Southwest Airlines is experimenting with expanding its operation overseas and has chosen Japan as its first test market. The company plans to fly into Narita, Japan. The expansion, renovation and cost of the landing slot(s) will be $150 million. These costs will be fully depreciated over 10 years on a straight line basis. Southwest's tax rate is 30%.

Southwest is expecting the average sales price of each ticket to be $675 roundtrip from San Francisco/Oakland/San Jose. The net profit margin will be equal 6.5% of the ticket price (revenue). For this project and this analysis, assume that everything else will remain the same (all other costs and revenues). To simplify, assume cashflow is equal to Net Income plus Depreciation.

For projects like this, Southwest uses a hurdle rate (discount rate) equal to its WACC + its before tax current bond rate¹. Beta is 1.15 for the company, Risk Free Rate is 5%, Market Return is 10%, the before tax cost of all its debt is 4.7% and its tax rate is 30%.

1.Assuming a 10 year project life, how many roundtrip tickets will Southwest have to sell in order to breakeven (NPV = $0) over the life of the project? Exclude the impact of financing.

2.At the breakeven point (NPV = $0), what will be Southwest's change to EPS (shares outstanding 758,823,529) for the first year? Exclude the impact of financing.

Note: Southwest Balance Sheet on Next Page

Southwest Balance Sheet

1/1/2010

Cash

1,114,000,000

S/T Investments & Other

2,244,000,000

Total Current Assets

3,358,000,000

PP&E

10,634,000,000

Other Assets

277,000,000

Total Assets

14,269,000,000

Current Liabilities

2,676,000,000

Long Term Debt

3,325,000,000

Other Long Term Liabilities

2,802,000,000

Total Liabilities

8,803,000,000

Common Stock

2,024,000,000

Retained Earnings

4,983,000,000

Accmulated other Comprehensive Loss

(578,000,000)

Treasury Stock

(963,000,000)

Total Equity

5,466,000,000

Total Liabilities and Equity

14,269,000,000