Question

Lon Timur is an accounting major at a midwestern state university located approximately 60 miles from a major city. Many of the students attending the university are from the metropolitan area and visit their homes regularly on the weekends. Lon, an entrepreneur at heart, realizes that few good commuting alternatives are available for students doing weekend travel. He believes that a weekend commuting service could be organized and run profitably from several suburban and downtown shopping mall locations. Lon has gathered the following investment information.
1. Five used vans would cost a total of $75,900 to purchase and would have a 3-year useful life with negligible salvage value. Lon plans to use straight-line depreciation.
2. Ten drivers would have to be employed at a total payroll expense of $48,010.
3. Other annual out-of-pocket expenses associated with running the commuter service would include Gasoline $16,000, Maintenance $3,310, Repairs $4,000, Insurance $4,200, and Advertising $2,490.
4. Lon has visited several financial institutions to discuss funding. The best interest rate he has been able to negotiate is 15%. Use this rate for cost of capital.
5. Lon expects each van to make ten round trips weekly and carry an average of six students each trip. The service is expected to operate 30 weeks each year, and each student will be charged $11.95 for a round-trip ticket.

Determine the annual (1) net income and (2) net annual cash flows for the commuter service.

Answer 1

Answer:

1. $4,240

2. $29,540

Explanation:

The computation is shown below:

1. For net income

Revenue ($11.95 × 6 students × 10 rounds × 30 weeks × 5 vans) $107,550

Less expenses

Depreciation ($75,900 ÷ 3 years) ($25,300)

Payroll expense ($48,010)

Gasoline expense ($16,000)

Maintenance expense ($3,310)

Repaired expense ($4,000)

Insurance expense ($4,200)

Advertisement expense ($2,490)

Net income $4,240

2. For Net annual cash flows

Net income $4,240

Add: Depreciation expense $25,300

Net annual cash flows $29,540

In the net income we deduct the all expenses from the revenues so that the net income could come and for net annual cash flows we added the depreciation expense to the net income