The management of Harbour Ferries Ltd is contemplating the replacement of its existing fleet of six ferries with three hydrofoils. The following estimates of costs etc have been calculated for each vessel.

Existing ferries		Hydrofoils
Estimated remaining life	5 years	Estimated life	10 years
Estimated scrap value: Now In 5 years time	$5m $1m	Estimated scrap value: In 5 years time In 10 years time	$20m $10m
Annual net cash inflows	$10m	Annual net cash inflows	$20m
		Cost	$50m

Management is also aware of the development of hovercraft, which the manufacturers estimate will be available in five years. The following estimates of costs, etc per hovercraft have been provided by the manufacturers.

Hovercraft
Cost	$60m
Estimated remaining life	15 years
Estimated scrap value: After 5 years operation After 15 years operation	$20m $5m
Annual net cash inflows	$25m

It is considered that two of the new hovercraft will be adequate to carry the estimated number of passengers.

Other information

• Management cannot foresee any further developments beyond the hovercraft.
• The annual net cash inflows are received at the end of each year.
• The opportunity cost of capital is 10%.
• The company tax rate is 30%.
• The existing ferries are assumed to be fully depreciated. The original cost per ferry was $15m.
• Straight line depreciation over useful life may be assumed.

REQUIRED:

1. Advise management whether they should replace the existing ferries with hydrofoils or hovercraft (using lowest common multiple method).

2. Advise management which of the following two strategies is best:
   1. Replace the existing ferries with hydrofoils now and replace them later with hovercraft in 5 years time.
   2. Retain the existing ferries for 5 years and then replace with hovercraft.

3. Advise management which of the following two strategies is best
   3. Retain the existing ferries for 5 years and then replace with hovercraft.
   4. Replace the existing ferries with hydrofoils now and replace the latter with hovercraft in 10 years time.