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MBAA 523 ? Fleet Replacement Assignment

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Fleet Replacement Analysis;This assignment has three objectives, to: 1) become familiar with the type and magnitude of mainline aircraft operating costs, 2) understand the operating economics of new versus older aircraft, and, 3) see how net present value analysis is used in capital acquisition decision-making. Allegiant Airlines has engaged the aviation consulting firm SH&E to evaluate whether it should continue its fleet expansion with new aircraft instead of the aging McDonnell Douglas MD-80 aircraft that are the backbone of its small fleet. You are the senior financial analyst assigned to this project and will prepare a memorandum with your conclusions to Allegiant?s president Andrew Levy.;Background;Allegiant Airlines, a small successful US low-cost- carrier, has been aggressively expanding by purchasing used MD-80 aircraft. In its latest acquisition of 18 MD -80s from Scandinavian Airways System, Allegiant paid roughly $4 million dollars per plane in an all cash transaction. Although these aircraft have a useful service life of 20 more years, Allegiant recognizes it must eventually modernize its fleet. As with all older aircraft, the MD-80 burns more fuel and requires more maintenance than new generation aircraft of equal mission capability. Skyrocketing fuel prices during the summer of 2008 added to senior management?s interest in evaluating new aircraft. As you will see, this decision is critically dependent on your projection for future fuel costs and the discount rate (interest rate) employed.;The Analysis;An Excel template is provided as an attachment for conducting your net present value analysis. You will need to insert costs into the template. You may wish to review the template before reading further.;Allegiant can purchase new Boeing-737-800 or Airbus A-320 aircraft for $60 million each. After twenty years, either of these new aircraft are estimated to be worth $25 million in the used market whereas an MD-80 will have only $100,000 in scrap value twenty years hence. Even if Allegiant should continue to operate the planes beyond 20 years, these values still represents an opportunity cost.;Your estimate of fuel prices over the next twenty years is critical. Review fuel cost data provided on the Air Transport Association website (Economics and Energy/Annual Crude Oil and Jet Fuel Prices and Monthly Jet Fuel Cost and Consumption Report;ATA Annual Crude Oil and Jet Fuel Prices;ATA Monthly Jet Fuel Cost and Consumption Report;Note that fuel prices increased dramatically during the global economic expansion of the mid-2000s peaking at nearly $4 per gallon in June 2008, but plummeted during the subsequent recession. Fuel costs will certainly increase again when world demand recovers. You will need to estimate future fuel costs for the analysis.;In preparing your analysis for Allegiant, you have obtained relevant cost data from the US Department of Transportation. Data are in the tables at the bottom of this document. Here are other relevant facts and assumptions needed to complete the analysis;All future operating costs are discounted to the present value at a discount rate. Although Baye refers only to the interest rate, finance theory tells us that the Weighted Average Cost of Capital is appropriate. This discount rate is the estimated return that shareholders demand of an airline from a purchase of new capital equipment. Derivation of this discount rate is beyond the scope of;this course but might vary between 8 and 20%. As one example, United Airlines raised some operating capital by selling corporate bonds secured by its spare parts inventory. The effective interest rate on this sale was 17%. Your fleet replacement decision will depend on what rate you choose. You should perform a sensitivity analysis (work the problem with at least two discount rates) to better understand and defend your recommendation.;Although Allegiant?s business model does not provide for high aircraft utilization, it estimates that a new aircraft?s annual utilization (block hours per year) will be 15% higher than the MD-80.;Allegiant plans to outsource its heavy maintenance, so it will pay another airline or maintenance facility for both direct and burden (overhead) costs. For the A-320, it estimates maintenance cost will be similar to JetBlue and USA 3000, both of which operate relatively new aircraft. All Boeing 737-800s are relatively new, so the industry average maintenance cost is a good estimate.;Allegiant configures its aircraft in high density, all-coach configuration like other LCCs USA 3000 Airlines and Sun Country.;5. Both the A-320 and B-737-800 are somewhat faster than the MD-80. Estimated block to block (taxi out to gate arrival) speed for A-320 and B-737 is 366 mph versus 340 mph for the MD-80.;6. Allegiant does not expect crew expenses to change with the choice of aircraft, so this and other minor immaterial costs are not included in the analysis (an extra flight attendant will be required but this cost is ignored here).;Task;Choose either the Airbus A-320 or the Boeing 737 for comparison with the existing MD-80. Enter data into the Excel template. Run a few ?sensitivity? analyses with varying fuel and discount rates to see how the fleet replacement decision changes. Remember that the net present value obtained is a total cost of operation. The spreadsheet computes the cost per available seat mile (CASM). The fleet alternative with the lowest net present value CASM is the best financial choice. Prepare a short memorandum to the President summarizing your analysis and making a recommendation. Remember that executive management needs to understand what you have done but will not read a memorandum more than two pages long. Explain your assumptions and methodology concisely. Insert or attach and reference Excel spreadsheets as appendices to support your fleet replacement recommendation.;See Purdue OWL for guidance on writing business memoranda and memo format. Search OWL for ?memorandum.?;The following page supplies the operating cost and statistics charts for McDonnell Douglas and Boeing aircraft.;Source: Aviation Daily. Available through Aviation Week Intelligence Network (AWIN), Hunt Library databases.;MBAA 523 ? Fleet Replacement Assignment CV 1010;MBAA 523 ? Fleet Replacement Assignment CV 1010

 

Paper#25025 | Written in 18-Jul-2015

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