All posts tagged 'Life Cycles'

Keep Those Older Business Jets Flying

EAA AirVenture 2012 has just wrapped up. If you were fortunate to have gone this year (sorry to say I was not), and I asked if you saw any antique airplanes, you might mention seeing a Waco, a DC3 or Ford Tri-Motor. But what about a Learjet 35A, Citation II or Hawker 700? Early serial numbers of these venerable business jets are well into their golden years as they all were in production during the late 1970s. These and many other business jets are well past age 30.

In our aircraft cost databases, we assume that all the business aircraft are maintained more or less the same way with new parts replacing old, worn out parts. As many operators of long-out-of-production aircraft are finding out, this is not the most cost effective way to keep these aircraft flying.

First off, availability of new parts for older aircraft is becoming harder to find. Some non-OEM vendors are no longer in business, or they have been acquired and merged into different entities. They do not keep production lines open year round or may only build spares as needed.

Overhauling of serviceable components is also getting harder to accomplish. Sure, you can overhaul a generator multiple times, but what about the holes for the mounting bolts? Over time, you can only use "oversize" bolts so often before the component case is no longer serviceable.

To say that avionics have evolved since the mode 1970s is an understatement! Many of these older aircraft use what we euphemistically call steam gages. And relative to today’s technology, that statement is not too far off. Repairing these older instruments is becoming more costly, as are replacements. Glass cockpit upgrades are available, but at what cost?

Perhaps the toughest choices come with the engines. The first and second-generation business jet engines are all into their second, third or fourth overhaul cycle. Guaranteed engine maintenance program rates reflect this with rates much higher than current generation engines. The cost to overhaul a pair of these engines can run to more than the cost of the aircraft itself. Even with fresh engines, a 35-year old business jet will not double in selling price.

Look at the very popular Citation II. According to the Aircraft Bluebook Price Digest (Summer 2012), the selling price of a 1978 Citation II is $650,000. The basic overhaul price is about $350,000 per engine. Add in some cycle-limited items like rotor disks and impellers and the price jumps to over $500,000 – each!

Overhaul a pair of run-out engines on your 35-year old business jet and you will be lucky to get 50% back if you sell it. There are just too many of theses aircraft available for sale and at very low prices.

I have talked with more than one operator of aircraft like these who will not, and cannot, pay for an engine overhaul. Instead they look for a similar model year aircraft with engines in good condition with maybe 1,500 hours remaining until overhaul. They buy the second airplane, swap engines and part the rest out. This recycling method is more cost effective for many of these older business jets.

I doubt values on these “vintage” jets will ever recover. So it looks like we will see a steady dwindling of whole aircraft as we see two aircraft make one flyable aircraft and so on. Keeping these older business jets flying is becoming more of an exercise of scrounging and cannibalizing versus one of replacing/overhauling.

Maintaining older aircraft in this manner requires time, and decreases the aircraft availability. You need to have two or three aircraft to keep one in flyable condition! It can be done, but it is better suited to a flier that can live with low utilization and decreased availability. So enjoy these aircraft now, because it won't be to many more years at Oshkosh before a Learjet 35 is parked next to the Staggerwing!

The Time Value of Money - A powerful tool in evaluating different cash flows

Aviation is an expensive pursuit. When looking at various options for air transport alternatives, we need a way to compare the costs of those alternatives.

One way that many get caught on is just looking at a single cost, such as the acquisition cost. Aircraft A costs $1 million while Aircraft B costs $1.5 million. So buy Aircraft A.  The US Government got into using that as the sole determinant on picking between various acquisitions. Once bidders knew the rules, they underbid the acquisition cost and grossly overpriced the costs of support, spare parts and upgrades.  In the early 1960s Secretary of Defense McNamera put an end to that practice and specified that they would look at the total cost of a project, including the cost to acquire, operate, and dispose of the asset.  This was called Life Cycle Costing.

In aircraft life cycle costing, you attempt to consider all of the costs associated with the aircraft. While acquisition cost is important, so too are the operating costs of the aircraft. In fact, after a while, the total costs of operation exceed the initial acquisition expense. 

When you finally dispose of the aircraft by selling the aircraft, that residual value reduces the total costs of ownership.  So a simple life cycle cost might look like:

 

               Aircraft A.         Aircraft B.

Acquisition     $1 Million          $1.5 Million

Op. Costs       $1.4                $1.2

Residual Value ($0.5)              ($0.85)

Total:         $1.9 Million         $1.85 Million

In this simplification, Aircraft B actually has a lower life cycle cost. While this is a far superior method than just acquisition cost alone, we need, or should, do more of an analysis. Allow me a diversion for a moment.

Suppose that Jeremy Cox owes you $10,000.  He offers to either pay you now, or in 5 years. Jeremy is a man of his word, but yet, any of us would choose to get paid now. 

What if the reverse were the case. One of you owes Jeremy Cox $10,000.  If you had the same terms of paying now or in 5 years, again I think all of us would tell poor Jeremy to wait it out the full 5 years to get his money.

What we have just done is assigned a Time Value to money. In both cases, $10,000 is the sum. But we correctly chose to pay our debt as far into the future as we can while asking for our income or revenue up front. 

In the case of the debt, in order to pay Jeremy now, I need the full $10,000. But if I can wait 5 years to pay him, I can put about $6,800 into an investment that returns 8% per year.  After 5 years, I will have the $10,000 for Jeremy.

So with an 8% cost of money or rate of return, my future value of $10,000 is really $6,800 today. The Time Value of money assigns not only the cost, but assigns a time cost or value to when the money is paid out or comes in.  If you do this sort of analysis with every cost and revenue involving our Life Cycle Cost, you end up with a financial analysis that not only tells what the total costs are, but also assigns a time value to each of those costs.  Summing these time values up and considering our initial investment (aircraft acquisition) gives us what is called the Net Present Value of the proposition.  This is the tool to use when considering high dollar, complex proposals such as aircraft. 

With a business use aircraft, the analysis will include things such as tax depreciation, the cost of a lease or loan and the opportunity to use the money for the aircraft in other areas.  A high net worth individual may make more money with their investments than the cost of a loan.  If the aircraft is for personal use, that same individual cannot use the tax depreciation of a business, so a lease may be a better deal in terms of the Net Present Value.

To calculate a Net Present Value, a spreadsheet can be used.  Inputs are the costs, revenues, time, and the cost of money (also called rate of return or desired return on investment). 

The Time Value of money is a powerful tool in evaluating different cash flows. It need not be for a business. It can help you to evaluate complex finances and be used as a tool to evaluate the true costs of owning and operating an aircraft.

Have any of you been involved in the financial analysis of an aircraft acquisition (or any high dollar acquisition such as a costly computer network for a business)? If so please reply and tell us your experiences.  We all learn if you share.

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