Question

(calculate step by step)

OpenSeas, Inc. is evaluating the purchase of a new cruise ship. The ship would cost $500 million and would operate for 20 years. OpenSeas expects annual cash flows from operating the ship to be $70 million (at the end of each year) and its cost of capital is 12%.

Show your calculations and answer the following questions

1. Calculate the NPV of the project if the cost of capital is 12%

2. Is the purchase an attractive investment?

3. Would your answer change if the cost of capital was 13%?

Answer 1

The NPV is computed as shown below:

= Initial investment + Present value of future cash flows

Present value is computed as follows:

Present value = Annual payment x [ (1 – 1 / (1 + r)ⁿ) / r ]

= $ 70 million x [ (1 - 1 / (1 + 0.12)²⁰ ) / 0.12 ]

= $ 522.8610537 million

So, the NPV will be as follows:

= $ 522.8610537 million - $ 500 million

= $ 22.86 million Approximately

Since the NPV is positive, hence this is an attractive investment

The NPV is computed as shown below:

= Initial investment + Present value of future cash flows

Present value is computed as follows:

Present value = Annual payment x [ (1 – 1 / (1 + r)ⁿ) / r ]

= $ 70 million x [ (1 - 1 / (1 + 0.13)²⁰ ) / 0.13 ]

= $ 491.7326105 million

So, the NPV will be as follows:

= $ 491.7326105 million - $ 500 million

= - $ 8.27 million Approximately

Since the NPV is negative, hence this is not an attractive investment

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