Question

OpenSeas, Inc., is evaluating the purchase of a new cruise ship. The ship will cost $500 million, and will 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%.1. Prepare an NPV profile of the purchase using discount rates of 2.0 %​, 11.5% and 17.0.
2. Identify the IRR on a graph.
3. How far off could​ OpenSeas' cost of capital estimate be before your purchase decision would​ change?4. Should OpenSeas proceed with the purchase? ​A. Yes, because at a 11.5% discount​ rate, the NPV is positive.
B. No, because at a 11.5 % discount​ rate, the NPV is positive.
C. Yes, because at a11.5 % discount​ rate, the NPV is negative.
D. ​No, because at a 11.5 % discount​ rate, the NPV is negative.

Answer 1

Answer:

1) initial outlay = -$500 million

NCF₁₋₂₀ = $70 million

NPV with a discount rate of 2% = $644.6 million

NPV with a discount rate of 11.5% = $39.69

NPV with a discount rate of 17% = -$106.06

2) IRR = 12.72%

3) when the cost of capital = 12.72%, the NPV = $0, so that is the point where your purchase decision might change

4) A. Yes, because at a 11.5% discount​ rate, the NPV is positive.

The NPV will be positive as long as the discount rate is lower than 12.72% (IRR). A project should be accepted if the NPV ≥ 0.

Answer 2

1. NPV discount rate of 17% = -$106.06

2. IRR = 12.72%

3. The cost of capital = NPV = $0

4. A. Yes, because at a 11.5% discount​ rate, the NPV is positive.

What is an NPV function?

1) When the initial outlay is = -$500 million

Then NCF₁₋₂₀ = $70 million

After that NPV with a discount rate of 2% is = $644.6 million

Then NPV with a discount rate of 11.5% = $39.69

Now, the NPV with a discount rate of 17% is = -$106.06

2) IRR on a graph is = 12.72%

3) when the cost of capital is = 12.72%, Then the NPV is = $0, so that is the point where your purchase decision might change

4) A. Yes, Reason: when at an 11.5% discount​ rate, the NPV is positive.

When The NPV will be positive as long as the discount rate is lower than 12.72% (IRR). A project should be acceptable if the NPV ≥ 0.

Therefore the correct option is A.

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