3. OpenSeas, Inc. is evaluating the purchase of a new cruise ship. The ship will cost $499 million, and will operate for 20 years. OpenSeas expects annual cash flows from operating the ship to be $68.4 million and its cost of capital is 11.6%. 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 11.5% is $_million. (Round to one decimal place.) The NPV for a discount rate of 17.0% is $___million. (Round to one decimal place.) The NPV profile is: Graph portion from picture. Identify the IRR on the graph. The approximate IRR from the graph is_%. (Round your answer to one decimal place.) Should OpenSeas go ahead with the purchase? (Select the best choice below.) A. No, because at a discount rate of 11.6%, the NPV is positive. B. No, because at a discount rate of 11.6%,the NPV is negative. C. Yes, because at a discount rate of 11.6%, the NPV is negative. D. Yes, because at a discount rate of 11.6%, the NPV is positive. How far off could OpenSeas' cost of capital estimate be before your purchase decision would change? (Note: Subtract the discount rate from the approximate IRR.) The cost of capital estimate can be off by ________%. (Round to one decimal place.

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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3. OpenSeas, Inc. is evaluating the purchase of a new cruise ship. The ship will cost $499 million, and will operate for 20 years. OpenSeas expects annual cash flows from operating the ship to be $68.4 million and its cost of capital is 11.6%.

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 11.5% is $_____________________million.

(Round to one decimal place.)

The NPV for a discount rate of 17.0% is $_____________________million.

(Round to one decimal place.)

The NPV profile is:

Graph portion from picture.

Identify the IRR on the graph.

The approximate IRR from the graph is_______________%.
(Round your answer to one decimal place.)

Should OpenSeas go ahead with the purchase?

(Select the best choice below.)

A. No, because at a discount rate of 11.6%, the NPV is positive.

B. No, because at a discount rate of 11.6%,the NPV is negative.

C. Yes, because at a discount rate of 11.6%, the NPV is negative.

D. Yes, because at a discount rate of 11.6%, the NPV is positive.

How far off could OpenSeas' cost of capital estimate be before your purchase decision would change?

(Note: Subtract the discount rate from the approximate IRR.)

The cost of capital estimate can be off by ______________%.
(Round to one decimal place.)

Transcribed Image Text:The graph depicted is titled "NPV Profile of Cruise Ship Investment." ### Description of the Graph: - **X-Axis (Horizontal Axis):** Labeled as "Discount rate (%)" - Ranges from 0% to 20% - Represented in 2% intervals - **Y-Axis (Vertical Axis):** Labeled as "NPV ($ millions)" - Ranges from -$200 million to $1,000 million - Incremented in steps of 100 million for positive values and 100 million for negative values ### Plot Line Description: - The plotted line starts at the top left corner of the graph (approximately at 0% discount rate and $1,000 million NPV) and curves downward to the bottom right (ending at approximately 20% discount rate and -$200 million NPV). - The line indicates how the Net Present Value (NPV) of the cruise ship investment decreases as the discount rate increases. This is consistent with how higher discount rates typically reduce the present value of future cash flows. ### Key Observations: 1. **At 0% Discount Rate:** - The NPV is at its maximum, starting at approximately $1,000 million. 2. **From 0% to 20% Discount Rate:** - The NPV steadily decreases, showcasing a negative slope as the discount rate ascends. 3. **Crossing the X-Axis:** - The curve crosses the x-axis around the 10% discount rate mark. At this point, the NPV is zero. This point is significant because it represents the Internal Rate of Return (IRR), where the discounted cash flows equal the initial investment outlay. ### Recommendation: To identify the IRR on this graph, note where the curve intersects the x-axis (0 NPV line). This intersection approximately occurs at a 10% discount rate, indicating that the IRR for the cruise ship investment is around 10%. The visual representation provided by this graph helps in understanding the relationship between discount rate and NPV, illustrating a fundamental concept in capital budgeting and investment analysis.

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