Galveston Excursons Corporation
Galveston Excursons 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.Galveston Excursons' cost of capital is 14 percent,and its marginal tax rate is 35 percent.
Refer to Galveston Excursons 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 find the annual labor cost savings needed to generate a net present value (NPV) of $0, we first calculate the annual depreciation expense, which is the cost of the ship ($600,000) divided by its useful life (15 years), resulting in $40,000 per year. The after-tax savings from depreciation is then calculated by multiplying the depreciation expense by the tax rate (35%), which gives us $14,000 ($40,000 * 35%). To find the present value of these tax savings, we multiply the annual after-tax savings by the present value annuity factor for 15 years at 14%, which is approximately 5.2161. This gives us a present value of tax savings of about $73,025 ($14,000 * 5.2161).Next, we need to calculate the annual labor cost savings required to offset the initial investment and provide an NPV of $0. The initial investment is $600,000, and we subtract the present value of the tax savings from this to find the net investment needed to be recovered by the labor cost savings. This gives us $526,975 ($600,000 - $73,025). To find the annual labor cost savings, we divide this net investment by the present value annuity factor for 15 years at 14%, which gives us approximately $97,685 ($526,975 / 5.2161). This is the annual labor cost savings needed to achieve an NPV of $0.

Galveston Excursons Corporation Galveston Excursons Corporation Is Considering the Purchase of a New