15. Present values and opportunity cost of capital (S2.1) Halcyon Lines is considering the purchase of a new bulk carrier for $8 million. The forecasted revenues are $5 million a year and operating costs are $4 million. A major refit costing $2 million will be required after both the fifth and tenth years. After 15 years, the ship is expected to be sold for scrap at $1.5 million. a. What is the NPV if the opportunity cost of capital is 8%? b. Halcyon could finance the ship by borrowing the entire investment at an interest rate of 4.5%. How does this borrowing opportunity affect your calculation of NPV?
15. Present values and opportunity cost of capital (S2.1) Halcyon Lines is considering the purchase of a new bulk carrier for $8 million. The forecasted revenues are $5 million a year and operating costs are $4 million. A major refit costing $2 million will be required after both the fifth and tenth years. After 15 years, the ship is expected to be sold for scrap at $1.5 million. a. What is the NPV if the opportunity cost of capital is 8%? b. Halcyon could finance the ship by borrowing the entire investment at an interest rate of 4.5%. How does this borrowing opportunity affect your calculation of NPV?
Essentials Of Investments
11th Edition
ISBN:9781260013924
Author:Bodie, Zvi, Kane, Alex, MARCUS, Alan J.
Publisher:Bodie, Zvi, Kane, Alex, MARCUS, Alan J.
Chapter1: Investments: Background And Issues
Section: Chapter Questions
Problem 1PS
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![### Present Values and Opportunity Cost of Capital
**Problem Statement:**
Halcyon Lines is considering the purchase of a new bulk carrier for $8 million. The forecasted revenues are $5 million a year, and operating costs are $4 million. A major refit costing $2 million will be required after both the fifth and tenth years. After 15 years, the ship is expected to be sold for scrap at $1.5 million.
#### Questions:
a. What is the Net Present Value (NPV) if the opportunity cost of capital is 8%?
b. Halcyon could finance the ship by borrowing the entire investment at an interest rate of 4.5%. How does this borrowing opportunity affect your calculation of NPV?
**Explanation:**
This problem explores the concepts of present values and opportunity cost of capital by assessing a real investment scenario. You'll need to calculate the NPV by considering all cash inflows and outflows over the period of investment.
1. **Initial Investment:**
- $8 million for the purchase of the bulk carrier.
2. **Annual Cash Flows:**
- Revenue: $5 million/year.
- Operating Costs: $4 million/year.
- Net Cash Flow = Revenue - Operating Costs = $1 million/year.
3. **Additional Cash Outflows:**
- Major refit costs: $2 million each after the fifth and tenth years.
4. **Terminal Value:**
- Scrap value after 15 years: $1.5 million.
To answer part a, you'll discount all these cash flows at the opportunity cost of capital (8%).
For part b, you'll analyze how borrowing the entire investment at an interest rate of 4.5% instead of relying on your own funds affects the NPV calculation.
### Detailed Calculation:
#### Part a: NPV Calculation with an 8% Cost of Capital
To calculate NPV:
- Identify and list the cash flows for each year.
- Discount them back to their present value using 8%.
- Sum these present values.
\[ \text{NPV} = \sum \frac{\text{Net Cash Flow}_t}{(1 + 0.08)^t} - \text{Initial Investment} \]
#### Part b: Impact of Borrowing
- Compare the cost of borrowing at 4.5% against the 8% cost of own funds.
- Adjust cash flows to reflect loan repayments if](/v2/_next/image?url=https%3A%2F%2Fcontent.bartleby.com%2Fqna-images%2Fquestion%2Fb4843067-77f2-4785-8c2b-1f36c75d37de%2Fd96ecf20-b66f-4a4b-851d-85ad4766ea01%2Frxqbplf_processed.png&w=3840&q=75)
Transcribed Image Text:### Present Values and Opportunity Cost of Capital
**Problem Statement:**
Halcyon Lines is considering the purchase of a new bulk carrier for $8 million. The forecasted revenues are $5 million a year, and operating costs are $4 million. A major refit costing $2 million will be required after both the fifth and tenth years. After 15 years, the ship is expected to be sold for scrap at $1.5 million.
#### Questions:
a. What is the Net Present Value (NPV) if the opportunity cost of capital is 8%?
b. Halcyon could finance the ship by borrowing the entire investment at an interest rate of 4.5%. How does this borrowing opportunity affect your calculation of NPV?
**Explanation:**
This problem explores the concepts of present values and opportunity cost of capital by assessing a real investment scenario. You'll need to calculate the NPV by considering all cash inflows and outflows over the period of investment.
1. **Initial Investment:**
- $8 million for the purchase of the bulk carrier.
2. **Annual Cash Flows:**
- Revenue: $5 million/year.
- Operating Costs: $4 million/year.
- Net Cash Flow = Revenue - Operating Costs = $1 million/year.
3. **Additional Cash Outflows:**
- Major refit costs: $2 million each after the fifth and tenth years.
4. **Terminal Value:**
- Scrap value after 15 years: $1.5 million.
To answer part a, you'll discount all these cash flows at the opportunity cost of capital (8%).
For part b, you'll analyze how borrowing the entire investment at an interest rate of 4.5% instead of relying on your own funds affects the NPV calculation.
### Detailed Calculation:
#### Part a: NPV Calculation with an 8% Cost of Capital
To calculate NPV:
- Identify and list the cash flows for each year.
- Discount them back to their present value using 8%.
- Sum these present values.
\[ \text{NPV} = \sum \frac{\text{Net Cash Flow}_t}{(1 + 0.08)^t} - \text{Initial Investment} \]
#### Part b: Impact of Borrowing
- Compare the cost of borrowing at 4.5% against the 8% cost of own funds.
- Adjust cash flows to reflect loan repayments if
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