Reference no: EM132064363

Computing WACC and its use in determining firm value & Economic Analysis

Suppose that you are the CEO for a small steel freight line operating on the Mississippi River. You have twelve freight boats that haul steel scrap to the mills. The price for you to haul the scrap is $0.23 per lb; the railroad charges 100% more and the trucking lines (your primary competitors) charges 200% more. For your inland customers, you estimate that local shipping charges raise their costs another 1-2 cents.

There is one other competing boat line with five boats - but due to the owner's health problems, there is no fleet expansion planned by that family owned company. You also estimate that you are currently handling about ten percent of all the scrap being shipped in your area. Moreover, there appears to be a back-log in current scrap shipments, and the backlog is expected to grow.

You have four 15-year old boats that are in need of immediate overhaul, the cost for each boat will be $6 million, and it will extend their service life by five years. The overhaul for each will take approximately 6 months and they can be done two at a time.

Alternatively, you could purchase four new boats, two of which will be ready in 1 month. The others will be built per your specification and will be available in two years. A new freight boat will cost you $15 million, will last 15 years, and it takes one year(s) to build (there is only one builder in the area with limited capacity that can deliver two boats per year; the builder has other commitments for the next year). Your cost of capital (a bank loan) is 8%; assume payment is delivery for both options.

You estimate that each boat produces $7500000 in revenues annually, and has the following costs: $3000000 crew salaries/benefits, $800000 fuel expenses, and $650000 in maintenance. Your marginal tax rate is 40% and you use the straight-line depreciation for tax reporting.

1) First, calculate OCF & NPV for both options 1 & 2

2) then the corresponding equivalent Annual Equity Cost (AEC)

3) Select the better option based on financial point of view and also the potential growth of the business based on economic analysis of the whole business environment and potential market. List the reasons for your decision making.