The Government of Metropolis has offered your company, RoadRunner Inc., a contract to transport 50,000 tonnes of
The Government of Metropolis has offered your company, RoadRunner Inc., a contract to transport 50,000 tonnes of asphalt each year for the next five years, as part of a provincial infrastructure project focusing on the province's northern roads. The busy season lasts for four months, beginning after the spring thaw and wrapping up in the fall. As a small transport company owner, this contract is desirable for you but you don't currently have any extra equipment available.
To take the contract you would need to purchase 3 highway tractor units, 3 trailers, and 1 wheel loader. The loader and highway tractors could be purchased used, in good condition. However, it is difficult to find a good used asphalt trailer, so the trailers would be purchased new. All equipment has a CCA rate of 30%. In addition, you would have to invest $25,000 in initial working capital which you expect to recover at the end of the project.
Your administrative staff is capable of handling the new work without additional help. The contract specifies first right of refusal meaning you are essentially guaranteed the full tonnage every year for the life of the contract. At the end of the contract, you will sell all the equipment as a package for $120,000.
Individual costs for equipment are as follows:
Used highway tractor $75,000
New asphalt trailer $25,000
Used wheel loader $65,000
For accounting purposes, all equipment will be depreciated over the 5-year life on a straight line basis. You expect to sell all the equipment as a package to another contractor for $48,200 at the end of the 5 years.
Expected revenues and expenses in Season 1 are as follows:
Labour $31,680 for the season
Fuel $125,000 for the season
Maintenance $35,000 for the season
Fixed costs $40,000 for the season (Includes administration, permits, and licensing)
The contract specifies that revenue will increase by 2.25% annually, to offset inflation. This is an excellent inclusion, but something that concerns you is the effect of inflation on your cost estimates. You estimate that the cost of fuel will increase at 2.5% per year while labour, maintenance, and fixed costs will probably increase at 1.5% per year. You have a corporate tax rate of 25% and a discount rate of 15%. Given all the risks involved in construction, you have a threshold payback period of 3 years for any new project that you undertake.
Forecast the project's cashflows per year