Question

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OpenSeas, Inc. is evaluating the purchase of a new cruise ship. The ship will cost $495 million, and will operate for 20 years. Open Seas expects annual cash flows from operating the ship to be $70.3 million and its cost of capital is 12.3%. a. Prepare an NPV profile of the purchase. b. Identify the IRR on the graph. c. Should Open Seas proceed with the purchase? d. How far off could Open Seas' cost of capital estimate be before your purchase decision would change? a. Prepare an NPV profile of the purchase. To plot the NPV profile we compute the NPV of the project for various discount rates and plot the curve. The NPV for a discount rate of 2.0% is $ million. (Round to one decimal place.)

Answer 1

NPV = PV of Cash Inflows - PV of Cash Outflows

NPV @ Disc Rate = 12.3%:

Year	CF	PVF @12.3%	Disc CF
1	$   70.30	0.8905	$   62.60
2	$   70.30	0.7929	$   55.74
3	$   70.30	0.7061	$   49.64
4	$   70.30	0.6288	$   44.20
5	$   70.30	0.5599	$   39.36
6	$   70.30	0.4986	$   35.05
7	$   70.30	0.4440	$   31.21
8	$   70.30	0.3953	$   27.79
9	$   70.30	0.3520	$   24.75
10	$   70.30	0.3135	$   22.04
11	$   70.30	0.2791	$   19.62
12	$   70.30	0.2486	$   17.47
13	$   70.30	0.2213	$   15.56
14	$   70.30	0.1971	$   13.86
15	$   70.30	0.1755	$   12.34
16	$   70.30	0.1563	$   10.99
17	$   70.30	0.1392	$      9.78
18	$   70.30	0.1239	$      8.71
19	$   70.30	0.1104	$      7.76
20	$   70.30	0.0983	$      6.91
PV of Cash Inflows			$ 515.38
Cost			$ 495.00
NPV			$   20.38

NPV if Disc Rate is 2%:

Year	CF	PVF @2%	Disc CF
1	$   70.30	0.9804	$      68.92
2	$   70.30	0.9612	$      67.57
3	$   70.30	0.9423	$      66.25
4	$   70.30	0.9238	$      64.95
5	$   70.30	0.9057	$      63.67
6	$   70.30	0.8880	$      62.42
7	$   70.30	0.8706	$      61.20
8	$   70.30	0.8535	$      60.00
9	$   70.30	0.8368	$      58.82
10	$   70.30	0.8203	$      57.67
11	$   70.30	0.8043	$      56.54
12	$   70.30	0.7885	$      55.43
13	$   70.30	0.7730	$      54.34
14	$   70.30	0.7579	$      53.28
15	$   70.30	0.7430	$      52.23
16	$   70.30	0.7284	$      51.21
17	$   70.30	0.7142	$      50.21
18	$   70.30	0.7002	$      49.22
19	$   70.30	0.6864	$      48.26
20	$   70.30	0.6730	$      47.31
PV of Cash Inflows			$ 1,149.51
Cost			$    495.00
NPV			$    654.51

IRR:

Year	CF	PVF @12%	Disc CF	PVF @13%	Disc CF
1	$   70.30	0.8929	$      62.77	0.8850	$   62.21
2	$   70.30	0.7972	$      56.04	0.7831	$   55.06
3	$   70.30	0.7118	$      50.04	0.6931	$   48.72
4	$   70.30	0.6355	$      44.68	0.6133	$   43.12
5	$   70.30	0.5674	$      39.89	0.5428	$   38.16
6	$   70.30	0.5066	$      35.62	0.4803	$   33.77
7	$   70.30	0.4523	$      31.80	0.4251	$   29.88
8	$   70.30	0.4039	$      28.39	0.3762	$   26.44
9	$   70.30	0.3606	$      25.35	0.3329	$   23.40
10	$   70.30	0.3220	$      22.63	0.2946	$   20.71
11	$   70.30	0.2875	$      20.21	0.2607	$   18.33
12	$   70.30	0.2567	$      18.04	0.2307	$   16.22
13	$   70.30	0.2292	$      16.11	0.2042	$   14.35
14	$   70.30	0.2046	$      14.38	0.1807	$   12.70
15	$   70.30	0.1827	$      12.84	0.1599	$   11.24
16	$   70.30	0.1631	$      11.47	0.1415	$      9.95
17	$   70.30	0.1456	$      10.24	0.1252	$      8.80
18	$   70.30	0.1300	$        9.14	0.1108	$      7.79
19	$   70.30	0.1161	$        8.16	0.0981	$      6.89
20	$   70.30	0.1037	$        7.29	0.0868	$      6.10
PV of Cash Inflows			$    525.10		$ 493.84
Cost			$    495.00		$ 495.00
NPV			$      30.10		$    -1.16

IRR = rate at which least +ve NPV + [ NPV at that Rate / Change in NPV due to 1% inc in Rate } * 1%

= 12% + [ 30.10 / 31.26 ] * 1%

= 12% +0.96%

= 12.96%

Part C:

Project can be accepted as it has +ve NPV or IRR > Costs of Capital

Part D:

The Project can be accepeted till the Cost of Capital is 12.96%

COC can be increased by 0.66% ( 12.96% - 12.6%) till the decision is unchanged.