MamB Airlines

Ramaswamy sat in his time one-roomed house (which he shared with seven
other people) in a slum off Prince Anwar Shah Road, preparing the business
plan of his proposed start-up, MamB Airlines, with the same business model
as Gupta Airlines. If his business plan showed that that the start-up would be
viableRamaswamy hoped for a better life. He had already identified a oneroomed house (that he only needed to share with six other people) in a slum
near Dum Dum, close to Kolkatta Airport where his start-up would be located.
Ramaswamy was being very careful with his money since he was the only
equity investor in MamB Airlines, with another Rs3 lakhs expected as a loan
from Saradha Finance, who would charge 20% per annum. The business plan
was also required by Saradha Finance. The loan from Saradha Finance would
be repaid in three equal annual installments. He hoped to get the loan and
buy the aircraft tomorrow, if he decided to go ahead.

The Gupta Airlines business model was simple. The Guptas (husband and
wife team) had bought an old aircraft no longer able to fly (it had no engines,
one wing was damaged, and most electronic equipment had been removed).
The plane was located within the boundaries of a small airport in Delhi.
Gupta Airlines ran several flights a day. Each flight mimicked a real flight.
Passengers were welcomed by a Gupta, and asked very politely to take their
seats. The same Gupta would then make pre-flight announcementsthe
usual fasten seat belts, keep the seat upright. Then the other Gupta in the
cockpit, would make jet-engine like noises, the plane would taxi and take
off. Refreshments would be served. The pilot would make the usual midflight announcement, and occasionally announce landing delays because of
fog and so on. The plane would land and passengers would disembark.
Almost all the passengers were happy paying Rs150 for a flight; most of
them had never flown earlier and did not expect to ever fly. For the record in
the year 2008, Gupta Airlines was perhaps the only profitable airline in India,
and also the safest.

Ramaswamys troubles began when he hired MamB as his first and only
employee. She insisted that the Airline be named after her. She was also
determined that she would be the captain and fly the aircraft; and she would
make all jet-engine like noises.

Ramaswamy planned to buy the aircraft for Rs10.00 lakhs from Spirited
Airlines. The aircraft was already in a distant corner in Netaji Subhas Chandra
Bose (Kolkatta) airport; and the airport authorities agreed to rent that distant
corner space to MamB Airlines at Rs1.00 lakh a year (payable at year-end)
for a three-year period. There was absolutely no likelihood that the rent
agreement would be renewed at the end of the three-year period.

The Companies Act allowed depreciation on aircraft at 16.2% WDV (writtendown value) or 5.6% on a straight line basis. The Income Tax Act allowed
depreciation on aircraft1 at a 40% WDV, on the cost of acquisition. While
Ramaswamy expected to sell the aircraft for Rs3.60 lakhs at the end of 3
years, this expected salvage value would not be allowed by the income tax
authorities to be deducted from the cost of acquisition while computing the
annual depreciation. Any capital gains or loss at the end of the three years
would be taxed at the normal income tax rate of 30%. The Income Tax Act
does not allow charging of depreciation in the year of sale of an asset.

Ramaswamy had earlier today (with the permission of the airport) built a
temporary shed that would be his office, at a cost of Rs1.75 lakhs. The entire
cost of the temporary shed could be written off as an expense (for tax
purposes) in the first year of operation. If it was decided not to go ahead with
the project, the shed could be sold immediately for Rs1.25 lakhs. There are
no tax consequences if such a sale is made. The shed will have no value at
the end of 3 years.

If the fare was set at Rs140 per passenger in the first year, Ramaswamy
expected 220 passengers to fly every day. He had originally forecast 250
passengers a day, but MamB had objected to flying potential passengers
who rode to the airport on bicycles. MamB Airlines would be unable/unwilling
to collect the fare from 20 passengers daily. These were very special
passengers, invited by MamB. Passenger would usually pay cash down, but
20% of the fare-paying passengers (identified by MamB, almost always
1 Ramaswamy had found out that the income tax authorities would accept his
acquisition as an aircraft despite its condition.

people dressed in green) would pay after 2 months. He expected to operate

300 days a year.

Food & beverage (F&B) would cost Rs80 per passenger. MamB Airlines would
keep a quarter-month inventory of F&B items, somewhat stale food was seen
as an important attribute of a genuine flight experience. F&B purchases are
made on cash basis.

On the other hand she wanted a salary of Rs20,000 a month. The basis for
this was her asking Ramaswamy, How much salary would you get if you do
not start your airlines but do identical work elsewhere? Ramaswamy in a fit
of honesty (that he later regretted) replied, Rs10,000 per month. That
settles it, said MamB, I am twice as good as you.
Ramaswamy checked and found out that although he was the owner, he
could legally claim a salary from MamB Airlines. But the amount had to be
reasonable or it would be disallowed by the income tax authorities.

Ramaswamy prepared his Year 0 and Year 1 cash flows, and then thought
about the future beyond the first year. F&B costs were expected to increase
at 20% annually; salaries were expected to increase at 12% annually. He
expected to increase the fare by Rs20 per passenger, annually. This would
not affect the number of passengers. No changes were expected in any other
item. He also found that he could earn 25% annually (nominal post-tax
return) on his capital from other businesses with identical risk.

When his business plan was ready, MamB turned up in her Nano. She was
clearly and loudly critical. The points she made, suitably censored were:
Ramaswamy had not treated the sunk cost of Rs1.75 lakhs correctly;
Ramaswamy should have calculated the interest amount on the loan on a
reducing balance (the correct amount according to her was Rs60,000 in Year
1, Rs40,000 in Year 2 and so on); Ramaswamy had failed to incorporate the
consequence of not providing free rides; that
Ramaswamy had not
accounted for F&B wastage20% of all the F&B bought would have to be
thrown away; she was also critical about the 25% cost of capital he was

usingfor if the Saradha Finance people are content with a 20% interest
rate, so should Ramaswamy; and finally she wanted Ramaswamy to factor in
any power paid for but not used.

She then had this idea of offering passengers who paid extra, other real
airline experiences. For instance she thought passengers would be willing to
pay Rs100 extra per flight for a lost baggage or a baby in the next seat
experience.

Ramaswamy managed to dissuade her from all such extras but at a

considerable personal cost. In-flight music was earlier supposed to be him
singing (he was rather vain about this), Ponnu Onru Kanden. But it would
now be MamB singing a Kabir Suman song, Ballad of a Chit Fund Agent.
But I thought you and he are no longer, said Ramaswamy only to find
that MamB had vanished. When he looked out of the window he could just
about read the Almost made in Singur sign on her car. Ramaswamy then
did a quick market survey of potential non-fare paying passengers. Even if
he did not give them free rides, they were very clear that there would be
absolutely no consequences, as long as they were treated like the other
passengers. Encouraged by this attitude, he agreed to provide free rides as
mentioned earlier. He double-checked the F&B wastage data. MamB was
indeed correct on this. He finally talked to Saradha Finance. They were
insistent that any working capital requirement be shown at the start of the
period (i.e. the requirement for the first year be shown at Year 0). They also
insisted that any projected income statement, cash flow or NPV, be reported
in Rupees lakhs using exactly two-decimal places. They advised that net
working capital be treated as liquidated at the end of Year 3.

Calculate the NPV of this project, as follows:

1. Prepare a forecast income statement
2. Prepare a statement of forecast net working capital
3. Prepare a statement of forecast book value of fixed assets and
accumulated depreciation
4. Prepare a cash flow for discounting purpose, and calculate the NPV