Brief particular of case in hand are given below

The Winning Edge, Inc. (TWE Inc.) - $60 million (mainly owned by institutional investors) sporting
goods retailer with sales outlets located in 42 states and headquartered in Amarillo

Mike Cramer – Founder, President and CEO of TWE Inc. and based on the challenges being faced, he
thinks that it’s good time to consider permanent change in the corporate travel arrangement.

1996 – Firm growth and expansion

Steadfast travel policy – schedule commercial flights and 5% growth per annum for TWE Inc.

US$ 250k were spent in previous fiscal year on IT infrastructure to revamp the management of
executive travel that might be wasted due to change in travel policy

Option I Option II Option III

Smallest change in the current New Cesssna Citattion II 25% ownership in Jet Share
policy Corporate jet for $2.5 million Inc. at $630,000. 5 year
straight line depreciation with
20% salvage value. Repurchase
option at the end of contract
at book value
Average ticket $1,000 and first 1600 nautical miles on full tank 2 hour advance notice for
class upgradation $ 300 per can cover one way trip exclusive flight
ticket, frequent flier discount
on both and annual prices
increase under term of
contract
Reservation at least 3 business 10 years useful life and $ 1,060 per hour of flight time
days before the departure depreciation over the 8 years for direct operating expense
with NRV of $325K and $ 134,580 per year of the
time shared contract.
Average delays of 4 hours per Hiring flight crew and Replacement cost and
round trip due to limitation of maintenance of aircraft operation cost to be beard by
connecting through same including forecasted increase TWE Inc. and will increase by
carrier in this cost 4% per year
Executive travel manager to No executive travel manager is
continue to coordinate the required and avoid dead time
travel arrangement
Corporate jet might be considered extravagant by the outside director and shareholders
 Questions and Answer

Q#01 Given the each of the three corporate transporation alternative covers a different length
of time, what time period should be used to compare these options?
A#01 The ten (10) years period should be used to compare these options due to:
a) 10 years executive travel forecast data is provided in table 2 relating to the
number of round trips flights; and
b) The 10 years data available for option 2 and option 3 whereas the data for
option one can be simulated for 10 years’ time period.
Q#02 In constructing the cash flows associated with each option, how should the analyst treat
The Winning Edge’s $ 250,000 expenditure for computer hardware and software to
coordinate its executive travel schedule? Why?
A#02 The expenditure incurred by The Winning Edge of $250,000 in previous fiscal year for
computer hardware and software to coordinate its executive travel schedule should be
treated as a sunk cost and will not impact on the decision making as it’s has already been
incurred irrespective of three option and cannot be reversed.
Q#03 In constructing the cash flows associated with the commercial airline contract option,
should the analyst include: (a) the average cost of coach tickets; (b) the cost of
upgrading a coach fare to a first-class ticket; and/or (c) both of these tickets prices? Be
sure to explain your answer, and indicate how each of these costs would appear in the
capital budgeting analysis
A#03 In constructing the cash flow associated with the commercial airline contract option, the
analyst should include only the average cost of coach tickets. Under this option
executive would continue to fly coach on schedule commercial flights.
In capital budgeting the average cost of coach tickets should be average round trip flight
per year multiple by net average cost of coach ticket (cost of ticket minus frequent flier
discount) multiple by average number of executive traveller per trip. Further, 6%
increase in the average cost of coach ticket should also be accounted for:

Description Y1 Y2 Y3-Y10
Average cost of coach ticket 50x 53x 56x…..
{($800*1.06)X4} {(848*1.06)X4)
Cost of upgradation to first- - - -
class ticket

Q#04 In constructing the cash flows associated with the commercial airline contract option,
should the analyst include the lost time that The Winning Edge’s traveling executive
spend waiting for connecting flights in airport terminal? If so how should this time be
represented in each year of the capital budgeting?
A#04 The lost time that The Winning Edge’s traveling executive spend waiting for connecting
flight in airport terminal should be treated as an opportunities cost. It should be
represented in ached year of capital budgeting as:
Total number of lost hours ( 200=average round trip per year 50 X average number of
lost hour per round trip 4) multiple by number of executive (4) multiple by average
salary per hour (102=$208,000/2040* hours).
*total number of days in a year 360 less 2 days off per week multiply by average 8 hours
per day. Due to lack of information relating to public holidays and leave, the assumption
is there are no public holidays and leaves option.
Description Y1 Y2 Y3-Y10
Lost time at airport terminal 50X4X4X$102 53*4*4*102 56x….
Q#05 What is the annual depreciation expense that The Winning Edge may claim against
taxable income under each of the three travel options?
A#05 Annual depreciation expense that The Winning Edge may claim against taxable income
under each of the three options are:
a) Option # 01: No depreciation expense based on the available information.
However, the expenditure of $250,000 incurred on computer hardware and
software can be depreciated using the company policies and/or tax law.
b) Option # 02: depreciation expense = $ 2.175 million= ($2.5 million - 0.0325
million
c) Option # 03: depreciation expense first 5 years = 504,000 = ($630,000 – 20% of
salvage value) for first five year
Depreciation expense next 5 year = $ 608,326 = 25% of $3.04 million (current
market price x 4% inflation factor 5 years) – $ 152,082 (20% salvage value)
Q#06 Does each of the three options contain a different risk level? If so, how should the
analyst incorporate this risk differential within the capital budgeting analysis? Be sure to
identify the appropriate discount rate necessary to evaluate each alternative in your
answer, and explain your selection of particular discount rate
A#06 Yes based on the available information and management assumption three options
contain different risk level. Further, the risk adjusted corporate capital cost (after tax) is
provided in the table 1 therefore the analyst should use the appropriate rate based on
the risk level of each option.
Following should be the appropriate discount rate based on the level of risk as outlined
in the case study:
Description Level of Risk* Discount rate
Option – 1 High Risk 7%
Option – 2 Lowest Risk 10%
Option – 3 Moderate Risk 14%
*level of risk per management….
Q#07 Should the capital budgeting analysis include the forecast inflation rate shown in the
Table 1? If so demonstrate how each of these inflation factors will affect the various
cash flows in the capital budgeting analysis.
A#08 Yes, as the inflation is specific to each item therefore it should be included in the capital
budgeting analysis. For detail please refer to above answers against question # 3 and # 4.

Q#08 What is the net salvage value that The Winning Edge can expect to receive from (a) the
aircraft purchase option, and (b) the aircraft time-share option.
A#08 Net salvage value from the aircraft purchase option = $ 325,000
Net salvage value from the aircraft time-share option = $ 126,000 ($630,000x20%) plus
$670,000 ($3.35 million – $0.67). For detail please refer to above answer against
question # 05.
Q#09 Based on your answer to Question 1 through 8, prepare a schedule of corporate cash
flow relevant to each of the three travel alternative, and calculate the present value of
total cost of each option. In developing the cash flows, assume that capital expenditure
necessary to fund the change in The Winning Edge corporate travel policy occur in the
current year Y0 and all the operating expenditures begin in the next fiscal year
A#09 Present Value of total cost of each option (for detail please refer to Annexure A):
Option Number Present Value of total net cost
Option # 01 $ 2.121 million
Option # 02 $ 2.872 million
Option # 03 $ 2.698 million
Q#10 In Question 9, should the analyst focus on the before tax or after tax cash flow? Why?
A#10 The analyst should focus on before tax cash flow as the “risk adjusted corporate capital
costs” are after tax.
Q#11
A#11 Yes, the growing profitability trends should have an influence on the answer number 10.
In case The Winning Edge would suffer several years of losses, the benefits of saving in
outflow of cash due to taxes would not be availed.
Q#12
A#12 Equivalent Annual Annuity is the method used to evaluate mutually exclusive project
with varying lives. In case of The Winning Edge, the information is available over the
same period of time (ten years) therefore this method should not be followed.
Q#13
A#13 Mike Cramer’s assessment of the risk level of each alternative is not a sufficient
justification for the analyst as it does not based on the risk free rate and market risk rate
it’s only consider the perception of directors and shareholders.
Q#14
A#14 Considering all the factors, Mike should select the option # 01 due to:
a) Lowest present value of total net cost; and
b) It does not deviate much from the current policy therefore the director and
shareholder will not show any resistance for this option.