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 Astronautics

Nanjing, Jiang Su, China
2011/04/28
 Engineering Economics Project Report 2

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.
 Engineering Economics Project Report 3

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.
 Engineering Economics Project Report 4

Table of Contents
TITLE PAGE……………………………………………………………………
DECLERATION…………………………………………………………........... ii
ACKNOWLEDGEMENT…………………………………………………….… ii
ABSTRACT…………………………………………………………………….. iii
LIST OF TABLES…………………………………………………………….…v
LIST OF FIGURES………………………………………………………............v

1. INTRODUCTION………………………………………………………..….1
2. KEYWORDS………………………………………………………………...2
3. OBJECTIVES…………………………..........................................................3
3.1 PROJECT OBJECTIVES………………………………………….......3
3.2 ACADEMIC OBJECTIVES…………………………………………..3

4. PROJECT OVERVIEW……………………………………………………..3
5. 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…………………………………………...15

7. CONCLUSION AND RECOMMENDATION……………………………..15

APPENDIX………………………………………………………………...…....16
REFERENCES………………………………………………………………......18
 Engineering Economics Project Report 5

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

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

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
 Engineering Economics Project Report 7

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
 Engineering Economics Project Report 8

3. Objectives
3.1 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. B777-200LR
2. A330-200
3. 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 million
Seats: 350
Cargo: 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 million
Seats: 350
Cargo: 70 tons
Range: 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 million
Seats: 78
Cargo: 17 tons
Range: 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.
 Engineering Economics Project Report 9

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

2016, 31%
2011, 39%

2015, 9%
2012, 6%
2014, 8%
2013, 7%

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

A330-200 2011 2012 2013 2014 2015 2016

Capital Cost (incl. spares) -200.8
Residual Value 100.4
Cash Operating Revenues 50 52 55 60 67
Cash Operating Cost 12.2 12.4 12.7 12.8 13.2
 Engineering Economics Project Report 10

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

2016, 30%
2011, 38%

2015, 9%
2012, 7%
2014, 8%
2013, 8%

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
Cash Operating Cost 1.1 1.2 1.3 1.3 1.4

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

2016, 32%
2011, 38%

2015, 8%
2012, 7%
2014, 8%
2013, 7%
 Engineering Economics Project Report 11

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 B777-200LR
For 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

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 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

 Engineering Economics Project Report 12

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

144.32

95
87
80
74
70

0 1 2 3 4 5

16.2

12.2 12.5 13 13.3 13.6

262.4
 Engineering Economics Project Report 13

For A330-200

A330-200 2011 2012 2013 2014 2015 2016

Capital Cost (incl. spares) -200.8
Residual Value 100.4
Cash Operating Revenues 50 52 55 60 67
Cash Operating Cost 12.2 12.4 12.7 12.8 13.2
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

100.4

67
60
55
52
50

0 1 2 3 4 5

12.2 12.4 12.7 12.8 13.2

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

200.8
 Engineering Economics Project Report 14

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 Cost 1.1 1.2 1.3 1.3 1.4
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-7212

5.9
5.5
5.4
5
4.7

0 1 2 3 4 5

1.1 1.2
1.3
1.3 1.4

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

5.2 Pay- back Period Analysis

 Engineering Economics Project Report 15

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 2016

Cash Flow -262.4 41.6 45.3 50.8 57.5 209.52
Cost of Funds (7%) 0 -18.37 -16.74 -14.74 -12.22 -9.05
Cumulative 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 2016

Cash Flow -200.8 37.8 39.6 42.3 47.2 154.2
Cost of Funds (7%) 0 -14.06 -12.39 -10.50 -8.26 -5.54
Cumulative 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)

So, the payback period for this aircraft is 4.53 years.

For ATR-72

Period 2011 2012 2013 2014 2015 2016

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

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

So, the payback period for this aircraft is 4.56 years.

5.3 IRR Analysis using Present Worth Profile

 Engineering Economics Project Report 16

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 aircrafts
For B777-200LR For A330-200 For ATR-72
MARR NPV MARR NPV MARR NPV
0 142.32 0 120.30 0 122
1 127.11 1 108.57 1 110.04
5 73.66 5 67.30 5 68.00
7 50.76 7 49.59 7 49.98
10 20.39 10 26.05 10 26.07
11 11.20 13.90 0 13.85 0
12 2.44 15 -6.52 15 -6.95
12.29 0 20 -32.59 20 -33.32
13 -5.92 25 -53.69 25 -54.61
15 -21.53 30 -70.98 30 -72.01
20 -54.95 35 -85.28 35 -86.37
25 -81.91 40 -97.22 40 -98.34
30 -103.91 45 -107.29 45 -108.40
35 -122.04 50 -115.84 50 -116.94
40 -137.14
45 -149.81
 Engineering Economics Project Report 17

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

200
150
100
pw (i) ($millions)

50
0 S eries1
-50 0 10 20 30 40 50

-100
-150
-200
i = MARR(%)

F ig 8 : P re s e n t-w o rth p ro file fo r A 3 3 0 -2 0 0

150

100

50
pw (i) ($millions)

0 S e rie s 1
0 10 20 30 40 50 60
-5 0

-1 0 0

-1 5 0
i = M A R R (%)
 Engineering Economics Project Report 18

F ig 9 : P re s e n t-w o rth p ro file fo r A T R -7 2

1 50

1 00

50
pw (i) ($millions)

0 S e rie s 1
0 10 20 30 40 50 60
-5 0

-1 0 0

-1 5 0
I = M A R R (%)

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

Aircraft IRR
B777-200LR 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
5 209.52 154.2 165
IRR 12.29% 13.90% 13.85%

Table 11: Cash flows (US$ millions) for B777-200LR, A330-200, and ATR-72
 Engineering Economics Project Report 19

In 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:

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.
 Engineering Economics Project Report 20

6. Results and Discussions

From the analysis done above we compared the results of each projects. According to
present worth analysis we have following results:

Aircraft NPV
B777-200LR: $50.76 million
A330-200 : $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 period

B777-200LR: 4.64 years
A330-200 : 4.53 years
ATR-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.
 Engineering Economics Project Report 21

From the IRR analysis we have the following results:

Aircraft IRR
B777-200LR 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.

Appendix

Interest Factors for Discrete Compounding

Engineering Economics Project Report 22
Engineering Economics Project Report 23
 Engineering Economics Project Report 24

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