Economy Shipping

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Submitted By cyuenshan
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Economy Shipping Company (Abridged)

Question 1. What are the relevant cash flows under each of the two alternatives? And in what years do they occur?

Alternative 1: Rehabilitation of the Conway

We decided to divide this alternative in two parts. Part A is Rehabilitation without parts and Part B is Rehabilitation with parts.

Facts/Assumptions

• Conway’s additional useful life of 20 years. • Book value of Conway: $39,500 • Market value of Conway: $25,000. This is the Opportunity Cost of not selling the Conway at year 0. • Rehabilitation costs: $115,000. If spare parts are used, rehabilitation costs would be $71,500. • Book value of spare parts if used on the Conway: $43,500. • Market value of spare parts: $30,000. This is the Opportunity Cost of not selling the spare parts at year 0. • Annual operating costs of Conway: $203,150 • No dismantling and scrapping costs at the end of useful life (This will be covered by the value of the scrap and used parts). • Return of 10% after taxes. • Tax rate: 48% • Book cost of Conway, including rehabilitation costs, would be depreciated over a 20-year period. • Depreciation according to the straight line method = (Cost - Residual value) / Useful life. For the rehabilitation alternative, residual value is zero at the end of year 20. • ATCF(After-tax cash flow) will be calculated using the formula = Operating Costs after taxes plus Tax shields from depreciation.

Part A: Rehabilitation without parts

Depreciation =(39500+115000)/20 = $7725 per year.
Tax shield from depreciation = $7725*0.48 = $3708 per year
Here are the depreciation cash flows, the tax shields from depreciation and their present value:

|BOOK VALUE |$39,500.00 | | | |
| | | |…...

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