# Calculating NPV in the given case

Halcyon Lines is considering the purchase of a new bulk carrier for $8 million. The forecast for revenues are $5 million a year and operating costs are $4 million. A major refit costing $2 million will be required after both the fifth and tenth years. After 15 years, the ship is expected to be sold for scrap at $1.5 million. If the discount rate is 8%, what is the ship's NPV?

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NPV

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#### Solution Preview

Please refer attached file for better clarity of tables.

Let us analyze cash flows associated with the project

Amount in million $

Year End Revenues Operating costs Others* Net Cash flow PV factor PV

n R O X C=R+O+X PVF=1/(1+8%)^n C*PVF

0 -8 -8 1.0000 -8.0000

1 5 -4 1 0.9259 0.9259

2 5 -4 1 0.8573 0.8573

3 5 -4 1 0.7938 0.7938

4 5 -4 ...

#### Solution Summary

Solution describes the steps to calculate net present value in the given case.

Capital Budgeting

Break-even cash inflows and risk Pueblo Enterprises is considering investing in either of two mutually exclusive projects, X and Y. Project X requires an initial investment of $30,000; project Y requires $40,000. Each project's cash inflows are 5-year annuities: Project X's inflows are $10,000 per year; project Y's are $15,000. The firm has unlimited funds and, in the absence of risk differences, accepts the project with the highest NPV. The cost of capital is 15%.

a. Find the NPV for each project. Are the projects acceptable?

b. Find the breakeven cash inflow for each project.

c. The firm has estimated the probabilities of achieving various ranges of cash

inflows for the two projects, as shown in the following table. What is the probability

that each project will achieve the breakeven cash inflow found in part b?

Probability of achieving

cash inflow in given range

Range of cash inflow Project X Project Y

$0 to $5,000 0% 5%

$5,000 to $7,500 10 10

$7,500 to $10,000 60 15

$10,000 to $12,500 25 25

$12,500 to $15,000 5 20

$15,000 to $20,000 0 15

Above $20,000

d. Which project is more risky? Which project has the potentially higher NPV? Discuss the risk-return tradeoffs of the two projects.

e. If the firm wished to minimize losses (that is, NPV $0), which project would you recommend? Which would you recommend if the goal was achieving a higher NPV?

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