Ondi Airlines is interested in acquiring a new aircraft to service a new route. The route will be from Tulsa to Denver. The aircraft will fly one round-trip daily except for s

Problem 14-39

Ondi Airlines is interested in acquiring a new aircraft to service a new route. The route will be from Tulsa to Denver. The aircraft will fly one round-trip daily except for scheduled maintenance days. There are 15 maintenance days scheduled each year. The seating capacity of the aircraft is 150. Flights are expected to be fully booked. The average revenue per flight (one way) is $235. Annual operating cost of the aircraft follow:

Fuel -- $1, 750,000

Flight personnel -- $750,000

Food and beverages -- $100,000

Maintenance -- $550,000

Other -- $100,000

            Total $3,250,000

The aircraft will cost $120,000,000 and has an expected life of 20 years. The company requires a 12% return. Assume there are no income taxes.

Required:

1. Calculate the NPV for the aircraft. Should the company buy it?

2. In discussing the proposal, the marketing manager for the airline believes that the assumption of 100 percent booking is unrealistic. He believes that the booking rate will be somewhere between 70 & 90 percent, with the most likely rate being 80 percent. Recalculate the NPV using an 80 percent seating capacity. Should the aircraft be purchased?

3. Calculate the average seating rate that would be needed so that NPV will equal 0.

4. Suppose that the price per passenger could be increased by 10 percent without any effect on demand. What is the average seating rate now needed to achieve a NPV equal to zero? What would you now recommend?