Rio Negro, Inc. (RNI) is a business that transports cargo between ports in California and Washington. Among all their fleets includes a small dry cargo vessel called, the Maracas, which is a 25-year-old vessel that is in need of an overhaul or replacement. Knowing this about Maracas, Rio Negro, Inc. (RNI) has been confronted with a major decision to either invest time and money to overhaul their vessel, or proceed with acquiring a replacement vessel. The three possible options for RNI are to produce a basic overhaul, have a basic overhaul of Maracas that included fixing the control system and adding a new engine, or trade Maracas out with a brand-new vessel. Before coming to a conclusion, RNI will consider all information to assure that they
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To make a final decision on these two proposals, the net present value (NPV) of both projects will be compared. The information given by RNI was collected and used to compute the future cash outflows using a top-down approach, and with this, the net present value can be computed. The life of the vessel with either proposal is 12 years. All operating costs and depreciation begins a year after the vessel resumes service for both proposed options, therefore these expenses begin at year 2 when service resumes at year 1. The detailed information and calculations can be seen in Exhibit …show more content…
The company will accept projects with the highest NPV, but this is not always effective. While comparing three projects with different life spans and assets, it would be most beneficial to use the Equivalent Annual Cost (EAC) method. The EAC is calculated using the NPV divided by the present value interest factor of an annuity, considering the life of the project and the real interest rate shown in Exhibit 3. RNI’s real interest rate is 7.16%, as displayed in Exhibit 3. The real interest rate reveals the real cost of the EAC for all three Rio Negro Inc. capital budgeting proposals as follows: basic overhaul -$853,872.17; overhaul plus new engine and control system -$803,892.25; and purchasing a new vessel -$637,548.99. It is recommended that Rio Negro Inc. should acquire the new vessel from Racette & Sons (R&S) because the new vessel presents the least expensive annual payment. This decision is also based on a thorough analysis of the costs for a basic overhaul as well as the overhaul including a new engine and control
To make a final decision on these two proposals, the net present value (NPV) of both projects will be compared. The information given by RNI was collected and used to compute the future cash outflows using a top-down approach, and with this, the net present value can be computed. The life of the vessel with either proposal is 12 years. All operating costs and depreciation begins a year after the vessel resumes service for both proposed options, therefore these expenses begin at year 2 when service resumes at year 1. The detailed information and calculations can be seen in Exhibit …show more content…
The company will accept projects with the highest NPV, but this is not always effective. While comparing three projects with different life spans and assets, it would be most beneficial to use the Equivalent Annual Cost (EAC) method. The EAC is calculated using the NPV divided by the present value interest factor of an annuity, considering the life of the project and the real interest rate shown in Exhibit 3. RNI’s real interest rate is 7.16%, as displayed in Exhibit 3. The real interest rate reveals the real cost of the EAC for all three Rio Negro Inc. capital budgeting proposals as follows: basic overhaul -$853,872.17; overhaul plus new engine and control system -$803,892.25; and purchasing a new vessel -$637,548.99. It is recommended that Rio Negro Inc. should acquire the new vessel from Racette & Sons (R&S) because the new vessel presents the least expensive annual payment. This decision is also based on a thorough analysis of the costs for a basic overhaul as well as the overhaul including a new engine and control