Island Airlines Inc. needs to replace a short-haul commuter plane on one of its busier routes. Two

Question:

Island Airlines Inc. needs to replace a short-haul commuter plane on one of its busier routes. Two aircraft are on the market that satisfies the general requirements of the route. One is more expensive than the other but has better fuel efficiency and load-bearing characteristics, which result in better long-term profitability. The useful life of both planes is expected to be about seven years, after which time both are assumed to have no value. Cash flow projections for the two aircraft follow.

a. Calculate the payback period for each plane and select the best choice.
b. Calculate the IRR for each plane and select the best option. Use the fact that all the inflows can be represented by an annuity.
c. Compare the results of parts (a) and (b). Both should select the same option, but does one method result in a clearer choice than the other based on the relative sizes of the two payback periods versus the relative sizes of the two IRRs?
d. Calculate the NPV and PI of each project assuming a cost of capital of 6%. Use annuity methods. Which plane is selected by NPV? By PI?
e. Calculate the NPV and PI of each project, assuming the following costs of capital: 2%, 4%, 6%, 8%, and 10%. Use annuity methods. Is the same plane selected by NPV and PI at every level of cost of capital? Investigate the relative attractiveness of the two planes under each method.
f. Use the results of parts (b) and (e) to sketch the NPV profiles of the two proposed planes on the same set of axes. Show the IRRs on the graph. Would NPV and IRR ever give conflicting results?Why?

Annuity
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Cost of capital refers to the opportunity cost of making a specific investment . Cost of capital (COC) is the rate of return that a firm must earn on its project investments to maintain its market value and attract funds. COC is the required rate of... Payback Period
Payback period method is a traditional method/ approach of capital budgeting. It is the simple and widely used quantitative method of Investment evaluation. Payback period is typically used to evaluate projects or investments before undergoing them,...