In 2016, an airline was considering getting a new jet plane. The plane costs $250 million new and depreciates over 20 years using straight-line depreciation. Rather than keeping the plane its full life, however, the airline would sell it after 10 years. Conversely, the company could have leased the plane for 10 years instead at lease payments of $25 million per year. There is no option to renew the lease at that point. The company’s tax rate was 20% and the risk-free rate is 5%. Is the lease likely to be a capital or operating lease and why? What would be the balance sheet and income statement implications of the lease? Would your answer to (2) change if the airline was considering the lease today instead? If the airline was cash constrained at the time of the decision, which option would it likely prefer? HINT: this is a qualitative answer – no number-crunching. Assuming the company was not cash-constrained, which option would it prefer (crunch numbers here).
In 2016, an airline was considering getting a new jet plane. The plane costs $250 million new and depreciates over 20 years using straight-line
- Is the lease likely to be a capital or operating lease and why?
- What would be the
balance sheet and income statement implications of the lease? - Would your answer to (2) change if the airline was considering the lease today instead?
- If the airline was cash constrained at the time of the decision, which option would it likely prefer? HINT: this is a qualitative answer – no number-crunching.
- Assuming the company was not cash-constrained, which option would it prefer (crunch numbers here).
In 2016, an airline faced a pivotal decision regarding the acquisition of a new jet plane. The aircraft came with a price tag of $250 million and had a depreciation period of 20 years using the straight-line method. However, the airline contemplated a different path, considering the option to lease the aircraft for a duration of 10 years, with annual lease payments amounting to $25 million. Crucially, there was no provision for lease renewal or a favorable purchase option at the end of the lease term. To navigate this complex financial decision, the airline had to weigh the implications on its balance sheet and income statement, factoring in a 20% tax rate and a 5% risk-free rate. In this analysis, determine the nature of the lease, evaluate its financial ramifications, and consider whether the perspective would change if the airline were making this decision today.
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