Question #3(15 marks)

Air Alberta is considering replacing the firm's regional jets with a new model, which has a total purchase price of $15 million.

The new jets will generate additional revenue of $3.5 million per year for the 20 years of the useful life of the jets.Expected added operational costs of the jets are 25% of revenues.

Air Alberta expects to use the new jets for 20 years, at which time, they would be replaced. The company estimates that all the new planes could be sold for a total of $4.7million (salvage value).

The new regional jets have a CCA rate of 25% (d = .25). Air Alberta has a corporate tax rate of 35%. The purchase would require a $2,000,000 increase in net working capital, which would be returned to Air Alberta when it sold the jets after 20 years.

Required:

Using a discount rate of 15%, calculate the NPV of the new jet purchase.Prepare a short memo and discuss your recommendation on the purchase of the regional jets.