CASE PROBLEM Zandts' Charter Sailboat After spending over a decade of 12-hour credits and decreased the rate of deprecia- workdays in successful management jobs, tion. The physician wanted to sell the Barbara and Jim Zandt were in a comfort- 5-year-old boat and did not want to re- able financial position. But they had no place it. Finding another investor seemed time for themselves. Feeling a strong need unlikely in the new tax environment. If to get away, the couple took a vacation on they wanted to continue in this lifestyle, a charter sailboat out of St. Thomas in the they would have to buy a boat themselves. Virgin Islands. By the end of the week, The Zandts faced several alternatives. they decided this was where they wanted They could buy the current 5-year-old boat to spend their lives. For the next 2 years, from the physician for $50,000. It was due they spent all of their vacation time in sail- for refurbishing, which would cost ing courses and all of their spare time $10,000. If they kept this boat for 5 years, studying, both to enhance sailing skills it could be sold for approximately and to understand the charter business. $25,000. If they kept this boat for 10 years, The Zandts learned that most charter it could be sold for $15,000, but an over- sailboats were owned by wealthy individu- haul after 5 years would cost $20,000. als who used the boats as tax-shelter invest Another alternative was to buy a new ments, spending no more than two weeks a boat for $100,000. At the end of 5 years, year on their boats. By joining several sail the alternatives with the new boat would ing clubs, advertising in a sailing magazine, be the same as those with the existing and inquiring among their personal con- boat. It could be sold for $50,000 or refur- tacts, they found a physician who agreed to bished and kept for either 5 or 10 more purchase a sailboat as an investment. The years, with an overhaul when it was 10 years physician would bear all operating costs as old if it were kept for 15 years. the owner, while the Zandts would receive A newer boat would attract more char- a percent of gross charter fees for their ser ter business and bring higher weekly fees. vices as captain, crew, and manager. Barbara and Jim estimated that revenue The arrangement worked fine for per year during the first 5 years of a boat's 5 years, but the tax laws changed during life would be $50,000, but revenue would that 5-year period. Typically, boats were decline to $45,000 a year in the second kept in charter for 5 years, until the advan- 5 years and $40,000 a year in the third tages of rapid depreciation had been used 5 years. The opposite would happen with up. The owner would then trade for a new operating expenses. Annual operating ex- boat or pull the old boat out of charter penses would be $20,000 during the first service for personal use. Unfortunately, 5 years, $25,000 during the second 5 years, the new tax law eliminated investment tax and $30,000 during the third 5 years. Chapter Ranking Mutually Exclusive Investments 219 A new boat would be nice. The Zandts income category that made taxes a negligi- would have to spend less time on mainte ble consideration. nance, and would have more time for pleasure. Also, it was fun to buy a new boat. On the other hand, their net worth Case Questions was $200,000, and they were hesitant to 1. List the alternatives to the Zandts. sink half of it into one investment. A boat 2. Identify cash flows, net present value, dealer had suggested that they could avoid and equivalent annuity for each the use of their capital by making a 25 per alternative. cent down payment and borrowing the 3. Discuss the risks that are inherent in rest at a 12 percent annual interest rate. each alternative. This, though, did not seem wise when they 4. Do the Zandts have a competitive ad- were only earning 10 percent on their own vantage? Is there anything they can do investments, which they guessed to be of to create or enhance a competitive similar risk to a boat. The dealer pointed advantage? out that the interest payments would be 5. Which alternative would you recom- tax deductible, but the Zandts were in an mend? Why? CELEATED CASE PROBLEM Zandts' Charter Sailboat After spending over a decade of 12-hour credits and decreased the rate of deprecia- workdays in successful management jobs, tion. The physician wanted to sell the Barbara and Jim Zandt were in a comfort- 5-year-old boat and did not want to re- able financial position. But they had no place it. Finding another investor seemed time for themselves. Feeling a strong need unlikely in the new tax environment. If to get away, the couple took a vacation on they wanted to continue in this lifestyle, a charter sailboat out of St. Thomas in the they would have to buy a boat themselves. Virgin Islands. By the end of the week, The Zandts faced several alternatives. they decided this was where they wanted They could buy the current 5-year-old boat to spend their lives. For the next 2 years, from the physician for $50,000. It was due they spent all of their vacation time in sail- for refurbishing, which would cost ing courses and all of their spare time $10,000. If they kept this boat for 5 years, studying, both to enhance sailing skills it could be sold for approximately and to understand the charter business. $25,000. If they kept this boat for 10 years, The Zandts learned that most charter it could be sold for $15,000, but an over- sailboats were owned by wealthy individu- haul after 5 years would cost $20,000. als who used the boats as tax-shelter invest Another alternative was to buy a new ments, spending no more than two weeks a boat for $100,000. At the end of 5 years, year on their boats. By joining several sail the alternatives with the new boat would ing clubs, advertising in a sailing magazine, be the same as those with the existing and inquiring among their personal con- boat. It could be sold for $50,000 or refur- tacts, they found a physician who agreed to bished and kept for either 5 or 10 more purchase a sailboat as an investment. The years, with an overhaul when it was 10 years physician would bear all operating costs as old if it were kept for 15 years. the owner, while the Zandts would receive A newer boat would attract more char- a percent of gross charter fees for their ser ter business and bring higher weekly fees. vices as captain, crew, and manager. Barbara and Jim estimated that revenue The arrangement worked fine for per year during the first 5 years of a boat's 5 years, but the tax laws changed during life would be $50,000, but revenue would that 5-year period. Typically, boats were decline to $45,000 a year in the second kept in charter for 5 years, until the advan- 5 years and $40,000 a year in the third tages of rapid depreciation had been used 5 years. The opposite would happen with up. The owner would then trade for a new operating expenses. Annual operating ex- boat or pull the old boat out of charter penses would be $20,000 during the first service for personal use. Unfortunately, 5 years, $25,000 during the second 5 years, the new tax law eliminated investment tax and $30,000 during the third 5 years. Chapter Ranking Mutually Exclusive Investments 219 A new boat would be nice. The Zandts income category that made taxes a negligi- would have to spend less time on mainte ble consideration. nance, and would have more time for pleasure. Also, it was fun to buy a new boat. On the other hand, their net worth Case Questions was $200,000, and they were hesitant to 1. List the alternatives to the Zandts. sink half of it into one investment. A boat 2. Identify cash flows, net present value, dealer had suggested that they could avoid and equivalent annuity for each the use of their capital by making a 25 per alternative. cent down payment and borrowing the 3. Discuss the risks that are inherent in rest at a 12 percent annual interest rate. each alternative. This, though, did not seem wise when they 4. Do the Zandts have a competitive ad- were only earning 10 percent on their own vantage? Is there anything they can do investments, which they guessed to be of to create or enhance a competitive similar risk to a boat. The dealer pointed advantage? out that the interest payments would be 5. Which alternative would you recom- tax deductible, but the Zandts were in an mend? Why? CELEATED