The board of education for the Central Catskill 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 $18,000 per year for each driver. In addition to the drivers’ compensation, the annual costs of operating and maintaining a full-size bus amount to $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 a full-size bus driver. The school district controller has estimated that it will cost the district $15,250, initially, to redesign its bus routes, inform the public, install caution signs in certain hazardous locations, and retrain its drivers.
A minibus costs $27,000, whereas a full-size bus costs $90,000. 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 $15,000 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 $30,000. The school district controller has estimated that this cost could be cut to $5,000 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.
Central Catskill School District uses a hurdle rate of 12 percent on all capital projects.
Required:
- 1. Think about the decision problem faced by the board of education. What are the board’s two main alternatives?
- 2. One of these main alternatives has two options embedded within it. What are those two options?
- 3. Before proceeding, check the hint given at the end of the chapter, which explains and diagrams the school board’s alternatives. Suppose the board of education chooses to buy the minibuses. Prepare a net-present-value analysis of the two options for the five full-size buses. Should these buses be sold now or kept in reserve?
- 4. From your answer to requirement (3), you know the best option for the board to choose regarding the full-size buses if the minibuses are purchased. Now you can ignore the other option. Prepare a net-present-value analysis of the school board’s two main alternatives: (a) continue to use the full-size buses on regular routes or (b) purchase the minibuses. Should the minibuses be purchased?
- 5. Compute the
internal rate of return on the proposed minibus acquisition. - 6. What information given in this case was irrelevant to the school board’s decision problem? Explain why the information was irrelevant.
- 7. Independent of requirements (1) through (6), suppose the
NPV analysis favors keeping the full-size buses. Michael Jeffries, the business manager for the Central Catskill School District, was prepared to recommend that the board not purchase the minibuses. Before doing so, however, Jeffries ran into a long-time friend at the racquet club. Peter Reynolds was the vice president for sales at a local automobile dealership from which the minibuses would have been purchased. Jeffries broke the bad news about his impending recommendation about the minibuses to his friend. The two talked for some time about the pros and cons of the minibus alternative. Finally, Reynolds said, “Michael, you and I go back a long time. I know you’re not paid all that well at the school district. Our top financial person is retiring next year. How would you like to come to work for the dealership?”
“That’s pretty tempting, Peter. Let me think it over,” was Jeffries’ response.
“Sure, Michael, take all the time you want. In the meantime, how about rethinking that minibus decision? It’s no big deal to you, and I could sure use the business.”
“But Peter, I told you what the figures say about that,” responded Jeffries.
“Come on, Michael. What are friends for?”
Discuss the ethical issues in this situation. What should Michael Jeffries do?
1.
Identify the two main alternatives for the board of education.
Explanation of Solution
The two main alternatives for the board of education are as follows:
(i) Usage of full-size buses on regular routes
(ii) Usage of minibuses on regular routes
2.
Identify the two options that is embedded within one of the two main alternatives.
Explanation of Solution
There are two options available for the full size buses, if the board of education decided to use minibuses, which are as follows:
- (i) Sell full size-buses
- (ii) Keep full size-bus in reserve
3.
Prepare a net-present-value analysis for the two options for the full-size buses, and determine whether these buses should be kept in reserve or sold now.
Explanation of Solution
Net present value method (NVP): Net present value method is the method which is used to compare the initial cash outflow of investment with the present value of its cash inflows. In the net present value, the interest rate is desired by the business based on the net income from the investment, and it is also called as the discounted cash flow method.
(a) Sell 5 full-size buses:
5 buses could be sold for $15,000 each. So, the sales proceeds will be
Note: No discounting is required for determining the net present value in this case, because the buses are sold now (time 0).
(b) Keep buses in reserve:
Particulars | Amount |
Annual savings on bus charter fees | $25,000 |
Annuity discount factor | |
Present value of savings | $90,125 |
Table (1)
Note: Annuity discount factor are taken from Table IV of Appendix A, where r = 0.12 and n=5.
Decision:
The present value of savings earned from keeping buses in reserve is $90,125.
The present value of savings earned from sale of buses is $75,000.
Based on the present value of savings, the board has to keep the full-size buses in reserve, as its net present value is greater than sale option.
4.
Prepare a net-present-value analysis of the school board’s two main alternatives, and determine whether the minibuses should be purchased.
Explanation of Solution
Prepare a net-present-value analysis of minibus purchase decision.
Particulars | Amount |
Incremental annual cost of compensation for bus drivers if minibuses are used | ($54,000) |
Incremental annual maintenance and operating costs if minibuses are used | $90,000 |
Incremental annual cash flow (favors minibuses) | $36,000 |
Annuity discount factor | |
Present value of incremental annual cash flows | $129,780 |
Cost of redesigning bus routes, retraining drivers, etc. (time 0) | ($15,250) |
Acquisition cost of minibuses | ($216,000) |
Present value of savings on bus charter fees, if minibuses are purchased | $90,125 |
Net present value | ($11,345) |
Table (2)
Note: Annuity discount factor is taken from Table IV of Appendix A, where r = 0.12 and n=5.
In the above incremental cost analysis, parentheses indicate cash flows favoring the full-size bus alternatives. Thus, the minibuses should not be purchased.
5.
Determine the internal rate of return on the proposed minibus acquisition.
Explanation of Solution
Step 1: Calculate the annual cost savings if the minibuses are used.
Particulars | Amount |
Annual savings on bus charter fees | $25,000 |
Annual incremental maintenance and operating costs | $90,000 |
Annual incremental cost of compensation for bus drivers | ($54,000) |
Total annual cost savings if minibuses are used | $61,000 |
Table (3)
Step 2: Calculate the initial cost if the minibuses are purchased.
Particulars | Amount |
Cost of redesigning bus routes, retraining drivers, etc. | ($15,250) |
Acquisition cost of minibuses | ($216,000) |
Initial cost | $231,250 |
Table (4)
Step 3: Calculate the internal rate of return.
3.791 factor lies in the 10% column of the 5-year row of Table IV in Appendix A, thus the IRR on the minibus alternative is 10%.
6.
Identify the information in this case, which is not relevant to the board’s decision problem, and explain the reason for the information was not relevant.
Explanation of Solution
The cost of purchasing a full-size bus ($90,000) is immaterial, since the board is not expecting the purchase of any full-size buses. The depreciation method (straight-line) is also irrelevant, because the depreciation expense is not a cash flow. The NPV and IRR methods focus on cash flows.
7.
Discuss the ethical issue and suggest the preferable action for Person MJ.
Explanation of Solution
Person PR is the vice president of the automobile dealership for sales, where his action is inappropriate. Person PR is not supposed to pressure his friend to recommend that the minibuses be purchased. He should search for a most qualified individual for appointing in the financial job at the dealership, but he offered that job to his friend for doing some favor for him.
Ethical standards demand that Person MJ decline to alter his recommendation to the school board. The NPV analysis indicates that the full-size bus option is preferable, and he should recommend accordingly.
Want to see more full solutions like this?
Chapter 16 Solutions
Managerial Accounting: Creating Value in a Dynamic Business Environment
Additional Business Textbook Solutions
Horngren's Financial & Managerial Accounting, The Financial Chapters (Book & Access Card)
Intermediate Accounting (2nd Edition)
Fundamentals of Cost Accounting
Cost Accounting (15th Edition)
Advanced Financial Accounting
Principles of Accounting Volume 1
- The Lake Placid Town Council decided to build a new community center to be used for conventions, concerts, and other public events, but considerable controversy surrounds the appropriate size. Many influential citizens want a large center that would be a showcase for the area. But the mayor feels that if demand does not support such a center, the community will lose a large amount of money. To provide structure for the decision process, the council narrowed the building alternatives to three sizes: small, medium, and large. Everybody agreed that the critical factor in choosing the best size is the number of people who will want to use the new facility. A regional planning consultant provided demand estimates under three scenarios: worst case, base case, and best case. The worst-case scenario corresponds to a situation in which tourism drops substantially; the base-case scenario corresponds to a situation in which Lake Placid continues to attract visitors at current levels; and the…arrow_forwardA Town Council has decided to build a new community center to be used for conventions, concerts, and other public events, but considerable controversy surrounds the appropriate size. Many influential citizens want a large center that would be a showcase for the area, but the mayor feels that if demand does not support such a center, the community will lose a large amount of money. To provide structure for the decision process, the council narrowed the building alternatives to three sizes: small, medium, and large. Everybody agreed that the critical factor in choosing the best size is the number of people who will want to use the new facility. A regional planning consultant provided demand estimates under three scenarios: worst case, base case, and best case. The worst-case scenario corresponds to a situation in which tourism drops significantly; the base-case scenario corresponds to a situation in which the town continues to attract visitors at current levels; and the best-case…arrow_forwardCity Bus Corporation provides school bus transportation to public schools in Lancaster County. City Bus owns 50 buses that are garaged in three different cities within the county. The firm faces competition from two larger bus companies that operate in the same area. Public school boards gener- ally award contracts to the lowest bidder, but the level of service and overall performance are also considered. b. Identify the major loss exposures faced by City Bus. c. For each of the loss exposures identified in (b), identify a risk management technique or combina- tion of techniques that could be used to handle the exposure. d. Describe several sources of funds for paying losses if retention is used in the risk management a. Briefly describe the steps in the risk management process that should be followed by the risk manager of City Bus. program. e. Identify other departments in City Bus that would also be involved in the risk management program.arrow_forward
- [The following information applies to the questions displayed below.] Washington County's Board of Representatives is considering the construction of a longer runway at the county airport. Currently, the airport can handle only private aircraft and small commuter jets. A new, long runway would enable the airport to handle the midsize jets used on many domestic flights. Data pertinent to the board's decision appear below. Cost of acquiring additional land for runway Cost of runway construction Cost of extending perimeter fence Cost of runway lights Annual cost of maintaining new runway Annual incremental revenue from landing fees In addition to the preceding data, two other facts are relevant to the decision. First, a longer runway will require a new snowplow, which will cost $105,000. The old snowplow could be sold now for $10,500. The new, larger plow will cost $6,000 more in annual operating costs. Second, the County Board of Representatives believes that the proposed long runway,…arrow_forwardA municipality plans to build a new roadway that will decrease the amount of time it takes commuters to get from the South end of the city to the North end. The cost to construct the roadway is $13,900,000 It is estimated that the increased efficiency for commuters has a value of $2.11 per car, per day as a result of the decreased operating costs and less time commuting. The new roadway will be adjacent to a large forest. As a result, there is an expectation that there will be an increase of 12 chipmunk-car collisions each year at an estimated cost of $19,528 per collision. The new roadway will have maintenance requirements that will cost $260,800 per year. The life of the new roadway is 45 years and the discount rate is 5.00% What is the minimum average number of cars per day that must use the new roadway in order for the project to be worthwhile?arrow_forwardJack and Jill’s Place is a nonprofit nursery school run by the parents of the enrolled children. Since the school is out of town, it has a well rather than a city water supply. Lately, the well has become unreliable, and the school has had to bring in bottled drinking water. The school’s governing board is considering drilling a new well (at the top of the hill, naturally). The board estimates that a new well would cost $7,374 and save the school $1,200 annually for 10 years. The school’s hurdle rate is 8 percent.Required:Compute the internal rate of return on the new well. Should the governing board approve the new well Questions? Internal Rate of Return: __________ Approve? Yes or Noarrow_forward
- Jack and Jill's Place is a nonprofit nursery school run by the parents of the enrolled children. Since the school is out of town, it has a well rather than a city water supply. Lately, the well has become unreliable, and the school has had to bring in bottled drinking water. The school's governing board is considering drilling a new well (at the top of the hill, naturally). The board estimates that a new well would cost $7,374 and save the school $1,200 annually for 10 years. The school's hurdle rate is 8 percent. Use Appendix A for your reference. (Use appropriate factor(s) from the tables provided.) Required: Compute the internal rate of return on the new well. Should the governing board approve the new well? Internal rate of return Approve? Yes %arrow_forwardJack and Jill's Place is a nonprofit nursery school run by the parents of the enrolled children. Since the school is out of town, it has a well rather than a city water supply. Lately, the well has become unreliable, and the school has had to bring in bottled drinking water. The school's governing board is considering drilling a new well (at the top of the hill, naturally). The board estimates that a new well would cost $3,325 and save the school $700 annually for 10 years. The school's hurdle rate is 8 percent. Use Appendix A for your reference. (Use appropriate factor(s) from the tables provided.) Required: Compute the new well's net present value. Should the governing board approve the new well? (Round your final answer to the nearest dollar amount.) Net present value Approve? Yesarrow_forwardA large land-grant university that is currently facing severe parking problems on its campus is considering constructing parking decks off campus. A shuttle service could pick up students at the off campus parking deck and transport them to various locations on campus. The university would charge a small fee for each shuttle ride, and the students could be quickly and economically transported to their classes. The funds raised by the shuttle would be used to pay for trolleys, which cost about $170,000 each. Each trolley has a 12-year service life, with an estimated salvage value of $12,000. To operate each trolley, additional expenses will be incurred, as given in the table below. If students pay 10 cents for each ride, determine the annual ridership per trolley (number of shuttle rides per year) required to justify the shuttle project, assuming an interest rate of 6%. Click the icon to view the additional expenses. Click the icon to view the interest factors for discrete compounding…arrow_forward
- Use the following information to answer Problems 45-47 (Algo) [The following information applies to the questions displayed below.] Washington County's Board of Representatives is considering the construction of a longer runway at the county airport. Currently, the airport can handle only private aircraft and small commuter jets. A new, long runway would enable the airport to handle the midsize jets used on many domestic flights. Data pertinent to the board's decision appear below. Cost of acquiring additional land for runway Cost of runway construction Cost of extending perimeter fence Cost of runway lights Annual cost of maintaining new runway Annual incremental revenue from landing fees $78,500 236,770 32,475 43,850 31,400 44,760 In addition to the preceding data, two other facts are relevant to the decision. First, a longer runway will require a new snowplow, which will cost $117,000. The old snowplow could be sold now for $10,850. The new, larger plow will cost $13,700 more in…arrow_forwardThe Anacome County Health Department is considering using 300 square feet of excess office space to provide a clinic for Healthchek visits. These visits are reimbursed $75 under a Medicaid program. Variable costs per visit are $45, and providing the service requires an additional physician assistant and nurse with prorated salaries of $85,000 and $65,000 respectively. The state has mandated efforts to increase the utilization of of Medicaid eligibility, so the Department of Social Services is conducting interventions to increase eligibility awareness in the community. As a result, the health department expects 12,000 Healthchek visits in the coming year. Nonavoidable overhead costs for the health department are $300,000 per year and will be allocated to each program based on its proportional share of the health department's total office space of 2,700 square feet. What are the total contribution margin and total product margin for a Healthchek visit? Considering the total…arrow_forwardFusion Metals Company is considering the elimination of its Packaging Department. Management has received an offer from an outside firm to supply all Fusion’s packaging needs. To help her in making the decision, Fusion’s president has asked the controller for an analysis of the cost of running Fusion’s Packaging Department. Included in that analysis is $9,100 of rent, which represents the Packaging Department’s allocation of the rent on Fusion’s factory building. If the Packaging Department is eliminated,the space it used will be converted to storage space. Currently Fusion rents storage space in a nearby warehouse for $11,000 per year. The warehouse rental would no longer be necessary if the Packaging Department were eliminated. Required:1. Discuss each of the figures given in the exercise with regard to its relevance in the departmentclosing decision.2. What type of cost is the $11,000 warehouse rental, from the viewpoint of the costs of the Packaging Department?arrow_forward