Zappe Airlines is considering two alternatives planes. Plane Ahas an expected li
ID: 2770659 • Letter: Z
Question
Zappe Airlines is considering two alternatives planes. Plane Ahas an expected life of 5 years, will cost $100 million, and willproduce net cash flows of $30 million per year. Plane B has a lifeof 10 years, will cost $132 million, and will produce net cashflows of $25 million per year. Zappe plans to serve the route for10 years. The company’s WACC is 12 percent. If Zappe needs topurchase a new Plane A, the cost will be $105 million, but cashinflows will remain the same. Should Zappe acquire Plane A or PlaneB? Explain your answer.
Explanation / Answer
PlaneA: Cost = $105,000,000.00
Net Annual Cash flows = $30,000,000.00 per year
Number of years = 5 years
PlaneB: Cost = $132,000,000.00
Net Annual Cash flows = $25,000,000.00 per year
Number of years = 10 years
Calculating Plane A’s NPV :
NPVA = $30,000,000 (PVoAF5, 12%) -$105,000,000
= $30,000,000 (3.6048) - $105,000,000
= $108,144,000 - $105,000,000
= $3,144,000
Adjusted NPVA = NPVA + NPVAdiscounted for 5 years
= $3,144,000 + $3,144,000 (PVF5,12%)
= $3,144,000 + $3,144,000 (0.5674)
= $3,144,000 + $1,783,905.60
= $4,927,905.60
PlaneA’s NPV =$4,927,905.60
Calculaitn Plane B’s NPV:
NPVB = $25,000,000 (PVoAF10, 12%) -$$132,000,000
=$25,000,000 (5.6502) - $132,000,000
=$141,255,000 - $132,000,000
PlaneB’s NPV = $9,255,000
Here Plane A has a 5-years life, while Plane B has a 10-years life.Under this approach, the projects would be extended to a commonlife of 10-years. Plane A would have an adjusted NPV equal to theNPVA + the NPVA discounted for 5 years at theproject’s cost of capital. Then the Plane with thehigher NPV would be chosen.
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