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Comparing Costs

by David Wyndham 1. August 2005 00:00
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It All Depends On How You Look At It.

About a year ago, my wife and I started keeping a detailed accounting of where we spent our money. Rather than just looking at the bills, we wanted to understand where the money went and to better control our spending. Initially, my categories and Laurie's differed. I was looking at it from the "give me the big picture" point of view and had six categories. Laurie wanted more detail because she wanted more specific knowledge, and control. As usual, the smarter person (Laurie) won out and we've been satisfied with the results.

When looking at the aviation-related costs, it also helps to know what results you are looking for and who is doing the looking:

· 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. Maintenance for the King Air is about $283 per hour ($142 for parts and labor, and $142 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 a King Air, that operating cost figure would amount to about $710 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 a King Air 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 King Air is $584,000 annually, or $1,460 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 as much as 60% 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.

Comparing Two or More Acquisition Options

When comparing different forms of ownership, all costs need to be factored in. Typically done over a defined period, Life Cycle Costing accounts for the value of any owned aircraft at the end of the term. Life Cycle Costing can also involve the time-value of money.

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. A NPV analysis takes into account the cost of money, as well as income and expense cash flows, type of depreciation, tax consequences, and residual value of the various options under consideration. 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.

Many organizations have a published internal rate of return (IRR) or return on investment (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%.

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.

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.

Even though acquiring an aircraft for personal use is more of an "I want it but can I afford it?" question, you still need to know all the costs and when they occur. Whether it is a used Cessna 172 for $50,000 or a business jet for $5,000,000, the methodology is the same, just with more zeroes.


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