Capital Budgeting Information (17 Marks)

Present an itemised breakdown (and the total) for each of the following:

Q1. The Cash Flows at the start.

Q2. The Cash Flows over the life.

Q3. The Cash Flows at the end.

Q4. The NPV of the capital budgeting decision and a short explanation of your recommendation.

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, theKing VoyagerandQueen 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 theKing VoyagerandQueen Spiritimmediately. The cost of theKing Voyageris $45 million, and theQueen Spiritcosts $42 million. TheKing Voyagerwill provide a cruise experience from Sydney to South Island New Zealand. TheQueen Spiritwill provide a cruise experience from Sydney to North Island New Zealand. The plan is to sell theKing VoyagerandQueen Spiritin ten years' time. The required rate ofreturn for theKing VoyagerandQueen Spiritinvestment project is 9%.

2. United Cruises will borrow $87 million from Macquarie Bank to fund the purchase of theKing VoyagerandQueen Spiritcruise 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 theDuke MagicandPrincess Platinum. Both of these cruise ships were purchased five years ago, and are being depreciated over a 25-year life. Margot wants theKing VoyagerandQueen Spiritto 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.

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25300 Fundamentals of Business Finance-Assignment

4. To navigate in and around the coast of New Zealand, both theKing Voyagerand theQueen Spiritneed to be fitted with a special propeller. For example, the special propeller allows theQueen Spiritto navigate in and around the narrow ports in Auckland and Wellington. The special propeller allows theKing Voyagerto navigate in and around Milford Sound (one of New Zealand's most popular touristattractions). 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 theKing VoyagerandQueen Spiritcruise 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. TheKing VoyagerandQueen Spiritcruise 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 theKing Voyagerand theQueen Spirit. Based on forecasts, annual insurance expenses relating to theKing VoyagerandQueen Spiritwill 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 VoyagerandQueen 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: