Problem 9-4

Marx Cruise Line is considering the acquisition of a new ship that will cost $200,800,000. 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

$120,940,000

$105,940,000

Less:

Direct program expenses

(25,090,000)

(24,120,000)

Indirect program expenses

(19,930,000)

(19,930,000)

Nonoperating expenses

(21,030,000)

(21,030,000)

Add back depreciation

115,000,000

115,000,000

Cash flow per year

$169,890,000

$155,860,000

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Caribbean/

Alaska Caribbean/Eastern

Canada

Net revenue $120,940,000 $105,940,000

Less:

Direct program expenses (25,090,000) (24,120,000)

Indirect program expenses (19,930,000) (19,930,000)

Nonoperating expenses (21,030,000) (21,030,000)

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

Cash flow per year $169,890,000 $155,860,000

For each of the itineraries, calculate the present values of the cash flows using required rates of return of both 7 and 11 percent. Assume a 15-year time horizon. (Round present value factor calculations to 4 decimal places, e.g. 1.2151 and final answer to 0 decimal places, e.g. 125. Enter negative amounts using either a negative sign preceding the number e.g. -45 or parentheses e.g. (45).)

Present value at 7%

Present value at 11%

Caribbean/Alaska

$

$

Caribbean/Eastern Canada

$

$

Should the company purchase the ship with either or both required rates of return?

The company should purchase the ship with

either of the two rates7% rate11% rate

of return.

Present value at 7% Present value at 11%

Caribbean/Alaska $

$

Caribbean/Eastern Canada $

$

The company should purchase the ship with

either of the two rates7% rate11% rate

of return.

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Focusing on a 7 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?

Opportunity cost

Opportunity cost