Question

As the newest business analyst for Qantas, you are meeting with the CFO, Sarah, to finalise the current quarter's acquisition proposals for aircraft. Upon sitting down in the meeting room, Sarah starts the conversation... Rather than buying aircraft outright, we are exploring a new offer from our bank for operating leases, where we rent the aircraft instead. So, we save on a capital purchase upfront but the lease clause includes an upfront aircraft insurance policy, that we have to pay as a lump sum premium. The lease payments are a percentage of the net revenue the aircraft generates each quarter, so our net cash flow will be the remaining quarterly net revenue after subtracting the lease payments. This net cash flow will be earned every quarter till the end of the lease maturity, after which we return the aircraft and don't have to bother with disposing of a capital asset. Sarah then hands you a briefing sheet with the following information ... Aircraft Insurance premium Initial Net Revenue/quarter Net Revenue growth/quarter Quarterly Lease payment Lease Maturity (Yr) Airbus A380 $890,000 $320,000 +2.5% 25% 2 Boeing 737 $950,000 $230,000 +5% 35% 2.5 Comac C919 $630,000 $420,000 -3% 30% 1.5 ​​​​​​​​​​​​​​​​​​​​​ Sarah nods her head... Ok, lets meet up after 2 hours and we can discuss your capital budgeting analysis that needs to include the payback period, discounted payback period, NPV, IRR and PI for all the leases. The cost of capital for Qantas is 12% p.a. so don't forget to adjust this to a quarterly discount rate. There is no cut-off payback period to be applied. Assuming mutually exclusive leases, which lease do you recommend by each of the metrics? Ignore that the projects have different lives and ignore having to use equivalent annual annuties (covered in the next topic). You reply...

1) With no cut-off period, the lease with the shortest payback and discounted payback period is the
a) C919 at 2.18 and 2.3 quarters
b) A380 at 1.18 and 1.3 quarters
c) 737 at 3.18 and 3.3 quarters

Answer 1

To provide a recommendation for which aircraft lease Qantas should use based on payback and discounted payback periods, a thorough capital budgeting analysis using provided financial metrics and taking the cost of capital into account is essential.

Step-by-step explanation:

To determine the lease with the shortest payback and discounted payback period, a detailed capital budgeting analysis must be conducted using all the provided financial metrics including payback period, discounted payback period, net present value (NPV), internal rate of return (IRR), and profitability index (PI). The choice of aircraft (Airbus A380, Boeing 737, or Comac C919) for Qantas's operating lease would depend on the outcomes of these analyses.

In essence, to ascertain which lease is most beneficial for Qantas, each lease's cash flows and costs, including the initial insurance premium, need to be compared against the lease payments, which are a percentage of net revenues, adjusted for revenue growth. The comparison should consider the cost of capital as a discount rate to compute NPV and the IRR which will assess the leases' profitability over time.