Southwest “Winglets” Case

Expected Future Cash Flow of Blended Winglet Project
The cash flow estimations for this project were based on assumptions gleaned from our engineering department, flight operations department, and facilities department. From our initial investment data, we assumed a winglet cost of $700,000 per aircraft, installation of $56,000 per aircraft, and an additional day of downtime for each aircraft at $5,000 per day. The total value of the winglet installation per aircraft was $761,000 which was depreciated over a 7-year modified MARCS depreciation schedule.

In addition to winglet installation, facility upgrade charges were deemed necessary by our Facilities Director. The final estimate for facilities
We calculated total debt, as of 31 December 2001, to be $4,624,486,000, as shown below.

TABLE 5: Debt Calculation (Dec 31, 2001)
Current Liabilities $2,239,185,000
LTD $1,327,158,000
Deferred Taxes $1,058,143,000
Total Debt $4,624,486,000

We then used total debt and total equity to find the weight of debt and weight of equity:

TABLE 6: Weight of Debt and Equity
Weight of Debt 0.2273
Weight of Equity 0.7727

wd = 0.2273 = $4,624,486,000/($4,624,486,000 + $15,722,280,000) ws = 0.7727 = $15,722,280,000/($4,624,486,000 + $15,722,280,000)

Based on Southwest’s marginal tax rate of 39%, we then used these weights and costs of debt and equity to calculate WACC = 6.291%.

WACC = (.0653)(.2273)(1-.39)+(0.7727)(0.069695) = 6.291%

However, we then adjusted this WACC to account for the potential changes in the weighted-average cost of capital over the lifetime of this long-term project by adding Southwest’s required 5% premium for long-term projects:

WACC + 5% return for long-term projects = 11.291%.

Thus, the relevant WACC for discounting the expected cash flows for the project is 11.291%.

Net Present Value of Blended Winglet Project

Based on the incremental cash flows calculated in Part I and the discount rate calculated in Part III, we find the net present value (NPV) of the Blended Winglet project as follows, based on possible changes in fuel