Question

As part of its continuous fleet renewal strategy, Golden Wings Airlines is considering investing in new aircraft. It has narrowed down its search to two options: the Boeing 787-8 Dreamliner range and the Airbus A350-800 range. The Boeing 787-8 Dreamliner costs $225 million and has an expected economic life of 18 years. The Airbus A350-800 costs $282 million and has an expected economic life of 20 years. Due to differences in capacity and fuel efficiency, the airline expects the annual net cash inflows from the Boeing 787-8 Dreamliner and Airbus A350-800 to be $75 million and $86 million per year, respectively. The residual values of both planes are expected to be 20% of cost. Golden Wings Airlines’ weighted average cost of capital is 15%. Assume no inflation in costs and revenues. You may also ignore taxation.
What is the Net Present Value (NPV) of investing in either plane and compare the planes based on their equivalent annual annuities (EAA) then in which plane should the airline invest?

Answer 1

Golden Wings Airlines is considering investing in a new aircraft. It has to decide out of the two options below:

1. Boeing 787-8 Dreamliner:
   • Initial cost is $225 million,
   • Economic life is 18 years
   • Residual value is 20% of initial cost (=45 million)
   • Annual cashflows of $75 million
2. Airbus A350-800:
   • Initial cost is $282 million,
   • Economic life is 20 years
   • Residual value is 20% of initial cost (=56.4 million)
   • Annual cashflows of $86 million

The cost of capital is 15%. In order to evaluate the two investment options, we need to find out the Net Present Value (NPV) as well as Equivalent Annual Annuities (EAA) of the two planes.

Net Present Values(NPV):

NPV = Present value of cash inflows - Present value of cash outflows.

Here, NPV = (Present value of annuities of annual cashflows + present value of residual value) - Initial cost (...which is already in present value)

Please refer to the excel file images below for further calculations:

The investment with a higher value of NPV is considered better. Here, NPV of Airbus A350-800 is higher than that of Boeing 787-8 Dreamliner. Let us evaluate the investments as per Equivalent Annual Annuities:

The Equivalent Annual Annuities are the equivalent to the positive cashflows that would generate each year of the economical life an asset. So, an investment that gives higher value of EAA should be considered better. Here, EAA of Airbus A350-800 is higher than that of Boeing 787-8 Dreamliner.

So, considering both NPV as well EAA evaluations, Golden Wings Airlines should go for Airbus A350-800 as a better investment option.