“Ocean Adventures Co.” is located near a beautiful beach in Southern California
ID: 2773240 • Letter: #
Question
“Ocean Adventures Co.” is located near a beautiful beach in Southern California and has been known for its surf board rentals for many years (this is a fictional company, by the way). The company’s manager has been contemplating for a long time to, at least temporarily, shut the surf board business down and switch to something more unusual, even if risky.
The company’s manager initially spent a month researching the potential of a new business idea. This cost him $5,000 about a year ago. In addition, he recently hired a group of local consultants, to whom he paid $20,000, to analyze the local market regarding the potential of a new project. Very soon the consultants came up with a recommendation to sell all surf boards and replace the surf board rental with a sailing catamaran rental business.
To start the new business, the company will need to purchase 60 brand new sailing catamarans at $10,000 per each. Unlike surf boards, catamarans are more durable and it takes 15 years for each to fully depreciate (under MACRS). “Ocean Adventures Co.” is currently planning to keep the new business for 7 years, and to shut the project down and sell all catamarans at the end of the 7th year. Currently, used catamarans can be sold in the market for an average of $1,500 per machine, and due to the growing popularity of this sport the price for used catamarans is expected to rise at an annual rate of 10 percent.
“Ocean Adventures Co.” currently owns 400 surf boards, half of which were purchased ten years ago for $1,000 a piece and the remaining half five years ago for the same price. Each could be sold today at the market price of $300 a piece. Each surf board’s normal economic life is ten years and each board depreciates at a constant rate each year to a zero book value at the end of its life.
The company expects that each year it will be able to rent each sailing catamaran to 500 customers at the price of $20 per person per hour. It assumes that each person will ride a catamaran for exactly an hour at a time. The company is hoping that the business will become very popular among the locals and so the number of customers would be increasing by 100 people each year. Miscellaneous fixed costs are expected to equal $20,000 each year. The cost of maintaining each catamaran will cost the company $8 per each catamaran rental. In order to cover unforeseen repair expenses, the company would need to immediately set aside $5,000 in cash, and it would need to increase this amount by $500 each following year. At the end of the final year of the sailing catamaran project the money would be recovered as the cash buffer would no longer be needed.
The corporate tax rate is 34%.
The riskiness of this project requires an 8% annual rate of return.
2.) (5 points) In the form of a table with “year0”, “year1”, “year2”, etc. in the top row show your calculations of the total cash flow for each year and all of its important components (like we did in class). Briefly explain in words and show all calculations and formulas.
3.) (5 points) Based on your calculations in 2.), what is the current value of the catamaran rental project? Is the project worth it? Briefly explain in words and show all calculations and formulas.
Explanation / Answer
Ocean Adventures company Cash Flow ananlysis for Catamaran Project All amounts in $ Details Year 0 Year 1 year 2 Year 3 Year 4 Year 5 Year 6 Year 7 Ignoring cost of business research as it occurred last year Local Consultant expense (20,000) Investment in 60 Catamaran (600,000) Depereciation rate under MACRS % 5.00 9.50 8.55 7.77 6.93 6.23 5.90 Depreciation Amt $ (30,000) (57,000) (51,300) (46,620) (41,580) (37,380) (35,400) Savage value afte 7 years per catamaran =1500*(1.10)^7 =1500*1.95=2925 per catamaran Total PV of salvage value of catamaran 102,403 175,500 Salvage value of 200 surf boats 60,000 Depreciation on remaining surf boats valued $200000 @10% (20,000) (20,000) (20,000) (20,000) (20,000) Expected catamaran customers per year 30,000 36,000 42,000 48,000 54,000 60,000 66,000 Catamaran rental @$20 per person per hr 600,000 720,000 840,000 960,000 1,080,000 1,200,000 1,320,000 Catamaran maintenance cost @$8 per rental (240,000) (288,000) (336,000) (384,000) (432,000) (480,000) (528,000) Fixed costs (20,000) (20,000) (20,000) (20,000) (20,000) (20,000) (20,000) Total Depreciation on catamaran & sailing boats (50,000) (77,000) (71,300) (66,620) (61,580) (37,380) (35,400) Net taxable Income 290,000 335,000 412,700 489,380 566,420 662,620 736,600 Corprate Tax @34% 98,600 113,900 140,318 166,389 192,583 225,291 250,444 Post tax return 191,400 221,100 272,382 322,991 373,837 437,329 486,156 Add back depreciation ( as net cash flow ) 50,000 77,000 71,300 66,620 61,580 37,380 35,400 Total available cash flow 241,400 298,100 343,682 389,611 435,417 474,709 521,556 Unforeseen repair cash pool set aside (5,000) (5,500) (6,000) (6,500) (7,000) (7,500) 37,500 Net available cash Flow 236,400 292,600 337,682 383,111 428,417 467,209 559,056 Discont rate @8% 0.926 0.857 0.794 0.735 0.681 0.630 0.583 PV of Cash Flows 1,931,605 218,889 250,857 268,063 281,598 291,574 294,421 326,204 Total PV of catamaran rental project cash flows 2,094,008 NPV 1,474,008 So, current value of project is $1,474,008 PI 3.38 As the PI is more than 3 times and required rate of return is only 8%, the catamaran rental project can be taken up definitely
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