Should Barnstorming Company Purchase a New Airplane?

Question:

Should Barnstorming Company replace their vintage airplane with a new one, considering the costs and savings involved?

Answer:

Based on the calculations of incremental cash flows, the Barnstorming Company should not purchase the new airplane and should continue to operate the old one. Let's break down the reasons for this decision.

Barnstorming Company currently owns a vintage airplane that was purchased 10 years ago for $250,000 and now has a book value of $75,000. The company is considering replacing this airplane with a different aircraft model that will cost $350,000. The current airplane could be sold for $50,000.

If the company buys the new airplane, it is expected that fuel costs will decrease from $80,000 annually to $45,000 annually and maintenance costs will decrease from $70,000 to $30,000. Both the current airplane and the new airplane will have a service life of ten years, after which they would have to be scrapped with no recovery value.

By calculating the incremental cash flows for both options, we can analyze the financial impact of purchasing the new airplane versus keeping the old one.

The cash flows with the old plane would be: Cost to purchase - Book value + (Annual savings x service life) = $250,000 - $75,000 + ($80,000 + $70,000) x 10 = $2,550,000

The cash flows with the new plane would be: Cost to purchase + (Annual savings x service life) = $350,000 + ($45,000 + $30,000) x 10 = $1,050,000

Calculating the incremental cash flow: Cash flows with the new plane - Cash flows with the old plane = $1,050,000 - $2,550,000 = -$1,500,000

Since the incremental cash flow is negative at -$1,500,000, it indicates that purchasing the new airplane would result in a significant financial loss for the company. Therefore, it is recommended that Barnstorming Company continues to operate the old airplane to avoid incurring this negative incremental cash flow.