Flyers plc operates public transport services in major cities in the United Kingdom
(UK). The company uses the accounting
methods to support investment decision making. You are a Senior Finance
Manager at Flyers plc.
The company intends to bid for new five-year contracts to operate bus services in
either Edinburgh, UK, or Newcastle upon Tyne, UK. Both contracts require
the successful bidder to pay a franchise fee to secure the contract and to invest in
a new fleet of buses. Sufficient funding is available to finance only one of these
options.
Edinburgh Newcastle
£000 £000
Franchise fee (year 0) 8,700 7,950
New buses (year 0) 4,120 3,890
Scrap value (year 5) 110 95
Year 1 3,780 3,500
Year 2 4,150 3,850
Year 3 4,550 4,200
Year 4 5,120 5,150
Year 5 4,900 4,950
Assume that all cash flows occur at the end of the respective year.
The company’s approach to investment appraisal was discussed at a recent
meeting of Flyers plc’s senior executive team. Changying Simmonds, Director of
Marketing at Flyers plc, is keen to understand the nature of investment
decisions. Changying has commented:
These decisions appear to have particular characteristics. We need to
understand why investment decisions are of importance to the business:
this will help us to appreciate if our approach to investment appraisal is
appropriate.
Travis van Riemsdyk, Chief Operating Officer at Flyers plc, has highlighted that the
has commented:
Like other investment appraisal methods, the IRR has both advantages and
disadvantages. I would like to know more about the strengths and
weaknesses of the IRR.
Required:
a. Calculate the payback for both the Edinburgh and Newcastle
upon Tyne contracts.
b. Critically evaluate the payback technique.
c. Advise Flyers plc’s senior executive team on the comments
made by Changying Simmonds and Travis van Riemsdyk. Your
advice should include an explanation of the characteristics of
investment appraisal decisions and the advantages and
disadvantages of the IRR. !!!!
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