Aircraft and engine economic evaluation for fleet renewal decision-making and maintenance contract valuation

Abstract

The fleet acquisition process represents a major gamble for airlines and aircraft leasing companies due to the fixed assumptions made when business plans are laid out and the abundance of uncertainties both at the technical and market levels. Indeed, the evaluation of aircraft and engine acquisitions is riddled with uncertainties regarding the product development (development schedule), the economic performance of the assets once in operations (operating cost), and the demand for air transportation. The trend in recent years has been for original equipment manufacturers to offer contracts and guarantees during sales campaigns that limit the exposure of airlines to technical uncertainty and that shift some of the operating risks from the airlines to the manufacturers. Airlines have embraced these “power-by-the-hour” maintenance contracts because they offer a way to mitigate operating risks and to anticipate cash outflows. Estimating the fair value of these contracts is paramount due to the significant risks faced by companies underwriting them. At the same time, valuing them is a daunting task due to the uncertainty regarding maintenance costs and their sensitivity to both the operations and the operating environment. Traditional evaluation methods are not always well adapted to perform these evaluations as they do not capture the problem in its entirety and they tend to oversimplify by using generic routes and surrogate models. This paper simultaneously proposes a customer-centric methodology to properly evaluate long-term aircraft and engine investments and a real-options inspired methodology to value long-term maintenance contracts and manufacturer guarantees.