Fly by Night Airlines

Content

1. Introduction page 3

2. Assumption page 3

3. Estimation page 3

4. Accounting data

Number of planes page 4

Ticket revenue page 4

Operating Cost page 5

Deprecation page 5

Operating cash flows page 5

NPV page 5

5. Evaluation page 6-7

6. Appendix

Introduction

Fly-by-night Airlines is a major commercial air carrier offering passenger service between most large cities in the US. Its profitable route is between Los Angeles and New York and the firm is considering replacing its old PJ-1 planes to PJ-2 or PJ-3 planes. Currently, James Baron has three options in hand to decide what to do. He uses 15 year planning horizon. Under option A, he plans to continue to use PJ-1s for three years and then replace them by PJ-2 for the remaining 12 years. Option B is the same as option A except at the end of the sixth year, PJ-2s will be replaced by the PJ-3s for the remaining 9 years. Option C doesn????t plan to use PJ-2 but only PJ-3. It is planned that the PJ-3s will replace PJ-1s at the end of sixth year and for the remaining 9 years. Assumptions and estimating are made in order to have an estimated cash flow and NPV.

Assumptions

1. There is a perfect and efficient market.

2. It is assumed that the entire project life is on the same stage of economic cycle. In other words, no recession or peak will occur.

3. It is assumed that the demand and supply remain constant in the entire project life.

4. It is assumed that the level of competition is fixed and the taste of customers remains the same for the entire projection.

5. It is assumed that PJ-2 and PJ-3 are introduced the same time as planned.

6. All cash flows are incurred at the end of accounting year.

7. It is assumed that all of the planes will be replaced andthe options are mutually independent.

Estimations

1. Depreciation is a straight-line basis.

2. Cost of capital is 15% to adjust the uncertainty of introduction of PJ-2 and PJ-3.

3. Fuel costs will be $0.55 per galloon by year-end and will grow at the constant rate of 9% per year.

4. Maintenance cost is $60000 per day per place and will grow at the constant rate of 5 % per year.

5. Upgrading costs will grow at a constant rate of 8% per year per plane

6. One-way ticket price will be $400 and will grow at a constant rate of 4%

7. Personnel and administrative cost are expected to be 85% of ticket revenue.

8. Marginal tax is 50%.

9. Individual estimations for PJ-1, PJ2 and PJ-3 are in the Figure 1.

Factors PJ-1 PJ-2 PJ-3

Fuel consumption(gallons/flight) 4000 3000 2000

Maintenance time(days per year) 40 30 20

Upgrading costs(dollars/year ) 100000 50000 16666.67

Capacity per plane 200 250 350

Passenger load factor 0.95 0.9 0.82

Number of one-way flights 300 320 335

Cost of purchasing(dollars) 15000000 20000000 30000000

Figure 1

Accounting data

Number of planes

Federal government regulatory agency requires the service of a minimum of 300000 passengers per year to allocate the route