36. The cost of excess capacity (S6.4) The president’s executive jet is not fully utilized. You judge that its use by other officers would increase direct operating costs by only $20,000 a year and would save $100,000 a year in airline bills. On the other hand, you believe that with the increased use the company will need to replace the jet at the end of three years rather than four. A new jet costs $1.1 million and (at its current low rate of use) has a life of six years.

Assume that the company does not pay taxes. All cash flows are forecasted in real terms. The real opportunity cost of capital is 8%. Should you try to persuade the president to allow other officers to use the plane?

180 Part One Value CHALLENGE