Question

Shao Airlines is considering the purchase of two alternative planes. Plane A has an expected life of 5 years, will cost $100 million, and will produce net cash flows of $28 million per year. Plane B has a life of 10 years, will cost $132 million and will produce net cash flows of $27 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 9%.

1. By how much would the value of the company increase if it accepted the better project (plane)? Enter your answer in millions. For example, an answer of $1.2 million should be entered as 1.2, not 1,200,000. Round your answer to two decimal places.
   $ million

2. What is the equivalent annual annuity for each plane? Enter your answer in millions. For example, an answer of $1.2 million should be entered as 1.2, not 1,200,000. Round your answers to two decimal places.

   Plane A	$ million
   Plane B	$ million

Answer 1

Annuity factor can be calculated as [1-(1+r)^-n / r] which we have calculated below for Plane A & Plane B

Plane A calculations Plane B calculation

= [1-(1+0.09)^-5 / 0.09] = [1-(1+0.09)^-10 / 0.09]

= 3.89 = 6.42

Present value of cash inflow will be = Annuity factor * net cash flow

Plane A (in million) Plane B (in million)

= 3.89 * 28 = 6.72 * 27

=108.92 = 173.34

Net present value = Present value of cash inflow - cost

Plane A (in million) Plane B (in million)

=108.92-100 =173.34-132

=8.92 = 41.34

Equivalent annual annuity = Net present value/annuity factor

Plane A (in million) Plane B (in million)

= 8.92/3.89 = 41.34/6.42

=2.29 = 6.44

A. Better project is Plane B as per Net present value calculation and the value of the company will increase by 41.34 million.

B . As per calculations done above equivalent annual annuity for Plane A is 2.29 million & for Plane B is 6.44 million.