S-Airlines is considering two alternative planes. Plane A has an expected life o
ID: 2653719 • Letter: S
Question
S-Airlines is considering two alternative planes. Plane A has an expected life of 5 years, will cost $100 million and will produce net cash flows of $32 million per year. Plane B has a life of 10 years, will cost $132 million and will produce net cash flows of $26 million per year. S-Airlines plans to serve the route for only 10 years. Inflation in operating costs, airplane costs, and fares is expected to be zero, and the company's cost of capital is 14%.
A) By how much would the value of the company increase if it accepted the better project (plane)? Enter your answer in millions.
B) What is the equivalent annual annuity for each plane? Enter your answer in millions.
Plane A $ million Plane B $ millionExplanation / Answer
Answer:
A
Calculation of value of the company increase if it accepted the better project (plane)
NPV of Project Plane A
$ Million
$ Million
Year
Cash Flow (CF)
PVF (14%)
PV = CF*PVF
Initial Cash outflow
0
(100.00)
1
(100.00)
Cash Inflows
1 to 5
32.00
3.43308
109.86
NPV = Sum of PVs
9.86
NPV of Project Plane B
$ Million
$ Million
Year
Cash Flow (CF)
PVF (14%)
PV = CF*PVF
Initial Cash outflow
0
(132.00)
1
(132.00)
Cash Inflows
1 to 10
26.00
5.21612
135.62
NPV = Sum of PVs
3.62
Value to be lost due to wrong decision making shall be difference in NPV of the project
Value to Be lost = 9.86 -3.62
6.24
Million $
B
Calculation of equivalent annual annuity
Project A
Project B
Initial Cash outflow (Million $) (A)
100.00
132.00
PVAF (14%) (B)
3.43308
5.21612
Equivalent annual annuity = A/B (Million $)
29.13
25.31
A
Calculation of value of the company increase if it accepted the better project (plane)
NPV of Project Plane A
$ Million
$ Million
Year
Cash Flow (CF)
PVF (14%)
PV = CF*PVF
Initial Cash outflow
0
(100.00)
1
(100.00)
Cash Inflows
1 to 5
32.00
3.43308
109.86
NPV = Sum of PVs
9.86
NPV of Project Plane B
$ Million
$ Million
Year
Cash Flow (CF)
PVF (14%)
PV = CF*PVF
Initial Cash outflow
0
(132.00)
1
(132.00)
Cash Inflows
1 to 10
26.00
5.21612
135.62
NPV = Sum of PVs
3.62
Value to be lost due to wrong decision making shall be difference in NPV of the project
Value to Be lost = 9.86 -3.62
6.24
Million $
B
Calculation of equivalent annual annuity
Project A
Project B
Initial Cash outflow (Million $) (A)
100.00
132.00
PVAF (14%) (B)
3.43308
5.21612
Equivalent annual annuity = A/B (Million $)
29.13
25.31
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