New Economy Transport (Revised)
The New Economy Transport Company (NETCO) was formed in 1952 to carry
cargo and passengers between ports in the Pacific Northwest. By
its fleet had grown to four vessels, one of which was a small dry-
cargo vessel, the Vital Spark.
The Vital Spark is badly in need of an overhaul. Peter Handy, the
finance director, has just been presented with a proposal, which would
require the following expenditures at the start of 2016:
New engine and associated equipment
Radar and other electronic equipment
Repairs to hull and superstructure
Painting and other maintenance
NETCO's chief engineer, McPhail, estimates the post-overhaul operating
costs for 2016 as follows: 2
Labor and benefits
The Vital Spark is carried on NETCO's books at a net value of
$350,000, but could be sold now "as is" for $550,000. If the Vital
Spark is overhauled, the $350,000 book value can be fully depreciated
There is no question that the Vital Spark needs a new engine and
general overhaul for the 2016 season. However, Mr. Handy feels it
unwise to proceed without also considering the purchase of a new boat.
Cohn and Doyle, Inc., a Wisconsin shipyard, has approached NETCO with
a new design incorporating a Kort nozzle, extensively automated
navigation and power control systems, and much more comfortable
1 The repairs and painting and other maintenance can be expensed in 2016. The new engine, radar, and other
equipment falls into the five-year MACRS class and must be depreciated starting in 2016. The overhaul can be
done without losing any operating time.
In future years, estimates of costs and revenues will increase with inflation. Mr. Handy's bankers have suggested
that inflation will average 3 percent a year.
accommodations for the crew.
Estimated annual operating costs of the
new boat for 2016 are:
Labor and benefits
The crew would require additional training to handle the new boat's
more complex and sophisticated equipment and this would probably lead
to additional costs of $140,000 at the beginning of 2016.
The estimated operating costs for the new boat assume that it would be
operated in the same way as the Vital Spark. However, the new boat
should be able to handle a larger load on some routes, and this will
generate additional revenues, net of additional out-of-pocket costs,
of $150,000 per year. Moreover, a new boat would have a useful
service life of 12 years. After 12 years it would not have any value.
The Vital Spark with an overhaul could not last that long - probably
only 8 years. At that point it would be worth only its scrap value of
about $100,000. Cohn and Doyle have offered the new boat for a fixed
price of $4,400,000, payable on delivery at the start of 2016.
NETCO is a private company, soundly financed and consistently
profitable. Cash on hand is sufficient to rehabilitate the Vital
Spark but not to buy the new boat. However, Mr. Handy is confident
that the funds necessary to purchase the new boat can be readily
obtained in the capital markets. NETCO has estimated that its
opportunity cost of capital for major business investments is
currently 15%. Mr. Handy feels that this is a reasonable number to
use for the dry-cargo business.
Required: Calculate equivalent annual costs of the two alternatives -
overhauling the current boat and buying a brand-new boat. To do the
calculation, prepare a spreadsheet table showing all costs after taxes
over each investment's economic life. Make assumptions as necessary.
Be sure to include the effects of inflation. The tax rate for NETCO
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