Shao Airlines is considering two alternative planes Plane A

Shao Airlines is considering two alternative planes. Plane A has an expected life of 5 years, will cost $100 million and will produce net cash flows of $32 million per year. Plane B has a life of 10 years, will cost $132 million and will produce net cash flows of $26 million per year. Shao plans to serve the route for only 10 years. Inflation in operating costs, airplane costs, and fares is expected to be zero, and the company\'s cost of capital is 14%.

a. By how much would the value of the company increase if it accepted the better project (plane)? Enter your answer in millions. For example, an answer of $1.2 million should be entered as 1.2, not 1,200,000. Round your answer to two decimal places.
$ .... million

b. What is the equivalent annual annuity for each plane? Enter your answer in millions. For example, an answer of $1.2 million should be entered as 1.2, not 1,200,000. Round your answers to two decimal places.

$ .... million

Solution

Requirement (a) - Value of the company increase if it accepted the better project

Net Present Value [NPV] – PLANE – A

= Present Value of cash flows – Initial Outflow

= $32 Million x [PVIFA 14%, 5 Years] - $100 Million

= [$32 Million x 3.4330809] – $100 Million

= $9.86 Million

Net Present Value [NPV] – PLANE – B

= Present Value of cash flows – Initial Outflow

= $26 Million x [PVIFA 14%, 10 Years] - $132 Million

= [$26 Million x 5.2161156] – $132 Million

= $3.62 Million

Increase in the value of the company if it accepted the better project (plane)

= $9.86 Million - $3.62 Million

= $6.24 Million

Requirement (b) - Equivalent Annual Annuity (EAA)

Equivalent Annual Annuity (EAA) = Net Present Value [NPV] / [ PVIFA r, n ]

Equivalent Annual Annuity (EAA) – PLANE A

= $9.86 Million / 3.4330809

= $2.87 Million

Equivalent Annual Annuity (EAA) – PLANE B

= $3.62 Million / 5.2161156

= $0.69 Million