Question

In: Accounting

section A and B Section A: Boeing & JAL - Initial Analysis Japanese Airlines (JAL) wants...

section A and B

Section A: Boeing & JAL - Initial Analysis
Japanese Airlines (JAL) wants to add one Boeing 787 to its fleet in January 2021. The current purchase price as provided by BA is $100M. JAL has the option to either purchase the aircraft or lease it. JAL is evaluating both the options, and needs your help
1. If JAL were to purchase the aircraft, it can borrow up to 70% of the value at Libor + 3%. Please calculate first year interest payment, assuming Libor is 2% -- 5pts
2. What will be JAL’s initial cash outlay? – 5pts
3. Since, the borrowing is planned for January 2021, what are some of the instruments, which JAL can use to fix its borrowing rate today? – 10 pts
4. BA is also offering a monthly lease option at a lease rate factor (LRF) of 0.7%, and a tenor of 12 years. Please calculate the monthly lease payments (Lease payments = LRF*Purchase Price) – 5pts

Section B: Boeing & JAL - Rate Locks
For the purchase option, an Investment Bank offered JAL the following rate lock strategy. JAL can enter into a forward contract with the bank,
where if Libor in January 2021 ends up higher than 2%, then the bank pays JAL the difference on $100M notional. The case will be reversed if
Libor ends up lower than 2%.
1. If Libor is 2.5% in January 2021, how much does JAL receive or pay to the investment bank in the first year? – 5pts
2. Continuing with 1 above, how much interest will JAL pay on its loan in the first year? – 10 pts
3. What kind of an instrument is this? – 5pts
For the lease option, the investment bank has offered to pay $80/bp for each basis point change in 7-year swap in January 2021 vs. now. From
Part A, remember that BA’s lease offer has $100/bp sensitivity to the 7-year swap…this $20/bp difference can be understood as risk
compensation…
4. If the 7-year swap in January 2021 is 3%, how much does JAL receive or pay to the investment bank? – 10 pts
5. Continuing with 4 above, what will be the monthly lease payments made to BA? – 10 pts
6. What is JAL’s net loss/gain on this deal? – 5 pts
7. What kind of an instrument is this? -- 5 pts

Solutions

Expert Solution

Section A: Initial Analysis

Basic Facts of the Question:

Buyer: Japanese Airlines
Seller: Boeing Aircrafts
Current Purchase Price: $ 100 Million

Whether to Purchase or Lease ?

1.  If JAL were to purchase the aircraft, it can borrow up to 70% of the value at Libor + 3%. Please calculate first year interest payment, assuming Libor is 2% :

LIBOR (London Interbank Offered Rate) ; 2%
Borrowing Rate: LIBOR + 3% = 2% + 3% = 5%
Borrowing Limit : 70% of Purchase Price

Borrowed Amount : 70 % of $ 100 Million = $ 70 Million

Therefore First Year Interest Payment: $ 70 Million * 5% = $ 3.5 Million

2. What will be JAL’s initial cash outlay?

Initial Cash Outlay : Purchase Price - Borrowed Amount

$ 100 Million - $ 70 Million

$ 30 Million

3. Since, the borrowing is planned for January 2021, what are some of the instruments, which JAL can use to fix its borrowing rate today?

a. Forward Rate Agreement
b. Interest Rate Futures : Allows the buyer and seller to Lock in Priceof Interest Bearing Asset for a Future Date.
c. Interest Rate Options (Cap , Floor , Collar)
d. Interest Rate Swaps

4. BA is also offering a monthly lease option at a lease rate factor (LRF) of 0.7%, and a tenor of 12 years. Please calculate the monthly lease payments (Lease payments = LRF * Purchase Price)

Lease Rate Factor: 0.7%
Purchase Price: $ 100 Million

Therefore Monthly Lease Payments = 0.7% * $ 100 Million = $ 0.7 Million

Section B: Rate Locks

JAL has entered into a Forward Contract to manage the Interest Rate Risk. This Rate Lock Strategy will enable JAL to keep its Interest Rate at Fixed Rate of 5%.

CASE 1: If LIBOR goes above 2 % , then JAL will receive the Interest Rate differential.

Therefore Effective Rate of Interest will be :
(LIBOR + 3%) - (LIBOR - 2%)
5%

CASE 2: If LIBOR goes down 2 % , the JAL will pay the Interest Rate differential.

Therefore Effective Rate of Interest will be :
(LIBOR + 3%) + (2% - LIBOR)
5%

1. If Libor is 2.5% in January 2021, how much does JAL receive or pay to the investment bank in the first year?

Actual LIBOR in January : 2.5 %
Notional Amount: $ 100 Million

As LIBOR goes above 2.5 % , JAL will receivethe Interest Rate differential.

(Actual LIBOR - 2%) * Notional Amount
( 2.5% - 2%) * $ 100 MIllion
$ 0.5 Million

2. Continuing with 1 above, how much interest will JAL pay on its loan in the first year?

Interest Payment on its Loan in First Year: $ 70 Million * 5.5% = $ 3.85 Million (SInce Interest Payment will based on Actual Rate)

Gain due to Forward Contract = (2.5% - 2%) * $ 100 Million = $ 0.5 Million

Net Interest Expense : $ 3.85 Million - $ 0.5 Million = $ 3.5 Million

Effective Interest Rate : $ 3.5 Million / $ 70 Million = 4.79% (This is not 5% because of the difference in Loan Amount and Notional Amount)

3. What kind of an instrument is this?

It is a Forward Rate Agreement through which a borrower/lender protects itself from the unfavourable changes to the Interest Rate.
Normally it is used by Banks to fix Interest costs on anticiapted future deposits or interest revenues on variable rate loans indexed to LIBOR
The Principal amount of the agreement is termed "notional" because it determines the amont of Payment , actual exchange of the Principal never takes place.
It is settled at maturity in cash representing the Profit or Loss.
A Bank that sells an Forward Rate Agreement agrees to pay the buyer the increased interest cost on some notional amount if some sprecified maturity of LIBOR ia above a stipulated Forward Rate. On the other hand , the buyer agrees to pay the Bank any decrease in Interest Cost if market interest rates falls below the forward rate.

It is a kind of Derivative Instrument which derives its value from the underlying Interest Rate u.e, LIBOR.

LEASE OPTION

4. If the 7-year swap in January 2021 is 3%, how much does JAL receive or pay to the investment bank?

Therefore Current Swap Rate :


Related Solutions

Discussion for boeing fraud analysis in accounting for managers?
Discussion for boeing fraud analysis in accounting for managers?
On Jan. 1, 2019 Spitfire Airlines buys a new Boeing 737 aircraft for $ 50,500,000. It...
On Jan. 1, 2019 Spitfire Airlines buys a new Boeing 737 aircraft for $ 50,500,000. It is expected to last 15 years and fly 50,000 hours. At the end of its useful life, Spitfire expects to sell the aircraft for $2,700,000. In 2019 the aircraft flies for 3,750 hours. a. What is the 2019 depreciation, assuming straight line depreciation is used?   $____________________________ b. What is the 2019 depreciation, assuming units of production depreciation is used? $_______________________ c. Suppose that straight...
ON BOEING AND  China Eastern Airlines Describe at least two differences in disclosure provided in the footnotes...
ON BOEING AND  China Eastern Airlines Describe at least two differences in disclosure provided in the footnotes of the competitors under IFRS and US GAAP. Example: The Property, Plant and Equipment footnote is much more detailed for Company X in IFRS than for Company Y using US GAAP. For each PP&E component, it reconciles the differences beginning and ending net book values including additions, disposals, currency translation effects, depreciation and impairments. Company Y lists the PP&E components only. For one of...
SWOT analysis of American airlines?
SWOT analysis of American airlines?
Late delivery ~ Amazon wants to maintain the existing customer loyalty. Initial data analysis revealed that...
Late delivery ~ Amazon wants to maintain the existing customer loyalty. Initial data analysis revealed that the proportion of orders that are delivered late to the customers is 0.099. They take measures to improve the quality of their delivery service. Alexa wants to determine if the actual proportion of orders that are delivered late to the customers is different from the value reported by the initial data analysis. In a recent random sample of 196 orders, Alexa found that 17...
10) Make a benefit/cost analysis by evaluating B/C for the following: a) a project with initial...
10) Make a benefit/cost analysis by evaluating B/C for the following: a) a project with initial cost = $7,254 , annual cost= $868, annual benefits= $ 1,867, disbenefits having a present worth PW value of $1,613, interest rate= 9% and life = 5 years b) a project with initial cost = $2,126 , annual cost= $1,806, annual benefits= $ 1,434, annual disbenefits= $408, interest rate= 3% and life = 9 years. c) a project with total annual cost= $7,744, annual...
A complex is divided into two​ parts: Section A and Section B. The plaintiffs in a...
A complex is divided into two​ parts: Section A and Section B. The plaintiffs in a lawsuit claimed that white potential renters were steered to section​ A, while black renters were steered to section B. The table displays the locations of recently rented apartments. Do you think there is evidence of a racial​ bias? Assume the conditions for inference are satisfied. Complete parts a through c. white black Total Section A 75 14 89 Section B 81 26 107 Total...
Industry and Competitive analysis: Southwest Airlines History Competitive analysis, porter five financial analysis (recent) Comfort analysis...
Industry and Competitive analysis: Southwest Airlines History Competitive analysis, porter five financial analysis (recent) Comfort analysis business strategy Performance growth factor key success analysis profitability analysis with comparison with rivals; ROE, EPS, Net profit, Revenue SWOT analysis Fuel Hedging Assets Awards
In your initial post, choose one manufacturing company (e.g., Boeing, Nike, and Ford) and one large...
In your initial post, choose one manufacturing company (e.g., Boeing, Nike, and Ford) and one large retail company (e.g., Walmart, Walgreens, Amazon). Analyze the differences in the supply chain organizational environments (e.g., customers, stakeholders, business operations, etc.).
The information below for questions (a) and (b) Toyoda Inc. is a Japanese firm located in...
The information below for questions (a) and (b) Toyoda Inc. is a Japanese firm located in Tokyo. The firm collected JPY 190,000 from customers in 2018. Of the amount collected, JPY 40,000 was from revenue accrued from services performed in 2017, and JPY 20,000 was received in advance for 2019 revenue. Furthermore, the firm incurred JPY 78,000 of expenses in 2018, which will not be paid until 2019. The firm also incurred JPY 29,000 of expenses in 2018 which had...
ADVERTISEMENT
ADVERTISEMENT
ADVERTISEMENT