Question

OpenSeas, Inc., is evaluating the purchase of a new cruise ship. The ship would cost $400 million today. OpenSeas expects annual cash flows from the new ship to be $70 million and these cash flows will last forever. The cost of capital is 16%.

What is the IRR of the new cruise ship? Please make your answer in the unit of percent.

______%

Following question 4, suppose the company has a desired payback period of 5 years.

Which statement is true about applying the payback method to the new project?

Answer 1

When the cash flows last forever it is a perpetuity.
Present value of a perpetuity = C/r
where C is the annual cash flow and r is the discount rate
The internal rate of return (IRR) is the discount rate or cost of capital for which the NPV is zero.
Year	0	1	2	3	4	5	6	7	8	9	10	11	in perpetuity
cash flow (in millions)	-400	70	70	70	70	70	70	70	70	70	70	70
initial investment	-400
sum of present values of future cash flows	70/r
where r is the internal rate of return
Net present value (NPV) = initial investment + sum of present values of future cash flows.
0 = -400 +70/r
400 = 70/r
r = 70/400
r = .175
The IRR is 17.5%.
Since the cost of capital (16%) is less than the IRR, the project will have a positive NPV
and is a profitable one.
The second question is not a full question.
Please send it as a separate question.