The Managing Director, Roads Infrastructure, has to decide whether to continue operating the in-house gravel road maintenance services or close it down and contract in an external service provider. Determine the best option for the next five years, accepting that the roads to be serviced will remain functional and grading and maintenance are done per annum. Road Infrastructure will receive R2Om in revenue in the first year of operations, and this amount will increase by 8% per year. Use a discount rate of 10, and a taxX rate of 27%
Option 1: In-house service: This option requires covering maintenance costs of the facilities and the budget in year one for this item is R1 500 000, an amount which will escalate by 5% per annum until the end of the five-year period. It however also requires immediate acquisition of urgently required new equipment at a cost of R15 750 000, with training cost of R250 000, and installation cost of R1 250 000. The book value of the equipment will be R200 000 at the end of the five-year period. Staff support services will amount to R410 000 in year one and will escalate by 7% per annum. Staff salaries will amount to R5 900 000 in year one and will escalate by 8% per annum. Materials required during the first year amounts to R6 050 000 payable at the end of the year. These prices are expected to increase by 10% per annum. Inventory of R200 000 will be required at the start of the project. Determine both NPV and the IRR