Clarifications:

• The investment is the purchase and install of the winglets. The return on investment is the savings in fuel. This question was asked several different ways late in the evening, after many of you had left. So, there it is for all of you.
• On question #2: Note: to be clear, at this point in the case we are using 2.5% savings.
• On question #4: Clarification: This is at the original savings of 2.5%
• On question #5: Clarification: This is directional, not computational. Will it Increase or Decrease? You may do the math to help find the answer but it is not required as part of the answer.
• On question #6 Bonus: Omission: you were given the new Beta of 1.2, asked to compute new cost of equity. But you also need: Market Rate of Return = 8%. Risk Free Rate = 1.6%.

AVA Airlines Winglets Case Study J. Dalton, Oct. 21, 2019 MB 510 AVA Airlines (Stock symbol AVA) is acquiring an older Boeing 737-800 to launch a new SEA-SFO route. The basic business case is sound, with a positive rate of return based on standard industry factors. However, this particular aircraft was previously owned by Sketchy Air, and was never upgraded with aerodynamic winglets that increase fuel economy. Winglets are a common upgrade to older airplanes, and provide a near-guaranteed cost savings in most applications. But each route is different, resulting in different savings. AVA wants to confirm that the expense of the retrofit has a positive rate of return, further boosting the business case. Winglets cost $1,200,000 with an additional install cost of $130,000. The work only takes a few weeks to complete. One-way (one segment) SEA to SFO is 600 nautical miles and requires 995 gallons of fuel. The route is 3 round trips a day, or 6 flight segments, running 365 days a year. Fuel cost is projected at $5.58 per gallon (average 2019 cost) into the foreseeable future. Fuel savings is estimated at 2.5% with winglets installed. Assume a 7-year life to this project, as by then the plane will be at the end of its passenger certified life. The go-to discount rate is the airline's WACC. The CFO has been generous enough to give us the cost of equity, 13.1%, but assumes we can take it from there. Debt has been issued at 6.5%, corporate tax rate is 25% and the company is 30% debt funded. 1) Using the firm's WACC: what is the NPV and IRR of this cost-saving project? 2) If we estimate the fuel cost at $6.04, what is the NPV? 3) A recent finance grad tactfully suggests to the CFO that the WACC isn't the last and only word on discount rates. The project would appear to carry less risk, as there is engineering-verified savings to be had with every mile flown. However, there is concern that the fuel savings will be only 2%. Could you make a case that the project produces a positive NPV at 2% savings? Yes or no, and support your view. 4) If you set aside the concept of discounting, looking at only nominal costs and savings, is there still a net benefit to this project at 4 segments per day? If so, how much? 5) AVA's current beta is high at 1.8. What will happen to the companies cost of capital as its beta moves closer to 1.0? Bonus 6) if bela dedines to 1.2, what is company's cost of equity