Question

Swimmers Co. operates a set of water parks with leisure facilities for families in Aqualandia. During January 20X1, Swimmers acquired a boat for organizing boat trips across the river Aquatica. Boat trip business went very well since then, however, competitor Royal Cruises decided to spread its business to the same location. At the end of 20X3, Swimmers Co. estimated that revenues from boat trips will go down by 12% as a result of new competitor. Managers adjusted projection of cash flows from boat during its remaining useful life of 7 years based on most recent budgets, all available supporting information and economic conditions surrounding boat business. These projections are justifiable for 5 years. Cash flows for years beyond 20X8 represent management's best estimate (refer to table below). Managers believe that at the end of boat's useful life, boat will be sold for 20 000 EUR (not included in cash flow projections below). According to management, appropriate pre-tax discount rate reflecting risks associated with boat but excluding inflation is 5% p.a. Cash flow projections are inflated by assumed inflation rate of 2% p.a.
Required: Calculate boat's value in use

Answer 1

The Swimmers Co.'s Boat's value in use (net present value) is Eur 321,221.

Data and Calculations:

Pre-tax discount rate = 5% p.a., excluding inflation

Inflation rate = 2% p.a.

Inflated discount rate = 7% (5% + 2%)

Salvage value = Eur 20,000

Projected cash inflows:

Year           Cash Inflows    Discount Factor     Discounted Cash flows

20X4         Eur 72,000              0.935                     $67,320

20X5        Eur 69,000               0.873                      60,237

20X6        Eur 64,000               0.816                      52,224

20X7        Eur 59,000               0.763                      45,017

20X8       Eur 52,000               0.666                      34,632

20X9       Eur 45,000               0.623                      28,035

20X10     Eur 38,000               0.582                        22,116

20X10     Eur 20,000              0.582                         11,640

Total discounted cash flows                         Eur 321,221

Thus, the Swimmers Co. will calculate the boat's value in use as Eur 321,221, taking into account all the discounted cash inflows.

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