2019 Fundamentals of Business Finance Assignment Solution

This document presents a comprehensive solution to a Business Finance assignment, addressing key concepts in capital budgeting. The assignment includes answers to questions related to depreciation, incremental cash flows, and the application of net present value (NPV) techniques. The solution demonstrates how to calculate NPV, considering initial investments, annual operating costs, and the impact of depreciation on tax shields. The case study analyzes the profitability of a cruise ship investment, evaluating cash inflows and outflows over a project's lifespan. The analysis considers factors such as refurbishment costs, resale values, and the required rate of return. The solution also includes formula views for calculations and references to relevant academic sources.

Running head: BUSINESS FINANCE
Business Finance
Name of the Student:
Name of the University:
Author’s Note:

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Table of Contents
Answer to Question 1:.....................................................................................................................2
Answer to Question 2:.....................................................................................................................2
Answer to Question 3:.....................................................................................................................3
Answer to Question 4:.....................................................................................................................3
Formula view:..............................................................................................................................3
Answer to Question 5:.....................................................................................................................5
Formula view:..............................................................................................................................5
References and bibliography:..........................................................................................................6

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Answer to Question 1:
Answer to Question 2:

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Answer to Question 3:
Answer to Question 4:
Formula view:
Net present value is the measure of profitability of any investment options in terms of
present value, which is calculated by applying the time value of money techniques. Net present
value is the difference between the present value arising from an investment and the initial
investment. To calculate present value of future cash flows, future cash flows are multiplied with
the discount rate. In most of the cases, the required rate of return is considered as the discount
rate and cash flows are multiplied with that rate to calculate the present value of cash flows. The
net present value is calculated by comparing the present value of cash flows and the initial
investment (Shah and Shah 2014). If the present value of cash inflow is more than the initial
investment, then the difference is known as a positive NPV and if the present value of cash flow
is less than the initial investment then, the difference is known as a negative NPV. Positive NPV
represents profitability over and above the cost of capital or the required rate of return and a

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negative NPV implies profitability less than the required rate of return or the cost of capital.
Hence, the acceptance or appraisal criterion in net present value technique is to select a project
with positive NPV and higher NPV denotes higher profitability (Carmichael 2014).
In the given case study, all the costs that need to be incurred for purchase of the “Pacific
Dream” cruise ship are included in the initial investment or the cash outflow at the beginning of
the project. The purchase new cruise ship will cause an increase in various fixed and variable
expenses annually. There will be also some opportunity costs of decrease in revenue for other
cruise ships and compensation. Taking all those annual variable and fixed costs and the initial
investment the net present value can be computed considering a discount rate of 12.5%. It can be
observed from the above computations that, the project is having a negative net present value of
$3.59 million. Hence, the project should not be accepted. If the project is accepted then there will
be an erosion of capital for the company. It can be observed that, the company is incurring an
refurbishment expenses over the 10 year life of the project for a total amount of $6.5 million, as a
result, the resale value of the “Pacific Dream” ship would be $22.9 million, otherwise the resale
value of the ship would be $15 million. If that change is considered, then also there will be a
negative net present value of $3.31 million. Hence, the project is not profitable with the given
demand and pricing of the services. If the demand can is increased or if the price for the services
are charged with a higher rate to make a significant cash inflows annually, then only the project
could be accepted (Chandra 2017).

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Answer to Question 5:
Formula view:

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References and bibliography:
Carmichael, D.G., 2014. Infrastructure investment: An engineering perspective. CRC Press.
Chandra, P., 2017. Investment analysis and portfolio management. McGraw-Hill Education.
DeFusco, R.A., McLeavey, D.W., Pinto, J.E., Runkle, D.E. and Anson, M.J., 2015. Quantitative
investment analysis. John Wiley & Sons.
Shah, N.H. and Shah, A.D., 2014. Optimal cycle time and preservation technology investment
for deteriorating items with price-sensitive stock-dependent demand under inflation. In Journal
of Physics: Conference Series (Vol. 495, No. 1, p. 012017). IOP Publishing.