10. You have become very successful and are considering the purchase of a plane

Question

10. You have become very successful and are considering the purchase of a plane for your firm. The Piper model has an initial cost of $375,000, annual operating costs of $24,000 and a salvage value of $150,000. Its estimated holding period is 7 years. The Cessna model has an initial cost of $325,000, but annual operating costs of $29,500 and an estimated salvage value of $100,000. Its estimated holding period is 8 years. Your cost of capital is fifteen percent. Ignoring depreciation and taxes, which model would be the best choice assuming they both would perform the required tasks?

Explanation / Answer

It would be better to purchase Cessna as it has a lower negative NPV.

Year Piper model Cessna model Piper model Cessna model Cash flows Cost of capital PV of cash flows 0 -$3,75,000 -$3,25,000 $1 -$3,75,000 -$3,25,000 1 -$24,000 -$29,500 $0.870 -$20,870 -$25,652 2 -$24,000 -$29,500 $0.756 -$18,147 -$22,306 3 -$24,000 -$29,500 $0.658 -$15,780 -$19,397 4 -$24,000 -$29,500 $0.572 -$13,722 -$16,867 5 -$24,000 -$29,500 $0.497 -$11,932 -$14,667 6 -$24,000 -$29,500 $0.432 -$10,376 -$12,754 7 $1,26,000 -$29,500 $0.376 $47,368 -$11,090 8 $70,500 $0.327 $0 $23,047 NPV -$4,18,460 -$4,24,686

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