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Hong Kong Dragon Airlines

In: Business and Management

Submitted By ria003
Words 498
Pages 2
Q1) The task force at Hong Kong Dragon Airlines (HKDA) was formed to evaluate the alternatives available to replace a spare engine. There are three options available to them. a. The first option is to buy the engine. They would have to place an order with the IAE and expect to get the engine in late 2007. However the cost of engine will be escalated (3-5%) and there was no full proof way to determine the exact cost of purchase of engine. As the cost of the engine was around $4.5M such an escalation was harmful for the company. b. The second option was to sale and lease back wherein the company had already consulted and arranged for another engine lease company to buy the engine from them and give them in lease. The rent would be 0.8% of the purchase price however there are some complications regarding the maintenance cost as the lease company bearing the cost of maintenance has put some constraints on HKDA. c. The third option was to simply lease from the concerned company however there was a long queue for taking the lease as the engine was a popular model and lease company was ready to buy the engine only if HKDA assured them that they would take up the engine therefore leading them to only two choices.
HKDA needs to consider the relevant cash flows and the discount rate for those cash flows in order to decide whether to buy or lease the spare engine. For the purchase option the cost of capital to firm should be used as company is not going for new debt or equity but using its internal cash. This cash could have been utilized for getting rid of existing debt or getting equity from market therefore the weighted average cost of capital (WACC) should be used in determining the net cash flows. The relevant cash flows to be considered are maintenance, depreciation, tax savings due to depreciations and cap gain in determining the net cash outflow.

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