Question

OpenSeas, Inc. is evaluating the purchase of a new cruise ship. The ship would cost

$ 496$496

​million, but would operate for

2020

years. OpenSeas expects annual cash flows from operating the ship to be

$ 68.6$68.6

million​ (at the end of each​ year) and its cost of capital is 11.7 %11.7%

a. Prepare an NPV profile of the purchase using discount rates of

2.0 %2.0%​,

11.5 %11.5%

and

17.0 %17.0%.

b. Identify the IRR ​(to the nearest​ 1%) on a graph.

c. Is the purchase attractive based on these​ estimates?

d. How far off could​ OpenSeas? cost of capital be​ (to the nearest​ 1%) before your purchase decision would​ change?

Note​:

Subtract the discount rate from the actual IRR. Use Excel to compute the actual IRR.

Answer 1

1) Calculation of NPV wit 2% discount rate

			Fig in $ Millions
Year	CF	DF (2%)	PV of cashflow (DF*CF)
0	-496	1	-496
1	68.6	0.980	67
2	68.6	0.961	66
3	68.6	0.942	65
4	68.6	0.924	63
5	68.6	0.906	62
6	68.6	0.888	61
7	68.6	0.871	60
8	68.6	0.853	59
9	68.6	0.837	57
10	68.6	0.820	56
11	68.6	0.804	55
12	68.6	0.788	54
13	68.6	0.773	53
14	68.6	0.758	52
15	68.6	0.743	51
16	68.6	0.728	50
17	68.6	0.714	49
18	68.6	0.700	48
19	68.6	0.686	47
20	68.6	0.673	46
NPV (Sum of PVs)			626

Calculation with 11.5% Discount rate

			Fig in $ Millions
Year	CF	DF (11.5%)	PV of cashflow (DF*CF)
0	-496	1	-496
1	68.6	0.897	62
2	68.6	0.804	55
3	68.6	0.721	49
4	68.6	0.647	44
5	68.6	0.580	40
6	68.6	0.520	36
7	68.6	0.467	32
8	68.6	0.419	29
9	68.6	0.375	26
10	68.6	0.337	23
11	68.6	0.302	21
12	68.6	0.271	19
13	68.6	0.243	17
14	68.6	0.218	15
15	68.6	0.195	13
16	68.6	0.175	12
17	68.6	0.157	11
18	68.6	0.141	10
19	68.6	0.126	9
20	68.6	0.113	8
NPV (Sum of PVs)			33

NPV with 17% discount rate

			Fig in $ Millions
Year	CF	DF (11.5%)	PV of cashflow (DF*CF)
0	-496	1	-496
1	68.6	0.855	59
2	68.6	0.731	50
3	68.6	0.624	43
4	68.6	0.534	37
5	68.6	0.456	31
6	68.6	0.390	27
7	68.6	0.333	23
8	68.6	0.285	20
9	68.6	0.243	17
10	68.6	0.208	14
11	68.6	0.178	12
12	68.6	0.152	10
13	68.6	0.130	9
14	68.6	0.111	8
15	68.6	0.095	7
16	68.6	0.081	6
17	68.6	0.069	5
18	68.6	0.059	4
19	68.6	0.051	3
20	68.6	0.043	3
NPV (Sum of PVs)			-110

b)

IRR comes to be 13%

hence when discounted at 2% and 11.5% that is when discount rate is less than IRR then the project seems attractive

c) open seas can pay cost of capital upto its IRR which is 13%