Case 3: Zirgin Atlantic Airlines

Introduction
36

Problem Statement Narrative

The CEO of Zirgin Atlantic Airlines, Richard Branford, is considering starting a new direct airline route from London to Montreal. Zirgin currently runs flights in
and out of both cities (as well as other cities globally) but not directly between the two cities. The company is currently at maximum capacity on their existing
jets so any new route would require the use of a brand new airplane.

Zirgin Atlantic operates a flat pricing structure for its customers and would like to charge all passengers $500 for a round trip flight on this route ($250 for a
one-way ticket). Luckily, Zirgin Atlantic’s strategy group has already conducted preliminary research and has discovered that in this current environment, this
pricing could likely draw an average of 200 round trip passengers every day for the company.

Branford has approached us to recommend whether or not to open this new route for the company. If we do decide to go forward with the route, he only wants
to use one incremental airplane in order to avoid being over capitalized.

Zirgin Atlantic operates flights around the world and this new route would be a small addition to its global network. In addition, Zirgin Atlantic is a subsidiary of
Zirgin, a global conglomerate that also operates in the media and entertainment industry. However, Branford has wanted to provide direct transportation to
London for business people in Canada for some time. As a benchmark, the company targets a 6 year payback period on its investments.

Overview for Interviewer Information to be Provided Up Front

This case has three main components. First is the stand-alone economics of opening up The problem statement gives some initial information.
this new airline route by purchasing a new plane. The interviewee will be asked to The rest of the information should be given as the
calculate a payback period and compare this to the company’s target payback period. interviewee works through the problem. The actual
numbers should make for fairly straightforward
Second, the interviewee will be asked to consider an alternative financing scenario calculations. The data assumes that prices, demand, and
where a plane is leased instead of purchased. He/she will evaluate the economics of this costs stay the same year after year so no need to
scenario and to provide thinking on the benefits/drawbacks to leasing versus buying. consider growth or inflation. All the costs are also bundled
into a generic variable / fixed split to make calculations
The third component is qualitative and asks the interviewee to consider upside catalysts easier.
and downside risks of opening the new airline route.
 Case 3: Zirgin Atlantic Airlines
Introduction
37

Part 1: If Zirgin decides to purchase one new plane to be used exclusively for the new route, does this investment meet Zirgin Atlantic’s corporate
investment criteria? Assume that demand, pricing, and costs stay the same year after year, and that a new plane has a useful life of 25 years.

Revenue Questions / Answers

Information to provide: Optional mini-questions:
Daily passengers = 200 round trip passengers (or 300 one-way) 1.  Why would the days operational per year be 300
Avg ticket price = $500 for round trip (or $250 for one-way) days instead of 365? It is impossible for planes to
Days operational / year = 300(1) be utilized all the time due to controllable factors
(scheduled maintenance) and uncontrollable
Calculation: factors (weather).
Daily revenue = Daily passengers * Average ticket price = 200 x $500 = $100,000 2.  What are some examples of variable costs for
Annual revenue = Daily revenue * days operational/year = $100,000 x 300 = $30M this case? Fuel, on-board labor, food/drinks
3.  What are some examples of fixed costs for this
Expensed Costs case? Gate fees, terminal labor, insurance

Information to provide: Main question:

Average variable costs(2) = $40,000 for a round trip flight Does the investment meet Zirgin’s corporate
Fixed costs (excluding price of plane)(3) = $3M / year investment criteria? Yes, on a standalone economic
basis, purchasing a new plane should generate a 5
Calculation: year payback period assuming no growth/decline in
Annual variable costs = Cost / round trip * Days operational = $40,000 x 300 = $12M demand or in pricing. This is below the company’s
Total annual costs = variable costs + fixed costs = $12M + $3M = $15M target of a 6 year payback. The useful life factors into
this analysis because, in order for the service to
Payback Period
continue, the company will have to buy a new plane in
Information to provide: 25 years. However, since this useful life is fairly long,
Cost of purchasing a new plane (capital investment) = $75 the route will payback the initial investment 5x before
a new plane is required.
Calculation:
Payback period = Capital investment / Annual profit = $75M / $15M = 5 years
 Case 3: Zirgin Atlantic Airlines
Introduction
38

Part 2: Richard Branford comes back and tells you that instead of buying a new plane, the company can also lease a plane
$12M a year, renewable at the same cost year after year in perpetuity. Do you think the company should pursue this new
route with this lease? Assume that demand, pricing, and costs stay the same year after year.

Annual Profit
Information to provide:
Annual cost to lease a plane = $10M

Calculation:
Annual profit = Annual profit excluding lease costs – annual lease costs = $15M - $10M = $5M

Questions / Answers
1.  Is leasing a new plane economically profitable for Zirgin Atlantic? Yes. If Zirgin decides to lease a plane, then they will generate a profit of
$5M a year without having to buy a new plane.

2.  What are the financial and risk implications of buying a new plane versus leasing a plane? If Zirgin buys a plane, the company needs to
invest $75M in order to generate $15M a year, or $375M total over the 25 year useful life of the plane. On the other hand, if the company leases
a plane instead, then the company generates $5M a year without the heavy initial investment. Just looking at pure numbers, the company will
generate a lot more overall profit in a long period of time by buying a new plane. However, buying a plane also encompasses more risks. First,
the purchase of a new plane increases the PP&E/asset base of the company, which some investors may be wary about. Second, if the company
buys a plane and the route ends up being unsustainable, then the company needs to resell the plane or use it for another route. Leasing a plane
presents a much more attractive exit option. Third, buying a plane requires significant initial capital and depending on the financial strength of the
company, Zirgin may want to conserve this capital for other means. This capital can also be used for other projects that may generate even
better returns.
 Case 3: Zirgin Atlantic Airlines
Introduction
39

Part 3: It seems like based on your analysis and the assumptions used thus far, it is financially attractive to open up this new
route. Aside from the pure economics of the route, what are some other potential upsides and risks to the plan?

Potential Upside (among others) Potential Risks (among others)

1.  Increase exposure / marketing: Even if the route was not
financially attractive on a standalone basis, opening up a new direct
route between cities could generate exposure for the Zirgin brand,
especially because of Branford’s desire to increase the company’s
presence in Canada.
2.  Synergies with other routes: The new route may provide both
revenue and cost synergies when combined with existing
operations. On the revenue side, a new direct route could mean
new alternatives for transferring passengers (which could mean
additional demand for other routes). On the cost side, the new route
can share administrative and labor costs with existing operations.
1.  Cannibalization: The case mentioned that Zirgin already operates
flights in and out of Montreal and London. Opening a direct route
between the two cities may cannibalize customers that already
make a similar trip (with stops or between nearby cities)
2.  Competition: Entering this new route invites competition from other
airlines, especially among those with similar routes
3.  General airline industry risks: There are inherent risks in the
airline industry including high sensitivity to consumer spending
levels, large fluctuations in energy costs, administrative risks
associated with doing business on a multinational level, etc
 Case 3: Zirgin Atlantic Airlines
Introduction
40

Part 4: You run into Richard Branford in the elevator as he is on his way to a meeting. He knows that you haven’t completely
finished your analysis yet but he wants a quick 30 second update on what your recommendation is.

Recommendation
The new proposed route seems attractive for Zirgin Atlantic. The economics appear most
favorable if the company buys a new plane, but depending on the capital situation and risk
tolerance of the company, the rental option is also financially viable. We should of course
view this in relation to other opportunities that the company is investing. There are also
risks to consider including how the new route will impact competition and existing Zirgin
operations. However, given the good economic implications of this opportunity, my
recommendation is to pursue the new route.