PROBLEM 9-4. Present Value and "What If" Analysis

National Cruise Line 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 $120,000,000.00 $105,000,000

Less

Direct program expenses $(25,000,000.00) $(24,000,000)

Indirect program expenses $(20,000,000.00) $(20,000,000)

Nonoperating expenses $(21,000,000.00) $(21,000,000)

Add back depreciation $115,000,000.00 $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 12 and 16 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 12 percent or a 16 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 12 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?