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Depreciation – Fact or Fiction?

Recently, we were taken to task by one of our friends who is an operator.


July 6, 2007
By Bill De Decker

Topics

216Recently, we were taken to task by one of our friends who is an
operator. He questioned the depreciation and the residual values we use
in the Helicopter Cost Evaluator and the Life Cycle Cost programs. His
point was that, for example, a 20-year-old helicopter will sell for
close to the same as the original purchase price, not the one third of
the original purchase price that we show. So, he argued, why worry
about depreciation?

Our
operator friend is of course absolutely right… and so are the values we
show. The difference is the point of view. There are basically two ways
of looking at depreciation and residual values. The first is how does
the resale value compare with what was originally paid for the
helicopter. That’s the point of view that is important when you are
financing or leasing an aircraft. Helicopters and aircraft in general
are quite unique in this respect, since a thirty-year-old helicopter
can be worth substantially more than its original selling price and
depreciation truly is not a factor.

The other point of view is
important if you are planning for future operations and want to know
what it will cost to replace your current helicopter with a like
machine at some point in the future. In that case, the focus is on the
resale value as a percentage either of the replacement cost or as a
percentage of the original purchase price adjusted for inflation. On
that basis, helicopters steadily lose value, as they get older, as do
all other pieces of transportation equipment and depreciation is a
vital part of long term planning.

To get a better understanding
of these numbers we analyzed the retail price histories for a variety
of helicopters, as shown in the current HeliValue$ Blue Book as well as
the Aircraft Blue Book Price Digest Helicopter section. Inflation used
in the analysis is based on the Consumer Price Index, as published by
the US Department of Commerce. And the new helicopter prices are as
published in our Helicopter Cost evaluator. The results of this
analysis are shown in Figure 1 (resale value as a function of the
original price) and Figure 2 (resale value as a percentage either of
the replacement cost or as a percentage of the original purchase price
adjusted for inflation).

Looking at Figure 1 shows that on
average, helicopters hold their value well and that beyond a certain
age, their value starts to increase. For example, while a 10-year-old
helicopter is worth about 65% of its original price, a 30-year-old
machine can be worth more than 140% of its original selling price!
There are a number of reasons for this startling trend. One reason for
the high prices for old helicopters could be that helicopters do not
yet have the serious regulatory noise problems (as is the case with old
jets). In addition, newer helicopters are not markedly more
fuel-efficient than the older ones, nor do they have significant aging
aircraft problems. Thus, a well-maintained old helicopter can be just
as cost effective as a new one. This, in turn helps maintain the price
of old helicopters (a good example of this is the Bell 205).

On
the other hand, not all helicopters maintain their value at the same
rate. Not surprisingly, the helicopters that have the highest residual
values are also the ones with a solid reputation for versatility and
profit potential. Helicopters in this category include the Bell 206L
and 407 series, the Eurocopter AS 350 series and the MD 500 series. One
group of helicopters that has a low residual value is the light twins
(BO 105, AS 355 and the older Agusta 109). The residual value for each
of these is well below the average. The obvious reason is a mismatch
between supply and demand. But the underlying reason is probably that
while these helicopters provide a larger margin of safety when an
engine fails, their payload and profit potential is not sufficient to
support their higher cost when compared with single engine competitors
of the equivalent size.

In Figure 2 we looked at the cost of
used aircraft as a function of their original purchase price adjusted
for inflation, as measured by the CPI and we looked at the cost of
helicopters as compared to their replacement cost. This is of course
the measure that counts when planning on the cost of replacing your
current aircraft. On this basis, helicopters steadily lose value as
they age. For example, a 10-year-old helicopter is worth about 55% of
its inflation adjusted or replacement value. A 20-year-old one is worth
about 35% and a 30-year-old one is worth around 25%.

The figure
also shows there is about a 10 to 15% difference between the residual
values based on the inflation adjusted original purchase price and the
residual value based on replacement cost. What this means is that the
replacement cost of a helicopter is higher than you would expect based
on the original purchase price adjusted for inflation. The reasons for
this are a reflection of the increased capability and equipment
installed in the replacement aircraft (even if it has the same model
number) and the increased regulatory burden on newer aircraft. Other
factors could include the increased cost of litigation, the demand for
greater warranties and the demand for better shareholder value.
Interestingly, the same difference between the two ways of calculating
resale value is also found in jets and turboprops.

What all this
means can be illustrated with the following example: Suppose you bought
a new light single engine turbine helicopter in 1986 for about $715,000
and you want to replace it this year with a new, like kind of machine.
Your 1986 helicopter will be worth about $575,000 on trade-in. This
equates to about 80% of what you paid for it and matches what Figure 1
indicates for a 20 year old machine at the high end. However, the new
helicopter will cost about $1,565,000. Put another way, the trade-in
value is about 37% of the replacement value (note that Figure 2
suggests a value of about 30% to 40%). In short, to replace your 1986
machine with a new one with like capability will require the old
machine plus $990,000. That equates to an effective depreciation of
about $50,000 per year or about $100 per hour if you are flying 500
hours per year.

How can you use this information? Well, when you
are talking to the bank about financing you talk about how these
aircraft really hold their value. On the other hand when you are doing
your cost analysis to get a good look at the rates you charge don’t
forget it takes $100 per hour to replace this machine in the future. In
short in the one case (talking to the banks) depreciation is not a real
factor. But if you are looking at the long term health of your
operation, depreciation is very real!


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