Originally Posted by PhilH
OK, putting my accountant's hat on...
If you pay an amount up front for life, the value of this to the airline is the total return it would earn on it over its lifetime. Now, say we take AA's $3m as an example. AA would invest this money into its business. Now say AA's cost of capital is (and I'm taking a bit of a stab in the dark here, but its not totally out of the bounds of possibility) 7%. Now, the total value of a one-off payment of $3m today to AA is $3m/7% = $42.8m. Wow.*
So, as some others have contributed already, that means only a total idiot would fly with AA. Ooops, er, I mean only a total idiot would pay $3m to fly with AA in F for life. Much better to put the money in the bank and pay for your F flights as and when you take them with the interest.
My very (very!) rough back of fag packet calculations indicate that you would have to take 80 return flights in F every year (that's one and a half a week) at say $5,000 a time to make this worthwhile** (including inflation at 3%). That's over 50 years by the way. AA are on to such a winner here, they must be laughing all the way to the bank.
PhilH
* What this total represents is the net present value (i.e. the value in today's money) of all the future in-flows of cash that AA will earn on this $3m if they were to keep it forever. Obviously the further into the future you get, the smaller the present value of future cash flows becomes, because of inflation. £100 tomorrow is better than £100 in 100 years. In 100 years, £100 will probably buy you only a loaf of bread.
**I've assumed that your own opportunity cost of capital is also 7%. I.e. this is the amount you could earn per annum on that amount of money over 50 years, based on historical stock market returns (in fact slightly less than the historic return on the stock market).
Sorry PhilH, but $42.8m is the present value of an income stream of $3m per annum forever, not one $3m payment. The "today's" value of $3m today is $3m.
Where does cost of capital come into it? Well if Mr sat-next-to-Dakota's-mate didn't give them $3m to operate their business, they'd have to get it somewhere else (or at least with 100 mugs' £3ms they can repay some debt/equity). That $3m will cost $3m*7%=$210,000 to finance so AA will be happy as long as Mr sntDm's F flights cost them less than $210k.
So if the annual spend is 210k but more than 150k (5%) everyone's happy. Well no. As has been mentioned, you're actually making an investment in AA, which ranks behind everyone if it winds up (and may even be invalid if it goes in and out of Chapter 11). So your required return needs to be a lot higher than 5%.
Long way round to the answer we already knew. Don't do it.