Operating Cost/hour The main assumption to work upon the scenarios is that the numbers generated for the different variables remain the same across the years. Initially, a base scenario is built and a profit-and-loss account for a typical year of operation is derived using the most likely values of the different parameters. Upon construction of the base scenario, the optimistic and pessimistic scenarios are also formulated in accordance to the assumptions by the President in respect to possible variations to higher and lower values than the most likely ones used for the base scenario.
For all three scenarios, the demand/cash flow is calculated revealing a wide range of values (from €273. 180 to -€39. 040) among the 3 possible cash flows. In addition, the one-way sensitivity analysis conducted for all six uncertain parameters demonstrate the impact of each parameter on annual cash flow and by the designation of a scatter plot, we can identify to what range of values every uncertain parameter affects the demand. Upon that, a Tornado diagram is plotted in order to visually demonstrate the range of impact of each parameter.
According to the diagram, ticket prices/hour and capacity of Scheduled flights seem to be the two important parameters that most influence the annual cash flow, whereas the ratio of charted flights and operating cost/hour are the ones affect the least. Following this determination, a two-way sensitivity analysis is implemented and the outputs shown in a 3D plot illustrate a one-level relationship between the variables. By assuming that the probability distributions are the ones assessed by Mr. Hadjistelios, a test scenario is run using the @RISK add-in with 50. 00 iterations and the results’ interpretation is described below. Interpretation of results The basic data and the main decision factors to be taken into consideration by the President are raised below in order to provide substantial argumentation for the final business decision. ? According to the given data, the annual cash flow of the base scenario is €46. 184, less than the breakeven point by €7. 513. Therefore, in case the base scenario will actually happen, the company will need more than a 5-year lifetime in order to pay out the investment of the new aero plane. In the optimistic scenario, the annual cash flow is €273. 180 and the difference from the breakeven point is €219. 483. According to this scenario, the investment is highly profitable and will be paid off by the end of the first year while a number of approximately €93. 180 profits will be generated. ? In the pessimistic scenario, the annual cash flow is - €39. 040 and the difference from the breakeven point is €92. 737. , which is a bad scenario but at the same time quite unlikely to happen. According to @RISK analysis, as illustrated in the figure below, some important observations are derived; [pic] The probability that the investment will be profitable within a 5-year lifetime is 73. 4%, meaning that the annual cash flow will be greater than the breakeven point of €53. 697. ? The probability the annual cash flow to be less than the breakeven point is 26. 6%, as presented in the graph above. ? However, it is important to refer that the same probability (26. 6%) applies for the company to generate cash over €96. 511. The above implies the fact that if in one year the cash flow is below breakeven point, this under the same probability can be offset by another year’s revenues. [pic] According to the normal probability distribution, the expected value (mean) is approximately €77. 342 that actually is translated into a €23. 645 return on investment. ? A probability over 50% that the company will generate cash flow of at least €74. 467 (median) which represents the 40% of the aeroplane current value. ? However, another important statistical parameter to be taken into account is the standard deviation of €35. 257 that describes a quite wide dispersion/variability of the probability distribution. ? If we do not take into consideration the discount rate of 15%, then the breakeven point will be 36. 00 (180. 000/5) and the probability of the investment to be profitable is 89%. ? In case the company self-funds the purchase out of the cash surplus of the company, the investment seems to be less risky since potential deviation from the breakeven point does not imply financial obligations to third parties, such as banks (loans and interest rates). [pic] ? The probability that the investment will be paid off already by the end of the first year is 0. 7% while the probability that the company will generate negative values by the end of the first year is 0. % which seems a quite extreme case, with a smallest value of -€22. 642. [pic] ? However, it should be considered that the company operates a number of business parts and it is being taxed for the total activities as a whole, thus with a tax rate of 33% the actual loss will be €22. 642 * 0. 67 =€15. 170, with the assumption that the company is profitable overall. Another important factor to consider is the operations’ expansions by 33% with the purchase of one additional aircraft to the current equipment of the three twin – engine aircrafts which provide charter flights and scheduled commuter services.
The company may redefine the strategy and decide to add new destinations in the services, currently limited to south Balkans, so as under the promising prospects analysed above, to further strengthen the company’s brand name and grow the Share of Market (SoM). The above can be well justified considering both cases of charter and scheduled flights. On the one hand, in respect to charter flights the company seems to have already identified available ground to grow by further building on the level of service.
On the other hand, the scheduled flights, currently holding a percentage of 60%, represent the variable that mostly affects the cash flow, according to Tornado diagram. This in combination with the fact that the company "had slightly more control over the ticket price per/hour of scheduled flights" demonstrates a high future development potential with a thorough strategy. The critical service category in the context of the new investment risk analysis for Eagle airlines to analyze is Scheduled flights.
Ticket prices/hour and capacity of Scheduled flights, the two most important and correlated variables, should be in depth evaluated according to the most likely possible estimations. For example, according to the data given, the variability for the price per ticket is greater in the higher values than the lowest ones. However, the actual price per ticket is highly correlated to the capacity/utilization rate and the flight hours. The base scenario argues for good prospects, but a deeper analysis could identify opportunities that Eagle airlines should closely monitor and evaluate in order to maximize its profits.
It is important also to refer that according to the estimations, there is no high variability of the operating costs compared to the expected value of €445/hour (only €15 in either direction). Some important facts are given also throughout the case providing additional argumentation over the purchase; Piper Chieftain has been maintained according to the legislations and regulatory environment, is in a good condition and the expected normal use is 5 years with possibilities for more, contains the necessary navigation and communication equipment, and insurance has been included in the fixed costs.
The above, in case were unknown, would be important cost factors to analyze and include in the risk analysis assessment. The above analysis argues the business decision to proceed with the investment in the Piper Chieftain, having calculating and evaluating the risks involved while recognising the opportunities.