Replacement chain Zappe Airlines is considering two alternative planes. Plane A
ID: 2775747 • Letter: R
Question
Replacement chain
Zappe Airlines is considering two alternative planes. Plane A has an expected life of 5 years, will cost $100 million, and will produce after-tax cash flows of $35 million per year. Plane B has a life of 10 years, will cost $138 million, and will produce after-tax cash flows of $30 million per year. Zappe plans to serve the route for 10 years. The company's WACC is 12%. If Zappe needs to purchase a new Plane A, the cost will be $110 million, but cash inflows will remain the same.
Should Zappe acquire Plane A or Plane B?
Explanation / Answer
NPV of plane A
= -100 -110/(1+12%)^5 + 35 * [1-(1+12%)^-10]/12%
= 35.34 million
NPV of plane B
= -138 + 30 * [1-(1+12%)^-10]/12%
= 31.51 million
since NPV of plane A is greater than plane B one should acquire plane A