Red Baron

From the way Red Baron analyzed this replacement decision, it is a good way that he used NPV rule. Because, NPV rule gives a direct profitability calculation from each option and it stated the best option for Red to undertake. NPV rule is also in line with the goal of capital budgeting to maximizing the wealth of the shareholders without focusing on the short-term basis to maximize profits. Red also considers about uncertainty, put prediction of growth rate to link with the cost, and he is able to build a clear calculation of which option to choose.

However, qualitative factors of this project haven't been put into account. Red fails to calculate the supply and demand factors of the airlines market. The taste and royalty of the customers may change during the project life which can lead to the changes of price and quantity of the tickets revenue.

Secondly, Red is too confident that every plane will be replaced when he bought the new plane. He doesn't consider about the opportunity cost of not selling all the planes. To put it in more detail, how many planes are exactly best to be replaced in order to maximize the NPV. Lastly, Red considers the calculation using the straight line depreciation. In the real world, depreciation is more complicated with inflation and tax problem.

In conclusion, Red calculate the options using a simple yet not a very convincing way. Some important factors failed to be considered by Red in the replacement process. More detail and rough analysis is highly recommended to do the investment decision in a long-term scale.

Question 7

Maintaining appropriate scheduled air services on routes between large cities are important for the economic