Question

In this exercise, your task is to work out the costs and benefits of two competing capital expenditure proposals and determine which proposal would lead to better business performance. The term capital expenditure will have a lasting value on producing income for the tennis club.

This exercise will involve using online loan repayment calculators to calculate the required monthly/yearly loan repayments that would be necessary for a certain level of borrowing. There are many such loan repayment calculators available on the Internet.
To use a loan repayment calculator you will need to enter:
• The amount to be borrowed (the Principal)
• The interest rate
• The term of the loan (the number of months in duration)
• The payment frequency, for this exercise use monthly
The task of working out which proposal is best has been made easier for you as I have provided an Excel template for you to use. The template will show you one way to set out the problem so that it is easy to read and understand.
The Scenario
A tennis center in southern Cliffsville has four grass courts. The Budget and Finance committee is considering two proposals for improving facilities. Both proposals will have some benefit on the long-term revenue of the club.
Proposal A
The four grass courts will be resurfaced as hard courts. This is estimated to increase court usage by 800 court hours per year. The capital cost will be $80,000.
Proposal B
The four grass courts will be covered with an airdome. It will be the only tennis facility with an airdome in Cliffsville. It is estimated that there will be an increase in court usage of 1,000 court hours per year. The capital cost of this project is $100,000.
Please note that for both options the cost of operating the courts will be the same.
Other details
The income raised per court hour while in use is estimated at $25.00 per hour.
The club will need to take a five-year loan from the bank in either case to raise the capital at 9% interest per annum.
Search for a loan repayments calculator on the Internet to assist you with this problem.

Answer 1

The exercise involves calculating payback periods for two capital expenditure proposals for a tennis center to decide which would provide a better return on investment. The proposals' costs are compared against the additional annual revenue from increased court usage to determine the more lucrative option.

Step-by-step explanation:

The question regards the evaluation of two competing capital expenditure proposals based on their expected benefits and the costs involved, including loan repayments for a tennis center in Cliffsville. To determine which proposal yields better business performance, one should calculate the increase in court usage revenue against the initial capital costs and ongoing loan repayments. We are asked to consider Proposal A (resurfacing grass courts into hard courts) and Proposal B (covering courts with an airdome), each with a different capital cost and an estimated increase in court hours. Both have the same operating costs, and the interest rate on the borrowed amount is 9% for a five-year term.

To evaluate each proposal, one would typically calculate the payback period, which measures how long it will take for the income generated by the investment to repay the initial capital cost. The extra income per court hour is given, and by multiplying this by the increase in court hours per year, we can estimate the additional annual revenue. This revenue is then used to calculate the payback period by dividing the capital cost by the annual additional income. The proposal with the shorter payback period is often considered the better investment.