Case 23: Southwest AirlinesCapital Budgeting: One Project - Accept/Reject DecisionThe airline industry is extremely cyclical. That is, when the economy does well, so too do airlines. In recent years, the airline industry has found itself with too many seats and too few passengers. Some experts point to the pastderegulation of the industry while others argue that technological advances such as teleconferencing are responsible. Several airlines such as Continental, America West, astern, and Trans World Airlines, have filed for Chapter !! "an#ruptcy. Some have fully recovered, while others have been forced to li$uidate %Chapter &'. (arrowing profit margins have prompted airlines to develop creative survival tactics.Southwest Airlines has successfully found its niche in the industry by providing direct flight service to less traveled routes such as those to and from smaller cities. Since these routes do not generate nearly as much revenue as ma)or city routes, Southwest has found ways to reduce its costs. Costs are reduced by following a no frills policy that the travelers refer to as *peanut flights.* This means that instead of serving costly meals %the $ualityof which passengers have historically complained about anyway', Southwest serves )ust a bag of peanuts and a soft drin#. With the recent success of short, direct flights, Southwest is considering the purchase of one such additional route."efore an airline applies to the federal government for a new route, a lengthy analysis is performed to determine the feasibility of the route. xpenses to consider include airport costs such as gate and landing fees andlabor costs such as local baggage handlers and maintenance wor#ers. +any times the airline will provide its own employees to load and unload luggage or to provide up#eep for their planes, but in the case of Southwest, they have so many small cities to service that the outsourcing of these )obs is notuncommon.Table ! provides a summary of the after,tax cash flows associated with the ac$uiring of an additional small route. All costs and revenues are reflected by the following numbers.a!le "Projected #et Cash $lows %in &illions o$ Dollars'Year Net Cash Flow0 -$20.81 $4.52 $6.33 $5.24 $3.95 $2.16 $1.37 $0.5The initial costs of the venture %i.e. year -' reflect the expenses involved with moving employees, .AA filing fees, the initial offering of low fares in order to gain customers, and the high advertising costs necessary to ma#e the public aware of the new route offering.(uestions!. What is the pro)ect/s (01 assuming Southwest has a discount rate of !-23 4ow do we interpret the (0135. What is the pro)ect/s I663 4ow is this measure different from the (013What is the interpretation of this number37. Calculate the pro)ect/s 0aybac# 0eriod.8. Assuming that Southwest has a re$uired paybac# period of 9 years and a hurdle rate of !-2, should Southwest accept the additional route3 "ased on the pro)ect/s (01, should it be accepted3 If conflicting conclusions occur, which criteria would you follow39. When will conflicts li#ely occur among the three criteria3:. Calculate the pro)ect/s +odified Internal 6ate of 6eturn %+I66'. What critical assumption does the +I66 ma#e that differentiates it from the I663&. Where does the value of +I66 fall relative to the discount rate and I663