For long distance transport of your expensive electronic products your company i
ID: 2739523 • Letter: F
Question
For long distance transport of your expensive electronic products your company is leasinga cargo-plane for $150,000 per year. Your annual costs depend on the miles of flights andthey are directly proportional to them at a cost of $5 per mile.
You have received an offer to purchase an airplane
- Initial investment of $1,000,000.
- The lifespan of the airplane is 8 years at which time it can be scrapped for $150,000.
- At 5 years a major maintenance of cost $150,000 will be required. Obviously at the end you do not have to perform maintenance.
- Due to its technological improvements the cost per mile is $4.6.
Evaluate the proposed offer using the net present value for an indicative annual mileage of 120,000 miles.
What is the Internal Rate of Return of the purchase versus the continuation of the lease? Do you recommend it? The discount interest rate (MARR) for the evaluation of the investments is set to 4%.
Explanation / Answer
Note: All the calculations have been rounded off to three decimal places to avoid complications.
Evaluation of purchase offer:
NPV = $319682
NPV @ 11%
NPV = -$4744
IRR = Lower rate + [Lower rate NPV / (Lower rate NPV - Higher rate NPV)] x Difference in rates
= 4 + [319682 / (319682+4744)] x 7
= 10.89%
The NPV of the proposal is positive. Also, the IRR of the proposal is greater than discount rate or cost of capital of 4%. Hence, the proposal should be accepted.
Year 0 1 2 3 4 5 6 7 8 Initial investment -1000000 Maintenance cost -150000 Savings per year 48000 48000 48000 48000 48000 48000 48000 48000 Srap value 150000 Savings of lease cost 150000 150000 150000 150000 150000 150000 150000 150000 Cash flows per year -1000000 198000 198000 198000 198000 48000 198000 198000 348000 PVF @ 4% 1 0.962 0.925 0.889 0.855 0.822 0.790 0.760 0.731 PV -1000000 190476 183150 176022 169290 39456 156420 150480 254388Related Questions
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