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:
|
Caribbean/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) |
| Non-operating 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:
Part a. For each of the itineraries, calculate the present values of the cash flows using required rates of return of both 10% and 15% Assume a 15 -year time horizon. Should the company purchase the ship with either or both required rates of return?
Present value of ship in Caribbean/Alaska itinerary at 10% Formula
Present value of ship in Caribbean/Eastern Canada itinerary at 10% Formula
Present value of ship in Caribbean/Alaska itinerary at 15% Formula
Present value of ship in Caribbean/Eastern Canada itinerary at 15% Formula
Part 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 to determine the correct required return may not be necessary.
Part c. Focusing on a 10 percent required rate of return, what would be the opportunity cost to the company of using the ship in the Caribbean/Eastern Canada itinerary rather than a Caribbean/Alaska itinerary?