Aircraft Equipment LLC is considering two investment initiatives for 2016. The f

Question

Aircraft Equipment LLC is considering two investment initiatives for 2016. The first (initiative #1) is to purchase a fleet of six helicopters for $30 million. These can be leased to an existing client under a ten year contract to generate $3 million per year in incremental cash flow. The second (initiative #2) is to purchase a short-haul passenger plane for $100 million. This can also be leased to an existing customer to generate $20 million per year in additional cash flow for the next ten years. After 10 years, the plane can be sold on the secondary market for $30 million.   Aircraft leases are paid annually in advance. The firm’s cost of capital is 4%.

a. Calculate the NPV, discounted payback period, and IRR for each initiative.

b. Which of the initiatives should the Company pursue, and why?

c. How does a 10% cost of capital affect your conclusion?

Explanation / Answer

From the above two initiatives, it looks like that initiative #2 is more attractive as it gives more return from investment and much shorter period than initiative #1. Even when the cost of capital is 10% the investment still looks good as its IRR is 17% compared to the #1 where the IRR is 0.

Initiative #1 Initiative #2 Year Cash Flow Year Cash Flow Year 0 -30,000,000 Year 0 -100,000,000 Annual CF 3,000,000 Annual CF 20,000,000 Period 10 Period 10 Interest Rate 4% Interest Rate 4% NPV ($5,667,312) Salvage Value 30,000,000 IRR 0% NPV            79,312,347 Discounted PBP (5.29) IRR 17% Interest Rate 10% Discounted PBP                         1.26 NPV@10% ($10,514,817) Interest Rate 10% NPV@10% 31,325,128

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