Zandts’ Charter Sailboat
After spending over a decade of 12-hour workdays in successful management jobs, Barbara and Jim Zandt were in a comfort-able financial position. But they had no time for themselves. Feeling a strong need to get away, the couple took a vacation on a charter sailboat out of St. Thomas in the Virgin Islands. By the end of the week, they decided this was where they wanted to spend their lives. For the next 2 years, they spent all of their vacation time in sailing courses and all of their spare time studying, both to enhance sailing skills and to understand the charter business.
The Zandts learned that most charter sailboats were owned by wealthy individuals who used the boats as tax-shelter investments, spending no more than two weeks a year on their boats. By joining several sailing clubs, advertising in a sailing magazine, and inquiring among their personal contacts, they found a physician who agreed to purchase a sailboat as an investment. The physician would bear all operating costs as the owner, while the Zandts would receive a percent of gross charter fees for their services as captain, crew, and manager.
The arrangement worked fine for 5 years, but the tax laws changed during that 5-year period. Typically, boats were kept in charter for 5 years, until the advantages of rapid depreciation had been used up. The owner would then trade for a new boat or pull the old boat out of charter service for personal use. Unfortunately, the new tax law eliminated investment tax credits and decreased the rate of depreciation. The physician wanted to sell the 5-year-old boat and did not want to re-place it. Finding another investor seemed unlikely in the new tax environment. If they wanted to continue in this lifestyle, they would have to buy a boat themselves.
The Zandts faced several alternatives. They could buy the current 5-year-old boat from the physician for $50,000. It was due for refurbishing, which would cost $10,000. If they kept this boat for 5 years, it could be sold for approximately $25,000. If they kept this boat for 10 years, it could be sold for $15,000, but an over-haul after 5 years would cost $20,000.
Another alternative was to buy a new boat for $100,000. At the end of 5 years, the alternatives with the new boat would be the same as those with the existing boat. It could be sold for $50,000 or refurbished and kept for either 5 or 10 more years, with an overhaul when it was 10 years old if it were kept for 15 years.
A newer boat would attract more charter business and bring higher weekly fees. Barbara and Jim estimated that revenue per year during the first 5 years of a boat's life would be $50,000, but revenue would decline to $45,000 a year in the second 5 years and $40,000 a year in the third 5 years. The opposite would happen with operating expenses. Annual operating expenses would be $20,000 during the first 5 years, $25,000 during the second 5 years, and $30,000 during the third 5 years.
A new boat would be nice. The Zandts would have to spend less time on maintenance, and would have more time for pleasure. Also, it was fun to buy a new boat. On the other hand, their net worth was $200,000, and they were hesitant to sink half of it into one investment. A boat dealer had suggested that they could avoid the use of their capital by making a 25 percent down payment and borrowing the rest at a 12 percent annual interest rate. This, though, did not seem wise when they were only earning 10 percent on their own investments, which they guessed to be of similar risk to a boat. The dealer pointed out that the interest payments would be tax deductible, but the Zandts were in an income category that made taxes a negligible consideration.
Case Questions
1. List the alternatives to the Zandts.
2. Identify cash flows, net present value, and equivalent annuity for each alternative.
3. Discuss the risks that are inherent in each alternative.
4. Do the Zandts have a competitive ad-vantage? Is there anything they can do to create or enhance a competitive advantage?
5. Which alternative would you recommend? Why?