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?