Reference no: EM131829523

PROBLEM - Present Value and "What If" Analysis

National Cruise Line, Inc. is considering the acquisition of a new ship that will cost $200,000,000. In this regard, the president of the company asked the CFO to analyze cash flows associated with operating the ship under two alternative itineraries: Itinerary 1, Caribbean Winter/Alaska Summer and Itinerary 2, Caribbean Winter/Eastern Canada Summer. The CFO estimated the following cash flows, which are expected to apply to each of the next 15 years:

                                                 Carribbean/Alaska                   Caribbean/Eastern Canada

Net revenue                                   $120,000,000                             $105,000,000

Less:

Direct program expenses                (25,000,000)                               (24,000,000)

Indirect program expenses              (20,000,000)                               (20,000,000)

Nonoperating expenses                   (21,000,000)                               (21,000,000)

Add back depreciation                    115,000,000                                 115,000,000

Cash flow per year                        $169,000,000                               $155,000,000

Required -

a. For each of the itineraries, calculate the present values of the cash flows using required rates of return of both 10 and 15 percent. Assume a 15-year time horizon. Should the company purchase the ship with either or both required rates of return?

b. The president is uncertain whether a 10 percent or a 15 percent required return is appropriate. Explain why, in the present circumstance, spending a great deal of time determining the correct required return may not be necessary.

c. Focusing on a 10 percent required rate of return, what would be the opportunity cost to the company of using the ship in a Caribbean/Eastern Canada itinerary rather than a Caribbean/Alaska itinerary?