north south airlines

7/27/2019 North South Airlines

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BACKGROUND OF THE COMPANY

Northern Airlines merged with Southeast Airlines to create the fourth largest U.S. carrier inJanuary 2008. The new North –South Airline inherited both an aging fleet of Boeing 727-300aircraft and Stephen Ruth. Stephen was a tough former Secretary of the Navy who stepped inas new president and chairman of the board. Peg Jones on the other hand is the vice president

for operations and maintenance.

DEFINE THE PROBLEM

Stephen’s objective is to gear the company’s financial perf ormance towards stability andcontinuous growth. This made him concern that the aging fleet of Boeing 727-300 aircraft’smaintenance cost may impede realization of this goal.

The significant difference in the reported B727-300 maintenance costs (from ATA Form 41s)both in the airframe and engine areas between Northern Airlines and Southeast Airlines madehim to probe through Peg Jones’ assistance on determining the quantitative and graphicalreport of the following :

Correlation of the average fleet age to direct airframe maintenance costs Linear relationship between the average fleet age and direct engine maintenance costs

CASE FACTS AND INFORMATION (INCLUDING LIMITATIONS & CONSTRAINTS)

In addition to the aging formulas below, Peg constructed the average age of Northern andSoutheast B727-300 fleets by quarter since the introduction of that aircraft to service by eachairline in late 1993 and early 1994 respectively.

TOTAL FLEET HOURS = TOTAL DAYS IN SERVICE X AVERAGE DAILY UTILIZATION

AVERAGE AGE OF EACH FLEET = TOTAL FLEET HOURS FLOWN# OF AIRCRAFT IN SERVICE

AVERAGE DAILY UTILIZATION = TOTAL FLEET HOURS FLOWNTOTAL DAYS IN SERVICE

In getting the average utilization, Peg used the actual fleet hours flown on September 30, 2007from Northern and Southeast data, and dividing by the total days in service for all aircraft at thattime. The average utilization for Southeast and Northern were 8.3 and 8.7 hours per dayrespectively. In addition, available cost data including the average fleet age were calculated foreach yearly period ending at the end of first quarter.



ALTERNATIVE APPROACHES TO SOLVING THE PROBLEM

Business asset depreciation depends on the cost of asset and its useful life. What is distinct aboutaircraft depreciation is that each component of an airplane is depreciated at different rates anddepreciation methods. The North-South Airline problem for this instance may also be resolved

by using depreciation methods as follows:

straight line with salvage value method = Asset Cost/ Useful Life

o The advantage of using the straight line method involves the ease of

calculating the annual depreciation amount. The disadvantage of

using the straight line method is that this method does not consider

the rate the asset will actually depreciate in value.

Declining balance method = Remaining Asset Value x Depreciation Rate

o The advantage of using this method is that it accelerates the depreciation

recorded early in the asset's life and thus reduces the taxable income and the taxes

owed during the early years. The disadvantage is that the method can be appliedonly when there is a residual value of the asset.

QUANTITATIVE METHOD/S EMPLOYED AND THE SOLUTION TO THE PROBLEM

Northern Airlines Data

AIRFRAME



ENGINE



Southern Airlines Data

AIRFRAME

Southeast Airline — airframe maintenance cost:

Cost = 4.60 + 0 (airframe age) = 4.60Coefficient of determination = 0.39

Coefficient of correlation = 0.62



ENGINE



Northern Airline — airframe maintenance cost:Cost _ 36.10 _ 0.0025 (airframe age)Coefficient of determination _ 0.7694

Coefficient of correlation _ 0.8771

Northern Airline — engine maintenance cost:Cost _ 20.57 _ 0.0026 (airframe age)

Coefficient of determination _ 0.6124Coefficient of correlation _ 0.7825

Southeast Airline — engine maintenance cost:

Cost __ 0.671 _ 0.0041 (airframe age)Coefficient of determination _ 0.4599

Coefficient of correlation _ 0.6782

ETHICAL CONSIDERATIONS

DEPRECIATION USED = SAFETY



The units of production method involves determining the cost to depreciate and dividing thatamount by the estimated production units the company expects to manufacture over the life of

the asset. The advantages of using the units of production method include the ease of calculating

the annual depreciation amount and that the depreciation is matched to the production quantity.The disadvantage of using the units of production method is that this method assumes the asset

will depreciate evenly over its productive life.

The graphs below portray both the actual data and the regression lines for airframe and enginemaintenance costs for both airlines.Note that the two graphs have been drawn to the samescale to facilitate comparisons between the two airlines.

Northern Airline: There seem to be modest correlations between maintenance costs andairframe age for Northern Airline. There is certainly reason to conclude, however, that airframeage is not the only important factor.

Southeast Airline: The relationships between maintenance costs and airframe age forSoutheast Airline are much less well defined. It is even more obvious that airframe age is notthe only important factor —perhaps not even the most important factor.

OVERALL CONCLUSION

Overall, it would seem that:1. Northern Airline has the smallest variance in maintenance costs, indicating that the day-to-day management ofmaintenance is working pretty well.

2. Maintenance costs seem to be more a function of airline than of airframe age.3. The airframe and engine maintenance costs for Southeast Airline are not only lower but morenearly similar than those for Northern Airline, but, from the graphs at least, appear to be risingmore sharply with age.4. From an overall perspective, it appears that Southeast Airline may perform more efficiently onsporadic or emergency repairs, and Northern Airline may place more emphasis on preventivemaintenance.

Ms. Young’s report should conclude that: 1. There is evidence to suggest that maintenance costs could be made to be a function ofairframe age by implementing more effective management practices.2. The difference between maintenance procedures of the two airlines should be investigated.

3. The data with which she is presently working do not provide conclusive results.

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