Question

Talbot and Flinders Services Pty Ltd (TFS) is a family-owned Sydney-based charter ferry operator that has a small fleet of sightseeing ferries. Rex Hunt originally started the company when he arrived in Australia back in 1945. TFS used to run a small private ferry service in the Georges River but has expanded into a major charter operator. Today, Kylie Hunt and some of her relatives run the company. TFS operates in and around Sydney and has been able to exploit some of the potential generated by the increasing interest in whale watching off the Sydney coast.

TFS is investigating an investment proposal that involves replacing their old Georges River ferry with a new, faster, 350 seat ferry. Chris Hunt has been looking at buying a new $9 million ferry that TFS will name “Princess Mary”. This ferry would be ideal for whale watching but only operate during the hours of 10am to 4pm. Chris is concerned that the financial benefits do not outweigh the large cost. Chris has discussed his concerns with Rex and Kylie who recommend that TFS also use the new ferry to commence a regular peak hour ferry commuter service operating between Manly and Darling Harbour. Given the well-publicised problems of Sydney Harbour Ferries, Chris believes the income from the commuter service would boost the likelihood that the new ferry would be financially viable.

The Darling Harbour to Manly ferry service would operate during peak hours with a one-way trip time of approximately 20 minutes and would compete with other operators that terminate at Circular Quay. Last month, Chris and Kylie paid for a study by Ocean Consulting at a cost of $125,000 and the study concluded that the large and growing Darling Harbour precinct will generate sufficient demand for a peak hour ferry service. Today, TFS must decide if they will proceed with the Princess Mary investment and associated sale of their existing ferry.

Chris is really keen to purchase “Princess Mary” as it is well suited for both a ferry service and whale watching. He also tells other members of the Hunt family that TFS would be able to obtain additional revenue out of the snack bar operations on the Darling Harbour-Manly service. The new Princess Mary ferry is a 34-metre 119 tonnes displacement ferry capable of 35 knots with two cabins and four outside decks with a capacity for 350 passengers. Princess Mary will cost TFS $9 million and according to the Australian Taxation Office (ATO) the ferry has an estimated life of eight years.

NSW Maritime requires that all vessels have a Certificate of Survey that indicates that the vessel has been inspected and found to comply with the standards set out in NSW maritime legislation. The compulsory certificate is required before TFS commences operations with “Princess Mary.” The certificate costs $210,000 and will remain valid for the life of the project.

Chris has suggested that TFS sell their existing Georges River ferry and buy Princess Mary. Even though Princess Mary has an effective life of sixteen years, the Hunt family will operate the ferry for ten years only. Kylie has arranged for the sale of the existing Georges River ferry to an overseas ferry operator for $275,000 today. The existing ferry has a Book Value of nil.

If TFS proceeds with the investment proposal, they would pay a dividend of (CREATE YOUR OWN FIGURE BETWEEN $500K AND $750K) to its majority shareholder today. Accounts payable will increase by $450,000.

At the moment, the current Georges River ferry produces annual cash sales of $8,750,000. This sales figure is predicted to remain constant for each of the next ten years. The new ferry will generate cash sales of ( CREATE YOUR OWN FIGURE BETWEEN $15M AND $20M FOR YEAR ONE) in year 1 and these sales will increase at a rate of 6% per annum for years 2, 3 and 4 then reduce to 3% per annum increases until the end of the project.

Rex has gathered some information regarding current and proposed costs. At the moment, fixed costs are $2M per annum. Fixed costs would rise to $3.5M each year with the new ferry. Currently, wages expense is (CREATE YOUR OWN FIGURE BETWEEN $2M AND $2.9M) each year and is predicted to increase to $3.6 million if they purchase the new ferry. Annual fuel expense is forecast to increase by $2,650,000 to $4,300,000.

The current annual maintenance cost of the existing Georges River ferry is $75,000. The new ferry will require no maintenance in the first four years of its life because it is covered by a manufacturer’s four-year warranty. However, after the warranty expires, the maintenance expense will be $125,000 p.a. The company’s existing insurance policy covers any number of vessels at a fixed annual amount of $525,000.

The Hunt family’s accountant has suggested that as the new ferry is analysed over a ten-year period they need to ensure that they recover costs related to the consultant’s fee

Ocean Consulting’s report forecasts that the new ferry will have a market value of $4,500,000 in ten years’ time.

Notes:

a) TFS will borrow $9 million using a secured ten-year interest-only loan at an interest rate of (YOU CREATE YOR OWN INTEREST RATE BETWEEN 6%pa-12%pa).

b) The ATO classifies the Certificate of Survey as a business expense and it therefore qualifies as a tax deduction when paid.

c) The company tax rate is 30%.

d) The required rate of return is 15%.

QUESTION

1. The cash flows at the start

2. The annual cash flows over the life

3. The cash flows at the end

4. The NPV of the project

Answer 1

Year	0	1	2	3	4	5	6	7	8	9	10
a..Cost of the ferry	-9000000
b.After-tax sale value of the old ferry(275000*(1-30%))	192500
c.Increase in A/cs payable(cash inflow)	450000										-450000
d. After-tax mkt. value(4500000*(1-30%)											3150000
e.After-tax Cerificate of survey cost(210000*(1-30%))	-147000
Operating cash flows:
1.Sales with current ferry		8750000	8750000	8750000	8750000	8750000	8750000	8750000	8750000	8750000	8750000
2.Sales with new ferry (assumed 15 mln.in Yr.1 & 1.06 in 2,3,&4 & 1.03 from yrs. 5 to 10)		15000000	15900000	16854000	17865240	18401197	18953233	19521830	20107485	20710710	21332031
3.Incremental sales(2-1)		6250000	7150000	8104000	9115240	9651197	10203233	10771830	11357485	11960710	12582031
4.Incl.fixed costs(3.5-2)mln.		-1500000	-1500000	-1500000	-1500000	-1500000	-1500000	-1500000	-1500000	-1500000	-1500000
5. Incl. wages(3.6mln.-2.5 mln.assumed))		-1100000	-1100000	-1100000	-1100000	-1100000	-1100000	-1100000	-1100000	-1100000	-1100000
6. Incl. fuel exp.		-2650000	-2650000	-2650000	-2650000	-2650000	-2650000	-2650000	-2650000	-2650000	-2650000
7.Incl.maintenance-Savings of 75000 in 1st 4 yrs. & (125000-75000)from yr.5		75000	75000	75000	75000	-50000	-50000	-50000	-50000	-50000	-50000
8. Existing ferry's Book Value given to be NIL, So.incl.st.line depn.(9mln./8yrs.)		-1125000	-1125000	-1125000	-1125000	-1125000	-1125000	-1125000	-1125000
9.EBIT(sum3 to 8)		-50000	850000	1804000	2815240	3226197	3778233	4346830	4932485	6660710	7282031
10. Incl.tax at 30%(9*10)		15000	-255000	-541200	-844572	-967859	-1133470	-1304049	-1479746	-1998213	-2184609
11. Incl.NOPAT(9+10)		-35000	595000	1262800	1970668	2258338	2644763	3042781	3452740	4662497	5097422
12. Add back: depn.(row 8)		1125000	1125000	1125000	1125000	1125000	1125000	1125000	1125000	0	0
13. Incl.Opg. Cash flow(11+12)		1090000	1720000	2387800	3095668	3383338	3769763	4167781	4577740	4662497	5097422
14. Net annual FCFs(a+b+c+d+e+13)	-8504500	1090000	1720000	2387800	3095668	3383338	3769763	4167781	4577740	4662497	7797422
15. PV at 15%(1/1.15^Yr.n)	1	0.86957	0.75614	0.65752	0.57175	0.49718	0.43233	0.37594	0.32690	0.28426	0.24718
16.PV at 15%(14*15)	-8504500	947826.1	1300567	1570017	1769958	1682117	1629773	1566823	1496471	1325373	1927403
17. NPV at 15%(sum of row 16)	6711829
Answers:
1.cash flows at the start- Col.2 (Year 0)	-8504500
2. Annual cashflows of the project	Yrs.1-10 col
3. cash flows at end(incl. yr. 10 opg.)	7797422
4. NPV of the project	6711829

Note:

1. Ocean Consulting cost of $125,000 --altready incurred--need not be considered(not as suggested by the accountant --it is a sunk cost now---nothing can done about it , now.

2. Dividend payment to its majority shareholder ----is a financing cash flow & need not be considered for calculating FCFs of a project.

3.The company’s existing insurance policy covers any number of vessels at a fixed annual amount of $525,000--- anyway going to be incurred---not incremental or due to undertaking this project

4. Interest expense on a ten-year interest-only loan---again a financing cashflow --need not be considered while calculating FCFs --which is meant to know the free cash available for both the capital holders , ie. Debt & equity.