Cargo Line is a massive cargo ship company that contracts with larger, well-known shippers to provide container shipping by sea to any deep water port in the world. Cargo Line owns 50 ships, and currently has contracts for 47 of those ships. The other shippers pay Cargo Line $2,500,000 per year to provide shipping services for their customers' containers. Cargo Line is considering a new 20-year contract where they would provide 5 ships to a new company for $2,250,000 per year. Each Cargo Line ship incurs yearly costs of $1,100,000 for labor, $300,000 for fuel, $1,000,000 in fixed overhead, and $500,000 in variable overhead. Because the contract is for 20 years, Cargo Line may not use any ships currently in use for the new contract. The cost of acquiring a new ship is $25,000,000, which is depreciated over a 20-year life.
What would be the differential gain or loss on this new contract?

Question

Quizplus · Accepted Answer

The fixed costs are not relevant to this decision. The company does not have the capacity to meet the order and would need to purchase additional ships.
The marginal income per ship is:
$2,250,000 Revenue - $1,100,000 labor - $300,000 fuel - $500,000 variable overhead
= $350,000
Net Differential gain: $350,000 × 5 ships x 20 years = $35,000,000
Cost of required additional ships to fulfill contract: 2 x $25,000,000 = $50,000,000
Net loss on 20-year contract: $35,000,000 - $50,000,000 = ($15,000,000)

Cargo Line Is a Massive Cargo Ship Company That Contracts