Handy feels it unwise to proceed without also considering the purchase of a new 

vessel. Cohn and Doyle Inc., an Australian shipyard, has approached NETCO

with an offer for a new vessel, the Galeota Passage, 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$-$ $ $380,000\mathrm{.}00$; labour & benefits$-$ $ $330,000\mathrm{.}00$; Maintenance $-$ $ $70,000\mathrm{.}00$ and other $-$ $ $105,000\mathrm{.}00.$

The 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 same way as the ReRe 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. 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 ReRe Spark as she chugged down

the bocas. A rusty old tub, he muttered, but shes never let us down. Ill 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 ReRe Spark? Sure, I

could run a $20-$year NPV spreadsheet, but I dont have a clue how the

replacement will be used by the end of that time. Maybe I could compare the

overall cost of overhauling and operating the ReRe 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 ReRe 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?

$(7$ marks$)$

$2.$ Suppose the replacements equivalent annual costs are higher than the

ReRe Sparks$.$ What additional information should Mr$.$ Handy seek in

this case?

Answer rating: 100% (QA)

To compare the equivalent annual costs of overhauling and operating the ReRe Spark for 12 more years with buying and operating the proposed replacemen... View the full answer