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How to Compare Aircraft Costs

by David Wyndham 1. October 2006 00:00
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Given all the recent activity in announcing new models, plus the general overall health of the economy, you may be fortunate to be in a position to acquire a new, or new to you, aircraft. It would be a grave error to focus in on the acquisition cost alone. Why?
While there is a ceiling on how much you can spend, the operating costs are a significant part of aircraft ownership. An extreme example is a Gulfstream GII. You can buy an early model GII for under $2 million, but to operate it for 5 years will likely cost you more than $14 million!
When you are 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. What is the general methodology to use when analyzing the acquisition of an aircraft? It is called Life Cycle Costing.
As the name implies, Life Cycle Costing looks at a period, or a "Life" of the asset. It does not have to be the entire useful life, but it should cover the anticipated period of ownership.
Life Cycle Costing also ensures that all appropriate costs should be considered. The Life Cycle Costing includes not only the acquisition cost, but also operating and maintenance costs, and market depreciation. If the acquisition is for business use, amortization, interest, depreciation, taxes and the cost of capital can be included. At the end of the Life Cycle, it also recognizes the estimated value of the asset (i.e. assumes a sale at the end). Think of Life Cycle Costing as a multi-year operating budget that also includes the acquisition and resale.
All your assumptions used need to be clearly spelled out. Fuel, hangar, insurance, all need to be reasonable estimates based on your experience, or that from a reliable source.
The costs should cover a specific period and take into account an expected aircraft value at the end of the term. If you plan to own the aircraft for 10 years, then that is your life cycle. As an estimate, I'd recommend at least 5 years to show the effects of a major inspection or two. The residual value or market value of the aircraft should be based on a combination of historical data and market prognostication. Don't forget about inflation. It adds to your costs and adds to the residual value as well.
When comparing two or more options, you should cover the same period of time and utilization. This provides for a fair comparison. A complete Life Cycle Cost can also account for the time- value of money in a Net Present Value (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. The NPV takes into account not only how much, but when expenses (and revenues) occur.
Calculating the NPV time value of money is a snap with a spreadsheet. In fact, doing the entire Life Cycle Cost in a well set up spreadsheet using reliable data is much easier that it sounds.
Different operations can have a different focus. Regardless of that focus, a well done Life Cycle Cost shows all the costs and allows the financial decision to be based on as complete a picture as possible. What methodology do you use to evaluate different aircraft costs? Are you directed to look only at certain costs? Please click reply and let me know.

How do you or your company determine Life Cycle Cost of the aircraft you fly. Do you follow the general outline listed above?



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