Shao Airlines is considering the purchase of two alternative planes

Finance Aug 23, 2020

Shao Airlines is considering the purchase of two alternative planes. Plane A has an expected life of 5 years, cost $100 million, and will produce net cash flows of $30 million per year. Plane B has a life of 10 years, will cost $132 million, and will produce net cash flows of $25 million per year. Shao 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 12%.

a. By how much would the value of the company increase if it accepted the better project (plane)?

b. What is the equivalent annual annuity for each plane?

Expert Solution

a). Since, the NPV of Plan A is higher than plan B. So, the Plan A is better project and will increase the value by $12.76 million.

b). Equivalent annual annuity (EAA) for plan A = $2.26 million

For plan B = $1.64 million

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