As low-fare airline, Southwest Airlines constantly focuses on ways to improve the efficiency of its operations and
Question:
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 expected to experience downtime for only 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 repair costs would average $ 2,100 yearly per aircraft due primarily to incidental damage.
The increased wingspan was expected to allow each of Southwests aircraft to fly up to 115 nautical miles further 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 Operations22 estimated that the additional lift capability provided by the winglets would reduce Southwests 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 fifty-nine airports Southwest utilized in its current route structure. The department estimated that the necessary facilities modifications could be achieved at a onetime cost of about $ 1,200 per aircraft.
The blended winglet project qualified 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 Exhibit P3-13.1 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 twenty 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.
Evaluate the project by analyzing the following:
a. Estimate the projects annual project free cash flow (FCF) for each of the next twenty years, as well as the initial cash outflow.
b. Calculate the NPV and IRR of the blended winglet project.
c. What is the breakeven jet fuel cost for the project? What is the breakeven fuel savings in gallons for the project, assuming jet fuel costs $ 0.80 per gallon?
d. How sensitive is the blended winglet projects NPV to changing assumptions regarding expected future fuel costs and fuel savings? Use scenario analysis to analyze a best-case scenario (jet fuel price of $ 1.10 per gallon and fuel savings of 214,000 gallons per year) and a worst-case scenario (jet fuel price of $ 0.50 per gallon and fuel savings of 142,000 gallons per year).
e. What potential risks and benefits do you see that are not incorporated into the quantitative analysis?
f. What is the impact on the projects NPV or IRR if the winglets have no salvage value?
g. Would you suggest Southwest Airlines undertake this project? Explain your answer.
Salvage value is the estimated book value of an asset after depreciation is complete, based on what a company expects to receive in exchange for the asset at the end of its useful life. As such, an asset’s estimated salvage value is an important... Cost Of Capital
Cost of capital refers to the opportunity cost of making a specific investment . Cost of capital (COC) is the rate of return that a firm must earn on its project investments to maintain its market value and attract funds. COC is the required rate of... Free Cash Flow
Free cash flow (FCF) represents the cash a company generates after accounting for cash outflows to support operations and maintain its capital assets. Unlike earnings or net income, free cash flow is a measure of profitability that excludes the...
Step by Step Answer:
Valuation The Art and Science of Corporate Investment Decisions
ISBN: 978-0133479522
3rd edition
Authors: Sheridan Titman, John D. Martin