Purchasing Economically Best Airplane

Purchasing Economically Best Airplane

Submitted to: Submitted by: Prof. Zhou Peng Binod Thapa 190861138 (陈小兵)

Rabin Shrestha 190861157 (张云海)

In partial fulfillment of the requirement for the completion Of engineering economics

Nanjing University of Aeronautics and AstronauticsNanjing, Jiang Su, China

2011/04/28

Engineering Economics Project Report

Declaration

We hereby declare that the project entitled “Purchasing Economically Best Airplane” submitted for the course completion of Engineering Mechanics is our original work and the project has not formed the basis for the award of any degree, associateship, fellowship or any other similar titles.

Signature of the students:Place: Nanjing University of Aeronautics and Astronautics, Nanjing, Jiangsu, China.Date: 2011/04/28

Acknowledgement

We would like to thank Prof. Zhou Peng for providing with the knowledge of engineering economics and giving us the opportunity to use the learned knowledge to apply for a real world problem, the aircraft manufacturing companies Boeing, Airbus, and ATR for providing the economical and engineering data required for the project. We would also like to thank Nepal Airlines Corporation for the information of the requirements and other facts.

Without the help of our friends Narayan poudel, Subas Regmi, Pun Krishna Kawai, Shree Krishna Kawai the problems arise during the course of completion of the project would not have been easy to solve so we would like to thank all of them for the help and the support they provided us.

This course has been very helpful to understand the economy of different fields, today’s financial condition of the aviation and to understand the use of Engineering Economics in daily life so we would like to thank NUAA for putting this subject in our course.

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Abstract

We provide the economical analysis of different options available to the Nepal Airlines who is looking to purchase airplanes. We use different analysis method based on the concept of Engineering Economics to analyze the three purchasing options provided by the airlines. Those three were chosen by the airlines based on the requirement, availability of the funds and other factors. A B777-200LR, A330-200 and ATR-72 are the three kinds of airplanes they are trying to buy from. Two of them are jumbo jets which can be used for the international flights and one is a small sized plane which is most suited for the domestic flights.

In this report we economically analyze these three kinds of airplanes and provide proper economical view of whatever benefits or loss they can expect. The airlines has specified the analysis period as 5 years and the fund available is around $200 million and they can also take loan from the bank if needed. In this report we provide all the analysis for 5 years.

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Table of ContentsTITLE PAGE……………………………………………………………………DECLERATION…………………………………………………………........... iiACKNOWLEDGEMENT…………………………………………………….… iiABSTRACT…………………………………………………………………….. iiiLIST OF TABLES…………………………………………………………….…vLIST OF FIGURES………………………………………………………............v

1. INTRODUCTION………………………………………………………..….12. KEYWORDS………………………………………………………………...23. OBJECTIVES…………………………..........................................................3

3.1 PROJECT OBJECTIVES………………………………………….......33.2 ACADEMIC OBJECTIVES…………………………………………..3

4. PROJECT OVERVIEW……………………………………………………..35. PROJECT ANALYSIS………………….......................................................6 5.1 PRESENT WORTH ANALYSIS…………………………………......6 5.2 PAY-BACK PERIOD ANALYSIS…………………………………..10 5.3 IRR ANALYSIS USING PRESENT WORTH PROFILE…………...11

6. RESULTS AND DISCUSSIONS…………………………………………...157. CONCLUSION AND RECOMMENDATION……………………………..15

APPENDIX………………………………………………………………...…....16REFERENCES………………………………………………………………......18

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List of TablesTABLE 1: AIRCRAFT INVESTMENT APPRAISAL CASH FLOW FORECASTS (US$ MILLIONS) FOR B777-200LR……………….4TABLE 2: AIRCRAFT INVESTMENT APPRAISAL CASH FLOW FORECASTS (US$ MILLIONS) FOR A330-200…………………..4TABLE 3: AIRCRAFT INVESTMENT APPRAISAL CASH FLOW FORECASTS (US$ MILLIONS) FOR ATR-72…………………….5TABLE 4: PRESENT WORTH (US$ MILLIONS) ANALYSIS FOR B777-200LR………………………………………………………….6TABLE 5: PRESENT WORTH (US$ MILLIONS) ANALYSIS FOR A330-200……………………………………………………………..8TABLE 6: PRESENT WORTH (US$ MILLIONS) ANALYSIS FOR ATR-72……………………………………………………………….9TABLE 7: PAY-BACK PERIOD ANALYSIS FOR B777-200LR (US $ MILLIONS)………………………………………………………..10TABLE 8: PAY-BACK PERIOD ANALYSIS FOR A330-200(US$ MILLIONS)…………………………………………………………..10TABLE 9: PAY-BACK PERIOD ANALYSIS FOR ATR-72 (US$ MILLIONS)…………………………………………………………..10TABLE 10: NPV (US$ MILLIONS) FOR DIFFERENT MARR FOR DIFFERENT AIRCRAFTS…………………………………………..11TABLE 11: CASH FLOWS (US$ MILLIONS) FOR B777-200LR, A330- 200, AND ATR-72……………………………………………………13

List of figuresFIGURE 1: PIE CHART OF THE CASH FLOWS OF B777-200LR………………4FIGURE 2: PIE CHART OF THE CASH FLOWS OF A330-200………………….5FIGURE 3: PIE CHART OF THE CASH FLOWS OF ATR-72……………………5FIGURE 4: NET CASH FLOW (US$ MILLIONS) DIAGRAM FOR B777-200LR……………………………………………………………7FIGURE 5: NET CASH FLOW (US$ MILLIONS) DIAGRAM FOR A330-200……………………………………………………………….8FIGURE 6: NET CASH FLOW (US$ MILLIONS) DIAGRAM FOR ATR-72…………………………………………………………………9FIGURE 7: PRESENT-WORTH PROFILE FOR B777-200LR…………………....11FIGURE 8: PRESENT-WORTH PROFILE FOR A330-200…………………….....12FIGURE 9: PRESENT-WORTH PROFILE FOR ATR-72……………………...….12

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1. Introduction

The world is getting advanced day by day. In the past it was like impossible for people to go from one country to another in limited time. But these days the world is so small to go around because of the aviation. On the other hand the time is money, nowadays people travel long distances for many different reasons and they want to save the time also, hence the importance of aviation is increasing day by day. Many airlines are competing to provide better and faster air service and get more profit. More and more advanced aircraft have been invented as is the nature of human beings to get better service but on the other hand they want better service in considerable fare. So it’s difficult for airlines to take a decision in choosing aircraft and earn reasonable profit. As the values of the aircrafts are higher than that of ground vehicles and it is high risk and high profit market.

Nepal Airlines (formally known as Royal Nepal Airlines) is the national flag-carrier airline of Nepal. Its main base is Tribhuvan International Airport, Kathmandu. The airline is established in July 1958 as Royal Nepal Airline Corporation (RNAC). Presently the airline operates the fleet of 25 aircrafts and flies to more than 50 destinations 12 of which are international. Now it is planning on increasing the number of aircrafts. Considering different facts NAC is planning to buy one of B777-200LR, A330-200 or 10 of ATR-72 as the ATR is small domestic aircraft and it cost considerably lower than the former two aircrafts. The board has asked us to provide with the decision by analyzing these three projects for 5 years. In this project we analyze these three projects using engineering economics and decide which of these generates maximum profit within the time we estimated.

B777-200LR A330-200

ATR-72

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2. Keywords

a) Revenue projects are those for which the income generated depends on the choice of the project.b) Operating costs are costs that are incurred by the operation of physical plants of equipment

needed to provide service: can recur over the project’s life. E.g. cost of labor and raw materials.

c) Capital recovery costs are costs that are incurred by purchasing assets to be used in production and service. That is one-time cost.

d) Rate of Return is a relative percentage method which measures the yield as percentage of investment over the life of a project.

The interest rate earned on the unpaid balance of an installment/amortized loan.

The break-even interest rate, i*, at which the present worth of a project is zero.

The interest rate earned on the unrecovered project balance of an investment project such that, when the project terminates, the unrecovered project balance is zero.

e) Simple investment is an investment in which the initial cash flows are negative and only one sign change occurs in the net cash flow series.

f) MARR (Minimum Attractive Rate of Return) is the rate of return if the money is not invested in the project. It is a function of these three components:

Risk-free real return, Inflation factor, and Risk premium

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3. Objectives3.1 Project objectives Analyze the projects using the concept of engineering economics and provide the board with the best option. 3.2 Academic objectives To be able to use the concept learned in the engineering economics to solve the real world

problems.

4. Project Overview

There are three kinds of aircrafts in option to buy.1. B777-200LR2. A330-2003. ATR-72

The Boeing 777-200LR is a long range, wide body twin engine jet airliner manufactured by

Boeing Commercial Airplanes. It is the world’s largest twinjet and is commonly referred to as the “Triple Seven”

Cost: $262.4 millionSeats: 350Cargo: 75 tons Range: around 15000 km

The Airbus A330-200 is a large-capacity, wide-body, twin-engine, medium-to long-rang commercial passenger jet airliner. The aircraft was the first Airbus airliner to offer a choice of three engine types.

Cost: $200.8 millionSeats: 350Cargo: 70 tonsRange: around 12000 km

The ATR-72 is a twin-engine turboprop short-haul regional airliner built by the French- Italian aircraft manufacturer ATR. ATR and Airbus are both built in Toulouse, and share resources and technology.

Cost: $20 millionSeats: 78Cargo: 17 tonsRange: 1324 km

The following cash flows are estimated based on the data provided by the respective manufacturer, density of the passengers in the past, fuel consumed in the test flights, maintenance cost of the past planes, engine capacity, other costs and revenues of the past aircrafts. There is a difference in payload or cargo capacity, number of seats, range; these will be reflected in the revenue forecasts. Cost differences will also be reflected in the cost projections. A higher residual value (55 per cent of cost) has been assumed for the B777-200LR in the base case, compared to 50 per cent for the A330-200 and 60 percent for the ATR-72 based on the quality, service, and prestige of the respective manufacturer.

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Table 1: Aircraft investment appraisal cash flow forecasts (US$ millions) for B777-200LR

B777-200LR 2011 2012 2013 2014 2015 2016

Capital Cost (incl. spares) -262.4

Residual Value 144.32

Cash Operating Revenues 70 74 80 87 95

Cash Operating Cost 12.2 12.5 13 13.3 13.6

Cash Loaned from the bank 62.4 - - - - -

Fig 1: Pie chart of the cash flows of B777-200LR

2015, 9%

2014, 8%2013, 7%

2012, 6%

2011, 39%

2016, 31%

Table 2: Aircraft investment appraisal cash flow forecasts (US$ millions) for A330-200

A330-200 2011 2012 2013 2014 2015 2016




Cash Operating Cost 12.2 12.4 12.7 12.8 13.2

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Fig 2: Pie chart of the cash flows of A330-200

2011, 38%

2012, 7%

2013, 8%2014, 8%

2015, 9%

2016, 30%

Table 3: Aircraft investment appraisal cash flow forecasts (US$ millions) for ATR-72

ATR-72 2011 2012 2013 2014 2015 2016

Capital Cost (incl. spares) -20

Residual Value 12

Cash Operating Revenues 4.7 5 5.4 5.5 5.9


Fig 3: Pie chart of the cash flows of ATR-72

2011, 38%

2012, 7%

2013, 7%2014, 8%

2015, 8%

2016, 32%

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5. Project Analysis

The analysis of the project was done in three different ways by the use of a Cash Flower Analyzer. We have given the value of MARR as 7% by the airline.

5.1 Present worth analysis Present worth is an equivalence method of analysis in which a project’s cash flows are discounted to a lump sum amount at present time.In our present-worth analysis we will assume that prices/costs remain constant over time. In other words, we will ignore the effects of inflation and deflation unless stated otherwise.

In the evaluation, we based our selection to investment on the following criterion. PW>=0, it means the investment would add value to the firm so, accept the investment;

PW<0, it means the investment would subtract value from the firm therefore reject the investment.The following formula has been used to calculate present worth: PV = F (P/F, i, N) Where i = MARR NPV = PV1 + PV2 + PV3 + PV4 + PV5 + PV6

For B777-200LRFor the loan taken from the bank: Present worth = $62.4 million Interest rate ( r ) = 9% compounded monthly So, Effective annual interest rate (ia) = (1 + r / M )M – 1 = 9.38% Where, M is interest periods per year Annual equivalent payment (A) = P (A/P, ia, N) = P (ia (1+ ia)N) / ((1+ ia)N-1) = $16.2 million

B777-200LR 2011 2012 2013 2014 2015 2016




Cash Operating Cost 12.2 12.5 13 13.3 13.6

Cash Operating Result 57.8 61.5 67 73.7 81.4

Cash Paid to the Bank 16.2 16.2 16.2 16.2 16.2

Net Cash Flow 41.6 45.3 50.8 57.5 209.52

Interest Rate 7%

NPV @ 7% 50.76

Table 4: Present worth (US$ millions) analysis for B777-200LR

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Fig 4: Net Cash flow (US$ millions) diagram for B777-200LR

70

16.2

12.2 12.5 13 13.3 13.6

74 80

0 1 2 3 4 5

12

8795

144.32

262.4


For A330-200

A330-200 2011 2012 2013 2014 2015 2016





Cash Operating Result 37.8 39.6 42.3 47.2 53.8

Net Cash Flow 37.8 39.6 42.3 47.2 154.2

Interest Rate 7%

NPV @ 7% 49.60

Table 5: Present worth (US$ millions) analysis for A330-200

Fig 5: Net cash flow (US$ millions) diagram for A330-200

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0 1 2 3 4 5

12.2 12.4 12.7 12.8 13.2

100.4

50 52

55 60

67

200.8


For ATR-72

ATR-72 2011 2012 2013 2014 2015 2016

Capital Cost (incl. spares) -20

Residual Value 12

Cash Operating Revenues 4.7 5 5.4 5.5 5.9


Cash Operating Result 3.6 3.8 4.1 4.2 4.5

Net Cash Flow 3.6 3.8 4.1 4.2 16.5

Interest Rate 7%

NPV @ 7% 5

NPV For 10 ATR-72 50

Table 6: Present worth (US$ millions) analysis for ATR-72

Fig 6: Net cash flow (US$ millions) diagram for ATR-72

5.2 Pay- back Period Analysis

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20

0 1 2 3 4 5

1.1 1.2 1.3

1.3 1.4

4.7 5

5.4 5.5

12

5.9


In this analysis method we calculate the payback period of each project that means we calculate the time at which the project pays for itself and starts to generate net profit. We calculate the payback period using a table for each project.

For B777-200LR

Period 2011 2012 2013 2014 2015 2016Cash Flow -262.4 41.6 45.3 50.8 57.5 209.52Cost of Funds (7%) 0 -18.37 -16.74 -14.74 -12.22 -9.05Cumulative Cash Flow -262.4 -239.17 -210.60 -174.55 -129.27 71.20

Table 7: Pay-back period analysis for B777-200 (US$ millions)

So, the payback period for this aircraft is 4.64 years.

For A330-200

Period 2011 2012 2013 2014 2015 2016Cash Flow -200.8 37.8 39.6 42.3 47.2 154.2Cost of Funds (7%) 0 -14.06 -12.39 -10.50 -8.26 -5.54Cumulative Cash Flow -200.8 -177.06 -149.85 -118.04 -79.10 69.56

Table 8: Pay-back period analysis for A330-200 (US$ millions)


For ATR-72

Period 2011 2012 2013 2014 2015 2016Cash Flow -20 3.6 3.8 4.1 4.2 16.5Cost of Funds (7%) 0 -1.4 -1.24 -1.07 -0.85 -0.62Cumulative Cash Flow -20 -17.8 -15.24 -12.21 -8.87 7.01

Table 9: Pay-back period analysis for ATR-72 (US$ millions)


5.3 IRR Analysis using Present Worth Profile

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Return on invested capital is defined as the interest rate earned on the unrecovered project balance of an investment project. It is commonly known as internal rate of return (IRR). Rate of return is also the break-even interest rate i* at which the present worth of a project is zero. In this analysis process we calculate different values of net present worth for different MARR and plot them into a graph. We have used Microsoft Excel to calculate the values of the net present worth for different MARR and put them into tables.

Table 10: NPV (US$ millions) for Different MARR for different aircraftsFor B777-200LR For A330-200 For ATR-72

Fig 7: Present-worth profile for B777-200LR

-200

-150

-100

-50

0

50

100

150

200

0 10 20 30 40 50

i = MARR(%)

pw

(i)

($m

illi

on

s)

Series1

MARR NPV0 120.301 108.575 67.307 49.5910 26.0513.90 015 -6.5220 -32.5925 -53.6930 -70.9835 -85.2840 -97.2245 -107.2950 -115.84

MARR NPV0 142.321 127.115 73.667 50.7610 20.3911 11.2012 2.4412.29 013 -5.9215 -21.5320 -54.9525 -81.9130 -103.9135 -122.0440 -137.1445 -149.81

MARR NPV0 1221 110.045 68.007 49.9810 26.0713.85 015 -6.9520 -33.3225 -54.6130 -72.0135 -86.3740 -98.3445 -108.4050 -116.94

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Fig 8: Present-worth profile for A330-200

-150

-100

-50

0

50

100

150

0 10 20 30 40 50 60

i = MARR(%)

pw (i

) ($m

illio

ns)

Series1

Fig 9: Present-worth profile for ATR-72

-150

-100

-50

0

50

100

150

0 10 20 30 40 50 60

I = MARR(%)

pw (i

) ($m

illio

ns)

Series1

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From this analysis we have found that the internal rate of return (IRR) for each kind of aircraft as:

Aircraft IRRB777-200LR 12.29% A330-200 13.90%ATR-72 13.85%

All of them are greater than MARR which is 7% so all three projects are acceptable but in order to choose the best project we need to further analyze them using incremental-investment analysis because of the difference in the initial investment for each project.

These alternatives are mutually exclusive so their cash flows are as follows:

n B A ATR

0 -262.4 -200.8 200 1 41.6 37.8 36 2 45.3 39.6 38 3 50.8 42.3 41 4 57.5 47.2 42 5 209.52 154.2 165IRR 12.29% 13.90% 13.85%

Table 11: Cash flows (US$ millions) for B777-200LR, A330-200, and ATR-72In which B represents B777-200LR, A represents A330-200 and ATR represents ATR-72.

To choose the best project, first we compute the incremental cash flow (US$ millions) for B – A.

n B - A 0 -61.6 1 3.8 2 5.7 3 8.5 4 10.3 5 55.32

Then we compute the IRR on this increment of investment by solving

-61.6 + 3.8(P/F, i, 1) + 5.7(P/F, i, 2) + 8.5(P/F, i, 3) + 10.3(P/F, i, 4) + 55.32(P/F, i, 5)= 0

We obtain i*B-A = 7% = IRRB-A which is equal to MARR so according to this analysis we can choose any one of them. Now we compare one of them with the ATR as follows:

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n B - ATR 0 -62.4 1 5.6 2 7.3 3 9.8 4 15.8 5 44.52

Then we compute the IRR on this increment of investment similar to above IRR. So we get the value of IRRB-ATR = 7% which means according to this analysis any one of them can be chosen. This happened because the IRR values of all three aircrafts are nearly equal.

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6. Results and DiscussionsFrom the analysis done above we compared the results of each projects. According to present worth analysis we have following results:

Aircraft NPVB777-200LR: $50.76 millionA330-200 : $49.60 million ATR-72 (10): $50 million

So, B777-200LR is the best option because it has the highest net present worth.

According to the pay-back period analysis we have the following results: Aircraft Pay-back periodB777-200LR: 4.64 yearsA330-200 : 4.53 yearsATR-72 (10): 4.56 years

So, A330-200 is the best option because it takes shortest time to pay for its capital cost and starts to generate profit.

From the IRR analysis we have the following results:

Aircraft IRRB777-200LR 12.29% A330-200 13.90%ATR-72 (10) 13.85%After further analysis we found that according to this analysis any one of the three projects

can be chosen.

7. Conclusion and Recommendation

From above analysis we have found that even if one project is best based upon one analysis, another project can be best based on other analysis method so we must choose the project by its effectiveness found by analyzing in different ways.

In this case even though the payback period of B777-200LR is longer than that of A330-200 we recommend B777-200LR to buy because it generates more profit by the end of year 5. The fact that the difference in the payback period is very small is also considered in the decision making process.

So in this report we have provided different analysis methods to get the clear view of the future expectation of each project and recommended the economically best project for Nepal Airlines Corporation.

We conclude that using the concept of Engineering Economics we can analyze the financial aspects of any project and choose best option.

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Appendix

Interest Factors for Discrete Compounding

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Engineering Economics Project Report 22


REFERENCES

[1]. Fundamentals of Engineering Economics by Chan S. Park[2]. Airline Finance Third Edition by Peter S. Morrell[3]. www.boeing.com[4]. www.airbus.com[5]. www.atraircraft.com[6]. www.wikipedia.org[7]. www.nepalairlines.com.np[8]. Basics of Engineering Economy by Leland T. Blank, Anthony J. Tarquin

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http://www.nepalairlines.com.np/

http://www.wikipedia.org/

http://www.atraircraft.com/

http://www.airbus.com/

http://www.boeing.com/

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Purchasing Economically Best Airplane