Question

OpenSeas, Inc. is evaluating the purchase of a new cruise ship. The ship will cost $ 501 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?

Answer #1

**a) NPV = PV of all cash inflows - PV of all cash
outflows**

**b)** IRR is the rate of return when NPV is zero.
Using the graph, the **IRR** comes out to be
**12.38%**.

**c) Yes**, as **NPV** **of the
project is positive** and **IRR is greater than the
cost of capital**, OpenSeas should proceed with the
purchase.

**d)** OpenSeas' cost of capital can max be equal
to the IRR (ie 12.38%). After which, the purchase decision would
change.

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