Cost and Risk Analysis

Project Desciption

Imagine that you are the asset manager for a major northern European Hub Airport. The airport is under strong competition from Amsterdam, Frankfurt, London, Madrid & Paris.

The probability of a winter snow closure is 0.333 per year. The downtime cost for the airport is €1m / day. In addition, the marketing department has estimated that reputation damage costs an additional €1m per closure.
With existing equipment it takes on average three days to clear snow during which time the airport has to be closed and penalties are incurred.
There is an option to buy new state of the art snow clearing equipment.
This equipment has been successfully used at Denver airport in the USA. It would cost €3m to buy and it would last 30 years if properly looked after and maintained. It is estimated that annual storage, upkeep, painting, maintenance and running costs for this equipment would be €50,000 per year. Training for drivers would be €10,000 initially and €500 / year thereafter. The snow clearance time with this equipment would be reduced from the current three days to one day.
Another option would be to lease the snow clearing equipment for €400,000 per year for a 30 year period. Under this option, the lease company would keep the equipment at the airport and undertake all maintenance and upkeep activities at their expense. You would still have to provide the drivers.
The airport finance department requires that all new investments have to make at least a 10% / year internal rate of return. It also states that a 5% discount rate has to be used in all financial calculations (this takes into account potential future inflation and the cost of raising capital).
Your task in this assignment is to consider the three available options:
1.           The status quo where no additional investment is made
2.           The purchase and upkeep of new snow clearing equipment
3.           The lease of new snow clearing equipment.
Fully discuss each of these three options. Consider all benefits, costs and risks associated with each one. Then state which would be your preferred option giving reasons. If you have to make any assumptions to complete your answer, then please state what these assumptions are and why you have made them.
Report presentation and content are both important. Good diagrams and relevant photos always add impact. Make sure that your report has an abstract, contents page, section headings and detailed descriptions of methodologies.
At least 5,000 words will be needed to adequately describe your analysis and recommendations.