chapter  8
43 Pages

Airline capital budgeting

The airline industry is highly capital-intensive and it requires billions of dollars in capital investment expenditures to remain operational. In 2011, before filing for bankruptcy, American Airlines ordered 200 new 737s from Boeing and 260 A320s from Airbus, worth up to US$40 billion at list prices (that is, before large discounts to reflect the size of the orders), in a drive to refresh its fleet and reinvigorate the business. No less than $13 billion was provided by the two manufacturers in the form of “committed financing” through lease transactions. The process of allocating capital and determining the profitability of long-term projects is called “capital budgeting.” Airlines, maybe more so than many other industries, require substantial long-term capital expenditures for profitable, sustainable, and efficient business operations. Commercial airlines are faced with many potential capital investment projects, but limited financial resources, so decisions have to be prioritized. Not all of the potential investments available can or should be pursued immediately. Some may have to be delayed until later years; some may not be suitable to be pursued at all. Huge amounts of money can be easily lost if the investment turns out to be wrong or uneconomic, for example with only 20 aircraft built, the development of the Concorde was a major financial disaster.