Airvalue Airways is a regional carrier whose strategy is to expand
gradually as they can identify routes that offer an attractive return on
the investment necessary to support successful coverage of the route.
As part of this expansion, the company is planning to buy a new plane in
the upcoming fiscal year. The purchasing department has narrowed the
choice down to two models. One is the A220 which is manufactured in
Europe. The other plane is the G435 which is built in the United
States. The two aircraft have similar profiles. However, the
locally-built G435 is significantly more expensive to purchase.
The A220 has an expected life of 5 years, will cost $90 million and its
use will produce net operating cash inflows of $30 million per year. The
G435 has a life of 10 years, will cost $128 million, and its use will
produce net operating cash inflows of $25 million per year. Airvalue
plans to serve the route for 10 years. When they need to purchase a new
A220 at the end of five years, the cost will be $115 million net after
allowing for salvage value of the used plane. Net operating cash
inflows will remain at $30 million throughout the second five years. At
the end of 10 years, salvage value of the G435 and of the second A220
are expected to be about the same at approximately $500,000 each.
As the company’s CFO you are to provide the financial analysis that will
be considered by the strategic planning executive committee during
evaluation of this expansion alternative. Your plan is to use a capital
budgeting approach to the analysis in order to best assure that the
decision will result in maximization of wealth for the company’s
stockholders. You also want to convert the entire committee to the
concept that capital budgeting should be used as the main tool for the
financial analysis of capital expenditure alternatives.
The company uses the historical difference in returns between the
S&P 500 and the Treasury bond rates of 7% as their estimated market
risk premium. The current yield to maturity on a 10-year Treasury bond
is 6.2%. Airvalue Airways’ common-stock equity beta is estimated as
1.40.
Airvalue’s capital structure is 58% common stock, 32% preferred stock
and 10% long-term debt. An 8.8% after tax cost of debt has been
determined and the cost of preferred stock is 12%.
Your task is to:
- Describe for other members of the strategic planning committee the role that capital budgeting should play in corporate strategic management.
- Explain why the NPV and IRR capital budgeting tools are superior to the accounting rate of return and simple payback techniques for determining the attractiveness of capital investment opportunities.
- Use the Capital Asset Pricing Model (CAPM) to identify the cost of common stock.
- Calculate the weighted average cost of capital (WACC) for the firm’s existing capital structure.
- Calculate the net present value (NPV) for each plane model using the company’s WACC as the hurdle rate.
- Recommend which plane should be purchased and justify your recommendation.
- Discuss the need to manage implementation of the project so that the higher returns can be realized. Include the strategic management keys to protecting the project from competitive forces that would erode the earning power of the project and jeopardize realization of the projected rate of return on the investment.
To complete this assignment, you must submit a 6-8 page paper that
addresses the seven elements of the task as listed above and exhibits
your calculations of the cost of common stock, the weighted average cost
of capital, and the NPV for each plane along with an explanation of the
calculations.
The paper must be submitted as a Word document and it must follow APA style guidelines.
Please provide 3 academic resources written in APA.
Click
here to claim a 30% discount on this essay. Our team is made up of professionals who
have excelled in different areas of academia. Try our service and you will
never be disappointed.
No comments:
Post a Comment