This is the accessible text file for GAO report number GAO-04-169R 
entitled 'Military Aircraft: Observations on DOD's Aerial Refueling 
Aircraft Acquisition Options' which was released on October 14, 2003.

This text file was formatted by the U.S. General Accounting Office 
(GAO) to be accessible to users with visual impairments, as part of a 
longer term project to improve GAO products' accessibility. Every 
attempt has been made to maintain the structural and data integrity of 
the original printed product. Accessibility features, such as text 
descriptions of tables, consecutively numbered footnotes placed at the 
end of the file, and the text of agency comment letters, are provided 
but may not exactly duplicate the presentation or format of the printed 
version. The portable document format (PDF) file is an exact electronic 
replica of the printed version. We welcome your feedback. Please E-mail 
your comments regarding the contents or accessibility features of this 
document to Webmaster@gao.gov.

This is a work of the U.S. government and is not subject to copyright 
protection in the United States. It may be reproduced and distributed 
in its entirety without further permission from GAO. Because this work 
may contain copyrighted images or other material, permission from the 
copyright holder may be necessary if you wish to reproduce this 
material separately.


GAO:

GAO-04-169R:

United States General Accounting Office:

Washington, DC 20548:

October 14, 2003:

The Honorable John Warner 
Chairman 
The Honorable Carl Levin 
Ranking Member 
Committee on Armed Services 
United States Senate:

Subject: Military Aircraft: Observations on DOD's Aerial Refueling 
Aircraft Acquisition Options:

During the Senate Armed Services Committee's September 4, 2003 hearing 
on the Department of Defense's (DOD) proposed lease of 100 Boeing 
KC-767A aerial refueling aircraft, you expressed concern about a 
significant "bow-wave" funding requirement in future years to pay for 
leasing and then buying these 100 aircraft at the end of their leases, 
while continuing efforts to modernize the remainder of the tanker 
fleet. Subsequently, you requested that DOD analyze the option of 
leasing 25 aircraft, followed by a procurement of the remaining 75 
aircraft. The Deputy Secretary of Defense responded to your request on 
September 22, 2003, identifying several alternative acquisition 
strategies, with associated cost and savings estimates. On September 
25, 2003, you asked that GAO review the DOD response and assess the 
validity of the department's assumptions and the accuracy of the cost 
and savings estimates, and identify any other alternative acquisition 
strategies that the Committee should consider. This letter responds to 
your request.

DOD's response compared the six acquisition options offered by the 
Deputy Secretary to acquire 100 KC-767A aircraft: (1) leasing all 
100 aircraft as outlined in the Air Force plan reported to the Congress 
in July 2003; (2) purchasing all 100 aircraft at the time of order 
under the same multiyear conditions as the lease; (3) leasing the first 
25 aircraft and purchasing the remaining 75 when the order is placed; 
(4) leasing the first 25 aircraft and purchasing the remaining 75 when 
the aircraft are delivered; (5) leasing 25 aircraft, followed by a 
traditional multiyear procurement of 75 aircraft under a separate 
contract, and (6) leasing all 100 aircraft initially, then planning to 
seek $2.4 billion between fiscal years 2008-2010 to purchase 26 of the 
100 aircraft.[Footnote 1]

To perform our work, we met with DOD and Air Force officials to obtain 
details on these options, including the assumptions and information 
used to generate the cost and savings estimates contained in DOD's 
response. We also conducted our own independent analysis. See enclosure 
I for more details on our scope and methodology.

Summary:

In our opinion, the assumptions used by DOD to develop its analysis of 
acquisition options generally appear to be reasonable, and the 
computations of the cost and savings estimates associated with these 
options appear to be accurate based on the current terms and conditions 
of the negotiated lease. We do believe, however, that the costs and 
savings numbers could be further refined under the options involving 
purchase. For example, Air Force officials indicated that The Boeing 
Company would pay the cost to underwrite the issuance of the bonds 
needed for financing in the original lease option. However, they could 
not definitively say whether the underwriting costs were included in 
the $131 million price for each aircraft. Because fewer bonds, if any, 
would be issued under the options involving purchase, the costs should 
be lower and the savings higher.

With the exception of the fifth option--Chairman Warner's suggestion of 
leasing 25 aircraft, followed by a purchase of the remaining 75 
aircraft at delivery--DOD did not significantly deviate from the costs, 
schedules, and support provisions contained in its July 10, 2003 report 
to the Committee and the Congress. Air Force officials stated that 
their analysis of options complied with the Chairman's request and that 
analyses outside the proposed lease's terms and provisions would be 
academic exercises that might not be representative of the final 
negotiated prices. These officials also stated that changes from the 
proposed contract would require new negotiations and new review and 
approval actions, and consequently would lead to additional delays.

In addition to the options presented by DOD, we believe two other 
possible approaches--lease fewer tankers or purchase tankers on a 
slower schedule--may be of interest to the Congress. Both options would 
involve fewer than 100 aircraft--one through leasing and one through 
direct purchase. Both options have advantages and disadvantages that we 
have not fully explored in the time available.

Our Assessment of DOD's Analysis:

In our opinion, the assumptions used by the DOD to develop its analysis 
of acquisition options generally appear to be reasonable, and the 
computations of the cost and savings estimates associated with these 
options appear to be accurate based on the current terms and conditions 
of the negotiated lease. Table 1 summarizes DOD's estimated costs and 
savings for the six options it considered, followed by our observations 
on the approach, data, and assumptions used. As indicated in table 1, 
the current proposal being considered by the Congress for the Air 
Force--the lease of 100 KC-767A aircraft for 6 years each, followed by 
their purchase at the end of the lease--is the most costly of the 
options over the next decade, requiring about $29.8 billion (then-year 
dollars). As we have testified,[Footnote 2] leasing requires the least 
up-front funding to the 2004-2009 Future Years Defense Program (FYDP), 
about $5.5 billion (then-year dollars). While purchase of the 100 
aircraft would cost the least amount over the long term--$24.3 billion, 
or $5.5 billion less than the lease, it would require the largest up-
front increase to the FYDP--nearly $13 billion more than the lease 
option. DOD approved the lease proposal, at least in part, because it 
requires the least amount of up-front funding for refueling aircraft 
while keeping the funding for other programs intact.

Table 1: Options and Cost Comparisons (then-year dollars in billions):

Options: 1. Lease 100; Cost during FYDP[A]: 5.5; Total costs[B]: 29.8; 
Savings over current lease proposal: NA.

Options: 2. Purchase 100; Cost during FYDP[A]: 18.4[C]; Total costs[B]: 
24.3[C]; Savings over current lease proposal: 5.5.

Options: 3. Lease 25/buy 75, pay when order; Cost during FYDP[A]: 16.6; 
Total costs[B]: 25.6; Savings over current lease proposal: 4.2.

Options: 4. Lease 25/buy 75, pay at delivery; Cost during FYDP[A]: 
10.1; Total costs[B]: 26.3; Savings over current lease proposal: 3.5.

Options: 5. Separate contracts (lease 25, buy 75); Cost during FYDP[A]: 
16.0; Total costs[B]: 27.1[C]; Savings over current lease proposal: 
2.7.

Options: 6. Lease with $2.4 billion increase; Cost during FYDP[A]: 7.5; 
Total costs[B]: 28.6; Savings over current lease proposal: 1.2.

Source: GAO analysis of Air Force data.

[A] Aircraft cost only. Includes cost of purchasing leased aircraft at 
end of lease.

[B] Includes operating and support costs, other government costs, and 
military construction.

[C] Assumes that multi-year procurement authority was granted.

[End of table]

We have the following comments and observations on DOD's options:

* The estimated costs and savings for all options except for number 5 
are based on the cost figures from the currently negotiated lease with 
Boeing. Based on our analysis, we believe these represent a reasonable 
estimate of the likely total costs and savings in then-year dollars. We 
do think, however, that the costs and savings numbers could be further 
refined in the options involving purchase or lease. For example, Air 
Force officials indicated that The Boeing Company would pay the cost to 
underwrite the issuance of the bonds in the original lease option. 
However, they could not definitively say whether the underwriting costs 
were included in the $131 million price for each aircraft. Because 
fewer bonds, if any, would be issued under the options involving 
purchase, the costs should be lower and the savings higher.

* The fifth option entails a contract for leasing 25 aircraft followed 
by a separate contract for a traditional multi-year procurement. With 
this option, Air Force officials stated that the capital markets may 
not support the lease because of risk concerns, particularly in 
exercising the option to buy the planes at the end of the lease, and, 
therefore, the option is potentially unexecutable. In examining this 
concern, we would point out that 90 percent of the present value of the 
fair market value of the aircraft will have been paid at the end of 
their 6-year leases, and it would make little sense not to purchase the 
planes. Also, given the long-term need to replace the tanker fleet, it 
is unlikely that the planes would not be purchased at the end of the 
lease.

* All of the options except for number 5 assume delivery of 60 aircraft 
during the FYDP period on the same delivery schedule. DOD believes 
option 5 would require new negotiations, internal and external review, 
and congressional approval--a process that could take as long as a year 
and could result in higher prices than currently negotiated for the 
lease of 100 aircraft. Because of this potential delay, DOD also 
estimates that this option would result in delivery of only 40 aircraft 
during the FYDP period. Based on our analysis, we believe the costs and 
savings estimates by the Air Force are more speculative for this 
option. It is unclear to us why the process to negotiate and process 
the changes would take so long to gain final approval. Also, any 
purchase of the aircraft, including those specified in each of the 
other options, required congressional approval.

* As presented by DOD, all the options considered represent a trade-off 
between more up-front budget authority during the FYDP period and more 
potential savings over the life of the program.

* All of the options except for number 5 assume the same early delivery 
schedule as the currently proposed lease; that is, the first 4 aircraft 
would be delivered at the end of fiscal year 2006, 16 in 2007, and 20 
per year in subsequent years until 100 have been delivered. This 
assumes that it is more urgent to begin replacement of the tanker fleet 
now rather than proceed with the previously planned procurement 
schedule, which the Air Force has said would begin delivering aircraft 
in fiscal year 2009.

* DOD was not asked to and did not assess other options outside the 
terms and provisions of the existing lease, which could potentially 
provide additional cost savings. For example, what costs and savings 
might accrue if the number of KC-767A aircraft leased and/or procured 
varied from 100 aircraft? How would competitive bidding by commercial 
airlines and independent maintenance, repair, and overhaul facilities 
for KC-767A maintenance and training support affect costs and savings? 
How would program costs change if the purchase price per plane was 
closer to the $120.7 million estimate postulated by the Institute for 
Defense Analyses, rather than the $131.0 million price contained in the 
contract?[Footnote 3]

* The Deputy Secretary's letter presenting the Air Force savings 
estimates states that the department proposes to find an extra $2.4 
billion to buy out the leases for 26 aircraft in the 2008-10 timeframe. 
Air Force officials told us that DOD will try to identify these funds 
in the current FYDP and may even seek support from the Army, Navy, and 
Marine Corps. This is option number 6 in the table. DOD and Air Force 
acquisition officials we spoke with said that the Deputy Secretary of 
Defense's letter to the committee represents a firm commitment to 
identify these funds in the fiscal year 2008-2010 time frame. If the 
Congress agreed to that approach, it might want more assurance that the 
increase in funding would really occur, otherwise the savings will not 
materialize and the Congress may simply be asked to provide additional 
budget authority.

The initial 100 KC-767A aircraft being discussed represent only about 
20 percent of the KC-135 inventory. DOD and the Air Force have stated 
that tanker replacement efforts need to continue beyond these aircraft, 
and that this will be an expensive and lengthy undertaking. As a 
result, the funding requirements for tanker replacement will extend for 
many years beyond those addressed in the lease proposal, and will have 
to compete with other high priority programs among the Air Force and 
the other services in a fiscally-constrained environment. Thus, the 
Committee's concern about a tanker "bow wave" is appropriate and 
relevant as we pointed out in our September 4, 2003 testimony, 
regardless of the option chosen for the first 100 aircraft. The options 
involving a 25/75 split of leased and purchased aircraft all have a 
positive effect on the "bow wave" concern beyond fiscal year 2012, as 
was discussed at the September 4, 2003 hearing. By committing more 
funding in the early years of the program, costs are reduced 
considerably in the out years. This should ease the burden on budgets 
for follow-on procurements of tanker aircraft. The proposal to plus up 
the budget by $2.4 billion to buy out 26 of the leases also has a 
positive effect on reducing the bow wave, but not to as great an extent 
as the other options. This approach still incurs costs in the $3 
billion range in fiscal year 2011-13. To illustrate the effect of DOD's 
various options on this long-term spending picture, we have developed 
charts showing the budget authority that would be required to execute 
the acquisition of the first 100 aircraft followed by a subsequent 
purchase of another 100 KC-767A aircraft. (See enclosure II).

Other Alternative Approaches:

The DOD response represents a reasonable analysis of the 25/75 split 
option and it offers an additional option--option number 6, which 
proposes to add $2.4 billion for tankers to be used to buy out leases 
for 26 aircraft. In effect, this would be a "lease 74/buy 26" approach. 
We believe at least two additional options may be of interest to the 
committee as it considers its decision. These include the following:

* Lease fewer tankers. Section 8159 of the 2002 Act[Footnote 4] 
authorized a pilot program for leasing no more than 100 Boeing 767s as 
tankers. The act did not specify leasing 100; it set 100 as the 
maximum. A smaller leasing program would still meet the intent of the 
act, would be less expensive, would start replacement of the KC-135s, 
and most importantly, would allow some time for the Air Force to study 
tanker force requirements and conduct a thorough analysis of 
alternatives before committing to a large acquisition program.[Footnote 
5] Such an approach would probably need to include leasing as many as 
40 to 50 aircraft to provide sufficient time for the needed studies. 
This approach is still more expensive than purchase, and it might still 
involve the use of the special purpose entity[Footnote 6] to facilitate 
lease financing, but it allows the program to proceed with early 
delivery of aircraft without disruption to Air Force budgets in the 
short-term. We do not know what effect this approach would have on 
delivery schedules or whether Boeing would agree to the same lease 
terms for fewer aircraft.

* Purchase tankers on a slower schedule. The Air Force plans to spend 
about $5.5 billion during the FYDP period for the proposed lease, and 
the Deputy Secretary stated in his letter to you that the department 
proposes to identify an additional $2.4 billion during this period to 
buy out some of the leases. If that total of $7.9 billion were applied 
toward purchase of tankers, it would represent a reasonable start 
toward replacing the tanker fleet through a normal acquisition process. 
Because the Boeing 767 commercial aircraft has been in production since 
1982 and thus represents little development risk, the Air Force should 
be able to negotiate a multi-year procurement for a substantial number 
of aircraft. This would not provide the same firm order for 100 
aircraft in the current lease proposal, but it would still represent a 
large transaction for Boeing on its 767 production line. However, this 
approach might involve delays in deliveries of the first aircraft, 
depending on how much budget authority is available in fiscal year 04 
and fiscal year 05. Deliveries might also have to be spread over a 
longer period if the Air Force and DOD do not provide additional 
funding priority for tankers. This approach, too, would provide the Air 
Force some time to study tanker requirements and analyze options before 
committing to a large program.

We could not develop costs for these two options in the time available. 
Air Force officials believe that adoption of either of these options 
would delay delivery of the first aircraft and further believe that 
while less costly in the short term, the proposals could increase total 
program costs.

Agency Comments and Our Evaluation:

In oral comments on a draft of this correspondence, DOD and Air Force 
officials generally concurred with our analysis. These officials also 
pointed out that their analysis, as contained in the letter from the 
Deputy Secretary of Defense, was limited specifically to the questions 
asked of them by you although they have considered other options that 
were not included.

We conducted this work from September to October 2003 in accordance 
with generally accepted government auditing standards.

Unless you announce its contents earlier, we plan no further 
distribution of this letter until 10 days from its issue date. At that 
time, we will send copies of this letter to the Chairman and Ranking 
Member of the Committee on Armed Services, House of Representatives, 
and the defense subcommittees of the Senate and House Committees on 
Appropriations. We will send a copy to the Chairman, Subcommittee on 
Readiness, House Committee on Armed Services, for whom we are 
conducting a broader body of work in this area. We will also send 
copies to the Secretary of Defense and the Director of the Office of 
Management and Budget. We will also make copies available to other 
interested parties upon request. In addition, the letter will be 
available at no charge on the GAO Web site at http://www.gao.gov.

We appreciate this opportunity to be of assistance. If you or your 
staffs have any questions regarding this letter, please contact me at 
(202) 512-4914 or Brian J. Lepore, Assistant Director, at (202) 512-
4523. Other key contributors to this review were Ann M. Dubois, Joseph 
J. Faley, Jennifer K. Echard, Kenneth W. Newell, Madhav S. Panwar, 
Charles W. Perdue, Kenneth E. Patton, and Tim F. Stone.

Neal P. Curtin, 

Director 

Defense Capabilities and Management:

Signed by Neal P. Curtin: 

Enclosures:

[End of section]

Enclosure I: Scope and Methodology:

To assess the validity of the Department of Defense's (DOD) 
assumptions, accuracy of cost and savings estimates associated with the 
various options addressed by the Deputy Secretary of Defense in his 
response to the Committee, and to identify alternative acquisition 
strategies, we met with DOD and Air Force officials to discuss detailed 
information related to the options. These discussions included the 
nature and scope of the options selected, as well as the assumptions 
and methodologies used in the analyses. We also obtained and reviewed 
Air Force data used to generate the cost and savings estimates 
contained in DOD's response, validated that the data was appropriately 
included or excluded to support the details of the individual options 
chosen, tested the accuracy of the computations, and conducted our own 
independent analyses.

To assess the funding impacts of the various options when combined with 
a subsequent purchase of 100 aircraft, we compared Air Force data for 
each of the options to a postulated buy of an additional 100 aircraft 
beginning in fiscal year 2012 at the rate of 20 aircraft per year. We 
used the Air Force's purchase price for the aircraft, spread the 
payments for each aircraft over a 4-year period per Air Force data, and 
adjusted the data to reflect then-year dollars.

[End of section]

Enclosure II: Impact of Air Force Options on Budget Authority 
Requirements:

Follow-on procurements to the initial lease of 100 aircraft will be a 
necessary part of any tanker replacement program. Because the funding 
requirements of the proposed lease are deferred until later years, 
those requirements will impact the requirements for subsequent tanker 
acquisitions. The following figures provide an approximate illustration 
of how the various options effect the funding requirements for future 
refueling aircraft purchases beyond the first 100.

Figure 1: Annual Budget Authority Required to Initially Lease 100 
Aircraft and to Purchase 100 Follow-On Aircraft:

[See PDF for image]

[End of figure]

Combining a follow-on purchase of 100 aircraft with the Air Force's 
original proposal to lease 100 aircraft, would require maximums of 
about $6.3 billion and $6.4 billion in budget authority in fiscal years 
2012 and 2013 respectively, as shown in figure 1. About $3.6 billion 
would be required during the current FYDP and a total of about $38.5 
billion would be required over the entire program.[Footnote 7]

Figure 2: Annual Budget Authority Required to Purchase Both an Initial 
100 And Second Block of 100 Aircraft:

[See PDF for image]

[End of figure]

Purchasing the initial 100 aircraft, when combined with a follow-on 
purchase, would have the least impact on overall budget authority 
requirements. As figure 2 shows, an initial purchase of 100 aircraft 
followed by a subsequent purchase of an additional block of 100 
aircraft would require maximums of about $3.4 billion in budget 
authority in fiscal years 2008 and 2013 to procure the aircraft. About 
$15.8 billion would be required during the current FYDP and a total of 
about $33 billion would be required over the entire program to procure 
the 200 aircraft.

Figure 3: Annual Budget Authority Required to Lease 25 Aircraft and to 
Purchase 75 Aircraft at Time of Order and to Purchase 100 Follow-On 
Aircraft:

[See PDF for image]

[End of figure]

Combining a follow on purchase of 100 aircraft with the alternative of 
initially leasing 25 aircraft and purchasing 75 others, would require 
maximums of about $4.1 billion and $4.3 billion in budget authority in 
fiscal years 2012 and 2013, respectively, as shown in figure 3, if the 
75 aircraft were paid for when ordered. About $14.5 billion would be 
required during the current FYDP and a total of about $34.3 billion 
would be required over the entire program.

Figure 4: Annual Budget Authority Required to Lease 25 Aircraft and to 
Purchase 75 Aircraft at Time of Delivery and to Purchase 100 Follow-On 
Aircraft:

[See PDF for image]

[End of figure]

Paying for the initial 75 aircraft in the previous option on delivery 
would require maximums of about $5.6 billion and $6.7 billion in budget 
authority in fiscal years 2010 and 2011, respectively, as shown in 
figure 4. About $8.1 billion would be required during the current FYDP 
and a total of about $35 billion would be required over the entire 
program.

Figure 5: Annual Budget Authority Required To Initially Lease 25 
Aircraft and to Purchase the Remaining 75 Aircraft of the Initial Block 
under a Separate Contract and to Purchase 100 Follow-On Aircraft:

[See PDF for image]

[End of figure]

Combining a follow-on purchase of 100 aircraft with the option of 
initially leasing 25 of the initial 100 aircraft and negotiating a 
separate contract for the purchase of the remaining 75 aircraft of the 
initial block, would require maximums of about $4.6 billion and $4.5 
billion in budget authority in fiscal years 2009 and 2013, 
respectively, as shown in figure 5. About $14.4 billion would be 
required during the current FYDP and a total of about $35.3 billion 
would be required over the entire program.

Figure 6: Annual Budget Authority Required to Initially Lease 74 
Aircraft and to Purchase 26 Aircraft and to Purchase 100 Follow-On 
Aircraft:

[See PDF for image]

[End of figure]

Combining a follow-on purchase of 100 aircraft with the option of 
purchasing 26 of the initial 100 aircraft, would require maximums of 
about $5.5 billion and $5.7 billion in budget authority in fiscal years 
2012 and 2013, respectively, as shown in figure 6. About $5.6 billion 
would be required during the current FYDP and a total of about $37.3 
billion would be required over the entire program.

FOOTNOTES

[1] Figures 4 and 5 of the Deputy Secretary's letter also mentioned 
another version of this--to identify $2 billion in fiscal year 2008-
2009, but this option was not discussed in the narrative of the letter.

[2] Military Aircraft: Observations on the Proposed Lease of Aerial 
Refueling Aircraft by the Air Force. GAO-03-923T. Washington, D.C.: 
September 4, 2003. 

[3] At your request, we reviewed the Institute of Defense Analyses 
study and concluded that its methodology was reasonable. See Military 
Aircraft: Institute for Defense Analyses Purchase Price Estimate for 
the Air Force's Aerial Refueling Aircraft Leasing Proposal. 
GAO-04-164R. Washington, D.C.: October 14, 2003.

[4] Department of Defense and Emergency Supplemental Appropriations for 
Recovery from and Response to Terrorist Attacks on the United States 
Act, Pub. L. 107-117,  8159, 115 Stat. 2230, 2284-85.

[5] Section 309 of the Emergency Supplemental Appropriations for Iraq 
and Afghanistan Security and Reconstruction for Fiscal Year, 2004, S. 
1689, 108th Cong.  309 (2003), requires that the Secretary of Defense 
submit a report to the congressional defense committees describing an 
analysis of alternatives for replacing the capabilities of the fleet of 
KC-135 fleet aircraft. The Air Force has indicated, however, that it 
will probably initiate a tanker requirements study sometime between 
fiscal years 2004-2006, followed by a formal analysis of alternatives 
(AOA). Air Force officials have stated that a formal AOA could take up 
to two years to complete.

[6] The Special Purpose Entity would be a trust created under the laws 
of Delaware that would issue bonds to raise sufficient capital to 
purchase the new aircraft from The Boeing Company and lease them to the 
Air Force.

[7] These totals include only procurement costs and do not represent 
total program costs.