Project 2

1. Project 2 Guidance on Southwest Airlines Strategic Profitability Analysis

2. Reasonable Grading Policy • No penalty for a few differences in income statement numbers if you got them from a reasonable source. • To ensure credit, insert comments in column headings or individual cells. For example: “In this column, the numbers for the 200x income statement came from the 200x 10-k statement, downloaded from Southwest.com” or “See p. xxx of the Southwest 10-k for Dec. 31, 2006, available at http://southwest.investorroom.com/sec-filings” • The income component calculations, which should add up to the annual differences, are most important.

3. Revenue Effect of Growth = Actual Units of Output Sold in the Current Period _ Actual Units of Output Sold in the Prior Period X Prior Period Selling Price Revenue Effect of Growth Effect of growth upon revenue if price were unchanged.

4. Revenue Effect of Growth = Revenue Passenger Miles in the Current Period _ Revenue Passenger Miles in the Prior Period X Prior Period Revenue per RPM Revenue Effect of Growth--SWA Note: Revenue Passenger Miles (hereafter RPM, is the activity level.

5. Cost Effect of Growth for Variable Costs = Units of Input Required to Produce Current Output in the Prior Period _ Actual Units of Input Used to Produce Prior Period Output X Prior Period Input Price Cost Effect of Growth for Variable Costs Change in inputs assuming last period’s efficiency and price.

6. Cost Effect of Growth for Salaries/wage expense = (2004 RPMs/2003 RPMs)* (Number of Employees, end of last year) _ (Number of Employees, end of last year) X Salaries/Wage Expense per EE Cost Effect of Growth for Variable Costs—SWA-- Salaries/Wage Expense Note: RPM is Revenue Passenger Miles, the activity level.

7. Cost Effect of Growth for Fuel, Commissions, Landing Fees = (2004 RPMs/2003 RPMs)* (Number of Trips Flown) _ Actual Units of Input Used to Produce Prior Period Output X Fuel, Commn, Landing Fees and Other Rentals Expense per Trip Cost Effect of Growth for Variable Costs—SWA--Fuel, Commissions, Landing Fees Note: RPM is Revenue Passenger Miles, the activity level.

8. Cost Effect of Growth for Fixed Costs • Assuming adequate current capacity: Note: This is zero assuming there was enough capacity last period to have produced this period’s output. If not, calculations are “beyond the scope of the book.”

9. Cost Effect of Growth for Fixed Costs--SWA • I threw you something of a curveball here, because we did not cover situations where capacity requirements are increasing. • The equation for cell C45 is: =(((C13/B13)*B31)-B31)*B28 • That is, use the same method as for the variable costs.

10. Revenue Effect of Price Recovery For Southwest, the prices are Revenue per RPM, and the units sold are RPMs.

11. Cost Effect of Price Recovery • Variable costs: Input prices are annual salaries for employees; Fuel, Commissions, Landing Fees and Other Rentals Expense per Trip for trips flown; Maintenance, Aircraft Rental, Depreciation, Other Expenses per Aircraft Seat for Estimated capacity in aircraft seats

12. Cost Effect of Price Recovery--SWA • Input prices are: • annual salaries--for employees; • Fuel, Commissions, Landing Fees and Other Rentals Expense per Trip--for trips flown; • Maintenance, Aircraft Rental, Depreciation, Other Expenses per Aircraft Seat--for Estimated capacity in aircraft seats • Moreover, here is the formula for cell C56: • =(C28-B28)*((C13/B13)*B31)

13. Cost Effect of Productivity for Variable Costs Inputs used compared to what would have been need at last year’s usage rate, times current price. Note similarity to labor and material efficiency variances.

14. Cost Effect of Productivity for VC--SWA “Number of employees” is one input. To get units required last period, multiply last period’s requirement by (This year’s RPM)/(Last Year’s RPM). The other two “inputs” (p. 541) are flight departures (or trips) and aircraft seats. Treat them the same way.