case2_05_2

case2_05_2 - FINANCIAL MANAGEMENT AND POLICY Capital...

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FINANCIAL MANAGEMENT AND POLICY Capital budgeting with staged entry GULF COAST FISHERIES, INC. (Case2) 15 th November 2005 Universiteit Maastricht Faculty of Economics and Business Administration Financial Management and Policy 3020B Tutor: J.Budek Tutorial Group: 2 Dehnadi, Zahir I252786 Sprengers, Rutger I232785 1
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1A The alternatives to the firms, buy new land for or to use land from its Shrimp division, both cost $1.5 million. The suitable opportunity costs are $1.5 mil. Still one hjas to take the inherent option into account. GCF has the opportunity to either buy land now or to delay the purchase. In latter case one has to take the options premium, the cash outflows and the land price in into consideration 1B. First, it is possible to buy the land now for $1.5 million. Second, one could acquire an option for $100.000 to buy the land in 1999 for $1.9 million. With an annual appreciation rate of 9% the sites value is $2.117.324 million(=$1.5mil*1.09 4 ). The gain on this option is simply the discounted difference of the value and the cost to buy the land in 1999. One could argue for a 10% as well as for a 7 % discount rate. 7% is feasible as the option to wait reduces the riskiness of the land acquisition. In either way the option is significantly valuable. If we take 10%, we get a value of $148468,3 1 ((2117372,4-1900000)/ (1,10) 4 ) and at a 7% discount level 165832,4((2117372,4-1900000)/(1,07) 4 ). 2A. To date $ 1.000.000 is spent on R&D. Of this $ 1.000.000 investment, $ 400.000 is already expensed for tax purposes. If the Catfish project is undertaken, the remaining $ 600.000 will be amortized over the first three years of the project using straight line depreciation, 1997, 1998 and 1999, amounting $ 200.000 per year. While only incremental costs are considered when evaluating a project, sunk costs like this are not included in the analysis. Sunk costs are costs that already have occurred and are not affected by the decision under consideration (Brigham & Daves, 2004). Incorporating taxes however this leads to a $ 80.000 cash flow per year (1997, 1998, 1999) and $ 240.000 in 1995 (40% * $ 600.000). 2B. At the end of the project, December, 2003, the buildings could probably be sold for about half their book value. Looking at the tax schedule below a loss occurs, amounting $ 1.940.000, when the building is sold at half its book value in 2003. This loss is tax deductible and would increase cash flows with $ 776.000, according to a 40% corporate tax rate (40% * 1.940.000). 1 ( 2117372,4-1900000) /(1,10) 4 /(1,07) 4 2
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1996 1997 1998 1999 2000 2001 2002 2003 Depr. 160 160 160 160 160 160 160 Book value 5000 4840 4680 4520 4360 4200 4040 3880 Sales 1940 Gain/loss -1940 Depreciation schedule (building large plant) * $1000 2C. End of Year
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case2_05_2 - FINANCIAL MANAGEMENT AND POLICY Capital...

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