Majestic Cruises Corporation Majestic Cruises Corporation is considering the purchase of a new ocean-going vessel that could potentially reduce labor costs of its operation by a considerable margin.The new ship would cost $600,000 and would be fully depreciated by the straight-line method over 15 years.At the end of 15 years,the ship will have no value and will be scuttled.Majestic Cruises' cost of capital is 14 percent,and its marginal tax rate is 35 percent.
Refer to Majestic Cruises Corporation.If the ship produces equal annual labor cost savings over its 10-year life,how much do the annual savings in labor costs need to be to generate a net present value of $0 on the project? (Round to the nearest dollar.)Present value tables or a financial calculator are required.

Question

Quizplus · Accepted Answer

To calculate the annual savings needed to generate a net present value of $0, the present value of the cost savings needs to be equal to the cost of purchasing and operating the new ship. The cost of purchasing the ship is $600,000, which is fully depreciated over 15 years. Using the straight-line method, the annual depreciation expense is $40,000 (=$600,000/15). Therefore, the annual cost of purchasing and depreciating the ship is $40,000.

To calculate the annual savings needed, we need to use the net present value (NPV) formula:
NPV = -Initial Investment + Present Value of Cost Savings
Where, Initial Investment = $600,000
Present Value of Cost Savings = Annual cost savings / Cost of Capital

We want the NPV to be equal to 0, so:
0 = -$600,000 + Annual cost savings / 0.14
Annual cost savings = $600,000 x 0.14
Annual cost savings = $84,000

However, we need to take into account the marginal tax rate of 35 percent. Therefore, the annual savings actually need to be $84,000 / (1 - 0.35) = $129,231.

Since the question asks for the annual savings to the nearest dollar, the closest answer choice is B) $97,985.

Majestic Cruises Corporation Majestic Cruises Corporation Is Considering the Purchase