Smooth Sailing Case Summary

Smooth Sailing has seen a decline in operating cash flows of 30 percent ($1.0 million). Smooth Sailing’s cruise ship has an estimated fair value of $3.0 million, a net book value of $4.6 million, and a remaining useful life of five years. The net carrying value of the nonrecourse debt is $4.0 million and there is $0.1 million of cash in the bank account that is directly associated with the cruise ship. An annual discount rate of 7 percent has been deemed appropriate by management of Smooth Sailing.
Issue
Smooth Sailing would like to evaluate different options for the upcoming years and beyond. Should Smooth Sailing:
A. Continue operating the ship in the current area.
B. Operate the ship in a new pirate-free area.
C. Operate the ship in the
Estimated Future Cash Inflows – Undiscounted
(in $ millions)
Option Probability of Occurring 2016 2017 2018 2019 2020 Total Probability
Weighted
A 10% $1.0 $.9 $.7 $.7 $.7 $4.0 $0.4
B 20% .6 .8 1.1 1.6 1.9 6.0 $1.2
C 70% $1.0 $3.0 $0 $0 $0 $4.0 $2.8
Total 100% $4.4
Since there are three different operating scenarios that will impact the recoverability test, an estimated future cash inflow weighted by probability of occurrence would be appropriate to use. For this method, the expected cash flow used for the recoverability test is calculated by multiplying the expected cash inflow for the respective scenario, multiplied by the probability of the scenario happening. The table for this calculation is as follows:

Due to the high probability of the foreclosure occurring (70 percent), it has a great impact on the estimated cash flows.
Conclusion
The weighted estimated future cash inflow for Option C is $2.8 million, due to the high probability of occurring. Option B has a higher estimated future cash inflow, before the probability weighted calculation