An airline was looking to add two additional aircraft to its fleet of over 200 airplanes. The purchase price for each new airplane would be $125 million. Leasing could be an option, however. In this case, a 15-year lease would be quarterly payments of $4 million for each airplane. This payment would be in arrears (like your home mortgage payment). Leasing may be good solution for this airline because of a net operating loss it has experienced. They had $2.5 billion of net operating loss to carry forward. These losses during this time were only allowed to be carried forward for a maximum of 20 years. During the period, the airline's capitalization was (in millions): Long Term Bonds $1,352 Capitalized leases 306 Total long-term debt $1,658 Preferred Stock 283 Stockholder's equity 305 Total long-term capitalization$2.246 Short-term debt 221 Total capitalization $2,467

The airline's cost of fully secured 15-year debt was 10% (80% of the value of collateral). It's cost of unsecured 15-year debt was 12% and its WACC was 15%. The airline was uncertain at the time about the residual value of the airplanes at the end of the lease period. They therefore estimated the following possible values and probabilities:

Residual value ($millions):	10	15	20	25	30	35	40	45	50
Probability (%):	5	10	10	15	20	15	10	10	5

Answer rating: 100% (QA)

To determine whether the airline should purchase or lease the two additional aircraft we need to calculate the present value of the costs associated w... View the full answer