- 20 Marks
PSAF – Nov 2023 – L2 – Q4 – Performance Measurement in the Public Sector
Calculate the NPV, IRR, and ROCE for FFTA’s investment in a second rail coach to meet increased passenger demand.
Question
Fakafiki Federal Transport Agency (FFTA) introduced a new rail coach, Luxury DV, to its range last year. The coach is used to transport passengers, addressing a serious bottleneck in the transportation process, with a maximum capacity to transport 5,000 passengers per annum.
The Luxury DV product has been a huge success, and consequently, all passengers showing interest were accommodated. Based on feedback from high-net-worth customers, the marketing department has prepared the following demand forecast for future years:
| Year | 1 | 2 | 3 | 4 |
|---|---|---|---|---|
| Demand (Number of passengers) | 7,000 | 9,000 | 11,000 | 4,000 |
The Directors of FFTA are now considering investing in a second coach that will allow the company to satisfy the increasing demand. The following information relating to this investment proposal has now been prepared:
- Initial investment: N350,000
- Maximum additional passengers: 5,000 passengers
- Current fare: N450 per passenger
- Variable cost of operation: N200 per passenger
- Fixed operating costs: N175,000
If tickets issued remain at 5,000, the current fare would continue for the remainder of the coach’s life. However, if passenger traffic is increased, the fare is expected to fall to N400 per passenger for all tickets sold. This fare adjustment will last for the remaining life of the coach.
No terminal value or coach scrap value is expected at the end of four years, when Luxury DV’s passenger service is planned to end. For investment appraisal purposes, FFTA uses a nominal discount rate of 10% per year and a target return on capital employed of 20% per year. Ignore taxation.
Required: Using an incremental approach, calculate the following values for the investment proposal of the second coach.
a. Net present value. (10 Marks)
b. Internal rate of return. (4 Marks)
c. Return on capital employed (accounting rate of return) based on initial investment. (6 Marks)
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