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This case analyzes the feasibility of starting a large-scale ferry boat system in Hawaii called Island
Ferry. Students are provided detailed information regarding the proposal and are required to analyze
this information to determine if the project should be undertaken. Students are offered the
opportunity to discuss changes to the ferry system that might increase its chance of success. Spirited
discussions among students frequently occur.
CASE DESCRIPTION
The primary subject matter of this case concerns capital budgeting. Secondary issues
examined include cash flow estimation and calculation, decision criteria, and strategic
planning. The case is designed to be taught in 1.5 class hours and is expected to require 4
hours of outside preparation by students.
CASE SYNOPSIS
In this case the JTA&T Company is faced with an investment decision. The decision
is if the firm should invest in an enterprise called Island Ferry. Island Ferry will offer inter-
island ferry-boat service between the Hawaiian Islands. The managerial staff of JTA&T has
collected various financial information regarding the project. The company is now in the
process of analyzing the data to make a final decision to accept or reject the project. The
new Chief Financial Officer, Sharon Coto is assigned the task of analyzing the data.
INTRODUCTION
Today is January 1, 2002. JTA&T company, an Oregon based company, is
considering starting a new division called Island Ferry. The new division is a ferry boat
system that will transport passengers, vehicles and freight between the islands of Hawaii.
Island Ferry will be operated in a manner similar to the Washington State Ferry. The JTA&T
managerial staff have spent the past several months gathering information about the project to
determine its desirability. It has turned the information over to the new Chief Financial
Officer, Sharon Coto to analyze. Sharon is immediately approached by a disgruntled member
of the Board of Directors, Brian Bikus, who makes it clear that he has concerns about the
project.
Brian: You know Sharon, starting a new business in Hawaii is not as easy as the managerial
staff seems to think. Hawaii is known as one of the most difficult states to do
business in.
Sharon: I have also heard stories of difficulty associated with doing business in Hawaii.
However; it is possible that the prospects for this type of business are different now
than previously.
Sharon: I understand that inter-island airfares have increased dramatically over the past five
years. These increased fares could allow Island Ferry to offer a very competitively
priced service. So what may not have been profitable previously might now be
profitable.
Brian: Price doesn’t matter. People want fast transportation. They just will not accept the
slower fairy boat service. I overheard the marketing folks discussing the Island Ferry
sales forecasts. They are crazy if they think they will achieve the numbers they were
discussing.
Sharon: Thank you for expressing your concerns to me, I will make sure to take the
possibility of sales forecast errors into account when I complete my analysis.
While the majority of tourists arrive by airplane to the island of Oahu, some international and
mainland flights operate from the islands of Maui, Kauai and Hawaii. In addition, about
44,000 visitors arrive by cruise ship each year. Visitors spend an average of 8.9 days visiting
the islands and spend an average of $171.30 per person per day (DBEDT 1999).
The second clientele are local tourists. Currently, in order for local tourists to visit
alternate islands, they must generally fly from island-to-island, and rent a car on the
destination island. A couple planning a three-day get away would spend about $450 on
transportation (4 inter-island airplane tickets at $75 each and three days of car rental at $50
per day). Island Ferry would allow local tourists to travel more economically. The trip
described above could be completed for about $200 using island ferry. As with other tourists,
the ferry is expected to become a tourism activity by itself for local tourists.
The third clientele are inter-island commuters. The unemployment rate in the
Hawaiian Islands varies substantially from island-to-island. Differences in unemployment
rates are in part due to the difficulty of commuting between islands to seek employment.
While there are currently some employment commuters, the price of inter-island air travel
limits this practice to relatively well-paid individuals. The lower price of inter-island travel
available through Island Ferry will permit more individuals to island-commute.
In addition to passengers and cars, Island Ferry will offer freight service. Freight
services are currently provided by airplane as well as by sea. Airplane freight services are
provided in conjunction with passenger service. Freight-carrying sea vessels visit each island
about once per week. Inter-island freight transported by sea are dominated by two
companies, Matson and Young Brothers (U.S. Coast Guard 2001). 4,287,500 tons of freight
are shipped between the islands each year (Wedemeyer 2001). Island Ferry will be able to
offer very competitive freight service. While freight prices will be similar to those charged
by existing seaboard freight service, Island Ferry will have the competitive advantage of
providing daily service.
A group of anonymous men, eager for JTA&T to open the business, as it will create
many jobs and will increase tourism to the state, and increase sales at their respective
businesses. As such, they have agreed to give Island Ferry an incentive to open the business.
The incentive is a cash payment of $10,000,000 at the end of each of Island Ferry’s first five
years of operation (not including the construction time). In addition, the state has negotiated
a tax deal for Island Ferry so that Island Ferry is exempt from all federal, state, and general
excise taxes for the construction (startup) period and the first five years of operation. After
that, Island Ferry’s combined federal and state income tax rate will be 38 percent. In
addition, Island Ferry will have to pay a general excise tax of four percent of sales after the
exemption expires.
Island Ferry will begin providing passenger service on January 1, 2005. The boats
will operate 365 days per year. At any given time, 24 hours per day, seven of the small boats
and seven of the large boats will be operating. The remaining boats will be shut down for
repairs and maintenance. The large boats have a capacity of 200 cars, 1500 passengers and
500,000 pounds of freight. In addition, the large boats will have thirty sleeping/meeting
rooms each. The small boats have a capacity of 100 cars, 750 passengers and 200,000
pounds of freight. The small boats will not be equipped with sleeping/meeting rooms. Each
boat will be equipped with airplane-style seating. The car storage area of each ship can be
utilized for additional freight when demand dictates. The boats will have a cruising speed of
40 knots (about 46 miles per hour). The boats will average 55 percent full of both
automobiles and people on each trip in the first year of operation. Usage statistics for the
other years of operation are presented in Table 3.
Island Ferry will begin offering freight service on January 1, 2006. The average
freight charge will be $0.02 per pound of freight transported in the first year of freight
operations. The freight charge will be increased by 2 percent in each subsequent year. Sixty-
five percent of the base freight capacity (not including the extra capacity that can be obtained
by utilizing the car storage areas of the boats for freight) will be utilized in the first year that
Island Ferry offers the freight service. A full listing of the freight capacity usage is presented
in Table 4. Income from all sources will be received in cash at the end of each respective
year.
Thirty-two people will be employed at each terminal. They will average earning $35,000 per
year including benefits. In addition, forty people will be assigned to work on each of the
fourteen operating boats. They will average earning $40,000 per year including benefits. In
addition, there will be two maintenance personnel assigned to each terminal. Each
maintenance person will earn $45,000 per year including benefits. Once Island Ferry begins
freight service, it will need 8 additional employees at each freight warehouse. These
employees will earn an average of $45,000 per year including benefits. A three percent
annual salary increase for each employee has been negotiated with the union. Based on
figures reported by the Washington State Ferry System, fuel costs for the operating boats will
are estimated to be $4,000 per day for the large boats and $2,500 per day for the small boats
for each day the boat is in operation (Washington State Department of Transportation 2001b).
Fuel costs are expected to increase by ten percent per year. Island Ferry will enter into a
warranty contract with the boat manufacturer so that it will pay $200,000 per year for each of
the twenty boats in the fleet for repairs and maintenance. The contract is for ten years and the
price will be the same $200,000 per boat for each year of the contract. Utilities at each
terminal will be $240,000 per year starting on the day that the firm begin offering service.
Utilities at the freight warehouse are expected to be an additional $120,000 per year, starting
the day the firm begins offering freight service. Utility prices are expected to increase by ten
percent per year. In addition, after the tax exemption the state has granted Island Ferry
expires five years after you start operating, the firm will have to pay $100,000 in property
taxes on each of the terminal/warehouse facility combinations each year. Food costs are
expected to be 50 percent of the food sales price. Insurance costs will be $8,000,000 per year
covering the boats the passengers, the freight, the employees and the terminals. The
insurance contract calls for Island Ferry to pay the insurance both during the construction
phase and during the operating phase. General administrative expenses will be $300,000 per
year during the construction period and will increase to 500,000 when the firm begins
offering service. General administrative expenses are not expected to change throughout the
first ten years of operation. Marketing Expenses will be $3,000,000 for each year the boats
operate (Island Ferry will not pay marketing expenses during the start-up years). The
insurance and marketing costs will remain constant for ten years. All expenses discussed in
this paragraph, as well as travel agent commissions, are paid in cash at the end of each
respective year.
The Shark Marine Company who recently heard of the venture have agreed to
purchase the entire operation from JTA&T at the end of the seventh year of operation.
JTA&T is not required to sell the operation to them, but have the option to do so if they wish.
The Shark Marine Company has agreed to purchase the operation from JTA&T for
$1,758,500,000. $1,500,000,000 is for the boats, $95,000,000 is for the terminals,
$65,000,000 is for the freight warehouses, $18,500,000 is for the freight handling equipment,
and $80,000,000 is for the land. In addition, JTA&T will be able to withdraw the working
capital from the company immediately prior to the sale. JTA&T has estimated the cost of
capital for this project to be 14.5 percent.
The figures reported here are believed to be reasonably accurate. However, the
primary goal of this paper is as an educational tool. Substantial differences might occur
between what is reported here and what might be expected in any live future implementation
of a ferry boat system.
QUESTIONS
1. Create a cash flow analysis for capital budgeting purposes for this project. Assume
that JTA&T will sell the entire operation to Shark Marine Company at the end of the
seventh year of operations.
2. Use a scientific technique to determine if you should undertake the project.
3. What, if anything, should Sharon do to address Brian’s concerns about an overly
optimistic sales estimate?
4. Discuss modifications to the plans developed here that might improve its chances of
success. It is not necessary to provide a numerical analysis of your recommendations.
REFERENCES
Department of Business, Economic Development and Tourism (DBEDT) [1999], “1999
Annual Visitors Research Report,” www.hawaii.gov/dbedt/
Department of Business Economic Development and Tourism (DBEDT) (2001), “State Fact
Sheet,” www.hawaii.gov/dbedt/.
Wedemeyer, Starr (2001) “Shipping Company Plans for $2.3 Million in Renovations,” West
Hawaii Today, May 14, Local News Section.
United States Coast Guard (1999), Marine Safety Office Honolulu Fact Book, Freight and
Cargo Fact Sheet, Honolulu, Hawaii,
www.uscg.mil/d14/units/msohono/factbook/freightcargo.htm.