Fleet Replacement Analysis

  1. Obtain and interpret operational cost data for commercial aircraft.
  2. Use data to estimate future operating costs for new and older airline 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 prepare a memorandum with your analysis and recommendations to Mr., 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 carefully before beginning work. Ensure that your submission includes all required elements.

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 that the B-787-9 is the best financial choice for WestJet. It may or may not.

Your team has developed a template which is provided as an attachment for conducting your net present cost analysis:
Excel Template (XLSX)
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 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 2 Performance Data and Costs (DOCX)
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 the Aerospace/Aviation Research Databases (Hunt Library) (Links to an external site.). When you’ve accessed The Airline Monitor, select Online Edition and follow this path: Document Archives/2019 Publications/ Block Hour Operating Costs for the year 2019 (August).
Note: The Airline Monitor has released a publication annually for many years, but it discontinued the database in 2020. It may be a casualty of the pandemic-recession which devastated the airline industry.
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.
  3. WestJet’s European routes are relatively long, so its B-787-9 operation will be very efficient. Of the airlines included in the Airline Monitor database that operate the B-787-9, WestJet projects it will match the lowest fuel consumption (gallons per block hour) and highest speed (miles per block hour).
  4. Because of the 787 increased range and reliability, WestJet expects its annual utilization (block hours per year) will be 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.
  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 259 seats. Because of the 787-9’s 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 and oil prices 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 are volatile tending to increase during periods of economic expansion and plummet during recessions. There is no single best method for estimating future jet 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, explain your methodology for estimating future prices so that he and his finance staff can duplicate your results.
    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 a 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 rates you choose; explain your rationale to Mr. Taylor.
    Enter data into the Excel Template (XLSX). 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.
    Prepare 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.
    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 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.
    The assignment is not in APA style. It’s a report for Mr. Taylor in business memorandum format. See OWL(University) (Links to an external site.) or another online source for guidance on writing business memoranda and memo format.
    Finally, remember that you are writing to Mr. Taylor. You may assume that he understands aircraft operating costs and financial analysis including net present value, but do not assume that he is intimately aware of all the assumptions underlying the analysis or how the comparison between the aircraft was developed (the methodology). Although he has not been directly involved in your analysis, he will need to explain the details to his senior management team. IFC International is a consultant hired to provide a carefully researched recommendation. Include sufficient detail in the memorandum and appendices so that he will not have to ask for additional information.
    The assignment should be in a business memorandum format, not in APA style. The memorandum should be approximately two pages not including appendices for the Excel spreadsheets and other information Mr. Taylor will need.
    Review the Written Assignment Standards for this and all written assignments (excluding the APA requirements).
    Save your assignment using a naming convention that includes your first and last name and the activity number (or description). Do not add punctuation or special characters
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