Air South, a leading regional airline that is now carrying 54% of all the passengers that pass…

Air South, a leading regional airline that is now carrying 54% of all the passengers that pass through the Southeast, is considering adding a new long-range aircraft to its fleet. The aircraft being considered for purchase is the McDonnell Douglas DC-9-532 “Funjet,” which is quoted at $60 million per unit. McDonnell Douglas requires a 10% down payment at the time of delivery, and the balance is to be paid over a 10-year period at an interest rate of 12% compounded annually. The actual payment schedule calls for only interest payments over the 10-year period, with the original principal amount to be paid off at the end of the 10th year. Air South expects to generate $35 million per year by adding this aircraft to its current fleet, but also estimates an operating and maintenance cost of $20 million per year. The aircraft is expected to have a 15-year service life with a salvage value of 15% of the original purchase price. If the aircraft is bought, it will be depreciated by the 7- year MACRS property classifications. The firm’s combined federal and state marginal tax rate is 38%, and its required minimum attractive rate of return is 18%.

(a) Use the generalized cash flow approach to determine the cash flow associated with the debt financing.

(b) Is this project acceptable?

 

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