Question

An airline was looking to add two additional aircraft to its fleet of over 200 airplanes. The purchase price for each new airplane would be $125 million. Leasing could be an option, however. In this case, a 15-year lease would be quarterly payments of $4 million for each airplane. This payment would be in arrears.They had $2.5 billion of net operating loss to carry forward. These losses during this time were only allowed to be carried forward for a maximum of 20 years. During the period, the airline’s capitalization was (in millions): Long Term Bonds $1,352 Capitalized leases 306 Total long-term debt $1,658 Preferred Stock 283 Stockholder’s equity 305 Total long-term capitalization $2,246 Short-term debt 221 Total capitalization $2,467 The airline’s cost of fully secured 15-year debt was 10% (80% of the value of collateral). It’s cost of unsecured 15-year debt was 12% and its WACC was 15%. The airline was uncertain at the time about the residual value of the airplanes at the end of the lease period. They therefore estimated the following possible values and probabilities: Residual value ($ millions): 10, 15, 20, 25, 30, 35, 40, 45, 50 Probability (%): 5, 10, 10, 15, 20, 15, 10, 10, 5

          An airline was looking to add two additional aircraft to its fleet of over 200 airplanes. The purchase price for each new airplane would be $125 million. Leasing could be an option, however. In this case, a 15-year lease would be quarterly payments of $4 million for each airplane. This payment would be in arrears.They had $2.5 billion of net operating loss to carry forward. These losses during this time were only allowed to be carried forward for a maximum of 20 years. 

During the period, the airline’s capitalization was (in millions):
Long Term Bonds	$1,352
Capitalized leases	306
    Total long-term debt	$1,658
Preferred Stock	283
Stockholder’s equity	305
    Total long-term capitalization	$2,246
Short-term debt	221
Total capitalization	$2,467

The airline’s cost of fully secured 15-year debt was 10% (80% of the value of collateral). It’s cost of unsecured 15-year debt was 12% and its WACC was 15%. The airline was uncertain at the time about the residual value of the airplanes at the end of the lease period.
They therefore estimated the following possible values and probabilities:
Residual value ($ millions): 10, 15, 20, 25, 30, 35, 40, 45, 50
Probability (%): 5, 10, 10, 15, 20, 15, 10, 10, 5

Added by Joel W.

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