Western Airlines is considering a new route that will require adding an additional Boeing 777 to its fleet. Western can purchase the airplane for $224.10 million or lease it for $25.00 million per year. If it purchases the airplane, its seating can be optimized, and the new route is expected to generate profits of $51.70 million per year. If leased, the route will only generate profits of $36.70 million per year. Suppose the appropriate cost of capital is 12.50% and that, if purchased, the plane can be sold at any time for an expected resale price of $224.10 million. Ignore taxes.
a. As a one-year decision, does purchasing or leasing the plane have higher NPV?
The NPV of purchasing is $____million. (Round to two decimal places.)
The NPV of leasing is $_____million. (Round to two decimal places.)
As a one-year decision the NPV of ______ (purchasing or leasing) the plane is higher.
b. Suppose the funds to purchase or lease the plane will come from equity holders (for example, by reducing the amount of Western's current dividend). Western also has? one-year debt outstanding, and there is a 10.20% (risk-neutral) probability that over the next year Western will declare bankruptcy and its equity holders will be wiped out. Otherwise, the debt will be rolled over at the end of the year. Is purchasing or leasing the plane more attractive to equity holders?
The NPV of purchasing is $____million. (Round to two decimal places.)
The NPV of leasing is $_____million. (Round to two decimal places.)
c. At what (risk-neutral) probability of default would equity holders' preference for leasing versus purchasing the plane change?
The risk-neutral probability is_____%.