SOUTHWEST AIRLINES WNGLET PROJECT

As a low-fare airline, Southwest Airlines constantly focuses on ways to improve the efficiency of its operations and maintain a cost structure below that of its competition. In the spring of 2002, Scott Topping, the director of corporate, was approached by Aviation Partners Boeing (APB) regarding an innovative way to save on fuel costs-the installation of a new technology known as the Blended Winglet. The winglet made of carbon-graphite, were designed for the Boeing 737-700 aircraft. Southwest currently had 142 planes of this model in its fleet.

The Blended Winglet system was developed by APB, a joint venture between Aviation Partners Inc. and The Boeing Company. The main purpose of winglets was to reduce turbulence, leading to higher flying efficiency. As a result, the winglets provided three important benefits that allowed the airplane to extend its range, carry a greater payload, and save on fuel consumption. The winglets accomplish this by increasing the spread of the wing's trailing edge and creating more lift at the wingtips.

To complete his financial analysis, Scott had to verify potential costs and benefits as well as get the approval of the Maintenance Engineering Department, the Flight Operations Department, and the Facilities Department. However, Scott was well aware that regardless of the potential financial benefits, safety was the first priority. This process took several months due to the complexity of the project.

After discussing the project with the requisite departments, Scott made the following estimates of the costs and benefits of the winglet system to Southwest:

The winglets, which cost $700,000 a pair, could be installed at an additional cost of $56,000 per aircraft. Installation could be scheduled at each maintenance facility to coincide with regular maintenance. As a result, each aircraft was only expected to experience downtime for one extra day at a cost of $5,000.

After considering the short- and long-term effects of the winglets, the Maintenance Engineering Department estimated that, on average, repair costs would average $2,100 yearly per aircraft due primarily to incidental damage.

The increased wingspan was expected to allow each of Southwest's aircraft to fly up to 115 nautical miles farther and to decrease fuel usage by 4% to 6%. This meant that Southwest could expect to save 178,500 gallons of jet fuel per airplane per year.

Flight Operations estimated the additional lift capability provided by the winglet would reduce Southwest's costs of using restricted runways, with an estimated savings of $500 per aircraft per year.

The Facilities Department assessed the effect of the added wingspan on each of the 59 airports Southwest utilized in its current route structure. The department estimated the necessary facilities modifications could be achieved at a onetime cost of about $1,200 per aircraft.

The Blended Winglet project qualifies for accelerated tax write-off benefits under the Job Creation and Worker Assistance Act of 2002. With a marginal tax rate of 39% and using a seven-year depreciation schedule (see the table below), Southwest would be allowed to depreciate an additional 50% of the project in the first year.

The Blended Winglet project is expected to have a life of at least 20 years, at the end of which the winglets are anticipated to have a salvage value of $105,000. Assume a jet fuel cost of $0.80 per gallon and a cost of capital of 9.28% in your analysis. Items other than fuel are expected to escalate at a 3% rate. Conduct the analysis on a "per plane" basis.

Depreciation Details Normal MARCS Normal Table Year 1 Total Year Table Times 50% (additional 50%) (modified table) 14.29% 7.15% 50.00 % 57.15% 24.49% 12.25% 12.25% 17.49% 8.75% 8.75% 12.49% 6.25% 6.25% CO N O UA W N H 8.93% 4.47% 447% 8.92% 4.46% 4.46% 8.93% 4.47% 4.47% 4.46% 2.23% 2.23%