Fly by Night

CASE 2: FLY-BY-NIGHT AIRLINES:

Executive Summary

The author is charged with the responsibility of evaluating the beskt possible option Fly-by-Night airline company can do to upgrade their aircrafts that operates the most competitive busy route between Los Angeles and New York. The airline company has five PJ-1 planes that operate this route and the competition is very high on this route. The current fleet of aircraft are still reliable but the organization is considering not to be complacent with this old stock but to be ahead or on par with their competitors by evaluating purchasing new airplanes that are to be released soon.

The author will evaluate and do the analysis if the current PJ-1 planes which still have 15 years of life can be replaced by the PJ-2 at the end of three years (Option A) from now or replace PJ-1 with PJ-2 at the end of three years and further replace PJ-2 by PJ-3 at the end of the sixth year (option B). The last option is to evaluate if it is better to operate PJ-1 until PJ-3 is launched at the end of year six and then only replace PJ-1 (Option C). The analysis will be evaluated by computing the Net Present Value (NPV) and the Internal Rate of Return (IRR) for these three options.

From the analysis, both option A and Option B show negative NPV and very low IRR value. Both options A and B show that the organization will be making a loss by replacing their airplanes before they can recover their capital investment. There is a huge investment that will be initially invested on these aircraft and they are required to be replaced before their cost is recovered. Option C indicates a positive NPV value and IRR=11.5%. Option see allows the first airplanes (PJ-1) to continue to operate for the next six years and then only replace it with the new PJ-3. This analysis indicates that the company can continue with their old planes because they still have positive life to continue operating and only change with the most advanced PJ-3 planes. The PJ-3 are much better in size, they can carry more passengers. They are more environmental friendly, (i.e.) they are low in noise and air pollution and the fuel consumption is much lower than PJ-1 and PJ-2.The author therefore recommends that Fly-by-Night Airline Company should choose option C, and further recommends that they choose leasing their new planes than buying them. There are more advantages in leasing aeroplanes than in buying them. There are cost saving in maintenance and even when choosing to upgrade the planes, the owner carry the cost.

Problem Statement

Fly-by-Night Airlines is a major commercial air carrier offering passenger service between most large cities in the United States. One of the most profitable routes is between Los Angeles and New York and the competition is very intense on this route. This means the quality of services and the quality of your aircrafts on this route must be very competitive in order to survive the competition. Fly-by Night Airlines are also intending to keep up with the competition on this route by constantly upgrading the quality of their fleet of aircraft used on the Los Angeles-New York route.

Fly-by-night have been purchasing their airplanes from Puddle Jumper Aircraft Company in the past. They are marketing three airlines (i.e.) (1) the old reliable PJ-1, (2). PJ-2 soon to be introduced currently in the flight stage and (3) PJ-3, still in the design stage. Although PJ-2 and PJ-3 are not available immediately, Fly-by-night must put orders now in order to have deliveries earlier when they are released. PJ-2 and PJ-3 are the preferred planes compared to PJ-1 because they are more fuel efficient and less air and noise polluting, they are also costing less on maintenance.

Fly-by-Night currently has five PJ-1 planes which they bought ten years ago from Puddle Jumper Aircraft Company at a cost of $15 million each to service Los Angeles and New York route. Each plane is depreciating on straight-line bases to a salvage value of zero over 25 year's economic life from the date of purchase. Red Baron, transcontinental operations supervisor is considering replacing PJ-1 with either PJ-2 or PJ-3. PJ-2 will be available for delivery in three years and PJ-1's value will have dropped to $5million and $3million by the end of sixth year. PJ-3 will only be available for delivery in six years.

If Fly-by-Night replaces PJ-1 by PJ-2 in the third year from now when it is ready for delivery, it could start to generate its cash flow from commercial service in the forth year. The PJ-3 will only be able to generate its first cash flow in the seventh year. Baron wants to find out the net present values, Internal Rate of Returns and Profitability Index of the different investment options available for him.

Critical/Key Issues:

The key issue for Fly-by-Night is to stay in the business and make money. For them to stay in the business is to win in this competitive Los Angeles-New York commercial air passenger route. Since their business is passenger air lines, the competition is very tight. There is price competition, quality of services to customer and the comfort and safety of aircrafts to customers. Fly-by-Night should keep up with the competition in this competitive route if they want to continue being profitable.

The next most critical issue for the air line industry is the air emission reduction that is internationally pressured on the industry. The new PJ-2 and PJ-3 planes are set to be much compliant to international regulations on air pollution reduction and further more they are very economic on fuel consumption. The new planes are set to have reduced both the air and noise pollution.

The technological advancement on each new aircraft model that Puddle Jumper Aircraft company produce seems to be more technologically advanced to the company. See the table below:

|Aircraft Specification |PJ-1 |PJ-2 |PJ-3 |

|1. Fuel consumption (gallons/flight between L.A and N.Y.) |4000 |3000 |2000 |

|2. Maintenance time (maintenance days/year) |40 |30 |20 |

|3. Upgrading costs (dollars/year of operation) |100 000 |50 000 |16 666.67 |

|4. Capacity per plane 200 250 350 |

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