Stan Mayfield CEO of Mayfield Software is interested in acqu

Stan Mayfield, CEO of Mayfield Software, is interested in acquiring a used aircraft to facilitate business travel (primarily for travel between Melbourne and Sydney). The aeroplane he is interested in will cost $1,000,000. It has a five-year useful life with an anticipated residual value of $600,000 Mayfield estimates that he and three other executives each take 100 trips per year at a cost of S670 per trip (they fly business class and, often, two or more of the executives fly together) These costs are expected to increase at 4 percent per annum. If Mayfield buys the plane, a pilot will be hired at a cost of $95,000 per year. Fuel, maintenance, insurance, airport fees and other operating costs will be $360,000 per annum. This includes depreciation (calculated on a straight-line basis), but excludes the pilot\'s fees. The pilot\'s and operating costs (other than depreciation) are expected to increase at 4 percent per year due to general inflation. Mayfield values the time he and the other executives will save using a company plane at $500 per trip per person. He believes that the value of executive time will increase at least as fast as general inflation. The company tax rate is 33% and its required minimum attractive rate of return is 10 percent to cover loss of earning capacity and loss of purchasing power Analyse the investment in the aeroplane. In particular, PERFORM an NPV analysis ignoring tax. Now, REPEAT the calculation allowing for tax DETERMINE how sensitive the attractiveness of the investment is to uncertainty in the tax rate (there is an election not too far away and the Government is hinting it may decrease the rate for business); the inflation rate; and, the value of \"soft\" benefits, i.e. the value attributed to the executives\' time. (You are expected to carry out simple analyses by varying one parameter at a time, only) MAKE a recommendation to Stan regarding the purchase, with your reasoning.

Solution

Here we see as due to Tax increase the NPV of the gets reduced if in future the tax imposed by government is increased the NPV gets decreased and there is a chance to becomes NPV negative also

But the Proposal regarding the investment is acceptable as due to positive NPV in both Cases

		( NPV IGNORING TAXATION)
	Previous cost
	4*100*670		268000
		Year
		1	2	3	4	5
Cost without own plane	268000	278720	289868.8	301463.55	313522.1
Dep =	(1000000-600000)/5	80000
As per new proposal.		Cost per year	$500 per trip per person
		1	2	3	4	5
Pilot Cost		95000	98800	102752	106862.08	111136.6
Op. Exp. with out dep	280000	291200	302848	314961.92	327560.4
Dep		80000	80000	80000	80000	80000
TOTAL		455000	470000	485600	501824	518697
less:- Old cost without proposal		268000	278720	289868.8	301463.55	313522.1
Total cost benefits	187000	191280	195731.2	200360.45	205174.9
Benefits of cost reduction due to purchasing plane
Year	1	2	3	4	5	5(Salvage)
	187000	191280	195731.2	200360.45	205174.87	600000
Less:- Value of time	200000	208000	216320	224972.8	233971.71
	387000	399280	412051.2	425333.25	439146.58	600000
PVF@10%	0.909	0.826	0.751	0.683	0.621	0.621
PV of Cost benefits	351818.18	329983.47	309580.17	290508.33	272675.47	372600.00
Total PV of Cost benefits	1927165.62
less :- Cost of plane	1000000.00
NPV		927165.62