Solved: Island Airlines Inc needs to replace a short haul

commuter plan

Island Airlines Inc. needs to replace a short-haul commuter plane on one of its busier routes.
Two aircraft are on the market that satisfies the general requirements of the route. One is more
expensive than the other but has better fuel efficiency and load-bearing characteristics, which
result in better long-term profitability. The useful life of both planes is expected to be about
seven years, after which time both are assumed to have no value. Cash flow projections for the
two aircraft follow.

a. Calculate the payback period for each plane and select the best choice.
b. Calculate the IRR for each plane and select the best option. Use the fact that all the inflows
can be represented by an annuity.
c. Compare the results of parts (a) and (b). Both should select the same option, but does one
method result in a clearer choice than the other based on the relative sizes of the two payback
periods versus the relative sizes of the two IRRs?
d. Calculate the NPV and PI of each project assuming a cost of capital of 6%. Use annuity
methods. Which plane is selected by NPV? By PI?
e. Calculate the NPV and PI of each project, assuming the following costs of capital: 2%, 4%,
6%, 8%, and 10%. Use annuity methods. Is the same plane selected by NPV and PI at every
level of cost of capital? Investigate the relative attractiveness of the two planes under each
method.
f. Use the results of parts (b) and (e) to sketch the NPV profiles of the two proposed planes on
the same set of axes. Show the IRRs on the graph. Would NPV and IRR ever give conflicting
results?Why?

Island Airlines Inc needs to replace a short haul commuter plan

ANSWER
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