Question

United Airlines is considering purchase of two alternative planes. Plane A has an expected life of 5 years., will cost $100 million, and will result in net cash flow of $30 million every year. Plane B has a life span of 10 years, will cost $132 million, and will produce net cash flow of $25 million per year. United Airlines plan to serve the route only for 10 years. Inflation in operating costs, airline costs and fares are expected to be zero. The company's cost of capital is 12%. By how much would the value of the company increase if the company accepts the better project ( plane).

Answer 1

United Airlines

The value of the company would increase by $9.25 million if it accepts the better project (Plane B).

Step-by-step explanation:

a) Data and Calculations:

Alternative 1 Alternative 2

Plane A Plane B

Initial project cost $100 million $132 million

Annual net cash inflow $30 million $25 million

Expected lifespan 5 years 10 years

Cost of capital = 12%

Present value Annuity factor 3.605 5.650

Present value of cash inflows $108,150,000 $141,250,000

Net present value = $8,150,000 $9,250,000

The better project (plane) is Plane B.