Investment appraisal – Sensitivity testing

In the third edition of Buying The Big Jets you may recall Figure 9.18 in Chapter 9, covering investment appraisal. This chart is called ‘A Sensitivity Test’ in the book. Informally, I prefer to call it ‘The Flying Carpet’. As the book is printed in black and white, it is not so easy to track the various lines. Here is the colour version, which you may download. The different colours of the grid make it easier to see where you are on the various axes.

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The Flying Carpet is actually an Excel surface chart. This allows us to test the predicted operating margin for Air Ballistic of the APT300 aircraft on the Washington to Dublin route according to different combinations of fuel price and yield. The range of fuel prices is $2.5 up to $3.5 per gallon and the range of yields is from 0.1 cents to 0.11 cents. A coincidence of low fuel price and high yield might be expected to generate a 14% operating margin, shown as Point A in the chart. Conversely, a high fuel price and low yield would result in a minus 5.5% margin, shown as Point B.

The thick black dotted lines and arrows show an example. If fuel price were $2.9 and yield 0.107 cents, then the expected operating margin would be 8%.

Many different pairings of input could be tested in this way. A more complex sensitivity would test input changes against the NPV of the investment, rather than the operating margin on a single route. Testing aircraft pricing would be a good way for the aircraft manufacturer to get a feel for how far they might be prepared to go in a price negotiation.