How should the purchase of the pre-owned Airbus aircraft be financed? (6 marks) Discuss the advantages and disadvantages of each option in comparison to other options. Calculations are not necessary.

kumatima.com is South Africa's largest low-cost airline and operates only within the country. The business was launched with only two aircraft, and it took to the skies on 2 July 2014, operating between Cape Town and Johannesburg. The fleet of aircraft has now increased to 25 and operates flights to and from Cape Town, Durban, East London, George, Gqeberha and Johannesburg. Since kumatima.com's entry into the market, it is reported that the average cost of flying for the general public has been reduced by 30% and this has meant a shrinking demand for bigger international airlines which normally charge high fares for travel. Prior to the Covid-19 outbreak, kumatima. com had reported very low profits due to high costs usually incurred in the first few years of operation and low demand. The executive management team had previously projected an increase in profits from the 2021 financial year, however, travel restrictions introduced during the lockdown resulted in significant losses made by the company in the 2021 and 2022 financial years. The company has not paid its employees' salaries for the last two months of the 2022 financial year (the executive management team's salary payments are kept up to date as the company fears losing top talent to its rivals, should team members resign because of non-payment of salaries). As the company battles to return to profitability, it has become apparent that without capital injection and an increase in the number of passengers, kumatima. com will have to file for business rescue or, at worst, bankruptcy. From the projections provided by kumatima.com's management accountants, the company will return to profitability within weeks, provided that capital of R400 million is injected. A significant increase in domestic travel is anticipated both in the short and medium term, as the result of an expected decrease in fuel prices, the approaching summer season and fewer competitors going forward. Fifteen percent (15%) of the capital required will be used to bridge working capital requirements and the remaining balance will be invested in one of the two capital projects currently evaluated. A. WORKING CAPITAL REQUIREMENTS (fleet servicing) kumatima.com is already months behind on its short-term obligations (salaries and other payables) and needs additional funds to source enough jet fuel and pay for monthly operating costs. Most of these costs cannot be easily restructured as the company usually enters into long- term contracts with the relevant parties. However, kumatima. com is considering restructuring its aircraft maintenance contracts in order to save money. Based on an analysis performed recently, the following are probabilities of the number of services to be conducted in total on the fleet of 25 aircraft for a year (routine service takes place every 1-3 days): Total number of services Probability 4 400 50% 8 900 20% 3 400 30% The two options available to kumatima. com are presented below:Option A: Pay-as-you-go maintenance (service) Under this option, kumatima.com will only pay for the service done on each aircraft that goes in for maintenance. The recent analysis performed was mainly focused on this option (and kumatima.com has to make payment of R240 000 for this analysis to the consultant within the next 30 days). The average cost of one service is estimated at R36 500. This option requires intense administration to ensure that services are done on time and that the availability of resources and parts is also confirmed timeously. As a result, one full-time senior administration clerk currently working in Operations Department will be required to spend 20% of his time managing the maintenance schedule under this option. He currently earns R500 000 per annum. Option B: 1-year maintenance (service) plan kumatima. com has in the past entered into a fixed year-to-year contract with Air-motion (Pty) Ltd (also referred to as "Air-motion") to service its entire fleet. However, there are concerns that this may not be as cost effective as Option A above (pay-as-you-go maintenance). Although the contract is signed upfront, payment is only made at the end of the contract term. kumatima.com has recently paid Air-motion R168 million under last year's contract (inclusive of R8 million relating to late interest charged from the previous year). As kumatima.com is one of its highly valued clients, Air-motion always gives kumatima.com its Air-motion branded headphones to the fixed value of R1,25 million at no extra charge (the headphones are then sold to passengers to use on board at the same value). At the end of each year, kumatima.com has no headphones left in stock. Air-motion's contract price increases by 4% year on year. B. CAPITAL PROJECT INVESTMENTS To prepare for the anticipated spike in travel for the coming years, kumatima. com is considering investing the remaining balance of capital required in one of the two projects below (both projects require the same amount of capital): Capital project 1: Acquisition of 55% stake in Leeft Airlines Leeft Airlines is a newly established airline operating 3 medium-sized aircraft with direct regional flights between Johannesburg and Harare. Current evaluations estimate the net present value of this acquisition to be R43,20 million. The deal will be subject to competition authorities' approval in both South Africa and Zimbabwe. Capital project 2: Acquisition of a pre-owned (used) Airbus aircraft, A320 kumatima. com is also exploring the option of buying a pre-owned Airbus aircraft, A320 from the French-based company, Airbus SE. This fuel efficient and spacious aircraft carries a maximum of 200 passengers and can fly routes of up to 7 200 kilometres. Five members of the executive management team recently travelled to Toulouse, France, to negotiate favourable terms of purchase with Airbus SE management. This two-week trip cost kumatima.com R700 000 per member and their spouse. Airbus SE has agreed to reduce the purchase price to fit kumatima.com's capital budget (the initial price quoted by Airbus SE was R350 million) and will also provide free maintenance for 8 years, which is worth an average of R7,50 million per annum. Maintenance of this aircraft will not be covered under the existing fleet maintenance plan. The aircraft will be sold in the open market at R80 million after 8 years in use.It is estimated that revenue of R144 million in the rst year will be generated mainly from ticket and refreshment sales. This is based on sex capacity of the aircraft in year 1 and then the capacity levels will be increased by 1t] passengers per ight on average per annum until maximum capacity is reached. The ticket price (inclusive of refreshment sales] is estimated to average R1 Bill] for the next 3 years. Over iis 3year period, EEIITDA margin will be maintained at 513% each year, while depreciating the aircraft at 5% per annum. The operating costs {before depreciation and amortisation] are split 1,5: 1 between xed and variable respectively- The South African Revenue Services grants a special capital allowance on commercial aircraft at 25% per annum. Major software upgrades, as well as pilot training, are expected every 4 years at today's cost of RE- million. These costs are expected to increase at an ination rate of Edit: per annum. These costs are also not included in EEITDA {not considered part of day-to-dayroperating expenses of the company} but are fully tax deductible in the year in which they are incurred. At the time of acquisition, kumatrmacom will also require additional working capital of R43,ED million, which the company 1ll'll'ill make available at the start [if the project. This amount 1ll'll'ill be fully recovered when the aircraft is sold. O. FINANCING OPTIONS Many potential investors have already made commitments for funding having been convinced that the expansion plans of kumair'ma.com are likely to be highly protable. If the executive management team decides to invest in the oreowned A320 aircraft, each of the following investors can fully fund the project in the following rnannec Fleet-a-fair Capital This specialised commercial aircraft finance has agreed to a allyear assetbased nance deal. Instalments, which include the capital portion, are required to be made every six months {in arrears] at we basis points below the prime lending rate. EMBO Bank The bank has offered to provide a term loan for the full amount, where interest {at sea per annum} will be paid yearly with the full capital repayment at the end of year it]. Apart from the admin fee of sec lltl paid upfront, EMBD Bank also charges a late payment fee of {15% on the due amount. Induna Development Corporation [11:11:]: A government funding company, IDC, has committed to buy a 1d'l-l: stake in kumatimacom in exchange for the required funds. lDC's offer is at a premium of the value of kumatimacom as IDG sees the company as a strategic national asset, following the demise of one of the govemrnent owned airlines in which IDC had previously invested. I1 ADDITIONAL INFORMATION I The South African corporate tax rate remains at 23%- I The prime lending rate in South Africa is 3,25%. I All capital projects are currently evaluated using a discount rate of mess. I All cash flows take place at the end of each year, unless stated otherwise