In the seafood industry, Gulf Coast Fisheries is the leading seafood harvester and
processor. At the moment, they concentrate only on a variety of saltwater seafood,
however, due to increased competition they are considering to move part of their
operations into the freshwater catfish market. To examine if this shift is profitable and
which strategy they should adopt, we will come up with a recommendation based on
the following questions.
1
.
Consider the land acquisition.
a)
What
cost,
if
any,
should
be
attributed
to
the
catfish
project?
The firms already owns a suitable tract of land that can be sold now for $ 1.500.000,
but other suitable sites can also be purchased for this amount. Therefore, the costs that
should be attributed to the catfish project amounts $ 1.500.000. Gulf Coast Fisheries,
INC. has the option to acquire additional land for the Shrimp Division; this has not to
be taken in account considering the cost of land acquisition. If the land is used for the
catfish project, the Shrimp Division should purchase a new site by exercising the
option. The option that will pay $ 100.000 in December 1995 and $ 1.900.000 in
December 1999, is more valuable than buying land today for a price of $ 1.500.000.
The following question will give a more precise answer to this.
b) Assuming that the currently owned site is used for this project, how should the Gulf Coast
Shrimp Division obtain a site? What discount rate should be used in analyzing the option
alternative?
Using an annual appreciation rate of 9 percent, the value of the site can be calculated
as follows: $ 1.500.000 * 1,09
4
= $ 2.117.372,4. Next, this value can be used to
calculate the option gain: $ 2.117.372,4 - $ 1.900.000 / (1,04)
4
= $ 185.810,8. The
general inflation rate is 4 percent. Finally, the profit or loss of exercising the option
can be computed: $ 185.810,8 - $ 100.000 = $ 85.810,8. The option price is subtracted
of the option gain, that gives a option profit of $85.810,8.
In stead of buying the land today for $ 1.500.000, the Shrimp Divisions can earn a
profit. The discount rate used in the calculations is the inflation rate of 4 percent,
which is assumed to be the risk free rate.
2