Problem 1 (18 points)

The New Economy Transport Company (NETCO) was formed in 1959 to carry cargo and passengers between ports in the Pacific Northwest and Alaska. By 2015 its fleet had grown to four vessels, including a small dry-cargo vessel, theVital Spark.

TheVital Sparkis 25 years old and badly in need of an overhaul. Peter Handy, the finance director, has just been presented with a proposal that would require the following expenditures:

Mr. Handy believes that all these outlays could be depreciated in the seven-years.

NETCO's chief engineer, McPhail, estimates the post overhaul operating costs as follows:

The chief engineer also suggests installation of a brand-new engine and control system, which would cost an extra $600,000. This additional equipment would not substantially improve theVital Spark's performance, but would result in the following reduced annual fuel, labor, and maintenance costs:

Overhaul of theVital Sparkwould take it out of service for several months. The overhauled vessel would resume commercial service next year. Based on past experience, Mr. Handy believes that it would generate revenues of about $1.4 million next year and for the following years. But theVital Sparkcannot continue forever. Even if overhauled, its useful life is probably no more than 12 years at the most. Its salvage value when finally taken out of service will be trivial.

NETCO is a conservatively financed firm in a mature business. It normally evaluates capital investments using an 11% cost of capital. This is a nominal, not a real, rate. NETCO's tax rate is 35%.

Calculate the NPV of the proposed overhaul of theVital Spark,with and without the new engine and control system.