You are contemplating the purchase of a one-half interest in a corporate airplan

Question

You are contemplating the purchase of a one-half interest in a corporate airplane to facilitate the expansion of your business into two new geographic areas. The acquisition would eliminate about $220,000 in estimated annual expenditures for commercial flights, mileage reimbursements, rental cars, and hotels for each of the next 10 years. The total purchase price for the half-share is $6 million, plus associated annual operating costs of $100,000. Assume the plane can be fully depreciated on a straight-line basis for tax purposes over 10 years. The company’s weighted average cost of capital (commonly referred to as WACC) is 8%, and its corporate tax rate is 40%. Does this endeavor present a positive or negative net present value (NPV)? If positive, how much value is being created for the company through the purchase of this asset? If negative, what additional annual cash flows would be needed for the NPV to equal zero? To what phenomena might those additional positive cash flows be ascribable?

Explanation / Answer

NPV calculation : Year PV factor @8% Investment Annual Saving Annual Operating cost Annual Depreciation Net Taxable income Tax @40% Post Tax Income Add Back depreciation Post Tax Cash flow PV of Post Tax Cash flow Year 0            1.000        (6,000,000) (6,000,000) Year 1            0.926             220,000      (100,000)       (600,000) (480,000)    192,000 (288,000)    600,000    312,000         288,889 Year 2            0.857             220,000      (100,000)       (600,000) (480,000)    192,000 (288,000)    600,000    312,000         267,490 Year 3            0.794             220,000      (100,000)       (600,000) (480,000)    192,000 (288,000)    600,000    312,000         247,676 Year 4            0.735             220,000      (100,000)       (600,000) (480,000)    192,000 (288,000)    600,000    312,000         229,329 Year 5            0.681             220,000      (100,000)       (600,000) (480,000)    192,000 (288,000)    600,000    312,000         212,342 Year 6            0.630             220,000      (100,000)       (600,000) (480,000)    192,000 (288,000)    600,000    312,000         196,613 Year 7            0.583             220,000      (100,000)       (600,000) (480,000)    192,000 (288,000)    600,000    312,000         182,049 Year 8            0.540             220,000      (100,000)       (600,000) (480,000)    192,000 (288,000)    600,000    312,000         168,564 Year 9            0.500             220,000      (100,000)       (600,000) (480,000)    192,000 (288,000)    600,000    312,000         156,078 Year 10            0.463             220,000      (100,000)       (600,000) (480,000)    192,000 (288,000)    600,000    312,000         144,516 Total (3,906,455) So The endeavor has a negative NPV of = $   (3,906,455) PV annuity factor (sum of discount factors)=                6.7101 So Additional annula cash flows required for NPV to become 0=3906455/6.7101= $   582,176.93

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