fin mgt week 3.docxRio Claro, Inc. (RCI) is in the business of transporting cargo between ports in California and
Washington. Its fleet includes a small dry-cargo vessel, the Maracas. The Maracas is 25 years
old and badly in need of an overhaul.
It is March 2016, and Michael John, the finance director, has just been presented with a proposal
that would require the one-time expenditures shown below in Table 1. If the proposal is
accepted, these expenditures will be made in the next few days. Mr. John believes that all these
outlays could be depreciated for tax purposes in the seven-year MACRS class (see Table 2 below
for rates). Overhaul of the Maracas will begin as soon as the expenditures in Table1 are made,
but the vessel will be out of service for several months. The overhauled vessel would resume
commercial service in one year. RCI’s chief engineer’s estimates of the post-overhaul operating
costs are in Table 3.
In addition to the overhaul described above, the chief engineer suggests installation of a brandnew engine and control system. Installation of this new engine would cost an extra $600,000
(This additional outlay would also qualify for tax depreciation in the seven-year MACRS class.).
However, if the additional equipment is installed, it would result in reduced fuel, labor, and
maintenance costs as shown in Table 4.
The operating cost estimates in Tables 3 and 4 are current for March 2016. However, these costs
will increase with inflation, which is forecasted at 1.25% a year. Depreciation and operating
costs attributable to the overhaul of the Maracas will begin one year after the vessel is put back
into commercial service. The revenues from operating the vessel will be the same for both types
of overhaul.
Even with the proposed overhaul, the Maracas cannot continue forever. After the overhaul, its
remaining useful life is estimated to be only 12 years. Its salvage value when finally taken out of
service will be trivial. Thus, Mr. John feels it is unwise to proceed without also considering the
purchase of a new vessel. Racette & Sons (R&S), a Colorado shipyard, has approached RCI with
a design incorporating a Kort nozzle, extensively automated navigation and power control
systems, and much more comfortable accommodations for the crew. R&S is offering the new
vessel for a fixed price of $3,000,000, payable half immediately and half on delivery in one year.
Estimated annual operating costs of the new vessel are in Table 5. The operating cost estimates
in the table are current for March 2016, but will increase with inflation.
The crew would require additional training to handle the new vessel’s more complex and
sophisticated equipment. Training would result in a one-time cost of $50,000 payable one year
following delivery of the new vessel. This cost is tax deductible.
The estimated operating costs for the new vessel assume that it would be operated in the same
way as the Maracas. However, the new vessel will be able to handle a larger load on some
routes, which is expected to generate additional revenues, net of additional operating costs, of
approximately $175,000 per year in the first year of operation. These revenues are expected to
grow at the rate of inflation. Revenues and operating costs from the new vessel will begin one
year after it is delivered. The new vessel is estimated to have a useful service life of 20 years, but
it will be depreciated for tax purposes according to the 7-year MACRS schedule. The new vessel
is not expected to have any resale value at the end of its 20-year useful life. All revenues and
costs (including depreciation) associated with the new vessel will begin one year after it is
delivered.
The Maracas is carried on RCI’s books at a book value of only $100,000, but could probably be
sold “as is,” together with its extensive inventory of spare parts, for $200,000. The book value of
the spare parts inventory is $40,000.
Mr. John stepped out on the foredeck of the Maracas as she chugged down the Cook Inlet. “A
rusty old tub,” he muttered, “but she’s never let us down. I’ll bet we could keep her going until
next year while Racette & Sons are building her replacement. We could use up the spare parts to
keep her going. We should even be able to sell or scrap her for book value when her replacement
arrives.”
RCI evaluates capital investments of this type using a 8.5% cost of capital. (This is a nominal,
not real, rate.) RCI’s tax rate is 35%.
Table 1: Overhaul Expenditures
Overhaul engine and
generators
Replace radar and other
electronic equipment
Repairs to hull and
superstructure
Painting and other repairs
$340,000
75,000
310,000
95,000
$820,000
Table 2: Depreciation (in %) for the 7-year Modified Accelerated Cost Recovery System
Year
1
Year
2
Year
3
Year
4
Year
5
Year
6
Year
7
Year
8
14.29
24.49
17.49
12.49
8.93
8.93
8.93
4.45
Table 3: Post-overhaul Operating Costs (Basic Overhaul)
Fuel
Labor and
benefits
Maintenance
Other
$450,000
480,000
141,000
110,000
$1,181,000
Table 4: Post-overhaul Operating Costs (Overhaul plus new engine & contro system)
Fuel
Labor and
benefits
Maintenance
Other
$400,000
405,000
105,000
110,000
$1,020,000
Table 5: Operating Costs of New Vessel
Fuel
Labor and
benefits
Maintenance
Other
$380,000
330,000
70,000
105,000
$885,000
Guidelines for Case Analysis
The following aids are permitted for this analysis: You may use internet sources, books, all
posted materials (including Discussion Board Q&A), and your notes.
Any other aids are unauthorized and their use constitutes a violation of academic integrity.
This includes face-to-face or electronic correspondence concerning the specific details of the
case with any other person that is not a member of your assigned group, whether or not they have
current or past affiliation with Washington State University.
The case is due on the date indicated on the course schedule. Late papers may be accepted with a
reasonable excuse, but will be assessed a 20% grade reduction penalty. Cases should be typed
in 12- point font, double-spaced, with a minimum of 1 inch margins.
The case report should be written according to the following format:
1. Introduction
2. Analysis
3. Conclusion
The introduction sets the stage for the work to follow and should consist of a short paragraph of
the key problem(s) or issue(s) that your analysis addresses. The analysis will constitute the bulk
of the written presentation and will be a direct response to the questions below. Use clear,
concise, and complete sentences. Do not use bullet points or numbered paragraphs. The
conclusion should be a short paragraph that summarizes the key points of the analysis.
Your report should not exceed five pages of double-spaced text with 1 inch margins at the
sides, top, and bottom of the page. This does not include exhibits of your computations. You
may submit one Excel Spreadsheet that contains all your exhibits, clearly labeled, and
appropriately referenced in the text of your report.
Your analysis of “Rio Claro, Inc.” should consist of answers to the questions below. Do not
write the questions verbatim in your report. Instead, write a brief introductory statement that
summarizes the question before you proceed with your analysis.
1. Calculate the present value of the proposed overhaul of the Maracas, with and
without the new engine and control system. Should RCI do the basic overhaul or the
expanded overhaul with the new engine and control system? For the moment, ignore
the option to purchase a new vessel (you will evaluate that option in question 2
below).
Write a few paragraphs giving your answer and clearly explaining your reasoning
and computations; show detailed computations in your Excel spreadsheet labeled
Exhibit 1.
1. Calculate the present value of buying and operating the new vessel. What, if any,
additional information would be useful to you in your analysis?
Write a few paragraphs giving your answer and clearly explaining your reasoning
and computations; show detailed computations in your Excel spreadsheet labeled
Exhibit 2.
2. Calculate the equivalent annual costs of (a) overhauling and operating the Maracas
for 12 more years (with and without the new engine and control system) and (b)
buying and operating the proposed replacement vessel for 20 years. You should use
the real discount rate for this analysis. Based on your answer, what should RCI do?
Write one to two paragraphs giving your answer and clearly explaining your reasoning and
computations; show detailed computations in your Excel spreadsheet labeled Exhibit 3.
1. Why is the equivalent annual cost method potentially useful in decision making in this
case? Why would you use the real discount rate to compute the EAC? What problem(s)
do you see with using the equivalent annual cost method to evaluate RCI’s options?
One to two paragraphs.

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