Question

Based on your teams determination of the number of airplanes needed, ExpressJet is considering multiple options for acquiring the Embraer 170 airplanes at a price of $10.9 million each. The executives in charge of capital acquisitions at ExpressJet are relying on you to show and explain which option will place the company in the best financial position based on your Net Present Value calculations. In the past, all acquisitions have been in cash. However with the current trend of the company, the options being considered are as follows: ExpressJet will borrow the funds necessary on a 5-year note from Bank of America. This will cause the marginal tax rate to be 35% ExpressJet will lease the planes for 10 years from LeaseCo. This will be an operating lease. This will cause the marginal tax rate to be 35%. Calculate Net Present Value for all the scenarios as compared to a cash purchase. Use the below data to fill in the spreadsheet. Cost of new equipment: $10,900,000 Expected life of equipment in years: 30 Disposal value in 5 years: $1,090,000 Lifetime miles per plane: 1,575,000,000 Annual miles per year: 52,500,000 Number of workers needed: 3 Annual hours to be worked per employee: 2,000 Earnings per hour for employees: $35 Annual health benefits per employee: $2,000 Other annual benefits per employee—% of wages: 15% Cost per Passenger Seat Mile: $0.06 Other variable costs per Seat Mile: $0.10 Costs to purchase cans—per can: $0.50 Required rate of return: 11% Tax rate: 35% Monthly lease payments: $95,000 Lease term: 10 years Monthly Note payments: ($203,208.91) Note Term: 5 years Down payment: $1,000,000

Answer 1

1. 5 year note vs cash:

Under cash acquisation
If Epressjet maintains the status quo and acquire using cash the Net Present Value of this outflow would be:
Cash price	$ 10,900,000.00
Required return	11%
present value	$ 10,900,000.00
Additional cost details
annual miles per year	52500000
number of workers	3
number of hours worked per emploee	$             2,000.00
earnings per hour	$                   35.00
annual health benefits per employee	$             2,000.00
other annual benefits to employees_ of the wages	15%
Cost per Passenger Seat Mile	$                     0.06
Other variable costs per Seat Mile	$                     0.10
Costs to purchase cans—per can	$                     0.50
Required rate of return(r)	11%
Tax rate	35%
Annual costs:
Employee wages	$        210,000.00
Employee health benefits	$             6,000.00
Other employee benefits	$          31,500.00
Cost per Passenger Seat Mile	$    3,150,000.00
Other variable costs per Seat Mile	$    5,250,000.00
Costs to purchase cans—per can	$ 26,250,000.00
	$ 34,897,500.00
since the $34,897,500 will be constant over the five years lets use PVIFA= (1-(1+r)^-n)/r in order to calculate the present value
Present value interest factor of an annuity (PVIFA)	3.695897018
Present value	$    9,442,227.38
thus under cash total present value of outflows is:	$ 20,342,227.38
Under the 5-year note
If Epressjet will acquire using the 5-year not the Net Present Value of this outflow would be:
Down payment	$    1,000,000.00
Required return	11%
present value	$    1,000,000.00
Recurring outflows
5 year note yearly payments	$    2,438,506.92
Employee wages	$        210,000.00
Employee health benefits	$             6,000.00
Other employee benefits	$          31,500.00
Cost per Passenger Seat Mile	$    3,150,000.00
Other variable costs per Seat Mile	$    5,250,000.00
Costs to purchase cans—per can	$ 26,250,000.00
	$ 37,336,006.92
since the $37,336,006.92 will be repetitive over the five years lets use PVIFA= (1-(1+r)^-n)/r in order to calculate the present value
Present value interest factor of an annuity (PVIFA)	3.695897018
Present value of outflows	$ 10,102,014.95
Therefore the total present value of outflows is:	$ 11,102,014.95

2. Lease vs Cash:

Under cash acquisation
If Epressjet maintains the status quo and acquire using cash the Net Present Value of this outflow would be:
Cash price	$         10,900,000.00
Required return	11%
present value	$         10,900,000.00
Additional cost details
annual miles per year	52500000
number of workers	3
number of hours worked per emploee	$                    2,000.00
earnings per hour	$                          35.00
annual health benefits per employee	$                    2,000.00
other annual benefits to employees_ of the wages	15%
Cost per Passenger Seat Mile	$                            0.06
Other variable costs per Seat Mile	$                            0.10
Costs to purchase cans—per can	$                            0.50
Required rate of return(r)	11%
Tax rate	35%
Annual costs:
Employee wages	$               210,000.00
Employee health benefits	$                    6,000.00
Other employee benefits	$                  31,500.00
Cost per Passenger Seat Mile	$            3,150,000.00
Other variable costs per Seat Mile	$            5,250,000.00
Costs to purchase cans—per can	$         26,250,000.00
	$         34,897,500.00
since the $34,897,500 will be constant over the five years lets use PVIFA= (1-(1+r)^-n)/r in order to calculate the present value
Present value interest factor of an annuity (PVIFA)	5.889232011
Present value	$            5,925,645.30
thus under cash total present value of outflows is:	$         16,825,645.30
Under the operating lease
If Epressjet will acquire using the 5-year not the Net Present Value of this outflow would be:
Required return	11%
Recurring outflows
Yearly lease payments	$            1,140,000.00
Employee wages	$               210,000.00
Employee health benefits	$                    6,000.00
Other employee benefits	$                  31,500.00
Cost per Passenger Seat Mile	$            3,150,000.00
Other variable costs per Seat Mile	$            5,250,000.00
Costs to purchase cans—per can	$         26,250,000.00
	$         36,037,500.00
since the $36,037,500 will be recurring over the 10 years lets use PVIFA= [(1-(1+r)^-n)/r ]in order to calculate the present value
Present value interest factor of an annuity (PVIFA)	5.889232011
Present value of outflows under the lease	$            6,119,218.93