Finance-25300 Fundamentals of Business Finance Spring Semester 2015 Group Assignment

| January 30, 2017

Question
25300 Fundamentals of Business Finance
Spring Semester 2015
Group Assignment
Due by 9am Monday 12 October 2015
(Answers to be submitted using the Assignments feature of UTS Online)

Contributes 20% of your total assessment
1. Steven Gerrard, the Chief Executive Officer (CEO) of Australian Galaxy Cruises is
very excited about the preliminary financial analysis that the company has performed
in relation to purchasing a new superliner to be named Pacific Dream. Before
Australian Galaxy Cruises invests in the new superliner, a rigorous financial analysis
is required to determine whether a new superliner will increase the value of the firm.
Shortly after graduating from UTS you were hired by Australian Galaxy Cruises as a
financial analyst and have so far impressed senior management with your finance
knowledge. The CFO (James Milner) has asked you to perform a financial analysis of
a new superliner using a purpose-built preformatted EXCEL spreadsheet. You are
very excited because you get to apply the capital budgeting skills that you learnt at
University. Your analysis will be provided to the Board of Directors who will
formally decide on the new superliner investment, based largely on your
recommendation. The CEO‟s and CFO‟s salary will stay at $220,000 and $170,000
respectively, if the Board approves the investment in the new superliner.
2. Six-months ago Australian Galaxy Cruises paid TIA Consulting Group $250,000 to
conduct initial analysis of the cash flows associated with the Pacific Dream
superliner.
3. The purchase price of the new superliner, Pacific Dream, is $37 million. The
purchase transaction will occur today and, as explained in paragraph 16, it will be
partially funded with $7 million cash. To determine the tax-approved depreciation of
Pacific Dream one needs to refer to the Australian Tax Office (ATO) Taxation Ruling
TR2000/18 to determine the effective life. Superliners such as Pacific Dream are
classified under the „Ships and steamers‟ category of „Water Transport‟ and therefore
qualifies for an effective life of 20 years.
4. The sales team are quite excited with the new liner as it will increase the number of
cruises that they can offer each year. Steven advises James that Pacific Dream has the
capacity to operate 32 cruises a year. Based on 1,870 passengers and assuming
standard pricing, Pacific Dream is forecasted to generate cash sales of $34.6 million
each year. In order to ensure high occupancy levels when Pacific Dream is added to
the fleet, Australian Galaxy Cruises will heavily promote the new vessel through an
extensive $2.3 million annual marketing campaign in years 1 to 3. Steven tells James
that to save money he must reduce the current total annual advertising budget of the
existing cruises (Southern Dream and Eastern Dream) from $6.2 million to $5.5
million per year in years 1 to 3 only. The reduced advertising will not impact the sales
of Southern Dream and Eastern Dream.

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5. The initial euphoria generated by the promotion will allow Australian Galaxy
Cruises to add a premium to the standard prices. The premium prices will mean total
sales revenue for Pacific Dream of $37 million per year for years 1 to 4. For years 5 to
10, prices will revert to standard pricing levels and annual cash sales will revert to
$34.6 million. All sales are by credit card with instant funds transfer to Australian
Galaxy Cruises‟ bank account. Australian Galaxy Cruises‟ policy of not allowing
credit sales means they will not have any accounts receivable, and consequently have
zero defaults. James has enquired about the impact on sales of the existing Australian
Galaxy Cruises fleet (Southern Dream and Eastern Dream) and the sales team respond
that the impact on the two cruise liners is irrelevant. They state the only relevant sales
figure to justify the Pacific Dream investment is the sales that the new superliner itself
generates.
6. John Barnes is the firm accountant who works closely with James. John estimates
employee costs directly associated with Pacific Dream assuming a crew size of 296.
The industry standard salary in the cruise industry is $52,500 per year. John has
indicated other annual operating costs include: $0.7 million insurance, $3.7 million
food and beverages, and $0.59 million consumables. Australian Galaxy Cruises‟
headquarters overlooks Darling Harbour and Circular Quay. The personnel consist of
Steven, James, John, yourself, the sales team and the support staff. The total annual
operating costs of headquarters is $1.95 million. This cost is equally allocated
between Australian Galaxy Cruises‟ existing two cruise ships, Southern Dream and
Eastern Dream. Steven wants to ensure that if Pacific Dream is purchased, then it also
is allocated an equal share of the $1.95 million annual costs of operating the
Australian Galaxy Cruises headquarters. The annual headquarters operating costs of
$1.95 million are not expected to change with the introduction of Pacific Dream to the
Australian Galaxy Cruises fleet.
7. Australian Galaxy Cruises‟ existing cruise liners (Southern Dream and Eastern
Dream) berth at Wharf 7 Darling Harbour Passenger Terminal and total port charges
payable to Sydney Ports are currently $1,777,000 per year. However, Pacific Dream is
a large vessel that cannot be safely manoeuvred into Darling Harbour. Therefore, it
can only berth at the Overseas Passenger Terminal (OPT), Circular Quay. With the
introduction of Pacific Dream to Australian Galaxy Cruises‟ fleet, annual port charges
will increase to $2.44 million. The increased charges are due to the higher port
charges at the OPT compared to Wharf 7. Restaurants (for example: Quay and ARIA)
near the OPT experience a dramatic downturn in business when vessels berth there
because customers‟ views of Sydney Harbour are blocked. Therefore, even though
OPT port charges are high, Sydney Ports distributes $55,000 per annum of the port
charges that it collects to each restaurant as compensation for the loss of trade.
8. Due to previous oil spills in Sydney Harbour, it is now mandatory that all vessels
entering Sydney Harbour possess a Sydney Harbour spillage management plan and
have a certificate to say they comply. This certificate provides verification that the
vessel abides by strict safety standards. The certificate costs $1,156,000 and is valid
for four years only and must be renewed at the end of every four years. If Australian
Galaxy Cruises proceed with the Pacific Dream purchase, it is their responsibility as
the new owners to pay for the first certificate that is required today. The cost of the
certificate is a tax-recognised business expense when paid. The spillage management

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plan certificate cannot be separated from Pacific Dream and does not have a separate
salvage value.
9. At the moment, James has determined that total fixed costs across the entire
Australian Galaxy Cruises business are $8.41 million per year. These fixed costs are
expected to remain at the same level with the introduction of Pacific Dream. These
fixed costs exclude headquarter costs.
10. To operate Pacific Dream in Australian waters, it must be fitted with a bow
thruster and a silent drive. The bow thruster ensures that the superliner can manoeuvre
within the harbour without tugs, and the silent drive reduces the noise generated by
the superliner‟s twin propellers. To comply with Australian port authorities regulation
the $4.1 million bow thruster can only be fitted at an Australian shipyard. Once fitted,
the bow thruster will last for twenty years. The Australian Tax Office (ATO) has
provided a private ruling to Australian Galaxy Cruises declaring that the bow thruster
is eligible for a 20% depreciation rate. Australian Galaxy Cruises purchased a spare
silent drive five years ago for $3 million and at the time was provided a 25%
depreciation rate by the ATO. Currently, the silent drive can be sold for $50,000 and
will be worthless in 10 years‟ time. In addition, the driver has been written off for tax
purposes.
11. In 10 years‟ time, Pacific Dream can be sold for $25 million to Champions
League Voyages. The $25 million figure consists of $23.5 million value for the
superliner itself, and $1.5 million value for the bow thruster. John reminds Steven that
for management accounting purposes, the Board requires that Australian Galaxy
Cruises depreciates all assets over a ten year period.
12. John is aware that Steven has travelled around the world investigating different
types of cruise liners before deciding on Pacific Dream. When Steven returned to the
Sydney headquarters, John had to reconcile Steven‟s expenses. Australian Galaxy
Cruises records show that $69,000 was paid to Steven as reimbursement for his travel
expenses. These expenses have already been incurred so John recommends to James
that the $69,000 amount be included as an opportunity cost and included as a start
expense in the capital budgeting analysis.
13. Australian Galaxy Cruises policy is to have the world‟s youngest fleet so they
plan to sell Pacific Dream after 10 years. By sticking to a strict four-year maintenance
overhaul, Australian Galaxy Cruises ensures its fleet is kept in excellent condition
which also maximises each liner‟s salvage value. The maintenance overhaul will cost
$5.22 million in year 4 and $3 million in year 8. The maintenance overhaul expenses
are classified as an allowable tax deduction when paid. The overhaul means the cash
sales in year four and year eight are reduced to only 75% of annual cash sales. During
the maintenance overhaul in year 4 and year 8, Pacific Dream‟s annual operating costs
(with the exception of food and beverage) remain at the same level, regardless of
whether it is removed from service for maintenance or not. Food and beverage costs
are reduced to only 75% of annual food and beverage costs.
14. Pacific Dream will also require regular repairs such as daily cleaning of engine
parts and minor cabin upkeep. These repairs do not require that Pacific Dream be
removed from service. The total repairs expense is $2.09 million every year. To

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enable the maintenance to be carried out Pacific Dream also requires a large and
extensive spare parts inventory that must be purchased today amounting to $1.67
million. Spare parts are used as required and the cost of purchasing replacement spare
parts is included in the yearly repairs expense of $2.09 million.
15. Australian Galaxy Cruises‟ call centre that is based in rented premises in Adelaide
will have to be expanded with the addition of Pacific Dream. The current annual call
centre operating costs consist of $730,000 in rent and $690,000 in salary and wages.
Steven has told James that if the call centre does expand, it must relocate to cheaper
premises. John has negotiated with a property developer for a larger building on the
outskirts of Adelaide that will suit the expanded call centre at an annual rental cost of
$670,000. The salary and wages associated with the expanded call centre will increase
to $892,000 per annum compared to the figure at the current call centre. The timing of
rent payments for the Adelaide call centre occurs at the end of each year.
16. Pacific Dream‟s purchase price of $37 million will be funded by a combination of
$7 million from Australian Galaxy Cruises existing cash and the remainder will
represent debt. Steven informs James that the principal and interest repayments on the
fully amortising secured loan are $3,330,000 per annum. John‟s amortisation schedule
confirms that these repayments will ensure that the loan outstanding at the end of year
ten is zero.
17. James states the required return for Pacific Dream is 12.4%. This discount rate is
based on advice from their bankers. Steven is surprised that the discount rate is high
but James explains the reason is due to the relative high level of systematic risk
associated with the cruise liner industry.
18. During the project net income is projected to be:
Year
Net income
1
$6,037,500
2
$6,037,500
3
$6,037,500
4
-$3,133,200
5
$5,477,500
6
$5,477,500
7
$5,477,500
8
-$2,839,200
9
$5,477,500
10
$5,477,500
The information in paragraph 18 is to be used to calculate the accounting rate of
return only.
19. The current value of Australian Galaxy Cruises is $10,987,654. The initial book
value of Pacific Dream is $37 million. The tax rate is 30%. Tax is paid in the same
year as a profit, or rebated in the same year as a loss.
REQUIREMENTS
Your team must answer the following questions. All answers must be entered into the
preformatted EXCEL spreadsheet available on UTSOnline.

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Capital Budgeting Questions (20 Marks)
Present an itemised breakdown (and the total) for each of the following:
1. The cash flows at the start.
2. The cash flows over the life.
3. The cash flows at the end.
4. What is the NPV of Pacific Dream?
5. What is the market value of Australian Galaxy Cruises if they invest in Pacific
Dream?
6. What is the accounting rate of return (assuming the salvage value is equal to the
book value of the superliner in year 10)?
7. What is the payback period?
8. What is the profitability index?
9. What is the internal rate of return?
10. Would you recommend investing in Pacific Dream (restrict your answer to the
blank cells provided)?
Instructions
Enter your answers into the EXCEL spreadsheet provided under “Assignments” on
UTS Online. This spreadsheet is designed so that the answers to the ten questions will
fit on one A4 page which speeds up the marking process and enables faster feedback.
The spreadsheet is protected which means that only a restricted number of cells can be
used. The cells that you cannot use are coloured grey.
Right click on the link “FBF_Assignment.xlsx” and choose “Save Target As…”.
Open the spreadsheet and enter each team member‟s details and the tutorials details of
one team member. Marked spreadsheets will be returned in the nominated tutorial
only.
Enter your answers to the ten questions in the vacant white cells. For Q1, 2 and 3,
enter the cash flow description and the dollar amount in the appropriate cells. Use
whole dollars only – ignore cents. There are more rows than required, so if you‟ve
used all the rows then it means you‟ve got too many cash flow items. Q4 to 10 can be
answered using the vacant cells provided. Don‟t worry if any of your cells appear as
“######” because we can view it. Please use “Arial” font and size 9 text in your
spreadsheet.
It is your team‟s task as future financial managers to sort through the information and
correctly identify the cash flows. For this reason, we will not provide direct “yes/no”
answers to your UTS Online questions. We will of course clarify perceived
ambiguities.
We will not answer questions about the assignment by email. Please post your
questions on the discussion board as everyone benefits from your question and the
answer (whether the answer is supplied by us or another student).
Any one team member can submit the case study however it is each team member‟s
responsibility to ensure the case study has been correctly submitted. Everyone in a
team gets the same mark so ensure that all your team members contribute equally.

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