Calculate the cash flows OVER the life:
Background information:
Congratulations, you were hired as a financial analyst for United Cruises following your studies at the University of Technology Sydney. United Cruises is a cruise ship service provider in the Australasian region. You fought off tough competition for the job, the recruitment team selected you for your personable character, analytical mind, ability to solve problems, and experience of working well in teams. You have really impressed senior management with your finance knowledge and ability to get the job done. As a result, the Chief Executive Officer (CEO) Margot Robbie and Chief Financial Officer (CFO) Rafael Nadal have asked you to perform a capital budgeting analysis of two new cruise ships, the King Voyager and Queen Spirit. The capital budgeting decision is whether United Cruises should purchase both cruise ships today in 2020 (Note: The decision is that United Cruises either buys both cruise ships, or they do not buy any cruise ships at all). In order to conduct your analysis you will need to collect information from different departments of the firm. Beyonce Drake from the accounting department and Dwayne Johnson from the sales department have helped you obtain information from various departments. The information that you have collected is detailed in the numbered paragraphs below. It is your job as a financial analyst to decipher which information is relevant to the capital budgeting analysis. Upon completion, you will present your analysis to Senior Management who will approve/decline investment in the new cruise ships.
Information gathered from various departments:
1. United Cruises is a medium-sized Australian cruise experience provider. United Cruises will purchase the King Voyager and Queen Spirit immediately. The cost of the King Voyager is $45 million, and the Queen Spirit costs $42 million. The King Voyager will provide a cruise experience from Sydney to South Island New Zealand. The Queen Spirit will provide a cruise experience from Sydney to North Island New Zealand. The plan is to sell the King Voyager and Queen Spirit in ten years’ time. The required rate of return for the King Voyager and Queen Spirit investment project is 9%.
2. United Cruises will borrow $87 million from Macquarie Bank to fund the purchase of the King Voyager and Queen Spirit cruise ships. Beyonce creates an amortisation schedule that indicates that the yearly principal and interest repayments on the debt are $10 million.
3. United Cruises has been operating since 2010. The two existing cruise ships in the United Cruises fleet include the Duke Magic and Princess Platinum. Both of these cruise ships were purchased five years ago, and are being depreciated over a 25-year life. Margot wants the King Voyager and Queen Spirit to be depreciated over a 35-year life because these new cruise ships are more modern and larger than the existing cruise ships in the United Cruises fleet.
4. To navigate in and around the coast of New Zealand, both the King Voyager and the Queen Spirit need to be fitted with a special propeller. For example, the special propeller allows the Queen Spirit to navigate in and around the narrow ports in Auckland and Wellington. The special propeller allows the King Voyager to navigate in and around Milford Sound (one of New Zealand’s most popular tourist attractions). According to an email from Beyonce, United Cruises has two idle special propellers currently stored in their Balmain premises. The two idle special propellers were purchased nine years ago for $3 million each, both special propellers are compatible with either the King Voyager and Queen Spirit cruise ships, and both propellers have been written off for tax purposes. Forecasts from the accounting department indicate that each special propeller will be worthless 10 years from today. According to the International Sea and Port Authority each special propeller currently has a market value of $1,440,000. Hint: If an operating expense is incurred in Year 0, then you can record the tax deduction in Year 0.
5. The King Voyager and Queen Spirit cruise ships will each require spare parts inventory of $2.50 million immediately, will each require operating inventory of $3 million immediately, and will each incur maintenance expenses of $1.60 million per annum during the life of the project. The cost of replenishing spare parts inventory and operating inventory is included in the annual $1.60 million maintenance expenses incurred to operate each new cruise ship.
6. United Cruises total insurance yearly expenses is expected to increase by $3.22 million to $6 million from the introduction of the King Voyager and the Queen Spirit. Based on forecasts, annual insurance expenses relating to the King Voyager and Queen Spirit will increase by 0.5% every following year. Hint: assume that all operating cash flows occur at the end of the year, unless specified otherwise.
7. United Cruises paid $55,000 to Boomerang Marketing Group for market research investigating the demand for the new ships (i.e., King Voyager and Queen Spirit). The $55,000 fee was paid three months ago. United Cruises received the market research report from Boomerang Marketing Group two months ago. The report indicates that customers with the following characteristics are most interested in the new cruises offered by United Cruises:
Beyonce Drake suggests that the market research fee be included as an opportunity cost incurred in Year 0 of the King Voyager and Queen Spirit investment decision.
8. To ensure that customers get the premium experience on the King Voyager and Queen Spirit, a periodic $2.90 million “Premium Overhaul” per cruise ship is required every four years. The overhaul will update the customer cabins with new beds, bathrooms, and electronic appliances. The first “Premium Overhaul” for both cruise ships will occur at the end of Year 4.
9. Customers board all United Cruises at the Overseas Passenger Terminal in Circular Quay Sydney. The King Voyager and Queen Spirit will together increase total annual port charges for United Cruises from $1.45 million to $1.98 million. The port charges can be claimed as a tax deduction. The introduction of the King Voyager and the Queen Spirit will increase the total yearly fuel expense for United Cruises by $4.65 million to $7 million.
10. You receive a dossier which contains Table 1 (below) summarising relevant sales, food and drink costs, and crew costs (this data controls for seasonal patterns):
11. Using the information in Table 1 (above), the introduction of the two new cruise ships will result in bulk buying discounts for United Cruises. Without the King Voyager and Queen Spirit, food drink costs $32/kg for all cruise ships. With the King Voyager and Queen Spirit, food drink costs $28/kg for all cruise ships.
12. Currently two new policies are being examined by the Australian Government. The first policy supports climate change, and requires airline and cruise ship providers to pay a fee for contributing to harmful emissions that have a negative impact on the environment. It is anticipated that the first policy will be implemented in Year 2. United Cruises anticipates that the first policy will cost $0.35 million per year per cruise ship. The second policy requires airline and cruise ship providers to have a quarantine zone to protect customers from contagious viruses. United Cruises will have to hire an external team to operate and implement the quarantine zone. It is anticipated that the second policy will be implemented in Year 3. United Cruises forecasts that the second policy will cost a total of $0.05 million p.a. per cruise ship.
13. Six months ago, Rafael flew to New Zealand including Auckland, Wellington, and Christchurch to meet with vendors regarding places for the King Voyager and Queen Spirit cruise ships to dock, hotels for customer to stay at, and adventure/sports recreational activities for customers to undertake. Rafael’s New Zealand flights, accommodation, local fares and meal expenses totalled $3,000.
14. The United Cruises call centre is located in Parramatta. Currently, United Cruises currently rents the entire level eight of the Deloitte building for its call centre, with yearly call centre salary costs of $40,000 (this is the total United Cruises call centre salary costs). It costs $190,000 p.a. to rent out any one entire level in the Deloitte Building. To deal with additional customer support required for the King Voyager and the Queen Spirit, United Cruises will also rent out the entire level nine of the Deloitte building for its call centre activities and this will double its current total annual call centre salary costs.
15. In order to provide cruise ship services to customers, each cruise ship company must pay a one-off fee of $10 million to the International Sea and Port Authority at the establishment of the cruise ship company. No fee is required after the cruise ship company is established and operating. The fee allows cruise ship companies to operate in domestic/international waters. All operating expenses are tax deductible in the year the expense is incurred and the tax rate is 30%.
16. The total fixed costs for the King Voyager and Queen Spirit together are equal to $1.32 million per annum. Last year, United Cruises total annual fixed costs (excluding headquarter costs) were $2.15 million. United Cruises headquarters is situated in Chifley Tower in Sydney. The total yearly headquarter costs for United Cruises is equal to $2.99 million, and such costs are not expected to change due to the introduction of the King Voyager and Queen Spirit. To save money, Margot wants to allocate an equal share of the yearly headquarter costs for United Cruises across the King Voyager, Queen Spirit, Duke Magic and Princess Platinum.
17. A significant increase in tourism in Australia is forecasted to occur. As a result, a competing cruise ship company (Oceania Cruiseliners) will offer cruise ships journeys between Sydney and New Zealand, starting in Year 9, for a five-year period. Whilst Oceania Cruiseliners is operating and while the King Voyager and Queen Spirit are operating, United Cruises anticipates that cash sales for the King Voyager will drop to 85% of the projected annual value, and cash sales for the Queen Spirit will drop by $5 million p.a. (note: United Cruises operating expenses are expected to remain the same).
18. In 10 years’ time, the International Sea and Port Authority estimate that the market value of both the King Voyager and Queen Spirit will be $18 million if the regular four-year “Premium Overhaul” is not undertaken. However, if the regular four-year “Premium Overhaul” is undertaken, the King Voyager will be worth $26 million, and the Queen Spirit will be worth $24 million. In either case, the cruise ship propellers will have no value in 10 years’ time.
19. To boost awareness of the introduction of the King Voyager and Queen Spirit, United Cruises total marketing expenses p.a. will increase from $2 million to $6 million during Year 1, Year 2 and Year 3. As part of this initial marketing campaign, United Cruises will sponsor the Australian swimming and rowing team at the 2021 Tokyo Olympic games, and the Socceroos at the 2022 World Cup in Qatar. For the remainder of the project, marketing expenses directly relating to the King Voyager and Queen Spirit together are equal to $2.20 million per annum.
20. The Australian Tax Office (ATO) issues the rule 2000/18 “Passenger ships”, which indicates that the effective life of cruise ships like the Queen Spirit qualify for an effective life of 30 years. Through a special ruling, the ATO has indicated that the King Voyager has an effective life of 32 years because the King Voyager has a more advanced navigational system which is required due to blackspots in the southern parts of New Zealand. According to the ATO, special propellers (as used in the King Voyager and Queen Spirit) have an effective life of 8 years.
