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A Methodology For Comparing Aircraft Costs

by David Wyndham 13. July 2017 15:16
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When comparing aircraft costs, it is important to understand what costs are included and what aren't. Otherwise, you can end up comparing "apples and oranges." This can lead to making a decision with wrong or incomplete information. First off, let's review the predisposed views of some folks when talking about aircraft costs:

The Maintenance Director looks at what it takes to maintain the aircraft in an airworthy condition. The maintenance director can bid out major repairs to get the best price for quality work. Talk to maintenance professional and he/she will take that one "maintenance cost" item and really go into detail. As an example, a maintenance reserve for a twin-engine turboprop can be about $455 per hour ($180 for parts and labor, and $275 for the engine reserves).

The Pilot is responsible for the safe and efficient operation of the aircraft. That person is usually most concerned with fuel, maintenance (as one number), and travel expenses. The pilot can choose fuel vendors who have competitive prices. For our turboprop, that operating cost figure would amount to about $1,000 per hour. What else might be missing?

The Aviation Department Manager is concerned with the cost of the aircraft, plus the fixed overhead items such as hangar, training, insurance, and pilot salaries. Those items for our turboprop example can be about $300,000 per year, plus the hourly cost of the aircraft. For a nominal 400 hours per year operation, the Aviation Department Manager's budget for a turboprop is $700,000 annually, or $1,750 per hour average.

Lastly, the Executive/CFO is concerned with acquisition costs, amortization, interest, depreciation, taxes and the cost of capital. That can easily add another 70% onto the Aviation Department Manager's "costs" depending on the value of the aircraft. If the aircraft is operated for business use, the corporation has the ability to write off the expenses of ownership and operation. After taxes and depreciation, the total figure to own and operate an aircraft can change dramatically. An educated Executive will also consider not only what the costs are, but when they occur and the value of the aircraft at the end of a specified amount of time.

What is the general methodology to use when analyzing the acquisition of an aircraft? 

When analyzing the potential acquisition of a whole or share of an aircraft, Life Cycle Costing ensures that all appropriate costs should be considered. The Life Cycle Costing includes acquisition, operating costs, depreciation, and the cost of capital. Amortization, interest, depreciation, and taxes also play a part in what it costs to own and operate an aircraft and can be included in the Life Cycle Costing as appropriate.

The assumptions used need to be clearly spelled out. The costs should cover a specific period and take into account an expected aircraft value at the end of the term. Comparisons of two or more options should also cover the same period of time and utilization. This provides a fair (or "apples-to-apples") comparison. A complete Life Cycle Cost also accounts for the time-value of money in an NPV analysis. This way, the differing cash flows form two or more options that can be compared and analyzed from a fair and complete perspective. 

What is a Net Present Value? An aircraft acquisition involves a very complex financial decision. Accurately judging the financial impact of such a major acquisition project can best be done with a Net Present Value (NPV) analysis. An NPV analysis takes into account the time value of money, as well as income and expense cash flows, type of depreciation, tax consequences, and residual value of the various options under consideration. When an expense (or revenue) occurs can be as important as the amount of that item.

By using the time-value of money, an organization can thus judge whether a project will yield a better or worse return than the average return experienced on a company-wide basis. Thus, the NPV analysis allows the comparison of different cash flows based on a set target return. It also allows comparisons of buy versus lease versus finance options of the same aircraft. This type of analysis is also the only effective way of judging whether it is better to purchase, finance, or lease, even if different conditions and interest rates apply to each alternative, and is the standard financial analysis technique used by the chief financial officers of major organizations.

The Net Present Value calculation applies a time value of money rate to when income and expenses occur. This time value of money is referred to as internal rate of return (IRR) or return on investment (ROI). Many organizations have a published IRR or ROI target. For those that don't, a way to estimate it is by dividing the profit before taxes of the organization by the equity and expressing as a percentage the return the organization expects to make on the money it invests in the enterprise. For many organizations, such as Fortune 500 companies, this is typically from 10% to 25%. Government agencies can use the current rate of return for Treasury Bills or State Bonds.

An NPV of zero means that the target return has been met. A negative (less than zero) NPV means the target return has not been met. A positive (greater than zero) NPV means the target return has been exceeded.

When analyzing the potential acquisition of a whole or share of an aircraft, Life Cycle Costing ensures that all appropriate costs should be considered. The Life Cycle Costing includes acquisition, operating costs, depreciation, and the cost of capital. Amortization, interest, depreciation, and taxes also play a part in what it costs to own and operate an aircraft and can be included in the Life Cycle Costing as appropriate.

The assumptions used need to be clearly spelled out. The costs should cover a specific period and take into account an expected aircraft value at the end of the term. Comparisons of two or more options should also cover the same period of time and utilization. This provides a fair (or "apples-to-apples") comparison. A complete Life Cycle Cost also accounts for the time- value of money in an NPV analysis. This way, the differing cash flows form two or more options that can be compared and analyzed from a fair and complete perspective.

For a commercial operator, they expect a return on the money spent - or profit. An NPV of zero means that they have earned enough money to pay off their initial investment, plus pay all expenses and have generated a profit equal to their expected rate of return. 

Business aircraft do not directly generate revenue except for the sale of the aircraft. Thus, the NPV results are typically negative. When comparing negative NPVs, the "least negative NPV" is the more favorable. In other words, if option A has an NPV of ($5,000,000) and the NPV of Option B is ($6,000,000), Option A has the better NPV.

You don't have to be a financial expert to do an NPV.  There are spreadsheet programs that can do the math for you. Or leave it to the experts in finance, but understand what it means.


 

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David Wyndham

Co-ownership Tips

by David Wyndham 12. June 2017 14:49
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When I was in high school I worked as line crew at an FBO at the small airport in Rochester, NH. When I started work, my employer rented out Cessna 150s for $19 per hour and a Cessna 172 for $29 per hour. AvGas was less than a dollar per gallon. One local pilot owned a mid-1960s Cessna 172. He flew only on severe-clear days, which in New England was infrequent. At best he maybe flew 40 hours per year. I asked him why didn’t he just rent. He replied that he could buy AvGas to fly 3.5 hours for the cost of one hour of a rental. I did some quick math as I knew what his recent annual cost and what he paid for the tie-down space he rented. Throw in a wild guess for insurance and I came up with over $100 per hour for his 40-hour “bargain.” I asked about these costs. A few months later he took on a partner to co-own his plane.

Most turbine aircraft fly less than 400 hours per year. Many operators since 2008 have reduced their flight activity and it is not uncommon to see utilization below 300 or even below 200 annual hours. For private owners, the 200 annual hours is maybe toward the high side. If you are flying 200 annual hours, your aircraft is sitting idle most of the time. 

Aircraft are also expensive. Fixed expenses like crew salaries, hangar and insurance when the are spread over a small number of hours drive up the average hourly total costs. If you are not using your aircraft, why not get some revenues by having someone else use it? Putting your aircraft onto a charter operator’s certificate receives a lot of attention and is the first thing I think of for helping to offset the total costs of owning your own aircraft. But there are other options like my long-ago Cessna 172 owner found out.

My general discussion will use co-ownership and joint-ownership interchangeably as it involves the day-to-day functioning of the shared arrangement. We do define them slightly different. Co-Ownership is when two or more organizations share the use and expenses of an aircraft but the aircraft is operated by a management company. Joint Ownership is when two or more organizations share the use and expenses of an aircraft and the aircraft is operated by one of these organizations (not a management company). There are legal and tax subtleties between the two that I won’t cover.

The significant advantage of co-ownership is that the two individuals share not only the costs of operation, but also the acquisition cost. Thus, a $1 million acquisition budget is all that is needed for a $2 million aircraft. You can either get a larger aircraft for the money or apply it to a newer model of the desired aircraft. Which leads me to tip number one.

Don’t buy more aircraft as a co-owner than you can afford to buy alone. 

Co-ownership works best when both partners are financially sound enough not to “need” the other in order to make the payments or pay the bills. When (not if) one of the two of you wants to sell, when you can afford the whole aircraft then the negotiations can be less stressful and less likely to result in the complete sale of the aircraft. Maintain your financial independence with respect to the aircraft. Look for a co-owner who also has the financial resources to operate the aircraft.

Second, find someone who flies “not like you” to co-own. Best case is owner A flies for business during the week and owner B takes the aircraft on vacations and holidays. You will need to schedule your travel. Avoid disputes over needing the aircraft at the same time but having complimentary schedules.

Speaking of scheduling, “first come, first served” is not likely to be successful all on its own. I saw one partnership come unraveled when scheduling issues turned into one owner scheduling the aircraft every other week for the entire year. All week. One thing to consider is “on and off” weeks. When its your “on week” you get priority scheduling and when you are “off” the other owner gets first use. To make things work, you’ll both want to accommodate each other.  

Best scheduling tip is to both have travel schedules set well in advance with limited conflicts. Agree up front about who pays what costs when the aircraft is away for several nights. Owner A takes the aircraft away and plans to on vacation for two weeks. Owner B needs the aircraft during the interim while owner A isn’t needing to fly. Who pays for the repositioning trip?  Have an agreement that spells out all use and scheduling policies.

Make sure that both owners share similar financial goals with respect to the aircraft. Want the aircraft cosmetics maintained to the highest standards? Maintained only at the service center? Spell out the level of maintenance and upkeep of the aircraft. Also spell out exactly how expenses are to be shared. Separately discuss fixed cost sharing like hangar and insurance versus variable costs like fuel and maintenance. Set up a maintenance reserve account and possibly put the aircraft on a guaranteed hourly maintenance program for at least the engines. Have a budget.

Last tip is to plan for the sale of the aircraft and terms for the sale. A long running partnership may see another aircraft. Partnerships dissolve with the current aircraft when needs and finances of one owner change. Again, if both co-owners can afford the aircraft, the loss of one owner is inconvenient but not disastrous. 

A successful co-ownership lets two owners get 80% to 90% of their aircraft needs met for 50% of the cost. Advanced planning and written agreements along with both parties being transparent with respect to the aircraft are critical, but it can work. It worked for a Cessna 172 and it can work for a much bigger aircraft, too.

 

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Aircraft Sales | David Wyndham | Flying

Five Tips for Aircraft Financing/Leasing

by David Wyndham 3. May 2017 14:39
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There is money available today if you are interested in financing or leasing a business aircraft. Interest rates are still low. Here are five rules for getting financing or leasing.

Rule #1. Dance with the one you brought.

Relationships matter. Financial institutions are looking for long-term relationships. If you have done significant business with one institution over the years, they are the first ones to approach for any aircraft financing or leasing. One private banker told me "If you have $300 million in assets with (my bank) there is no way we won't do an aircraft deal with you." Part of this is the significant investment the financial institution has made in keeping you, and your cash, in the bank. The other is that in cultivation and supporting your business, they have a very good idea as to your character.

Rule #2. Character counts.

The Four C's of financing are Character, Credit, Collateral, and Cash Flow. Do you have the credit available for the deal in mind? Aircraft deals can be far more complex than other assets. Any financial institution needs to manage and measure their financial risk and it starts with your credit. Another part in managing the risk is what other assets do you have to guarantee the aircraft deal? Standalone, the financial institution may not want to do interest-only financing, but if you have cash, stocks, and other investments well in excess of the aircraft value, then the risk is lessened. Can you keep the aircraft flying? For $2 million you can buy a 15-year old turboprop or a 22-year old large cabin jet. However, the annual operating budgets are going to be vastly different. Can you afford the $3 million engine overhaul on the jet? Character, whether are you a person of your word, counts more than all the above.

Character ties into rule number one above. The financial institution wants to know, not only from a balance sheet perspective, but from who you our your company is, will you stand by the deal? Given enough money for lawyers, it seems like most contracts can be broken or amended. The financial institution is looking for a trustworthy account.

Our company founder and dear friend, Al Conklin, told me that he measured every sale by the value of the person's handshake. If he didn't trust the person, no amount of legal contracts and forms would make him feel good about the deal.

Rule #3. Get what you need, don't overbuy. 

Aircraft are wonderful business tools. They get you to many places far faster than any other mode of transportation. They enable you to make the out of every minute and do so in a safe and secure environment. Given the availability of pre-owned aircraft you can easily step up in size nod capability for not a lot more money. Get the aircraft that does the majority of your flying in a cost effective manner. Need or want the big cabin plane? Then charter one when necessary. 

I had one client who would not consider a plane in which he could not stand up in the use the lavatory! The smaller cabin jet was less costly to own and operate, but he wanted and was willing to pay to stand. He ended up not buying and continuing to charter. If you do decide to upsize, make sure you understand the ramifications of the budget and are willing to pay.

Rule #4. Communication is key. 

For the lessor, lender, or insurance broker to make sure you get the best service, make sure they understand how you plan to use the aircraft. Will you be doing charter? Will it stay in North America or spend a lot of time in other locations? Are their management agreements? If so, is the financial institution protected adequately in terms of a loss or lien?

Rule #5. Plan.

While a cash-only transaction can be done in the time it takes for a wire transfer to occur, even the aircraft registration process will take more time than that. A US-only financed deal can take three to four weeks at the absolute fastest. Better plan on a month or more. If there are two countries involved, if the Ex-Im Bank is involved in the financing, plan on three to four months minimum for the deal and the importation of the aircraft. 

Financing or leasing a business aircraft is complicated and involves significant finances. You should have qualified aviation legal and tax advice. 

 

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Aircraft Sales | David Wyndham | Aircraft For Sale

Oldies But Goodies, the decision to buy a new aircraft versus old(er) aircraft

by David Wyndham 18. April 2017 15:32
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The majority of manufacturers of new turbine business aircraft are still having difficulties selling their new aircraft. Sales remain sluggish. According to GAMA 2016 was the worst year for business jet deliveries since 2004. Ref: http://aviationweek.com/bca/business-jet-shipments-lowest-2004-gama-says

When I talk to brokers of pre-owned aircraft, many are reporting that 2016 was a very good year and that 2017 is continuing the upward trend. Why is that? One reason is that there are still a lot of quality pre-owned aircraft for sales at prices that have not recovered since the last recession. 

A friend in the finance industry who frequently works with high net worth individuals reports that for them, buying new is not financially the best option. Ten, 15 or 20-year old business jets are safe, have relatively low time versus their life, and, if you understand the maintenance requirements, can offer years of excellent service. 

Business jets still depreciate at alarming rates. A rule of thumb for a new business jet? Try 8% to 10% per year! Sources like Vref and the Aircraft Bluebook Price Digest support this with historical data. For a number of models, you can easily buy a seven-year old for about half or less than acquiring new. The manufacturers' sales people stress the new aircraft have much lower operating costs due to the lower maintenance costs, have the latest avionics, and new aircraft warranties. They are right, but still - that market depreciation! Being a numbers person, I ran some numbers.

looked at several popular large cabin business jets and the below is an average of a couple models. I used Vref pricing and ran operating costs to include the costs aging aircraft maintenance using our Life Cycle Cost software. Here are a couple things to consider.

Acquisition

New aircraft list = $44 million 

7-Year old model = $7.5 million

15-Year old model = $3 million

 

Knowing that acquisition is only part of the costs, what about the variable operating costs - including all the older aircraft maintenance?

Variable Cost Per Hour (on engine hourly maintenance program)

New aircraft = $3,800 per hour 

7-Year old aircraft = $4,900 per hour

15-Year old aircraft = $5,100 per hour

$1,300 per hour in operating cost is a lot - 34% greater than for the new model. The new jet, $44 million and you are good to fly right away. The 15-year old might need $2 million to $4 million in upgrades, new paint & interior, ADS-B, and some engine work. Even the 7-year old will need some upgrades. 

But when you look at residual values as a financier does, that difference in the operating cost budget pales in comparison to what (may) happen to the value. After seven years, that new jet may be worth half of new (or less) based on recent history. That $44 million jet may decline by $22 million! The older jet's value will be dependent on the maintenance status, especially the engines. It's possible that after seven years the now 15-year old may still get $2 million or more if the engines are in good shape. Even if you park the 15-year old jet after seven years' use, you are only out $4 to $6 million. 

One area not covered in these numbers is availability and utilization. A aircraft age, they require more maintenance and the extra maintenance burden requires more downtime. When the aircraft is in for maintenance, it is not available for flight. I you need high utilization, that older aircraft will likely make it difficult to maintain a busy flight schedule. But, for the lower utilization owner, such as many high net worth individuals, 200 hours a year is plenty and that 15-year old jet can easily keep up that schedule. 

Can you keep an older jet flying 30-hours a month? Maybe but not every month. I don't have an exact number as there are too many variables, but maintaining consistent 500-600 annual hours will be very difficult in all but newer models. A new aircraft can sustain that use with ease. That seven-year old model can probably sustain that level save for the "once every 8-year" type of heavy maintenance. 

Consider a company like NetJets. They need to minimize downtime. NetJets and the other fractional aircraft providers all tend to operate newer models. They do this to be able to offer the 800-occupied hours per year for their share owners. They cannot consistently get the revenue hours with older aircraft. 

can't ascertain that the new aircraft sales are going to the high utilization operators while the infrequent-fliers are buying the older models. But that can be one reason while the pre-owned aircraft brokers are enjoying a good year. 


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Aircraft Sales | Aviation Technology | David Wyndham

Can You Make Money In Charter As the Owner?

by David Wyndham 19. March 2017 15:16
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I recently received a call from a past client. He’s looking to acquire a business jet with a partner. When they are not using it, they want to put it on their management company’s charter certificate. He was told that the charter would offset the costs making his aircraft “almost zero to operate.” He was wondering if that was feasible.

Before answering that (no), here’s how this can be set up. The aircraft owner who is looking to reduce the cost of operating their aircraft, places the aircraft onto a commercial Part 135 certificate. When the owner is not using their aircraft, it can be earning revenue by flying charter. You will generate revenue that will offset the cost of owning and operating the aircraft.  You will not “fly for free.”

As a rule of thumb, the aircraft owner typically gets 85% of the base charter rate while the certificate holder keeps the remaining 15%. The aircraft owner typically pays all the aircraft specific charter expenses such as fuel and maintenance. The excess of charter revenue over those expenses helps offset the fixed costs resulting in a net decrease in total cost to the owner.

Charter rates in the US are very low relative to what these aircraft cost to operate. An aircraft that charters for $3,200 per hour can cost about $1,700 pr hour for the variable expenses. Since the charter operator gets 15%, the owner gets $2,720. So far they are ahead $1,020 per hour. But there are fixed costs such as hangar, insurance, pilot fees, etc. that might run $400,000 per year.

Also, this jet costs the owner $3 million to acquire. Lease payments can run to $300,000 per year. If the owner paid cash, there is a cost of capital to the owner as they cannot invest this money elsewhere. Adding the lease expense plus the fixed expenses, you get $700,000 per year. At an income over operating expenses of $1,020 per hour, our owner needs 687 hours of charter revenue to break even before tax considerations. Very, very few charter operators can generate that much revenue flying in a year. 

If this were easy to do, the charter operator would buy the aircraft and keep 100% of the revenues. When you factor in the fixed costs and cost of capital or leasing, charter rates don’t pay enough. But, for the owner who flies infrequently or on a very fixed schedule, the revenues from charter can help reduce their cost of flying. 

If the jet in the example above generated 200 charter hours and the owner flew 200 hours personally, this works to everyone’s advantage. The owner gets $204,000 in income, in effect cutting their fixed expenses in half. They also get to use their aircraft about 25 times per year at eights hours per round trip. The charter operator get the use of an aircraft without the large capital investment. Thus, they get to provide a service and stay in business at today’s charter rates.

For an aircraft owner placing their aircraft onto someone else’s commercial certificate requires careful planning and compromise. The arrangement can be beneficial for both aircraft owner and charter operator, but only if both parties compromise, cooperate and communicate. 

 


 

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David Wyndham



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