The question rises. Is it an optimal choice to buy the 15 engines we require or is it better to lease them? And if we lease them, what should we have in mind?
When searching for lease contracts the most possible time for a problem to arise is not upon engine transport and provision or while the engine is at operation, but at the moment that the product is given back to the Lessor. Having flawless and pre-agreed lease return settings and arrangements is vital so we can empower the horizontal product transfer and return from Lessee back to Lessor. The application and management of these conditions can vary widely in the market place and as such are integral to the lease, it is important that both Lessor and Lessee have a clear understanding of what is expected from the outset
Initially, let us define what is meant by lease return conditions: Lease “return state of affairs” or “redelivery state of affairs” are the conditions specified upon deal signature that outline the state of the engine when the product is returned to the Lessor
Let us give some areas of focus regarding the characteristics of the engines that :
Minimum life remaining on LLPs (life-limited parts) (for example, no life-limited part should have less than 4,000 cycles of life).
Power Assurance (for example, must have completed successful on-wing take-off EGT –Exhaust Gas Temperature- margin as derived from take-off data.
Time since Performance Restoration Visit (for example, must have completed no more than 3,000 cycles since last performance restoration shop visit).
The cost of purchasing a Boeing 767 200 is estimated at around $160.2 million while the PW JT9D-7R4E engine is estimated to cost around $10 million so the combined cost is approximately $150 million dollars for purchase, while since this is a part of a deal with the secondary seller we estimate that the price could be dropped at $120-$130 million. The JT9D engine was slowly replaced by the newer, more silent and approximately 8% more efficient PW4000 engine and the last of them was manufactured at 1990 (while the last classically built Boing 747 was built at 1991 so this transition made sense). Studying the relevant literature we observe that leasing or renting is a preferable option for smaller and “younger” carriers since an aircraft’s –or an engine’s lifespan is around 30 years- and the costs for buying is optimal to be directed to expansion routes, marketing, advertising, or research and development purposes.
According an The Economist’s article, “Paul Sheridan of Ascend, an aviation consulting group, estimates that of the globe’s chief 4 owners of airline carriages, 2 operate as lessors: ILFC, with 1,031 planes and GECAS, with 1,732 planes, a lot higher compared to Delta and American Airlines. A great number of the plane manufacturers expanded order come from leasing firms that are estimating that demand for leased airplanes will keep growing.”
Lease vs. Purchase Example
Details for an engines purchase versus a lease instance are shown in the table below. The engines have an initial purchase price of $150 million, including technical extras, and will be utilized for 10 years though we will use a time horizon of 5 years for the purposes of that study, it is assumed operating costs (labor, fuel, and repairs) are the same in all cases and insurance and housing costs are the same as well. That is, these costs are the same whether the combine is purchased or leased.
Purchase Price $150 million
Down Payment 20%
Interest Rate 6.9%
Loan Length 5 years
Annual Payment $29,18 million
Salvage Value (in five years) $76,77 million
Book Value (in five years) $27,85 million
Lease Length 10 years (we calculate a time horizon of 5 years)
Annual Payment $19,84 million
Fixed and Variable Costs
Annual Insurance and Housing $1,05 million
Annual Repairs2 $1,2 million
Annual Labor (50 dollar labor/hr) $1,94 million
Annual Fuel and Oil $8,32 million
Marginal Tax Rate 46.8%
After-Tax Discount Rate 3.67%
Yearly insurance and housing costs are calculated as 1% of average market value of the engine. b) Yearly labor costs are established on yearly machine engine hours (267) times 110% a wage rate of $50 per hour. c) Yearly fuel and oil costs are established on fuel utilization of 30 gallons per hour and a cost of $2.9 per kerosene gallon.
Buy or rent? (2012, January 12). The Economist.
Kafka, S. W. (1977). JT9D Engine Diagnostics: Task II Feasibility Study of Measuring In-service Flight Loads. Retrieved April 19, 2015, from http://ntrs.nasa.gov/archive/nasa/casi.ntrs.nasa.gov/19780019181.pdf
Pratt & Whitney. (n.d.). Pratt & Whitney's JT9D engine opened a new era in commercial aviation: the high-bypass-ratio engine to power wide-bodied aircraft. Retrieved April 19, 2015, from JT9D ENGINE: http://www.pw.utc.com/JT9D_Engine
TES Aviation Group. (n.d.). Lease Return Conditions; Planning Ahead To Avoid Surprises. Retrieved April 19, 2015, from http://www.tes-uk.com/en/content/cms/media-centre/articles/lease-return-conditi/