Question

​OpenSeas, Inc. is evaluating the purchase of a new cruise ship. The ship will cost $ 495 ​million, and will operate for 20 years. OpenSeas expects annual cash flows from operating the ship to be $ 70.7 million and its cost of capital is 12.1 %. 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

a.NPV Calculation

Initial inflow =$495 Million

Annual inflow = $70.7 Million

Inflow Years = 20

Cost of capital or discount rate = 12.1%

So NPV will be

Year	Cash Inflow (In Millions $)	Discounted Value Calculation	Final Value (In Millions $)
0	-495	-495	-495
1	70.7	=70.7/(1+12.1%)^1	63.0686886708296
2	70.7	=70.7/(1+12.1%)^2	56.2610960489113
3	70.7	=70.7/(1+12.1%)^3	50.1883104807416
4	70.7	=70.7/(1+12.1%)^4	44.7710173780032
5	70.7	=70.7/(1+12.1%)^5	39.9384633166844
6	70.7	=70.7/(1+12.1%)^6	35.6275319506551
7	70.7	=70.7/(1+12.1%)^7	31.781919670522
8	70.7	=70.7/(1+12.1%)^8	28.351400241322
9	70.7	=70.7/(1+12.1%)^9	25.2911688147386
10	70.7	=70.7/(1+12.1%)^10	22.5612567482058
11	70.7	=70.7/(1+12.1%)^11	20.1260095880515
12	70.7	=70.7/(1+12.1%)^12	17.9536213987971
13	70.7	=70.7/(1+12.1%)^13	16.0157193566432
14	70.7	=70.7/(1+12.1%)^14	14.2869931816621
15	70.7	=70.7/(1+12.1%)^15	12.7448645688333
16	70.7	=70.7/(1+12.1%)^16	11.3691923004757
17	70.7	=70.7/(1+12.1%)^17	10.1420091886492
18	70.7	=70.7/(1+12.1%)^18	9.04728741181908
19	70.7	=70.7/(1+12.1%)^19	8.07072918092692
20	70.7	=70.7/(1+12.1%)^20	7.19958000082687
NPV ( Sum of all discounted inflow - initial outflow)			29.80

b. IRR Calculation

IRR at the current cost of capital 12.1%

Year	Cash Inflow (In Millions $)
0	-495
1	70.70
2	70.70
3	70.70
4	70.70
5	70.70
6	70.70
7	70.70
8	70.70
9	70.70
10	70.70
11	70.70
12	70.70
13	70.70
14	70.70
15	70.70
16	70.70
17	70.70
18	70.70
19	70.70
20	70.70
IRR	13.06% (Should be calculated the IRR function of excel)

To represent IRR on graph, we have to calculate NPV on different Cost of capital. We can take cost of capital on different intervals for calculation purpose. NPV should be calculated as the above method

Cost of Capital	NPV
0%	919
2%	661.05
4%	465.84
6%	315.92
8%	199.14
10%	106.91
12%	22.09
14%	-26.74
16%	-75.83

Chart for the above table will be

c. Openseas' can proceed with the purchase as NPV is positive on current cost of capital.

d. As it clearly visible from the above chart and table that the NPV getting negative if the cost of capital goes above 13%, so they can change there decision to no purchase if cost of capital goes above 13%.