You are a Senior Analyst at Eagles LLP, a major advisory and professional services firm. One of your clients is Touchdown Trips Inc., a company that provides luxury package tours to watch sports events in North America. Touchdown Trips Inc. uses a luxury private jet aeroplane to carry clients to their destination. The company is planning to invest in a new luxury jet. Two possible investment options have been identified: the Gulfstream G650ER (option A) and the Boeing BBJ Max 7 (option B). Each option has an expected life of five years, after which the selected aeroplane will be replaced by a new luxury private jet aeroplane. Sufficient funding is available to finance only one of the options. Page 12 of 16 [2073] Option A Option B USD ($000 USD ($000) Initial cost (year 0) 51,000 76,500 Scrap value (year 5) 40,110 60,120 Forecast net cash inflows Year 1 3,200 3,900 Year 2 3,300 3,600 Year 3 3,100 3,300 Year 4 3,000 3,100 Year 5 2,900 2,600 Assume that all cash flows occur at the end of the respective year. Eagles LLP has a cost of capital of 12 per cent. Touchdown Trips Inc. have requested that the payback period and accounting rate of return techniques be used to support this capital investment decision. The company’s approach to investment appraisal was discussed at a recent meeting of Eagles LLP’s senior executive team. Bill Brady, Senior Partner at Eagles LLP is keen for the managers of Touchdown Trips Inc. to understand the characteristics of capital investment decisions: Bill has commented: We need to ensure that the managers at Touchdown Trips Inc. understand the characteristics of capital investment decisions. This might lead them to accept the use of capital investment appraisal techniques other than payback and accounting rate of return. Xiaolin Peng, Head of Asset Management at Eagles LLP, has highlighted that the internal rate of return technique may be suitable in this case. Xiaolin has commented: Internal rate of return is the rate of return that an investment project yields, taking account of the fact that cash may be flowing in and out of the project at various points in its life. If we explain the advantages and disadvantages of internal rate of return to the managers at Touchdown Trips Inc., this might encourage them to accept the use of this technique. Required: a. Calculate the payback period for both option A and option B. b. Critically evaluate the payback period technique. c. Advise the senior executive team on the comments made by Bill Brady and Xiaolin Peng. Your advice should include an explanation of the characteristics of investment appraisal decisions and the advantages and disadvantages of the internal rate of return technique.
You are a Senior Analyst at Eagles LLP, a major advisory and professional services firm. One of your clients is Touchdown Trips Inc., a company that provides luxury package tours to watch sports events in North America. Touchdown Trips Inc. uses a luxury private jet aeroplane to carry clients to their destination. The company is planning to invest in a new luxury jet. Two possible investment options have been identified: the Gulfstream G650ER (option A) and the Boeing BBJ Max 7 (option B). Each option has an expected life of five years, after which the selected aeroplane will be replaced by a new luxury private jet aeroplane. Sufficient funding is available to finance only one of the options.
Page 12 of 16 [2073]
|
Option A |
Option B |
|
|
USD ($000 |
USD ($000) |
|
|
Initial cost (year 0) |
51,000 |
76,500 |
|
Scrap value (year 5) |
40,110 |
60,120 |
|
|
||
|
Year 1 |
3,200 |
3,900 |
|
Year 2 |
3,300 |
3,600 |
|
Year 3 |
3,100 |
3,300 |
|
Year 4 |
3,000 |
3,100 |
|
Year 5 |
2,900 |
2,600 |
Assume that all cash flows occur at the end of the respective year. Eagles LLP has a cost of capital of 12 per cent.
Touchdown Trips Inc. have requested that the payback period and accounting
We need to ensure that the managers at Touchdown Trips Inc. understand the characteristics of capital investment decisions. This might lead them to accept the use of capital investment appraisal techniques other than payback and accounting rate of return.
Xiaolin Peng, Head of Asset Management at Eagles LLP, has highlighted that the
Internal rate of return is the rate of
Required:
a. Calculate the payback period for both option A and option B.
b. Critically evaluate the payback period technique.
c. Advise the senior executive team on the comments made by Bill Brady and Xiaolin Peng. Your advice should include an explanation of the characteristics of investment appraisal decisions and the advantages and disadvantages of the internal rate of return technique.
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