Financial Modelling Assignment 1

Marks 10
Due date November 12, 2017

BACKGROUND
A local authority in an East European city is looking at privatizing the bus network. The proposed new
company will take over the existing assets from the authority and will invest heavily in modernizing the
bus fleet and in the infrastructure (bus station, depot, bus stops and shelters, signage, etc.). A central
government grant has been made available, and the sponsor is seeking a loan to support the initial
investment. A base case financial model is required to test the underlying robustness of the business
case; the results will determine if the project has sufficient merit to require further analysis.

Objective
You are to prepare a financial model to calculate:
a) the net present value (NPV) and
b) the internal rate of return (IRR) of the project
c) the required increase in basic fare in order to achieve break even (NPV = 0)

The project sponsor uses a nominal discount rate of 15%. It may be helpful to prepare basic financial
statements, but these are not seen as necessary at this stage.

Assumptions
The project sponsor has provided the following assumptions. At this stage, assume that everything is in
the local currency (LCU), and that inflation will be applied to the forecast assumptions unless otherwise
indicated:

Forecast period should be 10 years, starting next year.

There are 15,000,000 journeys each year.
The average fare for next year is LCU 1.5
Growth is forecast at 5% each year (applicable on fare only).
The central government subsidy is LCU 200,000 each year.

Operating costs are simplified as follows:

Variable costs: LCU 0.5/journey.
Fixed costs: LCU 5,000,000 each year.
Local council rates are LCU 100,000 each year.
Transfer of existing assets of LCU 20,000,000 (investment to be done now)
Investment in new bus fleet: LCU 1,000,000 in the first 2 years, decreasing to LCU 500,000 for the
remaining 8 years.
Investment in infrastructure: LCU 10,000,000 in the first 2 years, decreasing to LCU 1,000,000 for the
remaining 8 years.
Depreciation uses the declining balance method, with the following rates:
Existing assets: 15% per year.
Fleet: 20% per year.
Infrastructure: 10% per year.
The proposed financing is a term loan, of LCU 12,000,000, drawn down at the start of year 1.
The loan will be repaid over 10 years, with an annual interest rate of 10%.
The tax rate is 30%; in the case of losses, assume zero tax.
Financial Modelling Assignment 1
Marks 10
Due date November 12, 2017
The project sponsor uses a nominal discount rate of 15%.
(Please note that interest and loan payments are not to be considered in calculating NPV)