Solution Pages: 1
Files that you will download:
Word (.docx) & Excel (.xlsx)
Questions Covered in Solution
Please look at the questions given below for setting your focus while analyzing the case. All you have to do is to write 1-page double-spaced response on which choice (buy vs. lease-buy) to use. Please provide the answer and any assumptions while calculating the answers. So DO attach the Excel file with all the calculations which will back your decision of lease-buy or buy.
Please use 6.34% as the discount rate.
1. Review your weighted average cost of capital calculations from part (A) of this case.
2. What are the after-tax cash flows relevant to the purchase of the V2533?
3. What are the after-tax cash flows relevant to the sale-and-leaseback of the V2533? The lease of the V2533 involves payments into two reserve funds (flight hour and flight cycle) described in the case. The size and timing of the payments are detailed in Exhibit 3. These reserve funds are like savings accounts, with the balances to applied toward any maintenance needed. The 2012 balance of the the flight hour reserve can be applied toward the anticipated heavy maintenance in 2012. The flight cycle reserve funds will likely be lost as they don’t anticipate needing a flight cycle-based maintenance during the period of time Dragon Air will need the engine.
4. What are the qualitative issues associated with the options given in the case?
5. Perform sensitivity analysis to identify the key bets/assumptions in your decision.
Sample of Solution
There were three options available in the case for the acquisition of Spare Engine, such as buy, sale-and-lease-back, and lease. The management explicitly rejected the third option which was to lease a new or used engine from a leasing company was explicitly rejected by the management. The remaining two options like buy a new engine or to go into a sale and leaseback agreement were weighted to realize the optimal alternative. For both of the options, the weighted average cost of capital was 6.38%, which was given in the case, which can be justified given the low-interest rates in the Hong Kong region. The tax rate considered for the calculation of after-tax cash flows was 17.5%, which was the standard rate in Hong Kong. Whereas, there was no tax on the income from capital gain. The escalation rate was taken to be 3% in the model. But, this rate was quite volatile, and hence it could vary from 1-5%. This was basically the increase in the cost or the purchase price over the year. The cash situation of the company was very good so, it could have gone with the first option.