CASE STUDY (Individual work):
AirAsia Airlines is planning a new route to Birmingham that will require adding an additional Boeing Lion Air to its fleet. AirAsia can purchase the airplane for RM332.55 million or lease it for RM37.5 million per year. If it purchases the airplane, its seating can be optimized, and the new route is expected to generate profits of RM74.25 million per year. If leased, the route will only generate profits of RM52.5 million per year. Suppose the appropriate cost of capital is 19.35% and that, if purchased, the plane can be sold at any time for an expected resale price of RM$332.55 million. Ignore taxes.
Required: Answer the following tasks and submission required 1500 words.
- As a one-year decision, does purchasing or leasing the plane have higher NPV?
(25 marks)
- Suppose the funds to purchase or lease the plane will come from equity holders (for ex-ample, by reducing the amount of Air Asia’s current dividend). AirAsia also has one-year debt outstanding, and there is a 13.65% (risk-neutral) probability that over the next year AirAsia will declare bankruptcy and its equity holders will be wiped out. Otherwise, the debt will be rolled over at the end of the year. (25 marks)
- Is purchasing or leasing the plane more attractive to equity holders? (10 marks)
- At what (risk-neutral) probability of default would equity holders’ preference for leasing versus purchasing the plane change? (30 marks)
- Discuss why NPV rule is most accurate and reliable method for allocating the firm’s resources as well as to maximize its value. (10 marks)