Amy's ice cream Essay

Submitted By Larissa111
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Pages: 2
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proposed sailboat purchase.
While the new sailboat is expected to generate additional operating profits of $18,000 per year for 10 years, and to be resold for $70,000 at the end of 10 years, it also requires substantial cash outlays. An immediate deposit of $80,000 is required, followed by $50,000 in one year’s time. In addition, sails will need to be replaced at the end of 5 years at an estimated cost of $12,000. The cost of raising the capital necessary to finance this sailboat purchase is 15% per year compounded annually.
As shown in Appendix 1(a), at the cost of capital of 15%, the net present value of all cash flows the new boat is expected to generate is -$21,803.62. Therefore, in terms of adding value for Pelican Charters, the new sailboat falls short by $21,803.62. Additional operating profits from the boat as well as its resale value will not be enough to compensate for the costs associated with its purchase.
It is interesting to note that if the cost of capital is 11%, the net present value of this sailboat purchase is exactly zero1 - the sailboat neither adds value nor represents a net cost to the company. Thus, purchasing this particular sailboat would be worth considering only if it could be financed at less than 11% per year.
In conclusion, given their cost of capital of 15% per year, Pelican Charters should reconsider their current expansion plans. These plans should be either abandoned, or modified to include a less expensive boat or strategies to lower the cost of capital to less than 11%, or possibly both. Only then can a purchase of a new sailboat become a financially viable option.

1

See Appendix 1 (b) for details.

1

Appendix
1 (a) NPV analysis of the sailboat purchase at the cost of capital of 15% per year:
Year
0
1
2
3
4
5
6
7
8
9
10

Cash outflow Cash inflow Total
-$80,000.00
$0.00 -$80,000.00
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