Chapter 12, Problem 15P

Fundamentals of Financial Manageme...

15th Edition
Eugene F. Brigham + 1 other
ISBN: 9781337395250

Chapter
Section

Fundamentals of Financial Manageme...

15th Edition
Eugene F. Brigham + 1 other
ISBN: 9781337395250
Textbook Problem

REPLACEMENT CHAIN Rini Airlines is considering two alternative planes. Plane A has an expected life of 5 years, will cost \$95 million, and will produce after- tax cash flows of \$35 million per year. Plane B has a life of10 years, will cost \$112 million, and will produce after-tax cash flows of \$25 million per year. Rini plans to serve the route for 10 years. The company's WACC is 9%. If Rini needs to purchase a new Plane A, the cost will be \$105 million, but cash inflows will remain the same. Should Rini acquire Plane A or Plane B? Explain your answer.

Summary Introduction

To Determine: Whether Company R 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 \$61,375,223.98.

Excel Workings:

Therefore the net present value of Plane A is \$61,375,223.98.

Determine the net present value of Plane B

Using a excel spreadsheet, the net present value of Plane B is determined as \$48,441,442...

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