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 12% and 16%. Assume a 15-year time horizon. Should the company purchase the ship with either or both required rates of return?
Part 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 to determine the correct required return may not be necessary?
Part C) Focusing on a 12 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?