Island Airlines Inc. needs to replace a short-haul commuter plane on one of its busier routes. Two aircraft are on the market that satisfy the general requirements of the route. One is more expensive than the other but has better fuel efficiency and load-bearing characteristics, which result in bet- ter long-term profitability. The useful life of both planes is expected to be about seven years, after which time both are assumed to have no value. Cash flow projections for the two aircraft follow:

Low Cost High Cost

Initial cost $775,000 $950,000

Cash inflows, years 1 through 7 154,000 176,275

a. Calculate the payback period for each plane and select the best choice.

b. Calculate the IRR for each plane and select the best option. Use the fact that all the inflows can be represented by an annuity.

c. Compare the results of parts (a) and (b). Both should select the same option, but does one method result in a clearer choice than the other based on the relative sizes of the two payback periods versus the relative sizes of the two IRRs?

d. Calculate the NPV and PI of each project assuming a cost of capital of 6%. Use annuity methods. Which plane is selected by NPV? By PI?

e. Calculate the NPV and PI of each project, assuming the following costs of capital: 2%, 4%, 6%, 8%, and 10%. Use annuity methods. Is the same plane selected by NPV and PI at every level of cost of capital? Investigate the relative attractiveness of the two planes under each method.

f. Use the results of parts (b) and (e) to sketch the NPV profiles of the two proposed planes on the same set of axes. Show the IRRs on the graph. Would NPV and IRR ever give conflicting results? Why?