Southwest Airlines plans to purchase 10 new Boeing jet aircraft to replace the same number of...
Southwest Airlines plans to purchase 10 new Boeing jet aircraft to replace the same number of older aircraft it currently operates. The new aircraft will not fly any more passengers than the aircraft they replace, so there will be no change in sales revenue. However, the new aircraft are more fuel efficient and will provide significant savings in fuel costs for Southwest. The aircraft being replaced will have a salvage value. To determine whether to proceed, Southwest should compute the net present value (NPV) and internal rate of return (IRR) based on project free cash flows for this investment opportunity (True or False?).
Group of answer choices
True
False
Homework Answers
Answer: True.
IRR: It is the discount rate at which the present value of projects cash outflows (cost) is equal to the present value of projects cash inflow.
The IRR must be above the cost of capital/required rate of return of the southwest.
To accept the replacement.
NPV = present value of cash inflow- the present value of cash outflow.
Discounted at the cost of capital/required rate of return of the southwest.
NPV must be positive to accept the replacement.
Answer: True.
Yes we will go for NPV calculation, because we have to know wether the cost savings is more than the cash outflows for the replacement of jet aircraft. Without NPV it is not possible to choose the option.
NPV is used in capital budgeting to compare projects based on their expected rates of return, required investment, and anticipated revenue over time. Typically, projects with the highest NPV are pursued.
For this option of replacing jet aircraft no need to calculate IRR, because there is no cash inflows in this option.
Functionally, the IRR is used by investors and businesses to find out if an investment is a good use of their money. An economist might say that it helps identify investment opportunity costs
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