The president’s executive jet is not fully utilized. You judge that its use by o
ID: 2417627 • Letter: T
Question
The president’s executive jet is not fully utilized. You judge that its use by other officers would increase direct operating costs by only $21,000 a year and would save $100,000 a year in airline bills. On the other hand, you believe that with the increased use the company will need to replace the jet at the end of three years rather than four. A new jet costs $1.11 million and (at its current low rate of use) has a life of six years. Assume that the company does not pay taxes. All cash flows are forecasted in real terms. The real opportunity cost of capital is 9%. PLEASE EXPLAIN ALL ANSWERS!!!
Calculate the equivalent annual cost of a new jet. (Round "PV Factor" to 3 decimal places and final answer to the nearest dollar amount.)
Calculate the present value of the additional cost of replacing the jet one year earlier than under its current usage. (Do not round intermediate calculations. Round "PV Factor" to 3 decimal places and final answer to the nearest dollar amount.)
Calculate the present value of the savings. (Do not round intermediate calculations. Round your answer to the nearest dollar amount.)
The president’s executive jet is not fully utilized. You judge that its use by other officers would increase direct operating costs by only $21,000 a year and would save $100,000 a year in airline bills. On the other hand, you believe that with the increased use the company will need to replace the jet at the end of three years rather than four. A new jet costs $1.11 million and (at its current low rate of use) has a life of six years. Assume that the company does not pay taxes. All cash flows are forecasted in real terms. The real opportunity cost of capital is 9%. PLEASE EXPLAIN ALL ANSWERS!!!
Explanation / Answer
Answer for subpoint a:
The present value annuity factor for years 3 to 9 (because the jet is replaced at the end of year 3 and would have a life of 6 years.
So, the annuity factor from year 4 to year 9 are as follows:
$1.1 million would be incurred at the end of year 3. So, the present value of the jet =$1,100,000 *0.77218= $849,401.8.
Equivalent annual cost= $849,401.8/3.464
=$245,211.80.
Answer to the subpoint b:
Present value of the jet for replacing at the end of year 3 =$1,100,000 *0.772 =$849,401.8.--------(1)
Present value of the jet for replacing at the end of year 4 =$1,100,000 *0.708 =$779,267.7---------(2)
Additional cost of replacing the jet one year earlier = (1) - (2).
=$70,134.1
Answer for subpoint c:
Present value of the savings = Incremental savings of using the jet * present value annuity factor for 3 years.
=$100,000 - $21,000
=$71,000 is the annual savings.
Present value of savings =$79,000 * 2.531
=$199,972.28
Year Present value factor @9% 4 0.708 5 0.650 6 0.596 7 0.547 8 0.502 9 0.460 Total 3.464Related Questions
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