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Return on Aircraft Investment

by David Wyndham 1. February 2007 00:00
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When working with our clients on fleet-planning, we almost always look at several forms of ownership and at several ways to pay for the aircraft. Often, we compare a loan with cash purchase. On the surface, the loan should cost more, right? After all, you pay interest on the amount borrowed. That's not quite the full story.

Whether your company is a sole-proprietorship or a Fortune 500, there is always a limited amount of money. Successful companies keep a close control on their cash and look at something called "return on investment" or ROI. Depending on the context used, this term can also be called the "hurdle rate" or even "cost of capital."

One way a large company uses its cash to invest in items that generate income. Unless the aircraft is used for hire it does not directly generate income any more than the computer I am using to write this article directly generates income for our company.  If a company buys an aircraft for cash, it is cash that they cannot put into something that directly generates income.

As an example, Widgets International Inc. needs an aircraft to better manage their far-flung widget manufacturing plants. They can buy a business jet for $13 million, or they can upgrade a widget plant for $13 million, increasing their net profits at that plant by 15%. The widget company will evaluate whether to put their money into the aircraft, or the plant. That 15% increased profit can be called their Return On Investment.

Let's assume that the bank is willing to loan the widget company money at 8%.  The widget company can use their cash to generate income at fifteen cents for each dollar and it will "cost" them only 8 cents on each dollar loaned. In an over-simplification, the company will make 15 cents at the expense of eight cents in interest for a net of seven cents.

If our fictitious Widgets International Inc. were acquiring an aircraft, they most likely would not pay cash, but instead take out a loan and "invest" the cash somewhere within the company where it could earn returns greater than the cost of the loan.

Large companies typically try to generate fifteen cents or more (on average) for each dollar spent.  That amount is their ROI.  When evaluating a large purchase, a company applies ROI to the purchase to see if that is the best use of their capital. Using this sort of calculation enable them to spend their money in the most productive ways. This is not done for every acquisition, but is usually required of large capital acquisitions.

Of course, there in never a guaranteed return in business. So the company has to access the risk of being able to get the return along with the magnitude of the return. Acquiring an aircraft for business use involves a careful consideration of the expenses, and whether it is better to pay by cash, a loan, or even to lease.

The calculations can be complex. Along with the tax implications, there is the impact on the balance sheet (see your CPA on that one). However, for many large companies, it does not pay to buy for cash.

Since there are many ways and forms to handle the ROI on an aircraft or cash investment what are some of the ways your company has handled this.  This is an interactive article so we would like to have your suggestions or comments on this article.  Please click on the link below "Reply to this Article"


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