Intermediate: Calculation of break-even point involving PV calculations CD is an aviation company engaged in providing transport services to tour operators and industrial customers. CD’s cost of money is 10%.

CD is considering the acquisition of three new aircraft which have a cost price of £2 000 000 each. Each aircraft has a useful life of five years, requires an overhaul (costing £600000) at the end of the third year of its life, incurs fixed operating costs of £100000 per year and has nil residual value at the end of its useful life.

If an aircraft is purchased and fully utilised then it flies for 2400 hours per year and generates an expected contribution of £1 600 000 per year.

As an alternative to buying an aircraft, it is possible to rent it via a broker. The terms of the rental are a fixed fee of £250 000 per year (payable annually in advance) and a variable charge of £361 per flying hour (calculated and paid annually in arrears). If an aircraft is rented, then CD will avoid fixed operating and overhaul costs. However, CD will incur the same variable operating costs regard¬ less of whether the aircraft is purchased or rented.

Requirements:

(a) Advise CD on the minimum average flying hours per year required in order to

• make renting an aircraft a viable proposi¬ tion,

• make buying an aircraft a viable proposi¬ tion, and advise CD on the average flying hours per year required in order to make buying and renting an aircraft equally viable propositions.

(15 marks)

(b) Advise CD as to how many aircraft it should acquire, and how it should acquire them (purchase or rent) on the basis of a flying hour requirement forecast of 5750 hours per year for five years.

Support your advice with a full financial analysis.

Note: You may ignore tax and inflation.

(10 marks) (Total 25 marks) CIMA Stage 3 Management Accounting Applications