Assignment:
In order to take advantage of market opportunities emerging in Europe and take market share from many flag carrier airlines, the Directors of Ryanair propose to expand their current fleet from 23 to 100. This expanded fleet would allow the airline to handle up to 40m passengers p/annum by 2010.
The expansion strategy is also attractive to Ryanair on safety grounds since it would also allow the airline to retire its existing (ailing) fleet of Boeing (737-200’s) on 31st Dec 2004, three years prior to the end of their useful lives, with the sale proceeds credited to Ryanair on 1st January 2005. Ryanair took stock of its existing fleet on 1st January 1988 for £22,150,000 p/aircraft, and in line with the norm in the aviation industry, depreciates all of its fleet using the straight-line method over 20 years.
Negotiations have come to a close with two major airline manufacturers; Boeing and Airbus. As an investment bank with a major holding in Ryanair stock, you have been presented with the following information prior to voting at the next annual general meting in favour of either proposal:
Option 1: Boeing
The first option is the purchase of 100 Boeing jets (Boeing 737-800’s), with maximum seat capacity of 189 costing £35,365,657 each. Under the terms of the deal, Boeing would deliver 40 aircrafts on 1st January 2005 and the remaining 60 on 1st January 2006.
Based on current growth of the airline, and the number of available seats at current load factors, revenues from such an expansion are expected to increase from £624,100,000 (today, 2003, Y0) as follows:
Year 0 (2003) £624,100,000
Year 1 £624,100,000
Year 2 £780,125,000
Year 3 £800,000,000
Year 4 £830,000,000
Year 5 £860,000,000
Year 6 £880,000,000
Year 7 (2010) £880,000,000
EXIM, the Export-Import Bank of the United States, is a US Government sponsored body whose primary objective is to assist US exports of capital goods. In order to safeguard the aviation industry, the US Government have convinced EXIM to guarantee any loan required by Ryanair for the purchase of UD-domiciled exports. EXIM’s normal fee for such an exposure is a one-off fee of 3% of the principal amount of the sums financed in respect of each aircraft, payable immediately upon delivery. To demonstrate its commitment to the aviation industry, the US Government has promised to pay EXIM 2% of the exposure fee on Ryanair’s behalf.
Largely owing to the EXIM guarantee, Ryanair has been approached by a US Bank, willing to finance the acquisition at a rate of 6.5% p/annum. This is a capital and interest loan, secured by a first priority mortgage on the relevant aircrafts in favour of EXIM.
Staff costs are £14,250,000 (Y0 & Y1), and estimated as £124,760,000 (Y2) and £61,900,000 (Y3 – Y10). Recruitment and training costs are £12,000,000 (Y0) and £25,000,000 (Y1), and estimated as £34,000,000 (Y2), £32,500,000 (Y3), falling to £18,000,000 (Y4) and £12,000,000 (Y5-Y7). Landing fees and en-route charges are £1,708,333 p/aircraft p/annum.
Maintenance costs on the existing fleet are £25,500,000 (Y0 and Y1). For the remainder of the investment period, maintenance costs on the new fleet are estimated as £20,300,000 (Y2), £30,800,000 (Y3), £34,500,000 (Y4-Y6) and £32,150,000 (Y7).
Option 2 Airbus:
The second option is the purchase of 100 jets from Airbus (Airbus 737-700’s), with maximum seating capacity of 149. Under the terms of the deal, Airbus would deliver an entire new fleet of 100 aircrafts on 1st January 2005. This is possible at short notice since Airbus are already in production, working on an order for a Swedish airline who recently went into receivership. In collaboration with the receivers and Airbus, the cost per aircraft would be £30,500,000. Once the existing fleet is retired, the delivery from Airbus would take to the skies on 1st January 2005.
Based on current growth of the airline, and the number of available seats at current load factors, revenues from such an expansion are expected to increase from £624,100,000 (today, 2003, Y0) as follows:
Year 0 (2003) £624,100,000
Year 1 £624,100,000
Year 2 £772,323,750
Year 3 £792,000,000
Year 4 £821,700,000
Year 5 £851,400,000
Year 6 £871,200,000
Year 7 (2010) £871,200,000
The European Union has refused to enter into discussions to assist the airline in obtaining a comparable loan guarantee for purchasing an Airbus fleet. Should Ryanair choose to place the order with Airbus, a number of banks have provisionally offered the airline a loan (capital and interest) of 7.5% p/annum, secured by a first priority mortgage on the relevant aircrafts in favour of the banks.
Staff costs are £14,250,000 (Y0), £14,250,000 (Y1), and estimated as £67,000,000 (Y2 – Y7). Recruitment and training costs are £12,000,000 (Y0) and £25,000,000 (Y1), and estimated as £42,300,000 (Y2), £23,500,000 (Y3), £18,000,000 (Y4), £15,000,000 (Y5), £12,000,000 (Y6 - Y7).
Landing fees and en-route charges are £1,708,333 p/annum while continuing to operate the existing Boeing fleet, reducing to £1,525,000 from 2005 onwards, reflecting the smaller size of Airbus aircraft.
Maintenance costs on the existing fleet are £25,500,000 (Y0 & Y1). For the remainder of the investment period, maintenance costs associated with operating an Airbus fleet are estimated as £36,780,000 (Y2), £30,900,000 (Y3), £41,000,000 (Y4-Y6) and £39,560,000 (Y7).
While the cost structures of both proposals differ significantly, you have been told that both options share the following information. From historical accounts, you have discovered that the finance costs for the existing fleet are £22,925,250 per annum, and will remain at this until the fleet is retired. Furthermore, the cost of the operations director and team are £28,330 p/aircraft p/annum (T0 – T7) regardless of age of the aircraft, or whether a Boeing or Airbus fleet is maintained.
You are also told that Ryanair has negotiated the exclusion of a clause, typical in the aviation industry, requiring it to pay 30% of the value of each jet in advance of delivery from the manufacturers. Under the terms of either of either deal, Ryanair would pay 100% of the outstanding invoice for each aircraft immediately upon delivery.
Ryanair set the cost of capital for investment projects according to the rate of return earned by the holding company. This currently stands at 10%.
The investment horizons of both projects have been set at 31st December 2010 Ignore taxation effects.