Depreciation and Vital Spark Essay

p. 182The New Economy Transport companionship (NETCO) was formed in 1955 to carry cargo and passengers between ports in the pacific Northwest and Alaska. By 2008 its fleet had grown to four watercrafts, including a broken dry-cargo vessel, the springy Spark.The decisive Spark is 25 years old and soberly in need of an overhaul. Peter accessible, the finance director, has just been presented with a proffer that would require the following expendituresMr. Handy believes that all these issuelays could be depreciated for revenue enhancement purposes in the seven-year MACRS class.NETCOs chief engineer, McPhail, estimates the postoverhaul in operation(p) salutes as followsThese monetary values more(prenominal) often than not increase with inflation, which is forecasted at 2.5% a year.The Vital Spark is carried on NETCOs books at a net depreciated value of only $100,000, but could plausibly be sold as is, along with an extensive inventory of redeem parts, for $200,000. The bo ok value of the sp are parts inventory is $40,000. Sale of the Vital Spark would generate an immediate tax liability on the engagement between sale price and book value.The chief engineer besides suggests installation of a brand- new-fashioned engine and master system, which would cost an duplicate $600,000.15 This additional equipment would not substantially improve the Vital Sparks performance, but would result in the following reduced one-year fuel, labor, and tutelage costsOverhaul of the Vital Spark would take it out of work for several months. The overhauled vessel would resume commercial service adjacent year. base on past experience, Mr. Handy believes that it would generate revenues of about $1.4 million next year, increasing with inflation thereafter.But the Vital Spark cannot continue forever. rase if overhauled, its useful life is probably no more than 10 years, 12 years at the most. Its salvage value when finally taken out of service will be trivial.p. 183 NET CO is a conservatively financed firm in a mature business. It normally evaluates capital investments using an 11% cost of capital. This is a nominal, not a real, rate. NETCOs tax rate is 35%.QUESTION1.Calculate the NPV of the proposed overhaul of the Vital Spark, with and without the new engine and control system. To do the calculation, you will deal to prepare a spreadsheet table show all costs after taxes over the vessels rest economic life. Take special care with your assumptions about depreciation tax shields and inflation.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 overly 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 areThe crew would require additional training to handle the new vessels 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 homogeneous way as the Vital Spark. However, the new vessel shouldbe 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.Cohn and Doyle offered the new vessel for a fixed price of $3,000,000, payable half directly 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 shes never let us down. Ill bet we could reinforcement her going until next year term Cohn and Doyle are building her replacement. We could use up the spare parts to keep her goin g. We might even be able to sell or challenge her for book value when her replacement arrives.But how do I equate the NPV of a new ship with the old Vital Spark? Sure, I could run a 20-year NPV spreadsheet, but I dont have a clue how the replacement will be used in 2023 or 2028. Maybe I could compare the overall cost of overhauling and operating the Vital Spark to the cost of buying and operating the proposed replacement.QUESTIONS1.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 replacements annual costs are the same or lower?2.Suppose the replacements equivalent annual costs are higher than the Vital Sparks. What additional tuition should Mr. Handy seek in this case?