This assignment has three objectives:

1. Obtain and interpret operational cost data for commercial aircraft.
2. Use data to estimate future operating costs fornewandolderairline aircraft.
3. Learn how net present value analysis is used in capital acquisition decision-making.

WestJet, Canada's 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 memorandum with your analysis and recommendations to Mr. Harry Taylor, WestJet's Chief Financial Officer.

This assignment has detailed requirements similar to those that would be given to a financial analyst.Read the requirements very carefullybefore beginning work. Ensure that your submission includes all required elements.

Assignment details/requirements are provided in the following sections: Background, The Analysis, Task, Notes, and Format.

Background

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.Do not assume, however, that your analysis will necessarily conclude thatthe B-787-9 is the best financial choice for WestJet. It may or may not.

The Analysis

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

Excel Template (XLSX)download

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 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 its performance and cost data for the current B-767 fleet. This data is available in the document below, along with other airlines operating the B-767-300ER.

Written Assignment 2Performance Data and Costs (DOCX)download

The Airline Monitor publishes extensive aircraft operating data including data for the B-787-9 you will need for your analysis. The Airline Monitor is available through theAerospace/Aviation Research Databases (Hunt Library)(Links to an external site.)

. When you've accessed The Airline Monitor, select Online Edition and then find Block Hour Operating Costs for the year (most current year).

IFC staff have surveyed WestJet's 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.
4. WestJet'sEuropean routesare relatively long,so itsB-787-9 operation will be very efficient. Of the airlinesincluded in the Airline Monitor database that operatethe B-787-9, WestJet projects itwill match the lowest fuel consumption (gallons per block hour) and highest speed(miles per block hour).
6. Because of the 787 increased range and reliability, WestJet expects its annual utilization (block hours per year) willbe the highest of any airline in the Airline Monitor database.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.
7. 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.
8. WestJet has a small business class in its 767s, but most of the cabin is configured in high-densitycoach class for a total of259seats. Because of the 787-9's larger size, WestJet plans a three-class cabin configuration total of 298 seats.
9. 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 fueland oilprices are available from several sources. The Airline Monitor includes this data in the Block Hour Operating Cost document. Data is also available from the industry association, Airlines for America. Select Economics & Analysis and 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.

Fuel prices arevolatile tending to increase during periods of economic expansion and plummet during recessions.There is no single best method for estimating futurejet fuel prices, but you will need to develop a logical methodology for your 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, explainyour methodology forestimatingfuture pricesso that he and his finance staffcanduplicateyourresults.

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 ofa10% 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 ratesyou choose; explain your rationale to Mr. Taylor.

Task

Enter data into theExcel Template (XLSX).

download

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.

a memorandum of not more than two pages (not including appendices of which there may be several) to Mr. Taylor summarizing your analysis and making a recommendation. Remember that Mr. Taylor and his staff will need to understand how the analysis was conducted. Explain your assumptions and methodology concisely. There are many ways to compare two aircraft types, so explain to Mr. Taylor how your comparison was developed.

The memorandum should be submitted in Microsoft Word. Insert (copy and paste) and reference Excel worksheets as appendices to support your fleet replacement recommendation. (Not incidentally, if spreadsheets are not included, it isn't possible to verify that the data were correctly extracted from the Airline Monitor). Use other tables and graphs as appropriate to support your recommendation.

Notes

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 the reported CASM for US airlines because many costs that do not affect the choice of aircraft typ 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.

The assignment should be in a business memorandum format, . The memorandum should be approximately two pages not including appendices for the Excel spreadsheets and other information

Instructions 1. Enter the discount rate (i) in cell C18 (enter as a decimal, e.g., 0.10). The yearly discount factor equal to 1/(1+i)^year is automatically computed and entered in column B. 2. Enter the fuel gallons burned per block hour in cells 118 and 018. 3. Enter the Block Hours per year (number of hours the representative aircraft type is flown in a year) for each aircraft type in 119 and 019. 4. Enter the total maintenance cost per block hour in 120 and 020. 5. Enter the seating capacity (number of seats per aircraft) in 121 and 021. 6. Enter the Speed in Miles per Block Hour in 122 and 022. 7. Enter the Purchase Price (including all cost needed to place the aircraft in service) in 123 and 023 8. Enter the Sale or Salvage Price in year 16 in 124 and 024. 9. Enter the estimated fuel price for each year in the column C31 through C45. The spreadsheet will automatically compute: 1) The Discount Factor for years 1 through 16, 2) The total fuel cost for years 1 through 15, 3) total maintenance cost for year one, 4) total operating costs for each year, 5) total net present cost per year, 6) total available seat miles (ASM) for the 15 years, 7) net present cost per seat mile over the 15 year operating plan. The maintenance costs for years 2 through 15 must be computed and entered Note: In this spreadsheet cash outflows are positive and inflows are negative. The spreadsheet converts the sales price to a negative. Parameters B-767-300 Operating Costs & Statistics B-787-9 Operating Costs & Statistics Discount Rate = Gallons/Block Hour = Gallons/Block Hour = Block Hours/year = Block Hours/year = Maintenance Cost/Block Hour = Maintenance Cost/Block Hour = Number of Seats = Number of Seats = Block hour Speed = Block Hour Speed = Purchase Price = Purchase Price = Sale Price in year 16 = Sale Price in year 16 = B-767 capital and direct operating cost B-787 capital and direct operating cost Year Discount Fuel S/gal Purchase Fuel Maint Total Annual NPV Purchase Fuel Maint Total Annual NPV Factor Price Cost Costs Operating Price Cost Costs Operating 0 1.000 0 0 1 1.000 0 0 0 0 0 0 1.000 0 0 0 0 0 1.000 0 0 0 0 5 1000 0 0 0 on 1.000 O 0 O 0 7 1.000 o 0 0. 0 1.000 o 9 1.OOO 10 1 000 O 11 1.000 12 1.000 0 13 1.000 o o o O 14 1.000 15 1.000 16 1.000 Net Present Value Cost = O Net Present Value Cost = B-767 NP CASM #DIV/O! B-787 NP CASM #DIV/01Operating Cost per Block Hour ($) $1,142.12 Flight Crew Cost $1,567.54 $1,609 94 $1,593.93 $1,568.25 Fuel Cost 2,587.78 2,489.48 2,596.15 2 666.81 2,449.43 Other Costs 34.30 80.22 5.76 30.05 181.71 Total Flying Cost 189.61 $4,179.64 $4,195.84 4 265.11 $3,773.26 Direct Maint. - Airframe 486.13 559.24 306.75 711.32 891.77 Direct Maint. - Engines 238.44 373.59 324.62 3.12 85.03 Total Direct Maintenance 724.57 932.84 631 37 714.44 976.80 Maintenance Burden 304.13 469.83 231.31 286.02 543.00 Total Maintenance Costs $1,028.70 1,402.67 $862.68 $1 000.46 $1,519.81 Deprecation 6.10.26 486.02 616.39 747.79 286.90 Aircraft Rent 213.48 483.65 103.63 80.04 1047.56 Total Cost per Block Hour $6,042.06 $6,551.98 $5 778.53 $6 093.40 $6,627.52 Ratios and Operating Indicators Cost per Available Seat Mile - 6.120 7.074 5.73g 6.390 5.660 Fuel Cost per ASM - 2.620 2.680 2.57 2.80 2.090 Total Cost per ASM ex. Fuel - 3.50# 4.380 3.150 3.59 3.57 Utilization - Block Hours per Day 11.07 9.17 12.40 10.79 9.17 Speed - Miles per Block Hour 463 449 466 452 Seats per Aircraft 213.2 206.4 216.5 202.6 259.0 Gallons of Fuel per Block Hour 1 560 1 522 567 1,588 1 490 Gallons per Block hour/per Seat 7.32 7.38 7.24 7.84 5.75 Fuel Cost per Gallon - $ $1.66 $1.64 $1.66 $1.68 $1.64 Average Flight Stage - miles 3 277 2,609 3 563 3,582 2 364 The Airline Monitor August 2018MBAA 523 Written Assignment 2 Aircraft Performance Data and Operating Costs The Airline Monitor Commercial Alrcraft Data Base Aircraft Types: 767-300ER/767-400 Year 2017 U.S. Block Hour Operating Costs by Alrcraft 767-300ER System Operations Total Delta American United WestJet All Services 767-300ER (6 300s) Operating Data Revenue Pass. Miles (mil.) 43,036.2 7,195.9 23,138.3 9,999.9 2,702.2 Available Seat Miles (mil.) 52,769.6 8,943.5 27 541.1 13,152.6 3,132.5 Load Factor 81.6% 80.5% 84.0% 76.0% 86.3% Revenue Miles (0000 247 516 43 332 127,181 64.906 12 096 Revenue Hours 494 445 87 829 253 ,616 128,203 24,797 Block Hours 534,111 96 445 272 978 137,913 26,775 Aircraft Days 48 232 10 521 22 014 12,777 2 920 Revenue Departures 75 540 16,608 35 ,695 18,120 5,117 Gallons of Fuel (000) 833,413 146 837 427 ,694 218,992 39 889 Number of Aircraft 132.1 28.8 60.3 35.0 Year End Pass. Fleet & % measured 160 82.6% Financial Data 1000 Flight Crew Expense $837 239 $155 270 $435,107 $216,282 $30 580 Fuel Expense 1,382,162 240 098 708 ,693 367 ,788 65 584 Total Flying Expense 2,237 ,719 403 , 105 1,145 371 588,214 101 029 Direct Maint. - Airframe 259 ,649 53 936 83 735 98, 100 23 877 Direct Maint. - Engines 127 ,353 36 031 88 615 430 2 277 Total Direct Maintenance 387 001 89 967 172 350 98,530 26,154 Maintenance Burden 162 440 45 313 63,142 39 ,446 14 539 Depreciation 325 947 46 874 168 260 103,131 7 682 Aircraft Rent 114022 46 646 28, 289 11 038 28 049 Total Operating Exp. $3,227,129 $631 ,906 $1 577 412 $840,359 $177 452