Question

“Amazon's Battle for the Air Just Got Easier; Airlines are dumping old planes, giving the e-commerce giant the perfect opportunity to expand its cargo fleet at a time of constrained supply
Wall Street Journal; New York, N.Y.; 01 May 2020.
…Due to Covid-19, airlines are now dumping older planes. According to international advisory firm Ishka, lease rates are down: Renting a Boeing 747-8 freighter is 13% cheaper than in January. Amazon might even consider using some of its vast cash holdings—$27 billion at the end of March—to start owning its own fleet. The market value of five-year-old 777s and Airbus 330s is down almost 10% this year, Ishka said…”
Jupiter Airline Ltd (JAL) is evaluating the possibility of tendering for the license to operate international flights from Canberra to Queenstown (NZ) for a 5-year period. If its bid is successful, JAL will have to acquire a new aircraft. Tupoloev Corporation has offered to sell JAL an aircraft at a price of $70 million. It could be depreciated at a rate of 10 per cent per annum, straight-line. The estimated disposal value in 5 years' time is $20 million. Alternatively, JAL can lease the aircraft from Hendrix Leasing. The lease contract calls for five annual lease payments of $15 million, due at the beginning of each year. Additionally, JAL must make a security deposit of $1 million that will be returned when the lease expires. JAL can issue bonds with a yield of 11 per cent per annum and the company income tax rate is 30%.
Required:
Considering both financial and non-financial aspects, advise with reasonings if JAL should purchase or lease the aircraft given the current market conditions. Show all workings where calculations are required.

Answer 1

Calculation of Depreciation

= Purchase cost - salvage value * Depreciation Rate

= (70000000 - 20000000) * 0.10

= 5000000

Calculation of cashflow ( tax savings)

= Depreciation * ( 1 - tax rate)

= 5000000 * ( 1 - 0.3)

=3500000

NPV of Cost of Purchase aircraft decision

A	B	C	D = C^A	E = B*D
Year	Cash flows	PV Factor
1	3500000	1.11	1.110	3153153.15
2	3500000	1.11	1.232	2840678.52
3	3500000	1.11	1.368	2559169.83
4	3500000	1.11	1.518	2305558.41
5	3500000	1.11	1.685	2077079.65
5	20000000	1.11	1.685	11869026.56
Present Value	24804666.12
Less : Initial Investments	70000000.00
Net Present Value	-45195333.88

NPV of Cost of Leasing of aircraft decision

A	B	C	D = C^A	E = B*D
Year	Cash flows	PV Factor
0	-15000000	1.11	1.000	-15000000.00
1	-15000000	1.11	1.110	-13513513.51
2	-15000000	1.11	1.232	-12174336.50
3	-15000000	1.11	1.368	-10967870.72
4	-15000000	1.11	1.518	-9880964.61
5	1000000	1.11	1.685	593451.33
Present Value	-60943234.02
Add : Initial Investments ( Security Deposit)	-1000000.00
Net Present Value	-61943234.02

Recommendation :

JAL should purchase aircraft as it is having lower negative net present value.

But, current market is volatile and adversely affected by Covid-19. It is better to keep cash in hand rather than investing 70 million strainght away. Aircraft is old. If, JAL chooses leasing option, he would lease another aircraft on later on basis with high technical upgradation and negotiation term and conditions regarding repair and maintenance of aircraft also. So, that, his post leasing cost will be minimize.