OpenSeas, Inc., is evaluating the purchase of a new cruise ship. The ship will cost $500 million, and will operate for 20 years. OpenSeas expects annual cash flows from operating the ship to be $70 million (at the end of each year) and its cost of capital is 12%.1. Prepare an NPV profile of the purchase using discount rates of 2.0 %, 11.5% and 17.0. 2. Identify the IRR on a graph.
3. How far off could OpenSeas' cost of capital estimate be before your purchase decision would change?4. Should OpenSeas proceed with the purchase? A. Yes, because at a 11.5% discount rate, the NPV is positive.
B. No, because at a 11.5 % discount rate, the NPV is positive.
C. Yes, because at a11.5 % discount rate, the NPV is negative.
D. No, because at a 11.5 % discount rate, the NPV is negative.

1) initial outlay = -$500 million

NCF₁₋₂₀ = $70 million

NPV with a discount rate of 2% = $644.6 million

NPV with a discount rate of 11.5% = $39.69

NPV with a discount rate of 17% = -$106.06

2) IRR = 12.72%

3) when the cost of capital = 12.72%, the NPV = $0, so that is the point where your purchase decision might change

4) A. Yes, because at a 11.5% discount rate, the NPV is positive.

The NPV will be positive as long as the discount rate is lower than 12.72% (IRR). A project should be accepted if the NPV ≥ 0.

Journal Entries

Dr. Investment in Apple stock                  $3,600

Dr. Investment in Under Armour stock    $800

Cr. Investment in Chipotle stock              $1,700

Cr. Unrealized gain Investments              $2,700

Explanation:

The Investments held at the fair value should be revalued at each period end and record the gain or loss arising from the fair value adjustments. This done to present the true position of the investments . Increase in the fair value as compared to prior value or cost will result as gain and decrease as loss.

Following is the working to make fair value adjustment.

                                   Cost        Fair Value   Difference

Apple stock               $5,700     $9,300         Increased by $3,600

Chipotle stock           $3,300     $1,600         Decreased by $1,700

Under Armour stock $12,900    $13,700       Increased by $800