Question: Net Present Value, Uncertainty 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 is150. Flights are expected to be fully booked. The average revenue per passenger per flight (oneway) is $235. Annual operating costs 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 percent 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 and 90 percent, with the most likely rate being 80 percent. Recalculate the NPV by 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 zero.
4. Conceptual Connection: 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?