Question

An airline is considering building its own maintenance facility for its fleet. At the current time the firm pays another airline to perform necessary maintenance at a cost per year of $300,000. The "do-it-yourself" plan will cost less per year, only $125,000, but requires an initial one-time investment of $2,250,000. The time horizon for the problem is 20 years because at that time the facility will need to be replaced. There are no terminal cash flows (e.g. salvage value) associated with the new facility. Using a discount rate of 13%, which would you recommend?

Answer 1

Solution :-

Due to its own Building facility

Savings every Year for 20 Years = $300,000 - $125,000 = $175,000

Discount Rate = 13%

But Requires Initial Investment = $2,250,000

Now we need to Find NPV = Present Value of Savings - Initial Investment

= $175,000 * PVAF ( 13% , 20 ) - $2,250,000

= ( $175,000 * 7.0248 ) - $2,250,000

= $1,229,331.53 - $2,250,000

= - $1,020,668.47

Now As the NPV of the Project is Negative so Don't Recommend the Project

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