- Allegiant Air is evaluating whether to continue expanding its fleet with used McDonnell Douglas MD-80 aircraft or invest in new Airbus A320 aircraft. - A financial analyst conducted a net present value analysis to compare the total cost per available seat mile of operating the MD-80 versus the A320 over the next 15 years under different fuel price and discount rate scenarios. - The analysis found that the A320 had a lower cost per seat mile when fuel prices are higher and the discount rate is lower, making it the preferred option to recommend to Allegiant for modernizing its fleet.

1. Break-Even Analysis: Multiproduct Environment
1. Donald Tweedt started a company to produce and distribute
natural fertilizers. Donald's company sells two fertilizers that
are wildly popular: green fertilizer and compost fertilizer.
Green fertilizer, the most popular among environmentally-
minded consumers, commands the highest price and sells for
$16 per 30-pound bag. Green fertilizer also requires additional
processing and includes environmentally-friendly ingredients
that increase its variable costs to $10 per bag. Compost
fertilizer sells for $12 and has easily acquired ingredients that
require no special processing. It has variable costs of $8 per
bag. Tweedt's total fixed costs are $35,000. After some
aggressive marketing efforts, Tweedt has been able to drive
consumer demand to be equal for each fertilizer.
Required:
Calculate the number of bags of green fertilizer that will be sold
at break-even.
Target Profit Analysis
2. Kingman Corp. has been concerned with maintaining a solid
annual profit. The company sells a line of fire extinguishers that
are perfect for homeowners, for an average of $10 each. The
company has perfected its production process and now produces
extinguishers with a variable cost of $4 per extinguisher.
Kingman's annual fixed costs are $92,000. Kingman's tax rate is
40 percent.

2. Required:
Calculate the number of extinguishers Kingman must sell to
earn an after-tax profit of $60,000.
Make or Buy: Effect on Income
3. Engstrom, Inc., uses 10,000 pounds of a specific component
in the production of life preservers each year. Presently, the
component is purchased from an outside supplier for $11 per
pound. For some time now, the factory has had idle capacity
that could be utilized to make the component. Engstrom's costs
associated with manufacturing the component are as follows:
In addition, if the component is manufactured by Engstrom, the
company will hire a new factory supervisor at an annual cost of
$32,000.
Required:
If Engstrom chooses to make the component instead of buying it
from the outside supplier, what would be the change, if any, in
the company's income?
Limited-Resource Decision
4. Kerrie Velinsky Productions produces music videos in two
lengths on separate compact discs. The company can sell its
entire production of either product. The relevant data for these
two products follow:
Total fixed overhead is $240,000. The company has only
100,000 machine hours available for production. Because of

3. the constraint on the maximum number of machine hours, Kerrie
must decide which CD to produce to maximize the company's
income.
Required:
Compute the contribution margin per machine hour for each
compact disk. Round to the nearest cent.
Sell-or-Process Further Decision
5. DePaulis Furniture Manufacturers makes unfinished furniture
for sale to customers from its own stores. Recently, the
company has been considering taking production one step
further and finishing some of the furniture to sell as finished
furniture. To analyze the problem, DePaulis is going to look at
only one product, a very popular dining room chair. The chair
can be produced now for $65 and sells for $85 unfinished. If
DePaulis were to finish the chair, the cost would increase to
$90, but the company could sell the finished chairs for $125.
Required:
Compute the following in support of your answer. Input all
amounts as positive values.
6. Matthew Hagen started his company, The Sign of Things to
Come, three years ago after graduating from Upper State
University. While earning his engineering degree, Matthew
became intrigued by all of the neon signs he saw at bars and
taverns around the university. Few of his friends were surprised
to see him start a neon sign company after leaving school.
Matthew is currently considering the introduction of a new
custom neon sign that he believes will sell like hot cakes. In
fact, he is estimating that the company will sell 700 of the

4. signs. The new signs are expected to sell for $75 and require
variable costs of $25. The new signs will require a $30,000
investment in new equipment.
Required:
A. How many new signs must be sold to break even?
B. How many new signs must be sold to earn a profit of
$15,000 before taxes?
C. If 700 new signs are sold, how much pre-tax profit will they
generate?
D. What would be the break-even point if the sales price
decreased by 20 percent? Round your
E. What would be the break-even point if variable costs per
sign decreased by 40 percent?
F. What would be the break-even point if the additional fixed
costs were $50,000 rather than
Special-Order Decision: Qualitative Factors
7. Lindsey Smith, Inc., has the following cost structure for the
upcoming year:
Required:
If an amount is zero, enter "0".

5. A. What is the expected level of profit?
B. Should the company accept a special order for 1,000 units at
a selling price of $20 if variable marketing expenses associated
with the special order are $2 per unit?
What will be the incremental profit if the order is accepted?
C. Suppose that the company received a special order for 3,000
units at a selling price of $19 with no variable marketing
expenses. What would be the impact on profit?
D. Assume that if the special order were accepted, all the
regular customers would be aware of the price paid for the
special order. Would that influence your decision?
Decision Focus: Eliminating Unprofitable Segments
8. Casagrande Company is currently operating at 80 percent
capacity. Worried about the company's performance, Mike, the
general manager, reviewed the company's operating
performance. Following are sales and related cost information
about Casagrande, in millions of dollars:
Required:
A. What is the current operating profit for the company as a
whole?

6. B. Assume that all fixed costs are unavoidable. If Mike
eliminated the unprofitable segments, what would be the new
operating profit for the company as a whole?
C. What options does management have to maximize profits?
D. What qualitative factors do you think management should
consider before making this decision?
E. What impact could these qualitative factors have on the
decision?
CVP: What-If Analysis
9. Last year, Mayes Company had a contribution margin of 30
percent. This year, fixed expenses are expected to remain at
$120,000 and sales are expected to be $550,000, which is 10
percent higher than last year.
Required:
What must the contribution margin ratio be if the company
wants to increase net income by $15,000 this year?
Operating Leverage
Burger Queen Restaurant had the following information
available related to its operations from last year:
Required:
A. What is Burger Queen's operating leverage?

7. B. If sales increased by 30 percent, what would Burger Queen's
new net operating income be?
Break-Even Analysis
Jimmy's Seafood Restaurant is a family-owned business on the
North Carolina coast. In the last several months, the owner has
seen a drop-off in business. Last month, the restaurant broke
even. The owner looked over the records and saw that the
restaurant served 1,000 meals last month (variable cost is $10
per meal) and incurred fixed costs totaling $25,000.
Required:
Calculate Jimmy's average selling price for a meal.
1

8. MBAA 523
Written Assignment Standards
The standards for written assignments are as follows. These
standards will apply to all
written assignments, unless otherwise indicated.
not been previously
submitted to fulfill a requirement for another course).
the current edition of the APA
publication manual for
guidelines. These rules affect any tables or charts, citations,
references, running
head, page numbers, and section headings.
paper, name of author,
and date.
style requirements.
New Roman font,
12-pt font size, double-spaced text, with numbered pages.
aper must be grammatically sound and free of spelling
errors. See the
Resources area in the course for helpful writing skills websites.
types: .doc, .docx, or
.rtf.
e to the minimum/maximum page number

9. requirements as
given in each assignment. Do not count the title page or the
references page(s)
as part of the minimum total.
means that you
should primarily use peer-reviewed journal articles. Note: If
using a website as a
reference source, use only quality material. For guidance, see
Tips for
Evaluating Websites from ERAU's Hunt Library.
Additionally, review the evaluation rubric provided with each
written assignment activity
for details on grading criteria.
http://fusion.erau.edu/er/library/websites/rw/display.cfm?cat=42
http://library.erau.edu/shared/help/evaluating-websites.htm
http://library.erau.edu/shared/help/evaluating-websites.htm
MBAA 523
Written Assignment 2: Fleet Replacement Analysis
Page 1 of 4
This assignment has three objectives, to: 1) become familiar
with the type and magnitude of mainline
aircraft operating costs; 2) understand the operating economics
of new versus older aircraft; and, 3)

10. learn how net present value analysis is used in capital
acquisition decision-making. Allegiant has
engaged the aviation consulting firm SH&E to evaluate whether
it should continue its fleet expansion
with new aircraft instead of the aging McDonnell Douglas MD-
80 aircraft that are the backbone of its
small fleet. You are the senior financial analyst with SH&E
assigned to this project and will prepare a
memorandum with your conclusions to Allegiant’s Chief
Financial Officer D. Scott Sheldon.
Note: The assignment has detailed requirements similar to
those that would be given to a financial
analyst. Be certain to read carefully before beginning work.
Background
Allegiant Air bills itself “America's favorite small cities to
world-class destinations, Allegiant makes
leisure travel affordable and convenient.” As of 2013, it is the
most profitable U.S. airline based on
margin on revenue and unique in that it operates only used
aircraft. The backbone of the fleet is 57 MD-
80 aircraft, but it also operates 6 Boeing 757-200s and is adding
9 Airbus A319 aircraft. Allegiant
acquired 18 of its early MD-80s from Scandinavian Airways
System paying roughly $4 million dollars
per plane in an all cash transaction. Allegiant believes it can
continue its aggressive fleet expansion
with additional used MD-80s acquired for the same price as
American Airlines and Delta Air Lines
reduce their large MD-80 fleets. Although these aircraft have a
useful service life of 15 more years,
Allegiant recognizes it must eventually modernize its fleet. As

11. with all older aircraft, the MD-80 burns
more fuel and requires more maintenance than new generation
aircraft of equal mission capability.
Escalating and volatile fuel prices have added to senior
management’s interest in evaluating new
aircraft. Because it already operates Airbus 319s, the slightly
larger Airbus A-320 is its preferred option.
As you will see, this decision is critically dependent on your
projection for future fuel costs and the
discount rate employed.
The Analysis
An Excel template is provided as an attachment for conducting
your net present value analysis. You will
need to insert costs and performance figures into the template.
You may wish to review the template
before reading further.
In order to complete your analysis, you will need to obtain
current aircraft operating data and prices
from authoritative sources. The sources listed below are
sufficient and adequate for your project:
rices: Airbus publishes its aircraft list prices
periodically. Search the Airbus Industries
website or simply do a Google search for “Airbus aircraft list
prices.”
Monitor publishes extensive airline data
needed for your analysis. The Airline Monitor is available

12. through the Hunt Library
Aerospace/Aviation electronic databases. When you’ve accessed
The Airline Monitor, select Online
Edition, then Block Hour Operating Costs (pdf). This is a large
document. Be certain to use
Allegiant’s reported data for the MD-80 and industry data for
the A-320 (use the data for the A-320,
not the A0320neo). The data you need looks like this:
twenty years is critical. Historical data on jet
fuel prices are available from several sources. The Airline
Monitor includes this data in the Block
Hour Operating Cost document (above). Data are also available
from the industry association
Airlines for America. Select Economics & Analysis, then
Traffic & Financial Results. Scroll down to
select the appropriate reports. You may also find long-range
forecast energy prices from the
American Energy Information Administration useful.
Note that fuel prices increased dramatically during the global
economic expansion of the mid-2000s
peaking at nearly $4 per gallon in June 2008, but plummeted
during the subsequent recession. Fuel
costs will certainly increase again when world demand recovers.
You will need to estimate future
fuel costs for the analysis. Be certain that the fuel price for the
first year is the current jet fuel spot
price (available from several sources via a web search).
Conduct a sensitivity analysis for a range
of projected fuel prices. This is often done using optimistic,
pessimistic, and most likely projections.

13. appropriate rate varies by airlines; however, the
following extracts from the financial press are illustrative.
Alaska Air Group CEO Bill Ayer pointed to
“its target of 10% return on invested capital (ROIC). For its part
Delta, is also targeting a 10%
sustainable return on invested capital, according to President Ed
Bastian.” (CAPA, 2010, June 16).
Southwest Airlines is looking for a 15% ROIC. Your fleet
replacement decision will depend on what
rate you choose. Airlines with the best credit can borrow at the
lower rates which also decreases
the discount rate. You should perform a sensitivity analysis
(work the problem with several discount
rates) to better understand and defend your recommendation.
SH&E staff have surveyed Allegiant’s management to arrive at
several critical assumptions about
aircraft costs and performance.
1. Airlines with solid balance sheets, such as Allegiant, can
normally obtain new aircraft for about two-
thirds (2/3) of list price. After 15 years, an A-320 is estimated
to be worth about half of the original
purchase price (not list price) in the used market whereas an
MD-80 will have only $100,000 in
scrap value 15 years hence. Even if Allegiant should continue to
operate the new planes beyond 15
years, these values still represent an opportunity cost.

14. 2. Because Allegiant’s segment lengths are relatively long, it
believes fuel burns (gallons per block
hour) on a new A-320 will meet the lowest of any airline and
that speed in miles per block will equal
the highest of any airline.
3. Although Allegiant’s business model does not provide for
high aircraft utilization, because of the A-
320 greater range capability, annual utilization (block hours per
year) for the A-320 will be 20%
higher than for the MD-80. Note: This annual utilization is for
one aircraft, not the entire fleet.
4. Allegiant plans to outsource its heavy maintenance, so it will
pay another airline or maintenance
repair facility for both direct and burden (overhead) costs. If it
decides to purchase a new fleet type,
Allegiant believes that its first year maintenance expense will
equal the lowest for any airline
operating the Airbus 320 but that these costs will increase by
2% per year. However, as the current
fleet of MD-80s age, Allegiant believes that maintenance costs
for this fleet will increase by 5% per
year.
5. Allegiant configures its aircraft in high density, all-coach
configuration. It plans a seating capacity
equal to the highest of any airline.

15. 6. Allegiant does not expect crew expenses to change with the
choice of aircraft, so this and other
immaterial costs are not included in the analysis (an extra flight
attendant will be required but this
cost is ignored here).
Task
Enter data into the Excel template. Run a few “sensitivity”
analyses with varying fuel and discount rates
to see how the fleet replacement decision changes. Remember
that the net present value obtained is a
total cost of operation. The spreadsheet computes the cost per
available seat mile (CASM). The aircraft
with the lowest net present value CASM is the best financial
choice. Prepare a memorandum (not more
than 2 pages) to Mr. Sheldon summarizing your analysis and
making a recommendation. Remember
that executive management will need to understand how the
analysis was conducted. Explain your
assumptions and methodology concisely. Insert (copy and paste)
and reference Excel worksheets as
appendices to support your fleet replacement recommendation.
Use other tables and graphs as
appropriate to support your recommendation.
Notes:
Check carefully to ensure the inputs and results of the
discounted cost analysis are reasonable. The
NP CASM should be between 3 and 6 cents depending on the
input variables. This is lower than

16. reported CASM for US airlines because many costs that do not
affect the choice of aircraft type are not
included. The Airline Monitor report can be used to check for
reasonableness.
You may wish to present your sensitivity analysis of projected
fuel prices and discount rates in a single
table. A 3 by 3 table with 9 combinations of prices and discount
rates is one method.
Excel spreadsheets should not be submitted separately; Mr.
Sheldon wants the entire report in a single
document. The assignment is not in APA style. It’s a report for
Mr. Sheldon in a business format.
Remember that you are writing for Mr. Sheldon. He is very
knowledgeable of airline operations and
costs, but has not been directly involved in your analysis.
SH&E is a consultant hired to provide a
carefully researched recommendation.
See Purdue OWL for guidance on writing business memoranda
and memo format. Search OWL for
“memorandum.”
Sheet1Allegiant Air Fleet ReplacementInstructions1. Enter the
discount rate (i) in cell C19 (enter as a decimal, e.g., 0.10).
The yearly discount factor equal to 1/(1+i)^year is
automatically computed and entered in column B.2. Enter the

17. fuel gallons burned per block hour in cells I19 and O19.3. Enter
the Block Hours per year per aircraft in I20 and O20.4. Enter
the total maintenance cost per block hour in I21 and 021.5.
Enter the seating capacity (number of seats per aircraft) in I22
and O22.6. Enter the Speed in Miles per Block Hour in I23 and
O23.7. Enter the Purchase Price in I24 and O248. Enter the
Sale Price in year 16 in I25 and O25.9. Enter the estimated fuel
price for each year in the column C32 through C46.The
spreadsheet will automatically compute: 1) The Discount Factor
for years 1 through 16, 2) The total fuel cost for years 1 through
15,3) total maintenance cost for year one, 4) total operating
costs for each year, 5) total net present cost per year, 6) total
available seat miles (ASM) for the 15 years,7) net present cost
per seat mile over the 15 year operating plan. The maintenance
costs for years 2 through 15 must be computed and
entered.ParametersMD-80 Operating Costs & StatisticsA-320
Operating Costs & StatisticsDiscount Rate =Gallons/Block Hour
=Gallons/Block Hour =Block Hours/year =Block Hours/year
=Maintenance Cost/Block Hour =Maintenance Cost/Block Hour
=Number of Seats =Number of Seats =Block hour Speed =Block
Hour Speed =Purchase Price =Purchase Price =Sale Price in
year 16 =Sale Price in year 16 =MD-80 capital and direct
operating costA-320 capital and direct operating
costYearDiscountFuel $/galMD-80FuelMaintTotal
AnnualNPVA-320FuelMaintTotal
AnnualNPVFactorPurchaseCostCostsOperatingPurchaseCostCos
tsOperating01.000000011.0000000000021.00000000031.000000
00041.00000000051.00000000061.00000000071.00000000081.0
0000000091.000000000101.000000000111.000000000121.0000
00000131.000000000141.000000000151.000000000161.000000
0Net Present Value Cost =0Net Present Value Cost =0MD-80
NP CASM =0.00000A-320 NP CASM =0.00000
Sheet2
Sheet3