***Calculate the net advantage to leasing. Use the expected residual value and assume the airline can use all the tax benefits of ownership. The tax rate at the time was 40%. Assume straight-line depreciation to the expected residual value.

Scenario: 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 Capitalized leases Total long-term debt Preferred Stock Stockholder's equity Total long-term capitalization Short-term debt Total capitalization $1,352 306 $1,658 283 305 $2.246 221 $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 (Smillions): 10 15 20 25 30 Probability (%): 5 10 10 15 20 35 40 45 50 15 10 10 5 Scenario: 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 Capitalized leases Total long-term debt Preferred Stock Stockholder's equity Total long-term capitalization Short-term debt Total capitalization $1,352 306 $1,658 283 305 $2.246 221 $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 (Smillions): 10 15 20 25 30 Probability (%): 5 10 10 15 20 35 40 45 50 15 10 10 5