FlybyNight Inc. is a budget airline that is evaluating whether to lease an aircraft from Boing Inc. If FlybyNight does not lease the aircraft, its competitor will lease it today. If FlybyNight, Inc. does lease the aircraft, it will incur annual leasing cash outflows of $20 million for the next twelve years. There is currently a pandemic and a potential vaccine has been developed for the deadly virus. If the vaccine is effective, future cash inflows net of other non-leasing cash outflows is expected to be $25 million per year. Otherwise, the net cash inflows will be $18 million per year. As of today, both scenarios seem equally likely. Initial capital outlay associated with introducing a new route is $12 million and the discount rate is 10%.

(a) Calculate the NPV to determine whether FlybyNight Inc. should lease the aircraft.

(b) Suppose the efficacy of the vaccine will be known in a years time. At that time, Boing Inc. will give FlybyNight Inc. the right to lease an additional aircraft, provided that it leases an aircraft today.

(i) What is the present value of the option to lease an additional aircraft?

(ii) Given this option, should FlybyNight lease an aircraft today?

(c) Suppose the efficacy of the vaccine will be known in a little over a years time. If it is ineffective, the pandemic would have become widespread to the point where no additional vaccine is worth developing. FlybyNight Inc. is negotiating with Boing Inc. for the right to terminate the lease once the efficacy of the vaccine is known.

(i) If Boing Inc. agrees to the early termination option, should FlybyNight

Inc. lease an aircraft today?

(ii) If Boing Inc. requires payment in return for the early termination option, what is the maximum amount FlybyNight Inc. would be willing to pay for

this option?