From ScuzzSucker to The Albatross
How I Passed FIN442 and Saved the Earth
OR
Got Your Goat
Case 1 Due Jan 30
Case 2 Due Feb 20
Henry leaned back in his recliner, the one he had
been living in since his shoulder surgery two weeks earlier. He adjusted his
sling so his arm didn’t ache quite so much. Then he worked the electric control
to lift his legs, then forward to sit more upright, and then with a sigh moved
back only to discover he couldn’t reach the cup of coffee his long-suffering
wife had kindly set on his table. So he sat up, sipped the coffee, and realized
that now he couldn’t reach the light switch. So – well, I think you get the
point. He was going stark raving mad. Not that it was much change from his kind of normal. All this sitting
around. Maybe a little UTube? Hey, why not check out this one?
Uh, not so great. Birds, yeah. Birds will help him
relax. Here’s one.
Oh, man. This isn’t going well. Somebody needs to do
something about this. So Henry threw down the gauntlet, and his Big Gulp cup,
and got to work.
Your
assignment is to help Henry determine the feasibility of the following mutually
exclusive projects:
‘From
ScuzzSucker to The Albatross: How I Passed FIN442 and Saved the Earth’ OR
‘Got
Your Goat’
Alternative
1: The Albatross
Henry
can buy a very large ocean-going pontoon (kind of a modern day Kon Tiki (Google
it Millenials)) that was originally used by the Navy to patrol for marine mines
off Iraq and affectionately known to its crew as the ‘ScuzzSucker’. It will be
outfitted with retractable booms to channel a 100 yard wide swath of ocean into
a sieve patterned on a whale’s baleen. Plastic, and other debris, will be
collected and run into a modern plastic recycling plant mounted on the deck.
The plant is capable of sorting and converting 5 types of plastic into
marketable plastic resin pellets. Any plastic that cannot be processed, along
with wood and any other floating, uh, debris, will be fed into the ship’s high
temperature incinerator that will convert the mass into steam and produce
sufficient electricity to power the ship. Because the waste is burned at
extremely high temperatures there will be virtually no smokestack pollution.
Storage tanks will hold processed plastics until a transport ship arrives to
transfer the plastic to market. The transport ship will also bring supplies and
exchange crew as Henry plans for the ship, to eternally circle the North
Pacific Gyre (Yeah, Google this too assuming you skipped the videos) in the
same fashion as the albatrosses he is trying to save. That is why he has named
it The Albatross.
The
ScuzzSucker can be purchased at its Long Beach wharf for $780,000., the Navy’s
estimate of its scrap value. The cost of refurbishing and outfitting the ship
is estimated to be $2,300,000. The plastic recycling plant, consisting of
sorter, granulator, washer, sorter, and pelletizer, will cost $920,000
installed. The ship will be outfitted with a $1,300,000 ultra-high temperature
incinerator that converts heat into steam with the steam used to generate
electricity. Add to those capital costs a $2,800,000 desalinization plant also
powered by electricity. All capital costs listed in this paragraph will be
depreciated over a 10-year MACRS life although all of the equipment is
estimated to have a 20-year useful life.
The Albatross will employ an all-electric operating
system except for the steam-driven engines. This will free The Albatross from
the need for re-fueling. Sufficient power will be available from non-recyclable
debris to run all ship systems, including the desalinization plant and a waste
treatment system.
The only inputs The Albatross will need are food and
crew, both supplied by the transports that pick up the plastic resins produced
by The Albatross.
The price of the plastic resins produced by The
Albatross average 50 cents per pound. The Albatross is designed to produce, on
average, 4,500,000 pounds of plastic resin per year.
The crew will consist of a captain, 2 assistants, 3
engineers, 3 recycling specialists, a maintenance person, a fishing specialist,
and 2 cooks. Each crew member will work 8-hour shifts with no days off for 2
months followed by 2 months off. Total annual wages (fixed) are estimated to be
$800,000. Add 30% to that for payroll taxes and fringe benefits.
Additional fixed operating costs are $600,000
including food. Variable operating costs are only 5 cents per pound.
Some
other facts that may or may not be relevant:
The
Albatross has received a $1,800,000 one-time non-taxable federal grant.
The
new incinerator will replace the existing ship incinerator. The old incinerator
has no book value and can be sold to the DEA for $40,000 at time zero.
The
Albatross is capable of housing up to six researchers to study the garbage patch
and its’ impacts on the marine ecosystem. Several universities have pledged to
cover all costs of the research and to pay $100,000 annually to help cover the
operating costs of The Albatross beginning in year 1.
Universal
Worldwide Mega Studios has offered $3,000,000 for movie rights. This would be a
one-time payment at time one, taxable as ordinary income.
The
City of Long Beach will pay $7,000 (taxable as ordinary income in year one) for
The Albatross to take a load of municipal waste, sufficient to power the ship
to the garbage patch. The waste will not materially change plastic production
for The Albatross in year 1.
The
companies that build the plastic recycling equipment and desalinization plant
are expected to realize $40,000 per year of increased cash flow due to expected
positive publicity.
Henry
will need to take a full year off from his job as professor of BS at Central
Michigan University to manage the start-up of this project. He will be on paid
leave and the university will spend $28,600 to hire a Chimpanzee to teach his
classes. Student learning is expected to increase.
The
Albatross will require $275,000 of Net Working Capital to be invested at tine
zero.
Henry
expects to operate The Albatross for 20 years and then donate it to the nearest
Pacific island nation that is still above water. The market value of the boat
and equipment is expected to be zero. He will recover Net Working Capital.
Henry
estimates that Pacific island nations will have after-tax cash flow of
approximately $240,000 annually from The Albatross due to increased tourism and
business traffic associated with news coverage.
Henry
has already spent $10,000 to study the economics of The Albatross.
Alternative
2: Got Your Goat
Henry
buys an organic goat farm in Utah for $1,100,000. The goat farm has an annual
fixed operating cost of $180,000 and is expected to produce 100,000 pounds per
year of organic goat cheese. Organic goat cheese wholesales at $5.80 per pound
and he expects variable operating costs of $2 per pound.
The
$1,100,000 purchase price for the goat farm is not depreciable. However, the
goat farm requires $100,000 of new equipment at time zero with a 5-year MACRS
depreciable life.
Henry
expects to sell the farm at the end of 20 years for an amount equal to the present
value of year 19 capital budgeting cash flow treated as a perpetuity at a 10%
required rate of return.
The
goat farm requires $400,000 of Net Working Capital at time zero. Net Working
Capital would be included in the sales price of the farm.
Henry
has an antique ‘Encyclopedia of Goats’ which he was planning to sell. If he
buys the goat farm he will keep the book. It has a $100 book value and $500
market value.
Henry
expects to use honey, produced on another farm he owns, in the production of
goat cheese. The honey-producing farm will realize $1,000 per year in
before-tax profit.
But,
why goats? It’s obvious, isn’t it? Climate change is rendering large areas of
the world unsuitable for conventional agriculture. Henry will breed goats and
select those that do best in the driest and hottest conditions. Then he will
export these varieties to countries hard hit by climate change. He wants to
experiment with Nubian, a dairy goat well-suited to hot dry conditions, and
with upgrading local species such as the West-African Dwarf. Meanwhile, there
is the cheese.
Goat
exports are expected to begin in year 6. Henry expects to export 100 goats per
year at an average price of $600 per goat. The exports are expected to add $100
per exported goat to his variable costs.
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Common
facts:
Henry
can only manage one of these two alternative investments. The personal and
corporate tax rates are 30% and Henry is planning based on a 10% required rate
of return. Henry will form a For-profit company to own and operate either
company. Henry is confident of a 6% cash flow growth rate for either project,
although this number should not be used in Case 1.
Case 1: Capital Budgeting Cash Flows (Due Jan 30)
Provide
a spreadsheet solution for questions 1 and 2. Set up the spreadsheet so that it
is “functional”; that is, so that you can change the number of “Pounds” or
“Goats” and the spreadsheet automatically re-calculates the answers.
1)
Calculate the Initial Cash Outlay for both
alternatives.
2)
Calculate the relevant annual Capital
Budgeting Cash Flow for years 1 thru 20 for both alternatives. Be sure to
consider any sale (salvage) of the project in year 20.
3)
Discuss the option values of both
alternatives.
4)
Without performing any calculations,
what variable do you perceive as posing the greatest risk in each
business
plan? Why?
Case 2: Capital Budgeting
Techniques (Due Feb 20)
Provide
a functional spreadsheet solution for questions 1-6.
Remember
that Henry is planning based on a 10% required rate of return.
1) Calculate Payback Period, Net Present Value,
and Internal Rate of Return for both ‘The Albatross’
and
‘Got Your Goat’.
2) Re-calculate NPV and IRR for each project
assuming a 6% annual growth rate in cash flow.
3) How much growth does it take to make each
project worthwhile? A negative answer means Henry can
afford
a decline in cash flow.
4) Calculate the breakeven amount of Revenue ($)
(plastic or cheese) and the degree of operating
leverage
in year 5 for each alternative.
5)
Calculate the incremental NPV and IRR
from ‘The Albatross’ versus ‘Got Your Goat’, both with, and
without,
Henry’s expected 6% growth rate.
6) What cash flow growth rate would leave you
indifferent between the alternatives?
7) Considering the results from both cases 1 and
2, recommend a course of action. Defend your decision
using
the results you have calculated.
BONUS:
Up to 10 points for performing additional sensitivity analysis and
demonstrating with your
functional
spreadsheet.
BONUS:
Up to 10 points for financial breakeven ($ of plastic sales) for ‘The Albatross’.
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