Singapore Airlines (SIA) is considering an expansion of its fleet. Specifically, SIA is considering the purchase of twenty new A380-800 airplanes from Airbus. Airbus has offered SIA the following options concerning the transaction:
Option 1: SIA may purchase the planes on Jan. 1, 2016, and make a payment that day of $8.1 billion. Since the average list price of an A380 airplane is $414.4 million, this purchase price represents a discount to SIA for the size of the order.
Option 2: SIA may pay $3 billion on Jan. 1, 2016, and pay $1 billion on Jan. 1 of the subsequent six years.
(a) Based solely upon present value calculations, what is the maximum effective annual interest rate at which Airbus would be willing to offer the second option to SIA?
(b) Assume that when SIA conducts a present value calculation using what it considers to be the appropriate effective annual interest rate, the first option is less costly to the company. However, Go Choon Phong, the chief executive officer of the firm, is still interested in pursuing the second option. Offer suggestions as to why the firm’s senior management might choose the option with the higher present value cost.