case2_05

case2_05 - GULF COAST FISHERIES, INC. CASE 2 Universiteit...

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GULF COAST FISHERIES, INC. CASE 2 Universiteit Maastricht Faculty of Economics and Business and Business Administration Financial Management and Policy 3020B 15.11.2005 Keyvan Nassiri Fahgih 228990 Wenwen Ma 260029 Martin Maier 227153 Jonas Reinsch 229539 Tutor: Boris Pavlov
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1. a) In order to assess the costs of the land acquisition one must take into consideration the options to purchase land now or to delay the purchase. If the firm decides to acquire new land now the cost that should be attributed to the catfish project equals the market value of that site, $1.5 million. If the suitable tract owned by the Shrimp Division is used for the catfish project the cost factors, which we take into consideration, include the option premium, land price in 1995 and the cash outflow in 1999 if the option is exercised. b) If GCF decides to use the land owned by the Shrimp Division, the cash outflow on December 31 st 1995 is the option purchase price of $0.1m. With this option, GCF can purchase land in 1999 for $1.9m. Discount by the GCF’s WACC of 10 percent, the PV of the site is $1.3m (1.9m/(1.1)^4=1.3m); adding the costs of the option yields a total PV of $1.4m. If the project was classified as high risk, the discount rate of 13 percent should be used. In that case, the PV of the cost to acquire the land is $1.27m. In both cases the PV is lower than the current market price of $1.5 million. However, at GCF’s low discount rate of 7 percent, the PV of acquisition costs is $1,55m and thus higher than the current market price of $1.5m. Unless the project is classified as low risk, GCF should use the land already owned now and buy the option on land for the future expansion of the Shrimp Division. 2. a) There are no direct R&D cash flows in 1997 through 1999. However, the capitalized R&D expenses of $0.6m are to be amortized between 1997 and 1999. Cash flows 1997: 0.6*14.3%=0.09 1998: 0.6- 0.09=0.51 0.51*24.5%=0.126 1999: 0.5142-0.126=0.384 We use MACRS Depreciation Rates because GCF are required to amortize this $0.6m R&D cost within three years if the project is undertaken. No R&D cash flow is included for 1995 in the analysis as the $0.4m R&D costs have been expensed already and thus are considered sunk costs. b) The salvage value results from the assumption that the project would be terminated in 2003. The building and equipment can be sold at market values, which are given as half of the book value. The book value for the building under Plan L in 2003 can be derived by using the MACRS depreciation rates. Under Plan L the book value is $5m 2
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at present. Using MACRS 31.5-year depreciation, after 7 years, the book value is $3.98m ($5m*(1-0.032)^7) in 2003. Since the building is expected to be sold for half the book value, salvage value is expected to be $1.99m. This resembles an equivalent capital loss of $1.99m (BV – SV = Capital Loss) and yields a tax gain of $0.8m at a 40 percent corporate tax rate. Under Plan S the book value in 2003 is $5.2m depreciating the two investments ($2m*(1-0.032)^7+$4m*(1-0.032)^3). This yields a
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case2_05 - GULF COAST FISHERIES, INC. CASE 2 Universiteit...

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