Minicase

Memo For New Economy Transport Company

Project: Overhaul and Replacement of Vital Spark

Author: Yingchen Liu

Date: 02/11/2015

For the New Economy Transport Company, we have actual three choices to overhaul or to replace a new vessel:

The first choice is to overhaul the Vital Spark without new engine and control system. If you choose this method, the Vital Spark will has a 12-year use life, you need to pay $820,000 overhaul expenditure, depreciation for seven years use MACRS; the operating cost is $1,181,000, increase with inflation, which is forecasted at 2.5% a year; The operating revenue is $1,400,000 next year, increasing with inflation; the net present value for 12 years is $272,000. [The calculation is in the Appendix B]

The second choice is to installation of a brand-new engine and control system. If you choose this method, the Vital Spark also will has a 12-year use life, but you need to pay $1,420,000 overhaul expenditure, depreciation for seven years use MACRS; however, the operating cost will decrease, the cost is $1,020,000, increase with inflation, which is forecasted at 2.5% a year; The operating revenue is still $1,400,000 next year, increasing with inflation; the net present value for 12 years is $577,000. [The calculation is in the Appendix C]

The third choice is to purchase of a new vessel. If you choose this method, it will has a 20-year use life , but you need to pay the fixed price of $3,000,000, payable half immediately and half on delivery next year, depreciation for seven years use MACRS; Also, you need to pay the training cost $50,000; the operating cost is $885,000, increase with inflation, which is forecasted at 2.5% a year; The operating revenue will increase to $1,500,000, increasing with inflation; the net present value for 20 years is $1,581,500 . [The calculation is in the Appendix D]

It seems that the third choice, purchase of a new vessel have the highest NPV, which is $1,581,500, compared to the $577,000 of...