ECO Vietnam is planning to improve the transportation to Gia Bic Village by providing more ecofriendly option. The current fuel powered bus has been used for the past 4 years and was originally planned to be used for 10 years. It costed $1,000,000 to acquire, and was being depreciated straightline over 8 year period. However, it was found that the fuel powered bus began to emit black CO2 gases, and would violate their mission and vision as an ecotourism provider. The company would therefore like to investigate two mutually exclusive projects in order to replace the fuel powered bus. One option is an electric bus and another option is a hybrid electric bus. Both should be able to fit around 40 ecotourists. They have already conducted and paid $20,000 for an assessment of the potential of using electric and hybrid electric buses in ecotourism operations. The board of directors usually would like to gain back the investment amount within 5 years. The current fuel powered bus can be sold to another tourism operator at a salvage value of $170,000 if a new bus is acquired. The current corporate tax rate is 20%.
A new electric bus for use in protect areas cost $6,500,000, while the charging station for the bus costs $5,000 including installation. The firm’s financing costs are $32,000 per year. Administrative and legal fees associated with the capital acquisition are expected to be $9,000 and $4,000, respectively. The economic life of the investment is 7 years and will depreciate straight-line to a zero value over 10 years. Management team expects the electric bus can be sold after 7 years at a price of $2,000,000. ECO Vietnam expects the electronic bus will reduce fuel expenses by $980,000 annually, with additional revenues of $75,000 per year. Hopefully, with the word-of-mouth, more ecotourist will be attracted to visit this village, and should bring in 11% growth in revenues per year. Electricity fees initially are $80,000 and are expected to grow at 3% each year. To support the use of environmentally friendly transportation, the government will subsidize $50,000 annually for the first 5 years to companies not using fuel-powered buses.
The other option, a second hand hybrid electric bus costs $2,800,000, including maintenance fees. Administrative and legal fees associated with this acquisition are expected to be $5,000 and $8,000, respectively. The economic life of the investment is 5 years and will depreciate on a five-year MACRS to a salvage value of $0. Management team expects the hybrid electric bus can be salvaged at the end of it’s economic life at price of $280,000. ECO Vietnam believes fuel expenses will be reduced by $670,000 annually, with a 3% decrease in savings per year as the battery becomes less efficient.
Additional revenues will be the same as the electric bus of $75,000 per year, with a 11% growth in revenues per year. Electricity fees start at $15,000 and are expected to grow at 3% each year. For this kind of hybrid bus, additional spare parts of $5,000 will need to be prepared immediately, and accounts payable will increase about $3,000 annually once the bus is in use. Year 5-year MACRS 1 20.00% 2 32.00% 3 19.20% 4 11.52% 5 11.52% 6 5.76%
Currently ECO Vietnam has 20,000 zero coupon bonds with 10 year maturity, selling for 40% of the par value, 1,500,000 share of common stock, selling for $18 per share, with a beta of 1.3. Market risk premium is 6.50%, and the risk-free rate is 1.25%. The bus project is a little bit less risky than the company’s usual projects, so ECO Vietnam determined to apply an adjusted factor of -3% to the cost of capital. Given the above information about the projects and the cost of capital for ECO Vietnam, do all the calculations that are necessary in order to make a value creating decision. The general format is up to you, as long as all the components for making such decision are present. You should focus on using the right methods, rather than on getting the right answer.
Explain your recommendation to the board of directors