I must have the formula calculation view from the spreadsheet to s.pdf
- 1. I must have the formula / calculation view from the spreadsheet to solve the questions. So instead of just seeing that cell A25 is $XX.00, it should show the formula i.e. =A1*B2+A1. Thank you! Rio Claro, Inc. (RCI) is in the business of transporting cargo between ports in California and Washington. Its fleet includes a small dry-cargo vessel, theMaracas. The Maracas is 25 years old and badly in need of an overhaul. It is March 2016, and Michael John, the finance director, has just been presented with a proposal that would require the one-time expenditures shown below in Table 1. If the proposal is accepted, these expenditures will be made in the next few days. Mr. John believes that all these outlays could be depreciated for tax purposes in the seven-year MACRS class (see Table 2 below for rates). Overhaul of theMaracas will begin as soon as the expenditures in Table1 are made, but the vessel will be out of service for several months. The overhauled vessel would resume commercial service in one year. RCI’s chief engineer’s estimates of the post-overhaul operating costs are in Table 3. In addition to the overhaul described above, the chief engineer suggests installation of a brand- new engine and control system. Installation of this new engine would cost an extra $600,000 (This additional outlay would also qualify for tax depreciation in the seven-year MACRS class.). However, if the additional equipment is installed, it would result in reduced fuel, labor, and maintenance costs as shown in Table 4. The operating cost estimates in Tables 3 and 4 are current for March 2016. However, these costs will increase with inflation, which is forecasted at 1.25% a year. Depreciation and operating costs attributable to the overhaul of theMaracaswill begin one year after the vessel is put back into commercial service. The revenues from operating the vessel will be the same for both types of overhaul. Even with the proposed overhaul, the Maracas cannot continue forever. After the overhaul, its remaining useful life is estimated to be only 12 years. Its salvage value when finally taken out of service will be trivial. Thus, Mr. John feels it is unwise to proceed without also considering the purchase of a new vessel. Racette & Sons (R&S), a Colorado shipyard, has approached RCI with a design incorporating a Kort nozzle, extensively automated navigation and power control systems, and much more comfortable accommodations for the crew. R&S is offering the new vessel for a fixed price of $3,000,000, payable half immediately and half on delivery in one year. Estimated annual operating costs of the new vessel are in Table 5. The operating cost estimates in the table are current for March 2016, but will increase with inflation. The crew would require additional training to handle the new vessel’s more complex and sophisticated equipment. Training would result in a one-time cost of $50,000 payable one year
- 2. following delivery of the new vessel. This cost is tax deductible. The estimated operating costs for the new vessel assume that it would be operated in the same way as the Maracas. However, the new vessel will be able to handle a larger load on some routes, which is expected to generate additional revenues, net of additional operating costs, of approximately $175,000 per year in the first year of operation. These revenues are expected to grow at the rate of inflation. Revenues and operating costs from the new vessel will begin one year after it is delivered. The new vessel is estimated to have a useful service life of 20 years, but it will be depreciated for tax purposes according to the 7-year MACRS schedule. The new vessel is not expected to have any resale value at the end of its 20-year useful life. All revenues and costs (including depreciation) associated with the new vessel will begin one year after it is delivered. The Maracas is carried on RCI’s books at a book value of only $100,000, but could probably be sold “as is,” together with its extensive inventory of spare parts, for $200,000. The book value of the spare parts inventory is $40,000. Mr. John stepped out on the foredeck of the Maracas 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 Racette & Sons are building her replacement. We could use up the spare parts to keep her going. We should even be able to sell or scrap her for book value when her replacement arrives.” RCI evaluates capital investments of this type using a 8.5% cost of capital. (This is a nominal, not real, rate.) RCI’s tax rate is 35%. Table 1: Overhaul Expenditures Overhaul engine and generators $340,000 Replace radar and other electronic equipment 75,000 Repairs to hull and superstructure 310,000 Painting and other repairs 95,000 $820,000 Table 2: Depreciation (in %) for the 7-year Modified Accelerated Cost Recovery System Year 1 14.29 Year 2 24.49
- 3. Year 3 17.49 Year 4 12.49 Year 5 8.93 Year 6 8.93 Year 7 8.93 Year 8 4.45 Table 3: Post-overhaul Operating Costs (Basic Overhaul) Fuel $450,000 Labor and benefits 480,000 Maintenance 141,000 Other 110,000 $1,181,000 Table 4: Post-overhaul Operating Costs (Overhaul plus new engine & contro system) Fuel $400,000 Labor and benefits 405,000 Maintenance 105,000 Other 110,000 $1,020,000 Table 5: Operating Costs of New Vessel Fuel $380,000
- 4. Labor and benefits 330,000 Maintenance 70,000 Other 105,000 $885,000 Please take the time to answer all questions correctly and I will provide a very high rating. QUESTIONS (Show all work/calculations): What is the present value of the proposed overhaul of the Maracas WITH the new engine and control system? Show all work and cash flows used. What is the present value of the proposed overhaul of the Maracas WITHOUT the new engine and control system? Show all work and cash flows used. Should the company do the basic overhaul, or the expanded overhaul with the new engine and control system? Show all work and cash flows used. Choose only 1. What is the present value of buying and operating the new vessel? Show all work and cash flows used. What is the equivalent annual costs: (a) overhauling and operating the Maracas for 12 more years (WITH and WITHOUT the new engine and control system) and, (b) buying and operating the proposed replacement vessel for 20 years?(You should use the real discount rate for this analysis). Show all work and cash flows used. Based on your calculations, which of the 3 options should the company choose? Why? Overhaul engine and generators $340,000 Replace radar and other electronic equipment 75,000 Repairs to hull and superstructure 310,000 Painting and other repairs 95,000 $820,000 Solution Answer
- 5. Notes RCI evaluates capital investments of this type using a 8.5% cost of capital. (This is a nominal, not real, rate.) (1 + nominal rate) = (1 + real rate) (1 + inflation rate) (1 + 0.085) = (1+ Real rate) ( 1+ 0.0125) (1.085) = (1+ Real rate) (1.0125) (1+ Real rate) = (1.085)/ (1.0125) (1+ Real rate) = 1.071605 Real discount rate = 0.071605 Real Discount rate = 7.1605% Answer 1 What is the present value of the proposed overhaul of the Maracas WITH the new engine and control system?Show all work and cash flows used. Year Overhaul Cost New Engine and Control system Total Captial Cost MACR Depreciation rate Depreciation Depreciation Tax Benefits A B C D E F A+B C*D E*0.35 0 1 820000 600000 1420000 14.29% 202918
- 7. 7 820000 600000 1420000 8.93% 126806 44382.1 8 820000 600000 1420000 4.45% 63190 22116.5 Year Initial Overhual cost New Engine and Control system Post overhaul Operating cost after tax Benefit Depreciation Tax Benefits Real Discount rate = 7.1605% Present value A B C D E F 400000+405000+105000+110000*(1-taxrate) As per above table A+B+C+D E*F 0 -820000 -600000 0 0
- 10. -663000 0.54 -355796 10 0 0 -663000 0 -663000 0.50 -332022 11 0 0 -663000 0 -663000 0.47 -309836 12 0 0 -663000 0 -663000 0.44 -289132 Net Present value -6250484 Answer 2 What is the present value of the proposed overhaul of the Maracas WITHOUT the new engine and control system?Show all work and cash flows used. Year Overhaul Cost MACR Depreciation rate Depreciation
- 12. 73226 25629.1 7 820000 8.93% 73226 25629.1 8 820000 4.45% 36490 12771.5 Year Initial Overhual cost Post overhaul Operating cost Depreciation Tax Benefits Cash Flows Real Discount rate = 7.1605% Present value A B C D E F 450000+480000+141000+110000*(1-taxrate) As per above table A+B+C D*E 0 -820000 0 0 -820000 1 -820000
- 15. -767650 0 -767650 0.467324 -358741 12 0 -767650 0 -767650 0.436097 -334770 Net Present Value -6639735 Answer 3 The company should do the expanded overhaul with the new engine and control system as net Present value is more positive (-62,50,484) for expanded overhaul with the new engine and control system compared to basic overhaul (-66,39,735). Year Overhaul Cost New Engine and Control system Total Captial Cost MACR Depreciation rate Depreciation Depreciation Tax Benefits A B C D E F A+B C*D E*0.35 0 1