Federal Express (FedEx) is considering adding 18 used Boeing 757 jets by buying the twin engine planes to replace some of its oldest, least-efficient freighters, Boeing 727s. FedEx pays about $10 million each, then FedEx spends about $5 million each to refit the planes to carry cargo. FedEx is required to make a 10% down payment at the time of delivery, and the balance is to be paid over a 10-year period at an interest rate of 12% compounded annually. The actual payment schedule calls for only interest payments over the 10-year period with the original principal amount to be paid off at the end of the 10th year. FedEx expects to generate $45 million per year in fuel savings by adding these aircrafts to its current fleet. The aircraft is expected to have a 15-year service life with a salvage value of 15% of the original purchase price. If the aircrafts are bought, they will be depreciated by the seven-year MACRS property classifications. The firm’s combined federal and state marginal tax rate is 38%, and its required minimum attractive rate of return is 18%. (a) Use the generalized cash-flow approach to determine the cash flow associated with the debt financing. (b) Is this project acceptable?
Net Present Value
Net present value is the most important concept of finance. It is used to evaluate the investment and financing decisions that involve cash flows occurring over multiple periods. The difference between the present value of cash inflow and cash outflow is termed as net present value (NPV). It is used for capital budgeting and investment planning. It is also used to compare similar investment alternatives.
Investment Decision
The term investment refers to allocating money with the intention of getting positive returns in the future period. For example, an asset would be acquired with the motive of generating income by selling the asset when there is a price increase.
Factors That Complicate Capital Investment Analysis
Capital investment analysis is a way of the budgeting process that companies and the government use to evaluate the profitability of the investment that has been done for the long term. This can include the evaluation of fixed assets such as machinery, equipment, etc.
Capital Budgeting
Capital budgeting is a decision-making process whereby long-term investments is evaluated and selected based on whether such investment is worth pursuing in future or not. It plays an important role in financial decision-making as it impacts the profitability of the business in the long term. The benefits of capital budgeting may be in the form of increased revenue or reduction in cost. The capital budgeting decisions include replacing or rebuilding of the fixed assets, addition of an asset. These long-term investment decisions involve a large number of funds and are irreversible because the market for the second-hand asset may be difficult to find and will have an effect over long-time spam. A right decision can yield favorable returns on the other hand a wrong decision may have an effect on the sustainability of the firm. Capital budgeting helps businesses to understand risks that are involved in undertaking capital investment. It also enables them to choose the option which generates the best return by applying the various capital budgeting techniques.
Federal Express (FedEx) is considering
adding 18 used Boeing 757 jets by buying the
twin engine planes to replace some of its oldest,
least-efficient freighters, Boeing 727s. FedEx pays
about $10 million each, then FedEx spends about
$5 million each to refit the planes to carry cargo.
FedEx is required to make a 10% down payment at
the time of delivery, and the balance is to be paid
over a 10-year period at an interest rate of 12%
compounded annually. The actual payment schedule calls for only interest payments over the 10-year
period with the original principal amount to be paid
off at the end of the 10th year. FedEx expects to
generate $45 million per year in fuel savings by
adding these aircrafts to its current fleet. The aircraft is expected to have a 15-year service life with a
salvage value of 15% of the original purchase price.
If the aircrafts are bought, they will be depreciated
by the seven-year MACRS property classifications.
The firm’s combined federal and state marginal tax
rate is 38%, and its required minimum attractive rate
of return is 18%.
(a) Use the generalized cash-flow approach to determine the cash flow associated with the debt
financing.
(b) Is this project acceptable?
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