OpenSeas, Inc. is evaluating the purchase of a new cruise ship. The ship will co
ID: 2803265 • Letter: O
Question
OpenSeas, Inc. is evaluating the purchase of a new cruise ship. The ship will cost $496 million, and will operate for 20 years. OpenSeas expects annual cash flows from operating the ship to be $68.7 million and its cost of capital is 11.8%. 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? a. Prepare an NPV profile of the purchase. To plot the NPV profile we compute the NPV of the project for various discount rates and plot the curve. The NPV for a discount rate of 2 0% is million. (Round to one decimal place ) The NPV for a discount rate of 1 1 5% is $1 1 million (Round to one decimal place.) The NPV for a discount rate of 170% issL million (Round to one decimal place.) The NPV profile is: NPV Profile of Cruise Ship InvestmentExplanation / Answer
NPV can be calculated using PV function on a calculator
N = 20, PMT = 68.8, I/Y = 2%, FV = 0 => Compute PV = $1,124.98
NPV (2%) = 1,124.98 - 496 = $628.98
N = 20, PMT = 68.8, I/Y = 11.5%, FV = 0 => Compute PV = $530.44
NPV (11.5%) = 530.44 - 496 = $34.44
N = 20, PMT = 68.8, I/Y =17%, FV = 0 => Compute PV = $387.19
NPV (17%) = 387.19 - 496 = -$108.81
IRR can be calculated using I/Y function
N = 20, PMT = 68.8, PV = -496, FV = 0 => Compute I/Y = 12.57% = IRR
As the IRR > cost of capital (11.8%), OpenSeas should proceed with the purchase.
Upto cost of capital equals the IRR of 12.57%, OpenSeas should make the purchase. If the cost of capital is above 12.57%, in that case, it should not make the purchase.
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