Humbolt Shipping Line, Ltd. based in Hamburg, Germany, must continually make significant capital investments in ships. Some of these decisions require comparisons of strategic alternatives. For example, not all of the company’s ships are the same size. Different-sized ships offer alternative advantages and disadvantages. Suppose the company is currently trying to decide between two investment options. It is weighing the purchase of three extremely large ships for a total of €2,500,000 versus five smaller ships for a total of €1,400,000. Information regarding these two alternatives is provided below:

Three Larger Ships Five Smaller Ships
Initial investment €2,500,000 €1,400,000
Estimated useful life 20 years 20 years
Annual revenues (accrual) € 500,000 € 380,000
Annual expenses (accrual) € 200,000 € 180,000
Annual cash inflows € 550,000 € 430,000
Annual cash outflows € 222,250 € 206,350
Estimated salvage value* € 500,000 € 0
Discount rate 9% 9%

Instructions

1. Calculate the following parameters of these proposals:
A. cash payback (15%)
B. net present value (15%)
C. internal rate of return (15%)
D. annual rate of return (15%)

2. Discuss the implications of your findings. (40%)

*Estimated Salvage Value: the estimated sales price of the ships after its designated years of use.