The Bertie Hamilton Fishing Company (BHF) purchased a trawler 6 years ago for $420 000. At the time it was purchased, the trawler had a useful life of 10 years. If BHF were to retain this boat, it is anticipated that ultrasonic detection equipment would have to be installed in the second-last year of its life at a cost of $40 000. However, the Commercial Trawler Company (CT) has recently launched a faster, computer-assisted trawler that BHF is considering as a replacement. This trawler will cost $600 000 but will need immediate refitting to suit the purchaser’s specifications at an additional cost of $15 000. It has an expected useful life of 12 years.
If purchased, the new trawler is likely to increase cash operating costs by $10 per tonne of fish, which currently sells for $30 per tonne. However, future catches are likely to increase significantly by 6000 tonnes in the first year, and then at a rate of 1000 tonnes per annum, stabilising at 12 000 tonnes from Year 7 onward. Owing to intensive usage, it is expected that towards the end of the fifth year the new trawler will require a minor engine overhaul at a cost of $30 000. Part of the purchase agreement also involves a maintenance contract with CT covering the nets and trawling apparatus, which will cost BHF $12 000, payable at the end of every fourth year.
As a competitive strategy, CT offers an optional financing package for up to 80 per cent of the invoice price on any boat. The rate of interest on this amount is 12 per cent per annum, with the first payment deferred 1 year. If the financing package is adopted, BHF must undertake to sell the trawler back to CT in 12 years’ time for $50 000. BHF estimates that the current second-hand price of its present trawler is only $140 000. It is estimated that the new trawler can be sold for $100 000 at the end of its useful life.
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The company’s nominal required rate of return is 30 per cent.
a. Estimate the net cash flow (NCF) at the beginning of Year 1.
b. Estimate the NCF in Year 4.
c. Management believes that relative to today’s prices, the average inflation rate is expected to be 8 per cent per annum over the next 12 years. What is the Year 3 inflation-adjusted NCF?
d. Estimate the appropriate discount rate to perform an NPV analysis in real terms.