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Delta assignment

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Delta Case - Finance, Financial Calculations Delta Airlines

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Delta assignment

  1. 1. Q1. Calculate the annual depreciation expense that Delta and Singapore would record for each $100 gross value of aircraft. (a) For Delta, what was its annual depreciation expense (per $100 of gross aircraft value) prior to July 1, 1986; from July 1, 1986 through March 31, 1993; and from April 1, 1993 on? (b) For Singapore, what was its annual depreciation expense (per $100 of gross aircraft value) prior to April 1, 1989; and from April1, 1989 on? Ans. Delta Airlines always followed a Straight Line depreciation policy. So, annual depreciation expense, for $100 value of gross aircraft is given as Depreciation expense = (Cost – Residual Value)/Asset Life (i) Prior to July 1,1986 Residual Value = 10% of Cost Asset Life = 10 years Depreciation Expense = ($100-$10)/10 = $9 (ii) From July 1, 1986 through March 31, 1993 Residual Value = 10% of Cost Asset Life = 15 years Depreciation Expense = ($100-$10)/15 = $6 (iii) From April 1, 1993 onwards Residual Value = 5% of Cost Asset Life = 20 years Depreciation Expense = ($100-$5)/20 = $4.75 (b) Singapore Airlines also followed the Straight Line depreciation method and thus the same formula can be used here also (i) Prior to April 1,1989 Residual Value = 10% of Cost Asset Life = 8 years Depreciation Expense = ($100-$10)/8 = $11.25
  2. 2. (ii) From April 1, 1989 Residual Value = 20% of Cost Asset Life = 10 years Depreciation Expense = ($100-$20)/10 = $8 Q2. Are the differences in the ways that the two airlines account for depreciation expense significant? Why would companies depreciate aircraft using different depreciable lives and salvage values? What reasons could be given to support these differences? Is different treatment proper? Ans. Even though both airlines follow the Straight Line method, there is a significant difference in the salvage value (5% for Delta and 20% for Singapore) as well as the depreciable life (20 years for Delta and 10 years for Singapore), so we can say that there is a significant difference in the ways that these two airlines account for depreciation. Different airlines have different needs and methods of operation. Based on this, they will depreciate their aircraft using different depreciable lives and salvage values. In the current case, Delta Airlines was suffering from huge losses in 1993 and thus, they wanted to reduce their expenses as much as possible. The depreciation expense could be reduced considerably by increasing the asset life of the aircraft, which is exactly what they did. On the other hand, Singapore Airlines was in good economic health and could afford higher depreciation expense. It is also possible that Singapore Airlines want to resell their aircraft and thus had a shorter asset life while Delta Airlines plan to use their aircraft for a longer period and then discard them.
  3. 3. We should also note that Singapore Airlines has a higher capacity utilization rate (71.3%) and average miles per passenger (2720 miles) as compared to Delta Airlines (62.3% and 969 miles). Due to the higher utilization, Singapore Airlines might have taken a lower asset life. As long as the companies follow the accounting standards, the different treatment is proper because the depreciable life and salvage value differ for each company based on its needs and operation policies. Q3. Assuming the average value of flight equipment that Delta had in 1993, how much of a difference do the depreciation assumptions it adopted on April 1, 1993 make? How much more or less will its annual depreciation expense be compared to what it would be was it using Singapore’s depreciation assumptions? Ans. Average value of flight equipment owned by Delta in 1993 is: ($9,043 + $8,354)/2 + $173 = $8872 million Difference due to new depreciation expenses: $8872*($6 - $4.75)/$100 = $111 million Delta’s depreciation expense is less than what would be by Singapore’s method by amount: $8872*($8 - $4.75)/$100 = $288.4 million Q4. Singapore Airlines maintains depreciation assumptions that are very different from Delta’s. What does it gain or lose by doing so? How does this relate to the company’s overall strategy? Ans. Singapore Airlines is currently making good profits so it can afford to have high depreciation expenses. It stands to gain that in the future it can show much less
  4. 4. depreciation expense. Also, it will have a much depreciated asset later which it can sell to make larger profits at a later stage. The company can also save on taxes by showing higher expenses. The loss of doing so is that the company will show lower net revenue and the profit will also decrease as a result. The company’s overall strategy involves selling used aircraft at relatively higher prices after using them for a shorter period. This is supported by Exhibits 1 and 5 of the case which show Delta’s annual book gain on the sale of flight equipment during 1989-1993 was about $30 million, whereas Singapore’s average annual book gain on the sale of flight equipment was $74 million (after adjusting exchange rate). As a result, the company can buy new aircraft regularly. The average age of aircraft for Singapore Airlines is only 5.1 years as compared to 8.8 years for Delta. Purchasing new aircraft like the Boeing MEGATOP 747-400 regularly helps Singapore Airlines in providing better customer satisfaction. Exhibits 3 and 7 show that while Delta has no MEGATOPs, Singapore Airlines has 18 of them. Due to these reasons, Singapore Airlines follows a different strategy than Delta’s. Q5. Does the difference in the average age of Delta’s and Singapore’s aircraft fleets have any impact on the amount of depreciation expense that they record? If so, how much? Ans. No, the difference in the average age of Delta’s (8.8 years) and Singapore’s (5.1 years) aircraft does not have any impact on the amount of depreciation expense they record. This is because they both use the straight line method for recording depreciation and in this method, the depreciation expense is dependent only on the initial cost, salvage value and the depreciable life of the asset and not on the current age of the asset. However, we should take care not to depreciate an asset after its depreciable life is over.

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