New Economy Transport (B) There is no question that the Vital Spark needs an ove
ID: 2725553 • Letter: N
Question
New Economy Transport (B)
There is no question that the Vital Spark needs an overhaul soon. However, Mr. Handy feels it
unwise to proceed without also considering the purchase of a new vessel. Cohn and Doyle, Inc., a
Wisconsin shipyard, has approached NETCO with a design incorporating a Kort nozzle, extensively
automated navigation and power control systems, and much more comfortable accommodations
for the crew. Estimated annual operating costs of the new vessel are:
Fuel $380,000
Labor and benefits 330,000
Maintenance 70,000
Other 105,000
$885,000
The crew would require additional training to handle the new vessel’s more complex and sophisticated
equipment. Training would probably cost $50,000 next year.
The estimated operating costs for the new vessel assume that it would be operated in the same
way as the Vital Spark. However, the new vessel should be able to handle a larger load on some
routes, which could generate additional revenues, net of additional out-of-pocket costs, of as
much as $100,000 per year. Moreover, a new vessel would have a useful service life of 20 years or more.
Year
Depreciation
1
14.29%
2
24.49%
3
17.49%
4
12.49%
5
8.93%
6
8.92%
7
8.93%
8
4.46%
Cohn and Doyle offered the new vessel for a fixed price of $3,000,000, payable half immediately
and half on delivery next year.
Mr. Handy stepped out on the foredeck of the Vital Spark as she chugged down the Cook Inlet.
“A rusty old tub,” he muttered, “but she’s never let us down.” I’ll bet we could keep her going until
next year while Cohn and Doyle are building her replacement. We could use up the spare parts to
keep her going. We might even be able to sell or scrap her for book value when her replacement
arrives.
“But how do I compare the NPV of a new ship with the old Vital Spark? Sure, I could run a
20-year NPV spreadsheet, but I don’t have a clue how the replacement will be used in 2027 or
2032. Maybe I could compare the overall cost of overhauling and operating the Vital Spark to the
cost of buying and operating the proposed replacement.”
QUESTIONS
1. Calculate and compare the equivalent annual costs of (a) overhauling and operating the
Vital Spark for 12 more years, and (b) buying and operating the proposed replacement vessel
for 20 years. What should Mr. Handy do if the replacement’s annual costs are the same or
lower?
2. Suppose the replacement’s equivalent annual costs are higher than the Vital Spark ’s. What
additional information should Mr. Handy seek in this case?
Year
Depreciation
1
14.29%
2
24.49%
3
17.49%
4
12.49%
5
8.93%
6
8.92%
7
8.93%
8
4.46%
Explanation / Answer
The assumptions taken as per details given in the problem
The estimated annual operating cost of new vessel of
Fuel $380,000
Labor and benefits 330,000
Maintenance 70,000
Other 105,000
Total of $885,000
It also given that estimated annual operating cost is equal to existing vessel vital spark as the annual cost of $885,000 of overhauling and operating the Vital Spark for 12 more years
There is no tax rate given
the cost of capital is not given
the depreciation is useful in when tax rate is treated as expense and after tax cash inflow are effected in project NPV calculation
Now we calculate the annual cost if buying and operating the proposed replacement vessel
For 20 years
the cost of machinery is $3000,000
there will an additional operating cost of $50,000 in training the employees in new vessel
the total cost is $ 3050,000 adding both above
the annual cost is $1,52,000 (3,050,000 /20)
the annual net income is $100,000
the net increase in additional annual cost is = 152,000 – 1,00,000 = $52,000
the annual operating cost is $885,000 of fuel ,labor and benefits ,maintenance and others
the total annual cost is =885,000 +52,000 = $937,000
If replacement cost is equal and lower than go for purchasing the new vessel
. Suppose the replacement’s equivalent annual costs are higher than the Vital Spark ’s. What
Additional information should Mr. Handy seek in this case?
The tax rate as the depreciation expense benefit will adjusted in cashinflow
Related Questions
drjack9650@gmail.com
Navigate
Integrity-first tutoring: explanations and feedback only — we do not complete graded work. Learn more.