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Fundamentals of Financial Manageme...

14th Edition
Eugene F. Brigham + 1 other
ISBN: 9781285867977

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BuyFindarrow_forward

Fundamentals of Financial Manageme...

14th Edition
Eugene F. Brigham + 1 other
ISBN: 9781285867977
Textbook Problem

REPLACEMENT CHAIN Zappe Airlines is considering two alternative planes. Plane A has an expected life of 5 years, will cost $100 million, and will produce after-tax cash flows of $30 million per year. Plane B has a life of 10 years, will cost $132 million, and will produce after-tax cash flows of $25 million per year. Zappe plans to serve the route for 10 years. The company’s WACC is 12%. If Zappe needs to purchase a new Plane A, the cost will be $105 million, but cash inflows will remain the same. Should Zappe acquire Plane A or Plane B? Explain your answer.

Summary Introduction

To Determine: Whether Company Z should acquire Plane A or Plane B.

Introduction: The replacement chain is a technique of capital budgeting decision model that is utilized to look at least two mutually exclusive capital recommendations with uneven lives.

Explanation

Determine the net present value of Plane A

The EAA method cannot be used for Plane A, since the renewal investment changes. Hence the replacement chain method should be used.

Using a excel spreadsheet, the net present value of Plane Ais determined as $9,926,871.

Excel Spreadsheet:

Excel Workings:

Therefore the net present value of Plane A is $9,926,871.

Determine the net present value of Plane B

Using a excel spreadsheet, the net present value of Plane B is determined as $9,255,575...

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