Content

1. Introduction page 3
2. Assumption page 3
3. Estimation page 3
4. Accounting data Number of planes page 4 Ticket revenue page 4 Operating Cost page 5 Deprecation page 5 Operating cash flows page 5 NPV page 5
5. Evaluation page 6-7
6. Appendix

Introduction Fly-by-night Airlines is a major commercial air carrier offering passenger service between most large cities in the US. Its profitable …show more content…

It can be shown that option C generates the highest NPV value while the other two options have the negative NPV value. Hence, option C, which suggests replace PJ-1 by PJ-3 in year 6, appears a better choice for the replacement in terms of NPV rule.

Evaluation Upon the assumptions and estimations James Baron made, he is able to have a NPV value of each option to decide which option to undertake. It is a good way to use NPV rule when the projects are mutually exclusive as it gives the direct profitability of each project by magnitude. NPV rule is also consistent with the capital budgeting goal of shareholder wealth maximization. He takes the consideration of the uncertainty of the introduction of PJ-2 and PJ-3 and decides to use a higher cost of capital. By doing this, risk is adjusted to certain degree. He does take into account the estimation of the cost associate with the project by predicted growth rate. He suggests a Discount Cash Flow model to analysis the replacement decision which is easy to understand. In such ways, he is able to get a clear conclusion of which option to undertake. However, he fails to consider some qualitative factor which will have major influence into his estimation of accounting data. Firstly, he fails to consider the supply and demand of the airline market. He simply assumes the popularity of the Los Angeles-New York route stays unchanged and the taste and royalty of customers stay constant during the project life.