TO: Potential Investors for IsleMarine Boat Company

FROM: Nick Valdez

DATE: 9/25/2015

SUBJECT: Plan of Production and Cost of Debt Analysis

Overview: The start-up company “IsleMarine Boat Company” is looking to raise capital in order to develop a new product in the boating market. I will present two plans for production and our optimal cost of capital based on the amount of capital needed to start this company.

Problem: Chris Waterson has been involved in the boating business for the majority of his career. He is now looking to enter into the existing market with a brand new product. The challenge in entering this new market is the amount of capital needed. Our first production process (Plan A) we will discuss needs 40 million in capital. Our second production process (Plan B) will need 45 million in capital. Also we must take into consideration is the cost of capital. In our analysis we have calculated our optimal cost of capital.

EBIT and ROI: Plan A is a labor-intensive process that requires less capital but also has higher variable costs. As shown in the appendix, the capital needed for Plan A is 40 million dollars. The advantage of this plan is there is less risk than Plan B and there is less capital required. Through our research we found that there is a 25% probability that unit sales will be 1,800, 50% that unit sales will be 7,000 and 25% probability that the unit sales will be 12,000. By calculating the expected ROI (28.23%) we can predict that Plan A is a viable option and would be favorable over Plan B because it would need less capital and have a favorable expected ROI. In addition to expected ROI we compared the expected ROI’s standard deviation against the two plans. Plan A’s standard deviation was 19.84% versus Plan B’s standard deviation of 20.04%. A startup company must take into account

Breakeven and Indifference Analysis: In the appendix under breakeven sales, you can see the calculation for breakeven point in unit sales for each plan. Plan A takes less unit sales in order to breakeven than Plan B. Plan A’s breakeven unit sales are 1,818 versus Plan B’s are 1,920 unit sales. The indifference points for both plans are also in the appendix. There are two indifference calculations, first is the indifference point for EBIT and the second indifferent point calculates it for ROI. Plan B becomes the favorable plan once the EBIT reaches $1,866,666.67. Once the ROI reaches 56% Plan B is a more favorable option.

Cost of Capital: Our analysis shows several amounts of debt and its corresponding cost of debt associated with that amount. The optimal amount of debt is 28 million. The cost of capital for 28 million in debt is 11.13%. This calculation uses the after tax cost of debt. The weight of debt to achieve this cost of capital is 44%.

TIE Ratio: The TIE ratio for Plan A is 3.67. This proves that though our projected EBIT the company has sufficient earnings to make its debt payments. Plan B’s calculation is 4.08 which is higher than Plan A. The amount of interest

Recommendations: The differences shown between Plan A and Plan B may seem minimal, I think it is in IsleMarine Boat Company’s best interest to choose Plan A. Plan A is advantageous for several different reasons. First, it requires less capital, second it is less risky, and lastly its ROI is higher than Plan B. For all of these reasons mentioned above I would recommend Plan A. As for the Cost of Capital structure, the analysis shows that choosing the 28 million dollar amount along with a 44% weight of debt gives the company the optimal cost of capital.

APPENDIXPlan A: EBIT and ROI Calculation | | | | | | | | | Pessimistic | Most Likely | Optimistic | Sales revenue | $9,900,000 | $38,500,000 | $66,000,000 | Fixed costs | 4,000,000 | 4,000,000 | 4,000,000 | Variable costs | 5,940,000 | 23,100,000 | 39,600,000 | | ---------- | ---------- | ---------- | EBIT | ($40,000) | $11,400,000 | $22,400,000 | ROI | -0.10% | 28.50% | 56.00% | E(EBIT) | | $11,290,000 | | SD(EBIT) | | $7,934,501 | | CV(EBIT) | | 0.70 | | E(ROI) | | 28.23% | | SD(ROI) | | 19.84% | | CV(ROI) | | 0.70 | |

Plan B: EBIT and ROI Calculations | | | | | | | | | Pessimistic | Most Likely | Optimistic | Sales revenue | $9,900,000 | $38,500,000 | $66,000,000 | Fixed costs | 4,800,000 | 4,800,000 | 4,800,000 | Variable costs | 5,400,000 | 21,000,000 | 36,000,000 | | ---------- | ---------- | ---------- | EBIT | ($300,000) | $12,700,000 | $25,200,000 | ROI | -0.67% | 28.22% | 56.00% | E(EBIT) | | $12,575,000 | | SD(EBIT) | | $9,016,478 | | CV(EBIT) | | 0.72 | | E(ROI) | | 27.94% | | SD(ROI) | | 20.04% | | CV(ROI) | | 0.72 | |

The difference in expected EBIT between the two plans in not significant compared to the standard deviation EBIT. This comparison shows the significant riskiness of Plan B.

Cost of Capital Calculations: | | | | | | | | | | | | | | After-tax | | | | | | | Cost of | Cost of | | | Weight of | Wt. of | Cost of | Debt | Equity | Debt | Equity | Debt | equity | Capital | ------ | ------ | --------- | --------- | ------ | ----- | -------- | 0.00% | 12.00% | $0 | $56,450,000 | 0.00% | 100.00% | 12.00% | 5.40% | 13.00% | $14,000,000 | 46,292,308 | 41.54% | 58.46% | 11.24% | 6.60% | 15.00% | $28,000,000 | 32,840,000 | 44.00% | 56.00% | 11.13% | 8.40% | 18.00% | $42,000,000 | 18,033,333 | 46.67% | 53.33% | 11.28% | 10.80% | 23.00% | $56,000,000 | 3,156,522 | 46.96% | 53.04% | 11.45% |

The highlighted row is the optimal cost of capital. The company should use the 44% weighted debt and the 56% weight of equity to raise their capital needed.