OVERVIEW:

This assignment has three objectives:

1. Become familiar with the type and magnitude of mainline aircraft operating costs.
2. Understand the operating economics of new versus older aircraft.
3. Learn how net present value analysis is used in capital acquisition decision-making.

WestJet, Canadas second-largest airline behind Air Canada, has engaged the aviation consulting firm IFC International to evaluate whether it should continue its expansion to Europe with used Boeing 767-300ERs (ER stands for extended range; this model entered service in 1988) or purchase new Boeing 787-9 aircraft. You are the senior financial analyst with IFC assigned to this project and will prepare a memorandum with your analysis and recommendations to Mr. Harry Taylor, WestJets Chief Financial Officer.

WestJet was founded in 1996 based on the low-cost carrier model. It has since grown rapidly, expanding to the US and the Caribbean with a fleet of Boeing 737 aircraft. In 2016, WestJet began service to Europe utilizing used Boeing 767-300s. The start-up of European service was plagued by delays and cancellations, in part due to the lower reliability of older aircraft. Mr. Taylor, new to WestJet, has questioned whether the operational problems might have been avoided had the airline opted for new Boeing 787 aircraft rather the 25-year-old Boeing 767s. He believes that his staff may not be able to conduct an unbiased assessment having participated in the selection of the Boeing 767, so he has contracted with IFC to develop a financial comparison of the two aircraft types.

As with all older aircraft, the B-767 burns more fuel per available-seat-mile and requires more maintenance than new generation aircraft of equal mission capability. Though well-used, the B-767 still has a remaining useful life of at least 15 years. The Boeing 787-9 Dreamliner is much more expensive to purchase but promises better reliability and reduced fuel burn per seat-mile.

Note: WestJet did subsequently order new B-787-9s as a B-767 replacement, so imagine yourself conducting the analysis prior to this decision.

Your team has developed a template which is provided as an attachment for conducting your net present cost analysis:

You will need to insert costs and performance figures into the template. You may wish to review the template before reading further.

In order to complete your analysis, you will need to obtain current aircraft operating data and costs from authoritative sources. The sources listed below are sufficient and adequate for your project:

Aircraft Performance Data and Operating Costs

WestJet provided IFC with their performance and cost data for the current B-767 fleet. These data are available in the document below, along with other airlines operating the B-767-300ER.

Written Assignment 2 Performance Data and Costs (DOCX)

The Airline Monitor publishes extensive aircraft operating data including for the B-787-9 you will need for your analysis. The Airline Monitor is available through the Hunt Library Aerospace/Aviation electronic databases. When youve accessed The Airline Monitor, select Online Edition, then Block Hour Operating Costs (pdf).

IFC staff have surveyed WestJets finance staff to arrive at several critical assumptions about aircraft costs and performance.

1. Airlines with solid balance sheets, such as WestJet, can normally purchase new aircraft for about two-thirds (2/3) of list price. Boeing periodically publishes list prices for its aircraft. Search the Boeing website for aircraft list prices to determine the list price for new Boeing 787-9. After 15 years, a B-787-9 is estimated to be worth half of the original purchase price (not list price) in the used market. If WestJet continues to operate these planes beyond 15 years, this value represents an opportunity cost.
2. Used B-767-300ER aircraft are available from several sources as other airlines are beginning to replace their B-767 fleets with newer aircraft. For a 20 to 25-year-old B-767-300ER, WestJet paid an average of $35 million but spent an additional $10 million on the refurbishment of each aircraft. After 15 years, the B-767 will only have a scrap value of $1,000,000.
3. WestJets segment lengths are relatively long, it believes fuel burns (gallons per block hour) on a new B-787-9 will meet the lowest of any airline and that speed in miles per block hour will equal the highest of any airline.
4. Because of the 787 increased range and reliability, WestJet expects its annual utilization (block hours per year) will meet the industry average. Note: This annual utilization is for one aircraft, not the entire fleet. This number is not directly available in the Airline Monitor but can be easily computed.
5. WestJet plans to outsource its heavy maintenance, so it will pay another airline or maintenance repair facility for both direct and burden (overhead) costs. If it decides to purchase a new fleet type, it believes that its first-year maintenance expense will equal the lowest for any airline operating the Boeing 787-9 but that these costs will increase by 2% per year. However, as the fleet of B-767s age, WestJet believes that maintenance costs for this fleet type will increase by 5% per year.
6. WestJet has a small business class in its 767s, but most of the cabin is configured in high-density coach class for a total of 262 seats. Because of the 787-9s larger size, WestJet plans a three-class cabin configuration total of 298 seats.
7. WestJet does not expect crew expenses to change with the choice of aircraft, so this and other immaterial costs are not included in the analysis.

Fuel Prices

Your estimate of fuel prices over the next fifteen years is crucial. Historical data on jet fuel prices are available from several sources. The Airline Monitor includes this data in the Block Hour Operating Cost document. Data are also available from the industry association Airlines for America. Select Economics & Analysis, then Traffic & Financial Results. Scroll down to select the appropriate reports. Alternatively, you may wish to use long-range forecast energy prices from the American Energy Information Administration, the Federal Aviation Administration, or another authoritative source.

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 seem likely to increase again when world demand recovers. You will need to estimate future fuel costs for the analysis. Be certain that the fuel price for the first year is the current jet fuel spot price (available from several sources via a web search). Because fuel prices are difficult to predict, develop estimates for a range of projected fuel prices. The US Energy Information Administration does this with optimistic, pessimistic, and most likely scenarios. In your memorandum to Mr. Taylor, explain how you have estimated future prices.

Return on Invested Capital

The appropriate return on invested capital (the discount rate) varies by airlines; however, the following extracts from the financial press are illustrative. Alaska Air Group CEO Bill Ayer pointed to its target of 10% return on invested capital (ROIC). According to President Ed Bastian, Delta Air Lines is also targeting a 10% sustainable return on invested capital. Southwest Airlines is looking for a 15% ROIC. Your fleet replacement decision will depend on what rate you choose. Airlines with the best credit can borrow at the lower rates which also decreases the discount rate.

Enter data into the Excel template.

Ensure that the spreadsheet is fully complete; there should be no empty cells. As you will see, this decision is critically dependent on your projection for future fuel costs and the discount rate (ROIC) employed. Run a few sensitivity analyses with at least three estimates of future fuel prices and three discount rates to see how the fleet replacement decision changes. Remember that the net present value obtained is the cost of operation. The spreadsheet computes the cost per available seat mile (CASM). The aircraft with the lowest net present value CASM is the best financial choice. Include your sensitivity analysis in your memorandum. A 3-by-3 table with 9 combinations of fuel prices in columns and discount rates in rows is one way to the present the statistics. Include your rationale for the fuel price estimates and discount rates used in this sensitivity analysis.

Check carefully to ensure the inputs and results of the discounted cost analysis are reasonable. The NP CASM should be between 2 and 4 cents depending on the input variables. This is lower than reported CASM for US airlines because many costs that do not affect the choice of aircraft type are not included. Total annual operating costs should be in the millions of dollars. The Airline Monitor report can be used to check for reasonableness. Excel spreadsheets should not be submitted separately; Mr. Taylor wants the entire report in a single document.

$1,567.54 $1,142.12 Operating Cost per Block Hour () Flight Crew Cost Fuel Cost Other Costs 2,587.78 34.30 $1,609.94 2,489.48 80.22 $1,593.93 $1,568.25 2,596.15 2,666.81 5.76 30.05 2,449.43 181.71 Total Flying Cost $4,189.61 $4,179.64 $4,195.84 4,265.11 $3,773.26 486.13 Direct Maint. - Airframe Direct Maint. - Engines Total Direct Maintenance Maintenance Burden 559.24 373.59 932.84 891.77 85.03 238.44 724.57 306.75 324.62 631.37 231.31 711.32 3.12 714.44 976.80 304.13 469.83 286.02 543.00 Total Maintenance Costs $1,028.70 1,402.67 $862.68 $1,000.46 $1,519.81 6.10.26 747.79 286.90 Deprecation Aircraft Rent 486.02 483.65 616.39 103.63 213.48 80.04 1.047.56 Total Cost per Block Hour $6,042.06 $6,551.98 $5,778.53 $6,093.40 $6,627.52 6.39 Ratios and Operating Indicators Cost per Available Seat Mile - Fuel Cost per ASM - Total Cost per ASM ex. Fuel - 6.12 2.62 7.07 2.68 4.38 5.73 2.57 3.15 2.80 5.664 2.09 3.57 3.500 3.59 11.07 9.17 10.79 9.17 449 452 463 213.2 471 202.6 206.4 259.0 Utilization - Block Hours per Day Speed - Miles per Block Hour Seats per Aircraft Gallons of Fuel per Block Hour Gallons per Block hour/per Seat Fuel Cost per Gallon - $ Average Flight Stage - miles 1,522 12.40 466 216.5 1,567 7.24 $1.66 3,563 1,588 1,490 1,560 7.32 $1.66 3,277 7.38 $1.64 2,609 7.84 $1.68 3,582 5.75 $1.64 2.364 The Airline Monitor August 2018 Page 2 of 2 EMBRYRIDDLE Aeronautical University WORLDWIDE MBAA 523 Written Assignment 2 Aircraft Performance Data and Operating Costs Aircraft Types: 767-300ER/767-400 The Airline Monitor Commercial Aircraft Data Base Year 2017 U.S. Block Hour Operating Costs by Aircraft 767-300ER Total 767-300ER American Delta (6 300s) United WestJet' System Operations All Services Operating Data Revenue Pass. Miles (mil.) Available Seat Miles (mil.) Load Factor 43,036.2 52,769.6 81.6% 7,195.9 8,943.5 80.5% 23,138.3 27,541.1 84.0% 9,999.9 13,152.6 76.0% 2,702.2 3,132.5 86.3% (0000 64.906 Revenue Miles Revenue Hours 247,516 494,445 128,203 Block Hours Aircraft Days Revenue Departures Gallons of Fuel 43,332 87,829 96,445 10,521 16,608 12,096 24,797 26,775 534,111 48,232 75,540 127,181 253,616 272,978 22,014 35,695 137,913 12,777 18,120 2,920 5,117 39,889 (000) 833,413 146,837 427,694 218,992 132.1 60.3 35.0 8.0 Number of Aircraft Year End Pass. Fleet & % measured Financial Data (000) 28.8 82.6% 160 Flight Crew Expense Fuel Expense Total Flying Expense $837,239 1,382,162 $155,270 240,098 403, 105 $435,107 708,693 $216,282 367,788 $30,580 65,584 2,237,719 1,145,371 588,214 101,029 53,936 83,735 98,100 430 23,877 2,277 88,615 Direct Maint. - Airframe Direct Maint. - Engines Total Direct Maintenance Maintenance Burden 259,649 127,353 387,001 162,440 36,031 89,967 45,313 172,350 63,142 98,530 39,446 26,154 14,539 325,947 46,874 7,682 Depreciation Aircraft Rent 168,260 28.289 103,131 11.038 114.022 46.646 28.049 Total Operating Exp. $3,227,129 $631,906 $1,577,412 $840,359 $177,452 College of Business worldwide.erau.edu All rights are reserved. The material contained herein is the copyright property of Embry-Riddle Aeronautical University, Daytona Beach, Florida, 32114. No part of this material may be reproduced, stored in a retrieval system or transmitted in any form, electronic, mechanical, photocopying, recording or otherwise without the prior written consent of the University. EMBRY RIDDLE Aeronautical University WORLDWIDE $1,567.54 $1,142.12 Operating Cost per Block Hour () Flight Crew Cost Fuel Cost Other Costs 2,587.78 34.30 $1,609.94 2,489.48 80.22 $1,593.93 $1,568.25 2,596.15 2,666.81 5.76 30.05 2,449.43 181.71 Total Flying Cost $4,189.61 $4,179.64 $4,195.84 4,265.11 $3,773.26 486.13 Direct Maint. - Airframe Direct Maint. - Engines Total Direct Maintenance Maintenance Burden 559.24 373.59 932.84 891.77 85.03 238.44 724.57 306.75 324.62 631.37 231.31 711.32 3.12 714.44 976.80 304.13 469.83 286.02 543.00 Total Maintenance Costs $1,028.70 1,402.67 $862.68 $1,000.46 $1,519.81 6.10.26 747.79 286.90 Deprecation Aircraft Rent 486.02 483.65 616.39 103.63 213.48 80.04 1.047.56 Total Cost per Block Hour $6,042.06 $6,551.98 $5,778.53 $6,093.40 $6,627.52 6.39 Ratios and Operating Indicators Cost per Available Seat Mile - Fuel Cost per ASM - Total Cost per ASM ex. Fuel - 6.12 2.62 7.07 2.68 4.38 5.73 2.57 3.15 2.80 5.664 2.09 3.57 3.500 3.59 11.07 9.17 10.79 9.17 449 452 463 213.2 471 202.6 206.4 259.0 Utilization - Block Hours per Day Speed - Miles per Block Hour Seats per Aircraft Gallons of Fuel per Block Hour Gallons per Block hour/per Seat Fuel Cost per Gallon - $ Average Flight Stage - miles 1,522 12.40 466 216.5 1,567 7.24 $1.66 3,563 1,588 1,490 1,560 7.32 $1.66 3,277 7.38 $1.64 2,609 7.84 $1.68 3,582 5.75 $1.64 2.364 The Airline Monitor August 2018 Page 2 of 2 EMBRYRIDDLE Aeronautical University WORLDWIDE MBAA 523 Written Assignment 2 Aircraft Performance Data and Operating Costs Aircraft Types: 767-300ER/767-400 The Airline Monitor Commercial Aircraft Data Base Year 2017 U.S. Block Hour Operating Costs by Aircraft 767-300ER Total 767-300ER American Delta (6 300s) United WestJet' System Operations All Services Operating Data Revenue Pass. Miles (mil.) Available Seat Miles (mil.) Load Factor 43,036.2 52,769.6 81.6% 7,195.9 8,943.5 80.5% 23,138.3 27,541.1 84.0% 9,999.9 13,152.6 76.0% 2,702.2 3,132.5 86.3% (0000 64.906 Revenue Miles Revenue Hours 247,516 494,445 128,203 Block Hours Aircraft Days Revenue Departures Gallons of Fuel 43,332 87,829 96,445 10,521 16,608 12,096 24,797 26,775 534,111 48,232 75,540 127,181 253,616 272,978 22,014 35,695 137,913 12,777 18,120 2,920 5,117 39,889 (000) 833,413 146,837 427,694 218,992 132.1 60.3 35.0 8.0 Number of Aircraft Year End Pass. Fleet & % measured Financial Data (000) 28.8 82.6% 160 Flight Crew Expense Fuel Expense Total Flying Expense $837,239 1,382,162 $155,270 240,098 403, 105 $435,107 708,693 $216,282 367,788 $30,580 65,584 2,237,719 1,145,371 588,214 101,029 53,936 83,735 98,100 430 23,877 2,277 88,615 Direct Maint. - Airframe Direct Maint. - Engines Total Direct Maintenance Maintenance Burden 259,649 127,353 387,001 162,440 36,031 89,967 45,313 172,350 63,142 98,530 39,446 26,154 14,539 325,947 46,874 7,682 Depreciation Aircraft Rent 168,260 28.289 103,131 11.038 114.022 46.646 28.049 Total Operating Exp. $3,227,129 $631,906 $1,577,412 $840,359 $177,452 College of Business worldwide.erau.edu All rights are reserved. The material contained herein is the copyright property of Embry-Riddle Aeronautical University, Daytona Beach, Florida, 32114. No part of this material may be reproduced, stored in a retrieval system or transmitted in any form, electronic, mechanical, photocopying, recording or otherwise without the prior written consent of the University. EMBRY RIDDLE Aeronautical University WORLDWIDE