Real option analysis of aircraft acquisition: A case study

Abstract

This paper demonstrates that aircraft acquisition by airlines may contain a portfolio of real options (flexible strategies) embedded in the investment's life cycle, and that if airlines rely solely on the static NPV method, they are likely to underestimate the true investment value. Two real options are investigated: i) the “shutdown-restart” option (a carrier may shutdown a plane if revenues are less than costs, but restarts it if revenues are more than costs), and ii) the option to defer aircraft delivery. We quantify the values of these options in a case study of a major U.S. airline. The economic insight could help explain observed capital expenditures of airlines, and serve as a rule of thumb in evaluating capital budgeting decisions. A compound option (consisting of both the shutdown-restart and defer options) is also analyzed.