Study Case I - New Economy Transport A&B, BMA p168-169
New Economy Transport (A)
Before mentioning the assumptions made to find out the best project, it is important to point out three main assertions given in the text. First, the firm is said to be conservatively financed, and consequently the 11% nominal cost of capital is an adequate discount rate for the project. Also, the overhaul happens in period 0, and consequently the Cash Flow generated by the costs and revenues starts in period 1. Finally, the total book value of the vessel is constituted by its book value plus its spare parts.
The following has been further assumed for the spreadsheets A.1 and A.2 below:
* For the ...view middle of the document...
The reference year for inflation is the first year. Again, since the firm is said to be conservatively financed, the 11% nominal cost of capital is an adequate discount rate for the project. Eventually, it is important to note that the new vessel is built in period 0 and the replacement will happen in period 1. Consequently the Cash Flows generated by the costs and revenues starts in period 1 until period 20.
Moreover, the points below have been agreed upon regarding the calculation of the equivalent annual costs (EAC):
* According to Brealey, Myers & Allen, “most industrial equipment falls into the five-and seven-year classes” of MACRS, which explains the assumption of a similar depreciation schedule as in part A.
* Even if the director could have used the Vital Park as is in period 0, he finally decides to sell it now, and in doing so generates a Cash Flow from asset sales, from which taxes on capital gain need to be deduced.
* For the calculation of the EAC of overhauling, the overhauled Vital Park is considered as including the brand-new machine, since the NPV of this project is higher than without the new machine.
* The EAC of replacing the Vital Park have been evaluated without taking into account neither the revenues generated from operations nor the sale of the old vessel and its incurred tax.
* The non-discounted annual costs are the sum of the costs, the capital investments and the trainings charges, from which the tax shield is subtracted.
* The discount factor for the EAC is taken from the table of Brealey, Myers & Allen book1.
Equivalent Annual Cost of (a) overhauling & operating the...