Question

Stan Mayfield, CEO of Mayfield Software, is interested in acquiring a used aircraft to facilitate business travel (primarily for travel between Melbourne and Sydney). The aeroplane he is interested in will cost $1,000,000. It has a five-year useful life with an anticipated residual value of $600,000.

Mayfield estimates that he and three other executives each take 100 trips per year at a cost of $670 per trip (they fly business class and, often, two or more of the executives fly together). These costs are expected to increase at 4 percent per annum.

If Mayfield buys the plane, a pilot will be hired at a cost of $95,000 per year. Fuel, maintenance, insurance, airport fees and other operating costs will be $360,000 per annum. This includes depreciation (calculated on a straight-line basis), but excludes the pilot’s fees. The pilot’s and operating costs (other than depreciation) are expected to increase at 4 percent per year due to general inflation

Mayfield values the time he and the other executives will save using a company plane at $500 per trip per person. He believes that the value of executive time will increase at least as fast as general inflation. The company tax rate is 33% and its required minimum attractive rate of return is 10 percent to cover loss of earning capacity and loss of purchasing power.

Analyse the investment in the aeroplane. In particular, PERFORM an NPV analysis ignoring tax. Now, REPEAT the calculation allowing for tax. DETERMINE how sensitive the attractiveness of the investment is to uncertainty in the tax rate (there is an election not too far away and the Government is hinting it may decrease the rate for business); the inflation rate; and, the value of “soft” benefits, i.e. the value attributed to the executives’ time. (You are expected to carry out simple analyses by varying one parameter at a time, only). MAKE a recommendation to Stan regarding the purchase, with your reasoning.

Answer 1