WetEx is a profitable, over-the-water parcel delivery service operating in a large port. The firm will soon be purchasing 12 new delivery boats to replace boats in its fleet that are at the end of their useful lives. The WetEx management team has identified the size and configuration of the type of boat that best meets its general needs but has been unable to agree on the type of engine that would be used to power the boats. A poll of the 8-person management team finds three team members prefer a gasoline engine because of its higher speed while three others prefer a diesel engine because of its relative fuel efficiency; the remaining two team members are indifferent to the choice of engine. Those that favor diesel engines also claim that are safer because they are less flammable, as evidenced by the fact that the diesel-powered boats cost approximately $600 less per year to insure than the gasoline-powered boats. You have been tasked to help the management team to conduct a financial analysis of the options and recommend the type of engine to be used.1 To support you in this task, the management team has constructed the following table based on information available from the boat manufacturer. The estimate of fuel consumption in this table is based on the estimated average speed. Since the boats are used in harbors and for fairly short runs, the higher speed of the gasoline engine is only expected to produce an extra $100 per boat per day in additional revenue. When not in use, the gasoline engines will be turned off while the diesel units would continue to run at idle speed and burn fuel at the rate of 1 gal. per hour. Both types of boat are adequate to meet the delivery schedules and requirements of WetEx. The management team also has determined that the diesel engines would each require $9,000 in annual maintenance costs (mainly for the cooling system), while the gasoline engine unit would have an annual maintenance cost of $6,000. Oil changes are performed twice each month and cost $25 for the gasoline unit and $57 for the diesel unit. Diesel fuel is estimated to cost $2.90 per gallon while gasoline typically costs about 8% less. The boats will be docked at a WetEx maintenance facility overnight and the fuel tanks will be filled each night before the boats are turned over to the maintenance crew for service and cleaning. If a boat needs to be refueled during the day, it will cost an additional $40 over and above the cost of the fuel to do so. Oil changes and other maintenance activities take place when the boats are docked overnight. The diesel-powered boats typically travel 200 nautical miles in the course of the day while the faster gasoline-powered boats are expected to travel 10% farther in order to generate the additional revenue offered by their higher speed. Crews are changed every six hours and the delivery service operates 18 hours per day, 7 days a week. The diesel-powered boats, if purchased, will be kept in service for 6 years before being sold for $60,000 each; the gasoline units will be sold after 5 years of service for $48,000. 1 The firm is already profitable, so it only is trying to decide which type of engine should be used (and not whether any boats should be purchased). 2 A knot is one nautical mile per hour (1 knot = 1.15 miles per hour ).

Answer each of the following questions based on the information provided above. [The values in the square brackets show the proportion of total credit that can be earned for each part.] (a) [70%] Assuming that WetExs (before-tax) minimum attractive rate of return is 18%, which type of engine is preferred and why? Show (and describe, as needed) all your work. (b) [5%] The management team is concerned that the cost of fuel will climb back to levels seen about 5 years ago when diesel cost about $4 per gallon. Would this change your recommendation? Why or why not? (c) [5%] At what price for diesel fuel, if any, would the management team be economically indifferent to the type of engine used? (d) [20%] Now assume that WetEx is subject to a 42% combined state & federal tax rate and uses an aftertax MARR of 15%. Assuming that the MACRS method will be used to depreciate the boats (which belong to the 10-year MACRS GDS class), which type of engine is preferred and why? Use the information as originally given; not as modified in parts (b) or (c).

Purchase Price: Engine Size: Estimated Average Speed Gasoline-Powered $96,599 350 hp 21.1 knots Diesel-Powered $124,995 300 hp 17.4 knots Estimated Fuel Consumption: 24 gallons per hour 16 gallons per hour Fuel Capacity:3 300 gallons 300 Gallons