3. (a) The city of Urbano is renewing part of its bus fleet. It has the...

 

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3. (a) The city of Urbano is renewing part of its bus fleet. It has the choice of buying single deck buses, articulated buses or double deck buses. They all use the same drive technology as existing buses. There are lots of factors in deciding which type to go for, but one criterion will be which fleet promises the highest net present value. At peak times the new Urbano buses will have to move 50,000 people per hour. The respective capacities of the different types of bus are: . . One single deck bus can carry 400 people per hour (left, below). One articulated bus can carry 600 people per hour (centre, below). One double deck bus can carry 500 people per hour (right, below). The city already has a large fleet of single deck buses. The city has no experience of operating articulated or double deck buses. The following table sets out the relevant parameters for each type. Bus type Purchase price per bus Operating cost per bus per year in year 1 Single deck Articulated Double deck £260,000 £65,000 £150,000 £50,000 £200,000 £55,000 The buses will be acquired in year 0 and sold at the end of year 8. According the project estimates, their resale value at that point will be 25% of their initial purchase price. The total revenue from passengers will be £13 million per year in years 1 to 4 and £14 million per year in years 5 to 8. Operating costs per bus will rise by 3% per year after year 1. • The required rate of return is 5%. • Inflation is assumed at 2% per year over the period. The project risk factor is 5%. Using this data calculate which type of bus would promise the highest net present value. You may use either the standard NPV formula or the simple formula, but be clear about which you are using. [17 marks] (b) Why would it be unwise to rely entirely on a net present value analysis to decide which type of bus to buy? What other factors do you think would be important in making the decision? [8 marks] (c) Give an example of a situation where you might opt for a project with a negative NPV? [8 marks] 3. (a) The city of Urbano is renewing part of its bus fleet. It has the choice of buying single deck buses, articulated buses or double deck buses. They all use the same drive technology as existing buses. There are lots of factors in deciding which type to go for, but one criterion will be which fleet promises the highest net present value. At peak times the new Urbano buses will have to move 50,000 people per hour. The respective capacities of the different types of bus are: . . One single deck bus can carry 400 people per hour (left, below). One articulated bus can carry 600 people per hour (centre, below). One double deck bus can carry 500 people per hour (right, below). The city already has a large fleet of single deck buses. The city has no experience of operating articulated or double deck buses. The following table sets out the relevant parameters for each type. Bus type Purchase price per bus Operating cost per bus per year in year 1 Single deck Articulated Double deck £260,000 £65,000 £150,000 £50,000 £200,000 £55,000 The buses will be acquired in year 0 and sold at the end of year 8. According the project estimates, their resale value at that point will be 25% of their initial purchase price. The total revenue from passengers will be £13 million per year in years 1 to 4 and £14 million per year in years 5 to 8. Operating costs per bus will rise by 3% per year after year 1. • The required rate of return is 5%. • Inflation is assumed at 2% per year over the period. The project risk factor is 5%. Using this data calculate which type of bus would promise the highest net present value. You may use either the standard NPV formula or the simple formula, but be clear about which you are using. [17 marks] (b) Why would it be unwise to rely entirely on a net present value analysis to decide which type of bus to buy? What other factors do you think would be important in making the decision? [8 marks] (c) Give an example of a situation where you might opt for a project with a negative NPV? [8 marks]

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