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An airline was looking to add two additional aircraft to its fleet of over 200 airplanes. The purchase price for each new airplane would be

An airline was looking to add two additional aircraft to its fleet of over 200 airplanes. The purchase price for each new airplane would be $125 million. Leasing could be an option, however. In this case, a 15-year lease would be quarterly payments of $4 million for each airplane. This payment would be in arrears (like your home mortgage payment). Leasing may be good solution for this airline because of a net operating loss it has experienced. They had $2.5 billion of net operating loss to carry forward. These losses during this time were only allowed to be carried forward for a maximum of 20 years. During the period, the airline's capitalization was (in millions): Long Term Bonds $1,352 Capitalized leases 306 Total long-term debt $1,658 Preferred Stock 283 Stockholder's equity 305 Total long-term capitalization$2.246 Short-term debt 221 Total capitalization $2,467

The airline's cost of fully secured 15-year debt was 10% (80% of the value of collateral). It's cost of unsecured 15-year debt was 12% and its WACC was 15%. The airline was uncertain at the time about the residual value of the airplanes at the end of the lease period. They therefore estimated the following possible values and probabilities:

Residual value ($millions):

10

15

20

25

30

35

40

45

50

Probability (%):

5

10

10

15

20

15

10

10

5

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