Question

The assignment is based on the case information below. While the Gold Coast City Council (GCCC) does exist, the financial data as well as the scenario in this case study are fictitious¹, however the context is not. Many businesses and government departments face similar investment decisions in order to remain competitive as well as being more environmentally and socially responsible.

The Gold Coast City Transport Strategy 2031 (hereafter ‘the Strategy’) is a plan founded by the City of Gold Coast Council that addresses the needs for transport on the Gold Coast into the future. This strategy focuses on reducing traffic congestion and bottlenecks as well as looking for environmentally friendly alternatives for travel. If this strategy is successful, 80% of residents on the Gold Coast will live within a 10-minute walk of public transport.

Traffic congestion on the Gold Coast has become an ever-increasing problem that will continue because the population forecast suggests continued growth. Therefore, objectives of the Strategy are to encourage the use of public transport, promote walking and cycling, as well as carpooling to create a healthier and more environmentally conscious community. Other initiatives include the extension of the light rail network South to the Gold Coast Airport, giving Southern residents quicker access to the Northern suburbs. Rapid bus services will be added further inland and the existing heavy rail network will receive seven new stations.

When the original strategy was created, there was no mention of public transport being introduced onto the water. This extended proposal will incorporate the introduction of a ferry system that will run adjacent to the business hub of Southport and Surfers Paradise as well as routes to other business areas and schools on the Gold Coast. Financed via a Commonwealth government grant, infrastructure for this proposal at a cost of $60 million is currently under construction but nearing completion.

The GCCC has approached a private provider On the Water Pty Ltd (OTW) to implement and maintain the ferry project for them.

OTW is interested in bidding for this contract with the GCCC. The CEO of OTW the has asked you to undertake a financial analysis of the project and present your recommendations in a short memo.

Financial assumptions and projections

OTW have identified that they will need to initially purchase five (5) ferries with an upfront investment of $2 million each, that will be depreciated to a zero book value on a straight-line basis over 7 years. Financing for part of the purchase of the 5 ferries will be via a new 7 year debt issue, resulting in interest costs of $35,000 payable at the end of each year. The investment in the 5 ferries will provide adequate capacity to meet the Council’s forecasted transport needs over the period of life of the ferries. After this, it is expected that the 5 ferries will have no salvage value and another investment decision will need to made about the ferry system’s continued operation.

OTW have paid Harbour Consulting $25,000 to provide the estimates of the costs of the project and provide them with feasibility studies.

OTW have forecast initial sales revenue for year 1 of $15 million and this is expected to grow by 5% in each of the remaining years of the project.

The current estimate for variable costs per annum over the life of the project are forecast to be $8 million per annum. These variable costs include but are not limited to fuel costs, maintenance costs for the ferries and terminals (that will use in-house resources) and wages for casual staff members.

Over the life of the ferries, it is estimated that variable costs will increase by 4% per annum. This increase incorporates any future price increases for fuel, maintenance costs and mandatory government increases to wages for staff.

The fixed costs related to the project are expected to be $4 million dollars per annum. These costs incorporate but not limited to insurances, wages for new permanent staff, advertising costs and other related administrative costs.

Other information:

On the Water Pty Ltd has a 7% weighted average cost of capital and is subject to a 25% tax rate on its income.

Required:

Prepare (1) a spreadsheet financial analysis of the proposed project and (2) a memo to the CEO of On the Water Pty Ltd that briefly explains and justifies your chosen methods, inputs and any assumptions made, summarises your findings, and presents your recommendations on the proposed options. Ensure you not only address base case cash flows but also analyse potential uncertainty using appropriate techniques taught in the unit.

Recommendations should address the decision to be made, along with any further follow up or other matters the company should consider prior to making a final decision.

Answer 1

		NOTE:
		1Cost of Feasibility Studies is a Sunk Cost
		It is not relevant for this analysis
		Amount of debt is not given. It is ignored
		Present Value(PV) of Cash Flow:
		(Cash Flow)/((1+i)^N)
		i=discount rate=weighted average cost of Capital=7%=0.07
		N=Year   of Cash Flow
	N	Year	0	1	2	3	4	5	6	7
	I	INITIAL CASH FLOW(5*$2 million)	-$10,000,000
		ANNUAL CASH FLOW:
	a	Sales Revenue		$15,000,000	$15,750,000	$16,537,500	$17,364,375	$18,232,594	$19,144,223	$20,101,435
	b	Variable Cost		-$8,000,000	-$8,320,000	-$8,652,800	-$8,998,912	-$9,358,868	-$9,733,223	-$10,122,552
	c	Fixed Costs(Assumed it excludes depreciation)		-$4,000,000	-$4,000,000	-$4,000,000	-$4,000,000	-$4,000,000	-$4,000,000	-$4,000,000
	d	Depreciation($10million/7)		-$1,428,571	-$1,428,571	-$1,428,571	-$1,428,571	-$1,428,571	-$1,428,571	-$1,428,571
	e=a+b+c+d	Operating Profit before tax		$1,571,429	$2,001,429	$2,456,129	$2,936,892	$3,445,154	$3,982,429	$4,550,311
	f=e*(1-0.25)	After tax operating profit		$1,178,571	$1,501,071	$1,842,096	$2,202,669	$2,583,865	$2,986,822	$3,412,733
	g	Add: Depreciation (non cash expense)		$1,428,571	$1,428,571	$1,428,571	$1,428,571	$1,428,571	$1,428,571	$1,428,571
	H=f+g	Annual After tax Cash Flow		$2,607,143	$2,929,643	$3,270,668	$3,631,240	$4,012,437	$4,415,393	$4,841,305
	CF=I+H	Net Cash Flow	-$10,000,000	$2,607,143	$2,929,643	$3,270,668	$3,631,240	$4,012,437	$4,415,393	$4,841,305	SUM
	PV=CF/(1.07^N)	Present Valure	-$10,000,000	$2,436,582	$2,558,864	$2,669,839	$2,770,256	$2,860,812	$2,942,163	$3,014,921	$9,253,437
	NPV =Sum of PV	Net Present Value(NPV)	$9,253,437
		It is Financially acceptable
		NPV is positive
		RECOMMENDATION:
		Scenario Analysis and Sensitivity Analysis to be carried out before making the decision