Cash flows NPVs, IRRs, Payback periods

In order to take advantage of market opportunities emerging in Europe
and take market share from many flag carrier airlines, the Directors of
Ryanair propose to expand their current fleet from 23 to 100. This
expanded fleet would allow the airline to handle up to 40m passengers
p/annum by 2010.

The expansion strategy is also attractive to Ryanair on safety grounds
since it would also allow the airline to retire its existing (ailing)
fleet of Boeing (737-200’s) on 31st Dec 2004, three years prior to the
end of their useful lives, with the sale proceeds credited to Ryanair on
1st January 2005. Ryanair took stock of its existing fleet on 1st
January 1988 for Ј22,150,000 p/aircraft, and in line with the norm in
the aviation industry, depreciates all of its fleet using the
straight-line method over 20 years.

Negotiations have come to a close with two major airline manufacturers;
Boeing and Airbus. As an investment bank with a major holding in
Ryanair stock, you have been presented with the following information
prior to voting at the next annual general meting in favour of either
proposal:

Option 1: Boeing

The first option is the purchase of 100 Boeing jets (Boeing
737-800’s), with maximum seat capacity of 189 costing Ј35,365,657
each. Under the terms of the deal, Boeing would deliver 40 aircrafts on
1st January 2005 and the remaining 60 on 1st January 2006.

Based on current growth of the airline, and the number of available
seats at current load factors, revenues from such an expansion are
expected to increase from Ј624,100,000 (today, 2003, Y0) as follows:

Year 0 (2003) Ј624,100,000

Year 1 Ј624,100,000

Year 2 Ј780,125,000

Year 3 Ј800,000,000

Year 4 Ј830,000,000

Year 5 Ј860,000,000

Year 6 Ј880,000,000

Year 7 (2010) Ј880,000,000

EXIM, the Export-Import Bank of the United States, is a US Government
sponsored body whose primary objective is to assist US exports of
capital goods. In order to safeguard the aviation industry, the US
Government have convinced EXIM to guarantee any loan required by Ryanair
for the purchase of UD-domiciled exports. EXIM’s normal fee for such
an exposure is a one-off fee of 3% of the principal amount of the sums
financed in respect of each aircraft, payable immediately upon delivery.
To demonstrate its commitment to the aviation industry, the US
Government has promised to pay EXIM 2% of the exposure fee on
Ryanair’s behalf.

Largely owing to the EXIM guarantee, Ryanair has been approached by a US
Bank, willing to finance the acquisition at a rate of 6.5% p/annum.
This is a capital and interest loan, secured by a first priority
mortgage on the relevant aircrafts in favour of EXIM.

Staff costs are Ј14,250,000 (Y0 & Y1), and estimated as Ј124,760,000
(Y2) and Ј61,900,000 (Y3 – Y10). Recruitment and training costs are
Ј12,000,000 (Y0) and Ј25,000,000 (Y1), and estimated as Ј34,000,000
(Y2), Ј32,500,000 (Y3), falling to Ј18,000,000 (Y4) and Ј12,000,000
(Y5-Y7). Landing fees and en-route charges are Ј1,708,333 p/aircraft
p/annum.

Maintenance costs on the existing fleet are Ј25,500,000 (Y0 and Y1).
For the remainder of the investment period, maintenance costs on the new
fleet are estimated as Ј20,300,000 (Y2), Ј30,800,000 (Y3),
Ј34,500,000 (Y4-Y6) and Ј32,150,000 (Y7).

Option 2 Airbus

The second option is the purchase of 100 jets from Airbus (Airbus
737-700’s), with maximum seating capacity of 149. Under the terms of
the deal, Airbus would deliver an entire new fleet of 100 aircrafts on
1st January 2005. This is possible at short notice since Airbus are
already in production, working on an order for a Swedish airline who
recently went into receivership. In collaboration with the receivers
and Airbus, the cost per aircraft would be Ј30,500,000. Once the
existing fleet is retired, the delivery from Airbus would take to the
skies on 1st January 2005.

Based on current growth of the airline, and the number of available
seats at current load factors, revenues from such an expansion are
expected to increase from Ј624,100,000 (today, 2003, Y0) as follows:

Year 0 (2003) Ј624,100,000

Year 1 Ј624,100,000

Year 2 Ј772,323,750

Year 3 Ј792,000,000

Year 4 Ј821,700,000

Year 5 Ј851,400,000

Year 6 Ј871,200,000

Year 7 (2010) Ј871,200,000

The European Union has refused to enter into discussions to assist the
airline in obtaining a comparable loan guarantee for purchasing an
Airbus fleet. Should Ryanair choose to place the order with Airbus, a
number of banks have provisionally offered the airline a loan (capital
and interest) of 7.5% p/annum, secured by a first priority mortgage on
the relevant aircrafts in favour of the banks.

Staff costs are Ј14,250,000 (Y0), Ј14,250,000 (Y1), and estimated as
Ј67,000,000 (Y2 – Y7). Recruitment and training costs are
Ј12,000,000 (Y0) and Ј25,000,000 (Y1), and estimated as Ј42,300,000
(Y2), Ј23,500,000 (Y3), Ј18,000,000 (Y4), Ј15,000,000 (Y5),
Ј12,000,000 (Y6 - Y7).

Landing fees and en-route charges are Ј1,708,333 p/annum while
continuing to operate the existing Boeing fleet, reducing to Ј1,525,000
from 2005 onwards, reflecting the smaller size of Airbus aircraft.

Maintenance costs on the existing fleet are Ј25,500,000 (Y0 & Y1). For
the remainder of the investment period, maintenance costs associated
with operating an Airbus fleet are estimated as Ј36,780,000 (Y2),
Ј30,900,000 (Y3), Ј41,000,000 (Y4-Y6) and Ј39,560,000 (Y7).

While the cost structures of both proposals differ significantly, you
have been told that both options share the following information. From
historical accounts, you have discovered that the finance costs for the
existing fleet are Ј22,925,250 per annum, and will remain at this until
the fleet is retired. Furthermore, the cost of the operations director
and team are Ј28,330 p/aircraft p/annum (T0 – T7) regardless of age
of the aircraft, or whether a Boeing or Airbus fleet is maintained.

You are also told that Ryanair has negotiated the exclusion of a clause,
typical in the aviation industry, requiring it to pay 30% of the value
of each jet in advance of delivery from the manufacturers. Under the
terms of either of either deal, Ryanair would pay 100% of the
outstanding invoice for each aircraft immediately upon delivery.

Ryanair set the cost of capital for investment projects according to the
rate of return earned by the holding company. This currently stands at
10%.

The investment horizons of both projects have been set at 31st December
2010 Ignore taxation effects.