Final answer:
To assess the purchase of a new cruise ship by OpenSeas, Inc., NPV is calculated at different discount rates to determine financial viability. The IRR can be graphically identified and compared to the cost of capital to judge the investment's attractiveness. The sensitivity analysis shows the leeway in the cost of capital estimate before changing the purchase decision.
Step-by-step explanation:
Net Present Value (NPV) and Investment Decision Making
To evaluate the purchase of the new cruise ship by OpenSeas, Inc., it's necessary to calculate the Net Present Value (NPV) at varying discount rates. Given the cost of investment and the expected annual cash flows, the NPV for each discount rate would determine if the investment is financially viable. NPV is calculated by discounting all future cash flows to their present value and comparing it with the initial investment.
To find the Internal Rate of Return (IRR), you would plot the NPV values against different discount rates and identify the rate at which NPV crosses zero. IRR represents the break-even cost of capital for the project, and investments with an IRR above the cost of capital are generally considered attractive.
The attractiveness of the purchase is determined by whether the NPV is positive at the company's cost of capital, signaling that the investment would generate enough return to cover the cost of capital plus extra profit. However, estimating the exact IRR requires using a financial calculator or software like Excel.
The sensitivity of the investment decision to the cost of capital can be explored by looking at how much the cost of capital could increase before the NPV becomes negative, indicating the investment would no longer be financially attractive.