Question

​OpenSeas, Inc. is evaluating the purchase of a new cruise ship. The ship will cost $502 ​million, and will operate for20 years. OpenSeas expects annual cash flows from operating the ship to be $68.9 million and its cost of capital is 11.4%.

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

Answer a)

NPV or the net present value method is a famous method to evaluate alternatives by determining the the current value of the alternatives.

NPV is the current (present) value of all the future cashflows (in the lifecycle of the project) discounted to the present. So, if we discount all future cashflow and find their present value and sum them, we get the NPV.

Using excel we can find it directly

Cashflows:

NPV Profile:

Finding the same uptill 100%

Discount Rate	NPV of Cashflow (OpenSeas Inc.)
0%	$876.00
1%	$741.34
2%	$624.61
3%	$523.06
4%	$434.37
5%	$356.65
6%	$288.28
7%	$227.93
8%	$174.47
9%	$126.96
10%	$84.58
11%	$46.67
11.4%	$32.63
12%	$12.64
12.40%	$0.00
13%	-$17.99
14%	-$45.67
15%	-$70.73
16%	-$93.50
17%	-$114.25
19%	-$150.55
21%	-$181.15
22%	-$194.69
23%	-$207.20
24%	-$218.80
25%	-$229.58
26%	-$239.61
27%	-$248.96
28%	-$257.69
29%	-$265.87
30%	-$273.54
31%	-$280.75
32%	-$287.52
33%	-$293.91
34%	-$299.93
35%	-$305.63
36%	-$311.02
37%	-$316.13
38%	-$320.97
39%	-$325.58
40%	-$329.96
41%	-$334.13
42%	-$338.10
43%	-$341.89
44%	-$345.52
45%	-$348.98
46%	-$352.29
47%	-$355.47
48%	-$358.51
49%	-$361.44
50%	-$364.24
51%	-$366.94
52%	-$369.53
53%	-$372.03
54%	-$374.43
55%	-$376.75
56%	-$378.98
57%	-$381.14
58%	-$383.22
59%	-$385.23
60%	-$387.18
61%	-$389.06
62%	-$390.88
63%	-$392.64
64%	-$394.35
65%	-$396.00
66%	-$397.61
67%	-$399.17
68%	-$400.68
69%	-$402.15
70%	-$403.57
71%	-$404.96
72%	-$406.31
73%	-$407.62
74%	-$408.89
75%	-$410.13
76%	-$411.34
77%	-$412.52
78%	-$413.67
79%	-$414.79
80%	-$415.88
81%	-$416.94
82%	-$417.98
83%	-$418.99
84%	-$419.98
85%	-$420.94
86%	-$421.88
87%	-$422.80
88%	-$423.70
89%	-$424.58
90%	-$425.44
91%	-$426.29
92%	-$427.11
93%	-$427.91
94%	-$428.70
95%	-$429.47
96%	-$430.23
97%	-$430.97
98%	-$431.69
99%	-$432.40
100%	-$433.10

Plotting on graph

Answer b)

IRR is the rate at which NPV = 0

From the graph we can easily see that for NPV = 0, rate is near to 12.4%

Also using formula:

IRR

12.4002%

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Answer c)

Since, we have IRR > WACC (11.4%), company should accept the project as per IRR rule.

As per IRR rule, if the IRR > WACC, accept the project else reject

-----------------------------------------

Answer d)

Our choice of acceptance of the project will change when IRR < WACC.

Hence, as soon as cost of capital > 12.4002%, our decision will change.

It is supported by the fact that at 13% rate, NPV is negative.