2. Suppose that it is January 1990 and the New Economy Transport Company (NETCO)is evaluating a proposed expenditure of $400,000 for a new engine and general overhaulof one of its boats used to push barges up and down the Ohio River. The estimated annualoperating costs after the overhaul are $1,234,000. The boat is fully depreciated, so thatthe depreciation tax shield from the decision to overhaul would be based on theincremental investment of $400,000.The controller feels that it is unwise to proceed with the overhaul before considering thepurchase of a new boat. A new boat would cost $2,000,000 payable now and withdelivery in one year. The new boat would have annual operating costs of $800,000, andwould require $50,000 in expenditures now to train a new crew to handle the moresophisticated equipment on board. The old boat could be sold today (as is) for $150,000.(These revenues can be treated as an offset to costs.)The new boat would last 8 years whereas the old one would last another 4 years. (Assumethe salvage values are zero.) The corporate tax rate is 34 percent; depreciation is on astraight-line basis of 25 percent per year (that is, $100,000 per year for 4 years on theoverhaul option and $500,000 a year for 4 years on the new boat). The firm's opportunitycost of capital (discount rate) is 20 percent.A. What is the value of the depreciation tax shield per year for the overhaul option?B. What is the present value of the total costs of the overhaul option, taking into accountthe depreciation tax shield, operating costs, and the initial cost of the overhaul?C. Derive the present value of the total costs associated with the purchase of the new boatat time 0, including all costs, the depreciation tax shield, and revenues from the sale ofthe old boat.

Data given:: Tax rate= 34% Depreciation per year on the overhaul option for 4 years = $100,000…

Answered: 2. Suppose that it is January 1990 and…

Essentials Of Investments

11th Edition

ISBN:9781260013924

Author:Bodie, Zvi, Kane, Alex, MARCUS, Alan J.

Publisher:Bodie, Zvi, Kane, Alex, MARCUS, Alan J.

Chapter1: Investments: Background And Issues

Section: Chapter Questions

Problem 1PS

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