Question

​OpenSeas, Inc. is evaluating the purchase of a new cruise ship. The ship will cost $499 ​million, and will operate for 20 years. OpenSeas expects annual cash flows from operating the ship to be $69.9 million and its cost of capital is 12.2%.

a. Prepare an NPV profile of the purchase.

b. Identify the IRR on the graph.

c. Should OpenSeas proceed with the​ purchase?

d. How far off could​ OpenSeas' cost of capital estimate be before your purchase decision would​ change?

Answer 1

Solution: Cash outflow : -$499 million, Cash Inflow = $69.9 million for 20 years, Cost of capital = 12.2%

• Step 1: Calculate the discounted cash flow for 20 years
• Step 2: compare Discounted cash flow with cash outflow to get NPV
• Step 3: Select different rates to make NPV profile
• Step 4: Make graph of NPV with different rates

All the calculations and formula have been shown in excel

Question A) NPV profile is plotted on the given graph (y-axis: NPV, x-axis: Rate)

Question B) IRR has been identified as 12.73% and for this NPV is zero

Question C) Yes, Since NPV is $16.63 million and it is positive for 12.2% discount rate

Question D) Since IRR is 12.73% and NPV is zero here and NPV is negative after this rate so purchase decision will change over 12.73% cost of capital.