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Maine Marine Supply, Inc.
Teaching Commentary
OVERVIEW
This case represents a straightforward problem in capital expenditure analysis, with two complications. The
ANSWERS TO ASSIGNMENT QUESTIONS
Questions 1 and 2
See EXHIBIT 1
What About the Land?
1) Sell the land now for $1,500 or do the Navy deal?
2) But, if we do the contract, we still have the land in five years.
Value in five years?
Maine Seacoast Land Appreciation:
PV now of the land sale in five years?
3) But, should a manufacturing plant be built on ocean front resort property?
1) This suggests we do the deal on an industrial site. The company can speculate in the seacoast land, if it
chooses.
Questions 3 and 4
1) Will the Navy accept our forecast when it shows a 15% IRR?
This reduces the IRR to 9.8% :
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TEACHING STRATEGY
The calculations for the case are difficult for students, but not overwhelming. Some students will forget to exclude
financing issues when they do the five-year forecast. The case provides a good opportunity to review the logic for
keeping financing considerations separate from investment considerations.
In this case, where the project is self-contained, the incremental IRR is a good proxy metric for ROA.
Here, the projected return of 15% looks too high to the government. The low risk of a guaranteed government order
implies a lower hurdle rate from the government’s perspective.
Whether it would be okay to allocate some corporate overhead to the project is contentious. It can be
argued that all parts of MMS, including the sea bags factory, should be assigned a share of corporate overhead. A
rate of about 5% of sales would be typical. It can also be argued that the sea bags contract will not increase
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Exhibit 1
Five-Year Cash Flow Forecast
Ignoring Land Value
YEAR
1
2
3
4
5
At
Terminatio
n
Depreciation (MACRS)
Building
Equipment
50
160
90
256
72
154
58
92
46
92
TOTAL
210
346
226
150
138
540
334
381
381
315
189
117
133
133
110
Investment
W/C
Equipment
Building
Investment Recovery
W/C
425
Tax saved on write-offs
Equipment
Building
IRR = 18.5
NPV(@15%) = $149
Payback = 3.32 Years
750
680
607
531
453
BUT, THIS IS AN INCOMPLETE ANALYSIS BECAUSE OF LAND VALUE.