Question

Yes, the Max is grounded, but there will be a return to something more normal someday. Assume we've reached that point!  

Here’s an excerpt from a recent issue of ATA SmartBrief: “Southwest Airlines and American Airlines are pleased with the early performance of their Boeing 737 Max 8 passenger jets. Southwest officials say the aircraft is performing as expected and is 14% more fuel-efficient than Boeing's 737-800s.” Not surprisingly, Boeing prices the B-737 Max 8 higher than the otherwise comparable B-737-800. Based on the following data, is the Max 8 a good financial choice instead of the 800 series aircraft? Just as in all real-world financial analyses, you will need to make some assumptions. Please present your net present value computations to support your recommendation.

B-737 Max 8 list price: $112.4 million

B-737-800 list price: $98.1 million

Note that airlines typically receive a substantial discount off list price averaging about 33%.

B-737-800 average hourly fuel consumption: 850 gallons per hour

You will need the current price of jet fuel. Find it with a Google search for “spot price of jet fuel.” You will see that the price varies somewhat by purchase location, but you may choose a representative price.

Average yearly flight hour utilization for both 737 models: 3,600 hours years

Typical useful lifetime in major airline service: 20 years

Assume the resale value (or opportunity cost) at the end of 20 years of service is ½ of the initial purchase price

Answer 1

We assume a Discount Rate of 10% to calculate the NPV or Net present Value

Max 8:

Cost price = (1-33%) * $112.4 million = $74.93 million

Fuel consumption = 14% less than Series 800

Fuel consumption of Series 800 = 850 gallons per hour

Fuel consumption of Max 8 = 86% of 850 gallons per hour = 731 gallons per hour

Total Fuel consumption in per year = 731 * 20 gallons = 14620 gallons

As on April 2020, the price per gallon of fuel was 0.61 which is used for calculation.

Total fuel expense = $ 14620 * 0.61 = $8918.20

Salvage Value = 1/2 * $74.93 million = $37.456 million

NPV of cost of Max 8= $74.93 million + $8918.20/1.1^1 + + $8918.20/1.1^2 + ... + $8918.20/1.1^20 - $37.456 million/1.1^20

= $74.93 million + 8918.20/1.1 * (1/1.1^20 - 1) / ( 1/1.1 - 1) - $37.456 million / 6.727

= $74.93 million + 8918.20 / 1.1 * 0.85 / 0.0909 - $5.568 million

= $74.93 million + $75812.28 - $5.568million

= $69.438 million

Series 800

Cost price = (1-33%) * $98.1 million = $65.4 million

Fuel consumption of Series 800 = 850 gallons per hour

Total Fuel consumption in per year = 850 * 20 gallons = 17000 gallons

As on April 2020, the price per gallon of fuel was 0.61 which is used for calculation.

Total fuel expense = $ 17000 * 0.61 = $10370

Salvage Value = 1/2 * $65.4 million = $32.7 million

NPV of cost of Max 8= $65.4 million + $10370/1.1^1 + + $10370/1.1^2 + ... + $10370/1.1^20 - $32.7 million/1.1^20

= $65.4 million + 10370/1.1 * (1/1.1^20 - 1) / ( 1/1.1 - 1) - $32.7 million / 6.727

= $65.4 million + 10370 / 1.1 * 0.85 / 0.0909 - $4.861 million

= $65.4 million + $88153.82 - $4.861million

= $60.627 million

So as per NPV, considering 10% discount rate, it makes sense to go with Series 800 instead of Max 8.

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