HONG KONG DRAGON AIRLINES LIMITED (B) Case Study Solution

Lease VS Buy Decision

Introduction

In 1985, a regional airline- Dragonair was founded in Hong Kong by a local businessman. Dragonair was providing regional passenger services and has twenty-one Airbuses along with three Boeing 747 for facilitating its customers. In its A320s and A321s Airbuses, a V2500 engines was placed which was manufactured by International Aero Engines AG. Dragonair currently had three spare engines but in 2002, the management recognized the need for a fourth Spare engine for the A320family fleet which should be purchased by 2007.In a day, a fleet operated a total of four cycles from one aircraft along with total of 7.83 flight hours(SU HAN CHAN & CO WANG, 2015).

Airbus has been formed by the merger of two companies and consisted over 14 aircraft models which includes A318 to the A380 models. However, the company was successfully managing its A320 aircraft family but unbale to provide timely delivery of its A380 aircraft. It has same operating procedures, same cockpit type along with same cabin cross-section and systems. IAE’s V2500 engines were used for powering A320 aircraft family.

In 1984, IAE (International Aero Engines AG) first introduce V2500 engines. It was formed in 1983 by merging five giant companies. The market share had been increased by 83% in 2002. Its engines were considered as the most reliable engines during maintenance procedures.

Problem Statement

In January 2006, Hong Kong Dragon Airline’s management recognized that one of its spare engines should be replaced by a new engine because it could not be repaired (“BER”).A taskforce has been formed in which Bevis Ho along with John Walters has to find various potential options to acquire a new engine and should come up with the final recommendations which should be based on qualitative as well as quantitative analysis(SU HAN CHAN & CO WANG, 2015).

Situational Analysis

Dragonair currently had three spare engines but in 2002, the management recognized the need for a fourth Spare engine for the A320family fleet which should be purchased by 2007. For the purpose of proper maintenance and proper operations, a spare engine is needed for replacing the existing engine.

Different Alternative Options’ Concepts

Dragonair was considering three potential options for acquiring a new spare engine. For this the team had made a complete qualitative and quantitative analysis to examine which option is best. All the three options have been discussed in detail to provide complete information.

Purchase Option

This is thesimplest appraisal method which requires only one-time upfront payment. In this, a total amount has to paid in cash at the time of purchase. Additionally, it carries only two transactions through out the period. First at the time of the purchase valuation when scrap value of old engine has been deducted for the price of new engine to evaluate Net present value. Secondly, it will require further timely maintenance cost for running the operations smoothly. In the case of Dragonair, a spare engine could be acquired by simply placing an order with IAE. In 2006, the price of V2533 is US$8.15 million and according to the policies it should be charged by 3% more to arrive at estimated escalated price(Pulletikurty, 2011).

Sale and Leaseback

Sale and leaseback refer to purchase an equipment by our self and then after purchase sale it to a leasing company which will further lease this equipment to you on lease policies. In the case of Dragonair, a spare engine could be acquired by simply placing an order with IAE. After that sale it to a lease company for making a leasing contract in back. It requiresa selling price; monthly lease rental rate is 0.8% along with paying maintenance reserves.

Operating Lease

Operating lease refers to acquire an equipment directly from a leasing company. In the case of Dragonair, the company has to make a leasing agreement with a leasing company. But according to the market search, it was analyzed that the market is unable to satisfy Dragonair’s requirement with regard to spare engine. At last, the leasing company will have to make a contract with IAE for satisfying Dragonair’s requirements.

Financial Analysis

A detailed financial analysis has been performed in order o gain sight about the best potential alternative solution. The analysis has been categorized under two parts and the net present value has been calculated to analyze which option is best………………………

 

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