IntroductionFly-by-night Airlines is a major commercial air carrier offering passenger
service between most large cities in the US. The firm is considering replacing its old PJ-1
planes to PJ-2 or PJ-3 planes in one of its profitable route between Los Angeles and New
York since they are more fuel efficient, less polluting, less maintenance cost and quieter.
Currently, Red 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 is that the PJ-3s will replace PJ-1s at the end of sixth year for the
remaining 9 years. Assumptions and estimating are made in order to have an estimated
cash flow and NPV.
Estimations
Estimations are listed in two chart below.
Key Estimations (Year 1)
PJ-1 PJ-2 PJ-3
Passenger load factors 0.95 0.90 0.82
Capacity per plane 200 250 350
Number of one-way flight Los Angeles – New York per year 300 320 335
Theoretical Passenger per year (per plane) 60000 80000 117250
Actual Average passenger per year (per plane) 57000 72000 96145
Ticket price($) $400 $400 $400
Fuel cost/per gallon $0.55 $0.55 $0.55
Fuel consumption (Gallons) 4,000 3,000 2,000
Maintenance time (days) 40 30 20
Maintenance daily cost (dollars/day) $60,000 $60,000 $60,000
Upgrading Cost (dollars/year) 100,000 50,000 16,667
Appropriate Cost of Capital 10% 12% 15%
Purchasing plane cost 15,000,000 20,000,000 30,000,000
Economic life (years) 25 12 9
Salvage Value Estimation
PJ-1 PJ-2 PJ-3
Salvage value- 3 years later $5,000,000
Salvage value- 6 years later $3,000,000 $18,000,000
Salvage value- 12 years later $8,000,000
Salvage value- 9 years later $12,000,000
Inflation Rate Estimation
Ticket price growth rate 4%
Fuel cost per gallon growth rate 9%
Maintenance cost growth rate 5%
Upgrading cost growth rate 8%
Personel and adminstrative Expense Ratio of revenue 85%
Marginal tax rate 50%
Assumptions
Making some options is easy to make a decisions and make some estimations. The three
options on this case and estimations above are based on the the following assumptions,
some of them are implicit: the economy should grow gradually so that both the ticket price
and other costs are growing at a stable rate. No recessions and peaks will happen. And the
actual passengers per year do not change so much means that the both the market share
and the preference of consumer remains the same. A assumption which helps to
