Tortuga Tarpon Classic
The company has two separate research teams working on theproject and they develop two distinctly different fishingcombinations. The two rod and reel combinations are test marketedwith guides and past tournament champions and demand forecasts aredetermined. Most fishing gear has a relatively short life due tocontinual product innovation. Manufacturing of the two combinationsis estimated to require an upfront cost of $5 million to retool themachine shop. The process for manufacturing the two combinationsdiffer and ongoing variable costs are not the same. The net cashflows for the entire ten year expected life of the product is shownin Figure 1 as Project A and Project B (all figures are $thousandsof net cash flow).
Project A focuses on hand tooled fishing equipment which resultsin a more labor intensive process, but also allows for personalizedfeatures for customers. The price charged for customization offsetthe slower hand tooling process to generate substantial net cashflows. Part of the upfront $5 million includes the costs oftraining more machinists in the art of hand tooling, which issimilar to watch making but with a few less moving parts. Project Ais anticipated to generate lower cash flows in the early years dueto the length of time required to get machinists who are adept athand tooling to customer specifications. In fact, during the firstyear there will be continued expenses to attain these skills whichcauses year one net cash flows to be negative. Over time the cashflows increase as more machinists gain proficiency. The project isexpected to experience lower cash flows towards the end of its lifedue to market saturation. Due to the quality of the reels, they arebuilt to last and seldom fail or wear out. Technologicalobsolescence is certain although Tortuga will be investing cashflows into research and development to launch the next generationat the conclusion of the Tortuga Tarpon Classic life cycle.
Project B employs a mechanized approach to large scaleproduction of standardized equipment. Although the approach doesnot allow for personalization, it does allow Tortuga to build itsinventory quickly and capture positive net cash flows immediately.The upfront expense is almost completely devoted to toolingequipment procurement and the number of units produced will be muchhigher and at lower price points than the approach of Project A. Atthe end of both projects life it is assumed that there will be zerosalvage value as the pace of innovation will require a completere-tooling for the next generation and the useful life of theequipment will have been fully realized.
Brooks realizes that he will need to calculate the firm’s costof capital discount rate and apply this to the cash flowprojections of both projects. He recalls all of the assignments hecompleted at university and is thankful to have been sowell-prepared for this task. He gets a cup of coffee, sits down athis desk, and gets to work.
Figure 1 Project Net Cash Flows for Tortuga Fishing Equipment($thousands)
Year | Project A | Project B |
1 | -900 | 950 |
2 | 200 | 950 |
3 | 900 | 950 |
4 | 1800 | 950 |
5 | 2500 | 950 |
6 | 2500 | 950 |
7 | 1800 | 950 |
8 | 1200 | 950 |
9 | 800 | 950 |
10 | 200 | 950 |
What are the net present value (NPV), internal rate of return(IRR), and Payback Periods for Projects A & B? Assuming a WACCof 6.54%
