Cruisy Coaches Ltd - Bus Services in New Zealand

Financial year is 1 January to 31 December

Cruisy CoachesLtd (CC) is a New Zealand company providingbus services.CC’s financial year is 1 January to 31 December.Its Balance Sheet as at 31 December 2019is as follows:$000s$000sCurrent assets400Current liabilities400Non-current assets2,000Non-current liabilities800Equity:Preference capital (8%)300_____Ordinary capital900$2,400$2,400The issued capital comprises 30,000 Preference shares and 900,000 Ordinary shares. There are no Retained Earnings at 31 December 2019.CCneeds to raise funds for an upgrade of its busservices. The company wishes to maintain the currentproportions of long-term debt:equity. Funds can be raised as follows:•It can sell four-year,$1,000-face-value bonds with a7.5% annual coupon interest rate for $1,000. The cost of issuing these is $45per bond.•An unlimited number of 8% preference shares with a face-value of $10 can be sold for $10, but 80c per share will be retained by the brokers as their commission. The preference shares will be preferential as to both dividends and return of capital in the event of the company winding up.•CC’s ordinary shares currently sell for $2.25per share. New ordinary shares can be sold for $2.15per share, but it will cost 20c per share in flotation and commission costs. At the end of 2019 CCexpects to pay a dividend of 30c per share. Thereafter, future dividends are expected to grow by6% per annum.

2CC owns an existing bus which was purchased on 1 January 2018for $400,000. It is being depreciated at 20% per year using the prime cost/straight-linemethod.It could be sold on 1 January 2020for $265,000before tax. If not sold it could be used for another four years, then sold at the end of 2022to net $30,000before taxes.If used for another four years, the net profit before depreciation and before tax is expected as listed below:2020$300,0002021328,0002022330,0002023300,000A new bus can be purchased for $600,000to replace the existing bus. It would be depreciated over four years using the prime cost/straight-linemethod. If it is purchased, it can begin services for CC on 1 January 2020.It is estimated this new bus could be sold for $260,000at 31 December 2023.The following changes in current asset and current liability accounts are expected if the new bus is purchased.Cash-$2,500Prepayments+5,000Accounts payable+4,500Inthe first year of service of the new bus (2020) 30,000 passengers have been budgeted for with each passenger paying $30. Budgeted costs (excluding depreciation) for 2020are:Fixed operating costs320,000Drivers’ salaries110,000Variable operating costs50c per passengerThe following changes are expected over the four-year period:•Passenger numbers will increase by 5% in 2021, followed by a 3% increase in the following two years.•The fare per passenger will increase to $33, $35 and $38 in the years 2021, 2022and 2023respectively.•Drivers’ salaries are expected to increase by 3% per annum.•Variable costs are expected to increase by 2.5% in both 2021and 2022and by 4% in 2023.•Fixed costs (excluding depreciation) are expected to remain stable for the first twoyears, then increase to $340,000 for both of the last two years.In 2019CC spent $45,000 on market research costs to assess the feasibility of offering an upgraded service. These costs were written off in the 2019accounts. CChas arranged an overdraft limit of $250,000.The company undertakes projects with a payback period of less than twoyearsprovided the NPV is positive.3REQUIRED:PART AVIABILITY OF THE EXPANSION(56marks)1.Calculate the weighted average cost of capital.3.5marks2.Calculate a.the initial cost of the expansion,and b.the terminal cash flow.2.5marks3.a.Identify the sunk cost and advise how it should be treated.b.Calculate the break-even number of passengers for the new bus in 2020.3marks4.Assuming the expansion commences in 2020, prepare ONE statementfor the four-year period showing the annual budgeteda.Income Statement, and b.Discounted Cash Flow Statement,15marks5.Calculate the:a.payback periodb.NPVc.IRRd.profitability indexe.discounted payback period(Use your WACC calculated in Part 1 above where appropriate).6marks6.Because CCis in such a highly competitive industry with new travelofferingsentering the market all the time, one manager doesn’t think sufficient attention has been paid to risk. He provides you with the following certainty equivalents for the cash flows from the proposed expansion:YearCertainty equivalent20200.9020210.8020220.7520230.70