Question

suppose an airline buys a new boeing 737 airplane to start a daily return route between california and florida. in year 1, the plane costs them $90 million. over the life of the plane, they expect to pay $50 million in other costs (such as fuel and crew) and make $200 million in revenue. in year 2, after a year of operating the flight, a rival airline starts flying the same route. the expected revenue on the route over the life of the plane falls to $120 million. the plane can be sold used for $80 million. the remaining other costs are $48 million. a) what was the economic cost of starting the route? did it make economic sense to start operating the route in year 1? b) what is the economic cost of operating the route in year 2? does it make economic sense to continue operating the route? regardless of your answer to part b, the airline decided to keep operating the route. in year 3, there is a downturn in the airline market. the expected revenue over the life of plane falls to $100 million. at the same time, the market for used planes is in a slump, and now the plane can only be sold for $10 million. the remaining other costs are $46 million. november 8th, 2023 kym pram c) what is the economic cost of operating the route now? does it make economic sense to continue operating it?

Answer 1

a) The economic cost of starting the route in year 1 is -$60 million, so it does not make economic sense to start operating the route. b) The economic cost of operating the route in year 2 is -$72 million, so it does not make economic sense to continue operating the route. c) The economic cost of operating the route in year 3 is -$54 million, so it does not make economic sense to continue operating the route.

Step-by-step explanation:

a) To calculate the economic cost of starting the route, we need to consider the initial cost of the airplane ($90 million), other costs over the life of the plane ($50 million), and the present value of the expected revenue ($200 million). We can then subtract the present value of the expected revenue from the sum of the initial cost and other costs. So, the economic cost of starting the route is:

Economic cost = Initial cost + Other costs - Present value of expected revenue

= $90 million + $50 million - $200 million = -$60 million

Since the economic cost is negative, it does not make economic sense to start operating the route in year 1.

b) To calculate the economic cost of operating the route in year 2, we need to consider the remaining other costs ($48 million) and the present value of the expected revenue ($120 million). We can then subtract the present value of the expected revenue from the remaining other costs. So, the economic cost of operating the route in year 2 is:

Economic cost = Remaining other costs - Present value of expected revenue

= $48 million - $120 million = -$72 million

Again, since the economic cost is negative, it does not make economic sense to continue operating the route in year 2.

c) To calculate the economic cost of operating the route now (year 3), we need to consider the remaining other costs ($46 million) and the present value of the expected revenue ($100 million). We can then subtract the present value of the expected revenue from the remaining other costs. So, the economic cost of operating the route now is:

Economic cost = Remaining other costs - Present value of expected revenue

= $46 million - $100 million = -$54 million

Once again, since the economic cost is negative, it does not make economic sense to continue operating the route.