An airline is considering the purchase of an Airbus A-320neo which offers improv

Question

An airline is considering the purchase of an Airbus A-320neo which offers improved fuel efficiency over the previous generation of narrow-body aircraft. The finance department estimates the aircraft will generate a positive net cash flow of $6 million in the first year increasing by 5% annually owing to the aircraft’s fuel efficiency. The airline plans to operate the aircraft for 15 years, then selling it in year 16 for an estimated net cash price of $30 million. The airline targets a return on invested capital of 12% annually (use this rate rather than the interest rate to discount future cash flows). What is the maximum price the airline should be willing to pay for a new A-320neo? Note: This computation is easiest to perform using MS Excel. The Excel computations may be copied and pasted into MS Word.

Explanation / Answer

In year 15, net cash inflow = $6 million x (1.12)15 + $30 million = $61.68 million

The present value of future cash flows is as follows.

Since PV of future cash flows is $147.24 million, this is the maximum price.

Year Cash flow ($ Million) Discount factor@12% Discounted cash flow ($ Million) 1 16.00 0.8929 14.29 2 16.80 0.7972 13.39 3 17.64 0.7118 12.56 4 18.52 0.6355 11.77 5 19.45 0.5674 11.04 6 20.42 0.5066 10.35 7 21.44 0.4523 9.70 8 22.51 0.4039 9.09 9 23.64 0.3606 8.52 10 24.82 0.3220 7.99 11 26.06 0.2875 7.49 12 27.37 0.2567 7.02 13 28.73 0.2292 6.59 14 30.17 0.2046 6.17 15 61.68 0.1827 11.27 PV = 147.24

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