MBAA 523 Advanced Aviation Economics – Problem Set 1

20 Jun MBAA 523 Advanced Aviation Economics – Problem Set 1

1. An airline is considering the purchase of an Airbus A-320neo which offers improved fuel efficiency over the previous generation of narrow-body aircraft. The finance department estimates the aircraft will generate a positive net cash flow of $6 million in the first year increasing by 5% annually owing to the aircraft’s fuel efficiency. The airline plans to operate the aircraft for 15 years, then selling it in year 16 for an estimated net cash price of $30 million. The airline targets a return on invested capital of 12% annually (use this rate rather than the interest rate to discount future cash flows). What is the maximum price the airline should be willing to pay for a new A-320neo? Note: This computation is easiest to perform using MS Excel. The Excel computations may be copied and pasted into MS Word.

2. Complete the following table and answer the accompanying questions. Note: This computation is best completed in MS Excel. Copy and paste the resulting table into this Word document.

Control Variable Q

Total Benefits B(Q)

Total Cost C(Q)

Net Benefits N(Q)

Marginal Benefits MB(Q)

Marginal Cost MC(Q)

Marginal Net Benefits MNB(Q)

100

1200

950

210

40

101

1400

50

102

1590

60

103

1770

70

104

1940

80

105

2100

90

106

2250

100

107

2390

110

108

2520

120

109

2640

130

110

2750

140

A. At what level of the control variable are net benefits maximized?

B. What is the relation between marginal benefit and marginal cost at this level of the control variable?

3. Approximately 90,000 students per year apply to the top MBA programs.

C. Using the concept of net present value and opportunity cost, explain when it is rational for an individual to pursue and M.B.A. degree.

D. What would you expect to happen to the number of applicants if the starting salaries of managers with an M.B.A. degree remained constant but the salaries of managers with bachelor’s degrees increased by 15%? Why?

4. A small airline recently sold to a private equity group for $145 million. The airline has earned profits of $9 million last year. The new managers believe they can grow profits at 5% per year. The private equity group borrows money from wealthy individuals to invest in acquisitions. Because of the significant risk involved, lenders are promised a 12% return on their loans to the equity group. Is the purchase price of the new airline reasonable? Explain.