International Research Journal of Applied Finance ISSN 2229 6891

Vol. VI Issue 1 January, 2015 Case Study Series

Project Evaluation: Tortuga Fishing Equipment Company

Judson W. Russell
Abstract
This case study on project evaluation is applicable for beginning courses
in corporate finance or finance strategy. Two alternative investment
options are available to evaluate. Challenges are presented with the
inclusion of equity, bank debt, and bonds in the capital structure. Each
investment option need to be evaluated carefully and decision should be
made on the basis of thorough analysis of the data available using
various capital structure and capital budgeting techniques.
Keywords: Beta, Corporate Finance, Cost of Capital, Internal Rate of
Return, Net Present Value
Introduction
Brooks Hamilton recently accepted a job with Tortuga Fishing Equipment
Company1 (Tortuga) in the companys finance department. His first few
assignments were fairly straightforward and Brooks relied on his
background in both accounting and finance to get his career off to a
great start. His manager, the companys Chief Financial Officer (CFO) was
impressed with his work and decided to put Brooks on a new assignment.
The firm was embarking on a new project which would define its future
over the upcoming years. Given the importance of the project and
high degree of visibility with the firms senior management, Brooks was
flattered to be asked to assist and eager to show that he was up to the
task. The finance department was tasked with preparing an analysis to
make a decision between two competing project plans which could very
well decide the future of Tortuga in the competitive fishing equipment
industry. The Chief Executive Officer (CEO) wants to have an answer from
finance and expects a thorough analysis very quickly.
The Company
Tortuga is an Islamorada, Florida based company specializing in
manufacturing high-end fishing rods and reels. Tortuga was founded by a
retired university professor who fished all of his life and wanted to
create the best equipment possible to handle a variety of fishing
conditions and fish species. He partnered with an engineer who ran a
machine shop to produce some prototype reels and supplied these to
commercial fishing captains as test market research. The equipment
produced by Tortuga was a significant improvement over the current line
available and orders were strong. Through the years, the company made
some modest improvements to their original prototype and had become an
industry leader.
Tortugas products are used by tournament fishing teams around the world.
Over the past decade, tournament fishing has grown to become a big
business with corporate endorsements and prize money. This growth has
made what was once a recreational vocation into a full-time profession
for some anglers.

The company recently launched an extensive research and development

effort focused on a new flyrod and reel designed for one particular
species of fish, the Atlantic Tarpon (Megalops atlanticus). Tarpon are
long-lived fishes that migrate in the warmer climes of the Caribbean Sea,
Gulf of Mexico, and along the Atlantic Ocean coastlines. Although the
fish can reach lengths of eight feet (~2.4 meters) and weights of 280
pounds (127 kilograms), they inhabit the shallow flats and exhibit
acrobatic leaps when hooked. These traits make tarpon a popular game fish
for anglers. Fishing gear needs to be sturdy to handle the power of these
fish and Tortuga had developed products for this niche market which were
allowing anglers to be successful in their angling pursuits.
Recently, several sponsors had come together to launch competitive
angling events called tournaments, where the best anglers vie to catch,
and then release, the most and largest tarpon. Winners may receive up to
$50,000 in a single weekend tournament and the difference between
winning and losing could be a few pounds. With so much money at stake,
tournament teams purchase the best gear available and are always looking
for any competitive advantage with their equipment. Tortuga is looking to
capitalize on this trend by offering a new line called the Tortuga Tarpon
Classic. This new line incorporates the latest material and design
improvements and is predicted to be the gold standard for all serious
tournaments anglers. Tortuga plans to offer the Tortuga Tarpon Classic to
recreational anglers as well to capture the growing demand by affluent
anglers who want the same high-quality gear as the professionals.
Financial Information
Tortuga began with a modest amount of capital that the founder had
managed to save during his years in academia. As the firm grew, its
financing needs expanded as well. Through the years Tortuga had developed
and maintained a strong relationship with a large bank which provided
short-term working capital funds in the form of a revolving line of
credit. When a funding need arose, Tortuga would draw from this line of
credit and then repay the short-term draw as cash flowed back to Tortuga.
The $200 million revolving line of credit currently has $25 million
drawn at an interest rate of 3-month Libor plus 350 basis points2. The
remaining $175 million credit line can be assumed to have no fees
associated with it3. Brooks looks up the most recent 3- month U.S. dollar
Libor rate and sees that it is 1.50%.
Long-term financing was also in place in two forms. After several years
of revenue and earnings growth, Tortuga issued five million shares of
common stock at an issue price of $10 per share. The firm used this $50
million in funding to increase production lines and build a global
presence by opening an additional manufacturing facility in Panama.
Brooks finds the current price per share for Tortuga to be $16. Two years
ago, Tortuga issued a 10-year bond for $50 million face value. Each
$1,000 par bond carries a coupon of 8.5%. The bond pays interest
semi-annually and is currently trading in the market at $102.50 as a
percent of par. The company has a 34% corporate tax rate.

The firm calculates its required return on equity with the Capital Asset
Pricing Model (CAPM) using a 4.0% historical Treasury rate for the riskfree rate and 6.0% for the market return.

The annual stock returns versus the market are shown in Figure 1 below
for the past 10 years. Beta is calculated by regressing Tortuga stock
returns on the Standard & Poors (S&P) 500 returns. There are a variety
of methods for calculating beta.
Brooks only has 10 years of annual data available at the time and decides
to conduct the analysis with this information to get a quick response. He
will check his result with more data points before submitting his final
report to the CFO.
Figure 1 Returns on Tortuga Stock versus the Standard & Poor 500
Year Tortuga Return S&P 500 Return
Year
1
2
3
4
5
6
7
8
9
10

Tortuga Return
12
22
-2
14
9
19
16
-10
7
12

S&P 500 Return

7
16
-3
9
8
21
17
-5
9
14
Source: Author

After Brooks calculates beta he employs CAPM along with the risk-free
rate and market return rate to determine the cost of equity. The firms
weighted average cost of capital is a function of its equity market
capitalization, cost of equity, short- and long-term debt amounts
and costs, and the tax rate. Using formula (1) below, Brooks can find the
firms weighted average cost of capital (WACC).
WACC = Rd * D + Re*(E/D+E)
where:
WACC = weighted average cost of capital
Rd = Cost of Debt Rd1 (1-marginal tax rate)
Rd1= Companys before tax rate
D= weighted percent of debt
E= weighted percent of equity
Re = Cost of equity Rf +B*(Rm-Rf)

(1)

Rf= risk free rate

B= Beta
Rm= equity risk premium = (risk free rate market rate)
Tortuga Tarpon Classic
The company has two separate research teams working on the project and
they develop two distinctly different fishing combinations. The two rod
and reel combinations are test marketed with guides and past tournament
champions and demand forecasts are determined. Most fishing gear has a
relatively short life due to continual product innovation. Manufacturing
of the two combinations is estimated to require an upfront cost of $5
million to retool the machine shop. The process for manufacturing the two
combinations differ and ongoing variable costs are not the same. The net
cash flows for the entire ten year expected life of the product is shown
in Figure 1 as Project A and Project B (all figures are $thousands of net
cash flow).
Project A focuses on hand tooled fishing equipment which results in a
more labor intensive process, but also allows for personalized features
for customers. The price charged for customization offset the slower hand
tooling process to generate substantial net cash flows. Part of the
upfront $5 million includes the costs of training more machinists in the
art of hand tooling, which is similar to watch making but with a few less
moving parts. Project A is anticipated to generate lower cash flows in
the early years due to the length of time required to get machinists
who are adept at hand tooling to customer specifications. In fact, during
the first year there will be continued expenses to attain these skills
which causes year one net cash flows to be negative. Over time the cash
flows increase as more machinists gain proficiency. The project is
expected to experience lower cash flows towards the end of its life due
to market saturation. Due to the quality of the reels, they are built to
last and seldom fail or wear out. Technological obsolescence is certain
although Tortuga will be investing cash flows into research and
development to launch the next generation at the conclusion of the
Tortuga Tarpon Classic life cycle.
Project B employs a mechanized approach to large scale production of
standardized equipment. Although the approach does not allow for
personalization, it does allow Tortuga to build its inventory quickly and
capture positive net cash flows immediately. The upfront expense is
almost completely devoted to tooling equipment procurement and the number
of units produced will be much higher and at lower price points than the
approach of Project A. At the end of both projects life it is assumed
that there will be zero salvage value as the pace of innovation will
require a complete re-tooling for the next generation and the useful life
of the equipment will have been fully realized.
Brooks realizes that he will need to calculate the firms cost of capital
discount rate and apply this to the cash flow projections of both
projects. He recalls all of the assignments he completed at university
and is thankful to have been so well-prepared for this task. He gets a
cup of coffee, sits down at his desk, and gets to work.

Figure 1 Project Net Cash Flows for Tortuga Fishing Equipment

($thousands)
Year
Project A
1
-900
2
200
3
900
4
1800
5
2500
6
2500
7
1800
8
1200
9
800
10
200
Source: Author

Project B
950
950
950
950
950
950
950
950
950
950

Since Brooks is new to his role, you have been asked to review his work
and assess the financial viability of the projects. Given the importance
of this decision you are helping to make sure the firm makes the right
choice.
Notes:
1. Fictitious company created to illustrate corporate finance principles.
2. Libor is an acronym for London Interbank Offered Bank, which is a
standard floating interest rate benchmark for
credit facilities. A basis point is equal to 1/100th of 1%. One percent
is 100 basis points.
3. Typically a bank will charge a facility fee for the entire credit
facility, $200 million in this case and an interest rate
based on utilization. We assume no facility fee for simplicity.
4. The risk-free rate is determined based on the geometric average of the
long-term Treasury.
Specific Questions
1. Using the Capital Asset Pricing Model, what is the required rate of
return on equity, Re (cost of equity) for Tortuga?
2. What are the weights of equity and debt in the
capital structure? (Rd & Re)
3. Using the information provided, what is the firms weighted average
cost of capital (WACC)?
4. What are the net present value (NPV), internal rate of return (IRR),
and Payback Periods for Projects A & B?
5. What decision rules will you use to help Tortuga reach a decision?
6. What are the strengths and weaknesses of each of the evaluation tools?
Author
Judson W. Russell, Ph.D, CFA
Clinical Professor of Finance, Belk College of Business, University of
North Carolina Charlotte,
jrussell@uncc.edu

As modified by Professor William Keller