The United Overseas Airline Co. was founded five years ago by three Airline employees of TWA and Pan American airlines Company employees. The three founders own 100% of the United Overseas Airline Companys stock which has a market value of $5 per share. Below is the Balance Sheet of the company.

United Overseas Airline Company -Balance Sheet
Cash	$100,000	Accounts Payable	$150,000
Account Receivable	$300,000	Notes Payable	$50,000
Inventory	$250,000	Accrued Wages	$75,000
Current Assets	$650,000	Current Liabilities	$275,000
Gross Fixed Assets	$1,850,000	Common Stocks (1M shares at par value of $1.5)	$1,500,000
less: Accumulated
Depreciation	($300,000)	Retained Earnings	$425,000
Net Fixed Assets	$1,550,000	Equity	$1,925,000
Total Assets	$2,200,000	Total Debt & Equity	$2,200,000

The boards of directors of United Overseas Airline Company have asked Frank Norman, the financial officer of the company, to make the first major decision for the company's future financial planning.

The board has asked Frank to evaluate the profitability of two new small private jet each cost one million dollars and two medium size jet each costing $2.5 million dollars. (Table 1) show the information for both jets.

Table 1	Small Jets	Medium Jets
Purchase Price for two jets	$2,000,000	$5,000,000
Annual passenger	3,000	3,000
Annual growth in passengers	5%	5%
Service cost per passenger	$600	$600
Annual growth in service cost per passengers	3%	3%
Ticket price per passenger	$1,100	$1,250
Ticket price Increase	4%	4%
Beta	1	1.4
Tax Rate	40%	40%

All jets would be depreciated on a straight-line basis over their five-year life to a zero-salvage value.

Frank Norman, being a sophisticated financial analyst, obtained the following information in

Table -2 for the analysis of various investment and financial proposals.

Table 2	Expected Return	Variance	Covariance with Market Return
Risk-Free Rate	6%
Market Portfolio		20%
Rate of return on the Market	12%
United Overseas Airline			8%

Part I

1. What is the cost of capital for each investment?
2. Which of the two investments should be adopted? Why?
3. What would be the United Overseas Airline s cost of capital if these two investments are adopted?

4. Based on the expected rate of return of each investment which investment should be accepted? Why?

Part II

The UOA does not have any debt in its capital structure and some debt would be beneficial to the company. Frank proposed to the board of directors the company should finance half of each investment in jets by debt at the 10% interest rate and retire the debt over the life of the investment. If Frank Norman is correct with his assumptions and if his financial plan is adopted, what would the following be?

1. What is the Adjusted Present Value (APV), for Small and Medium size jets?

2. What would be the value based on the Weighted Average Cost of Capital (WACC)?

3. What is the Cash Flow-to-Equity (FTE) for Small and Medium size jets?
4. Explain the differences among the three methods for the level of debt financing.