In the early 1970s Trans World Airlines(TWA), then one of the largest domestic and international trunk carriers in the world, acquired a fleet of sixteen (16) Boeing 747 Aircraft. These planes carried passengers to over eighty destinations in some 110 countries around the globe. Each plane had the capability to carry over 340 passengers some 7,000 miles without refueling and also carry limited cargo, although cargo was not a major source of revenue for TWA at that point in time.

In the mid 1970s TWAs Boeing 747 planes carried passenger load factors of roughly 66%% on its domestic flights and over 72% on international flights. Some lucrative routes such as New York to Rome, Italy and Los Angeles to London carried passenger load factors in excess of 80%. Very little cargo however was carried on domestic or international flights.

During the 1970s the United States, like many other nations, were held hostage by OPEC the Organization of Petroleum Exporting Countries in the Middle East. They controlled the flow of oil and therefore the price of oil which included the cost of gasoline and jet fuel. Americans experienced shortages and increasing prices causing great upheaval in the markets, particularly those dependent on energy. The travel industry, hotels, airlines, cruise ship lines, rental car companies not to mention every day consumers, all were adversely impacted greatly during this period. Our government enacted mandatory jet fuel allocations to trunk air carriers which greatly restricted routes and also greatly curtailed business and personal travel. In addition, prices of various flights and destinations continued to increase which inevitably led to carriers initiating steps to cut back on ancillary services such as food service and other frills associated with air travel, especially on international flights.

It was during this challenging period that engineers and flight technicians began to explore ways TWA could operate more efficiently and profitably without necessitating the need to surrender lucrative routes to increasing competition of new airlines coming into the market, especially international airlines who were subsidized by foreign governments, and could offer extremely low prices. A team was assembled at TWA consisting of the very best technical and flight operations people in the industry as well as outside independent business and financial consultants to explore ways the airline could increase its competitive edge and increase operating efficiency and profitability. After several months of in depth analysis, and only after considering profound demographic, economic and institutional changes in the domestic and international business environments, the evaluation was made that there was indeed an opportunity to not only operate more efficiently but to actually increase revenues and, in many cases, passenger and cargo load factors. That opportunity called for a major upgrade to every JT9D7 Rolls Royce engine on every 747 aircraft in the TWA fleet, including spare engines at every major hub TWA aircraft flies into. The TWA Boeing 747 aircraft has four (4) engines. There are sixteen aircraft in the fleet and there are 16 hub sites (major cities with large airports and runways) around the globe, each with two (2) spare engines at all times. That is a total of 96 engines that would need to be upgraded with the help of TWA engineers and flight operations personnel and of course technicians and representatives from Rolls Royce. The upgrades would enable each aircraft to fly at higher altitudes (above 35,000 feet) where the air is thinner and the plane consumes significantly less fuel. The engineers estimated that on average, fuel costs, assuming existing routes and number of flights stay the same, would actually decrease by almost 9% from an average of 42,000 gallons of jet fuel per flight at $2.29 per gallon to 38,220 gallons consumed. Each 747 would normally fly an average of 12 flights per month.

In addition, the significant increase in thrust capacity of the newly modified jet engines would enable the TWA 747 Aircraft to take off with greater payloads including cargo and carry those longer distances with greater operating efficiency in getting products to market faster. Independent consultants did considerable work on identifying a growth oriented market for international companies relocating executives overseas to European and Asian countries and vice versa. In addition, TWA felt that there would be a growing economic benefit for both domestic and international companies desiring to get their products to their ultimate destinations and markets faster.. Conservative estimates indicated that each flight could carry an incremental payload of cargo equal to some 75,000 pounds per month without adversely impacting fuel, altitude or speed. At the time, freight charges cost roughly $11 per pound so each aircraft could produce incremental cargo revenues per month of $825,000.

Of importance, however, was the additional costs necessary to effectuate realization of this incremental revenue for TWA. It was immediately recognized that to carry such additional payloads, additional labor would be required along with the use of specially designed On Board Igloos, large metal containers into which cargo of all kind is to be stored and tightly secured. It was estimated that each hub site would need to contain a minimum of twelve (12) such On Board Igloos at a capital cost of $10,000 each along with trucks and forklifts necessary to accommodate cargo, Two trucks should be devoted to cargo at each hub site at a cost of $50,000 per truck plus $75,000 in specialized forklift equipment. Operational costs of the trucks, maintenance, fuel and well trained drivers were estimated to be $15,000 per month each.

Additional personnel necessary at each site to handle cargo revenue and tracking was budgeted at 14 people at a base cost of $35,000 in salary each person per year plus 17% in payroll and health care related overhead.

Now, turning back to the issue of engine modifications. All modifications and upgrades will take place at TWAs Main Maintenance Center at the Kansas City, Missouri Airport. Each modification for each Boeing 747 aircraft, including its four main engines and two spare parts could be accomplished over a period of two weeks time at a cost of $10.4 million including all materials and labor as well as testing. An additional $100,000 per site would be necessary to train existing maintenance personnel on necessary maintenance and repair of the newly modified engines. Outside independent consultants and filing fees for FAA Clearances would cost TWA $2.5 million over nine months for all 16 aircraft modified..

Thus, the fleet of sixteen TWA Boeing 747 aircraft could conceivably be fully operational with all 96 JT9D7 Rolls Royce Engines in a state of full readiness in a period of 32 weeks with a contingency period for possible delays due to weather or other unanticipated delays to 36 weeks or nine months.

TWA has a weighted average cost of capital/target rate of return on investment of 15%. Its effective tax rate is 30% Normal capital costs such as trucks, forklifts and other ground support equipment are depreciated over a ten year period using the straight line basis to zero salvage value. The effective useful production life of the newly modified JT9D7 Rolls Royce engines are expected to be 20 years.

One more unanticipated benefit to TWA not contemplated by the airline or its consultants that surfaced was the sudden ability of the airline to profitably lease three or possibly four of its 747 aircraft to other international carriers in off peak times (winter), generating incremental revenues of $2.0 million each for about three months time.

Your task is to begin the analysis of this real life project. Focus initially on the upgrade for one 747 aircraft only. Segregate and identify the capital costs and the relevant operational costs, calculate the annual depreciation, calculate the incremental operating costs and incremental operating savings and the relevant incremental revenues and structure the analysis

Your analysis should contain a recommendation to the TWA Board of Directors as it involves a significant capital investment. You should be able to determine the Internal Rate of Return on Investment and compare it to the TWA Cost of Capital; the Net Present Value of all Cash Inflows and Outflows discounted at the Cost of Capital, the Payback Period based on Net Cash Flow and you should clearly identify the total capital investment required and the additional operating expenses to be incurred as a consequence of the investment along with the additional incremental revenues of cargo and cost savings in jet fuel to be realized. And, your analysis should identify any pitfalls or potential contingencies that might modify or alter your recommendation (sensitivity analysis) to provide the Board with the degree of risk involved.